Provident Financial Holdings, Inc. (PROV) Q4 2015 Earnings Report, Transcript and Summary

Ladies and gentlemen, we'd like to thank you for standing by, and welcome to the fourth quarter earnings teleconference call. [Operator Instructions] I would now like to turn the conference over to your host and facilitator, Mr. Craig Blunden. Please go ahead, sir.

Thank you. Good morning, everyone. This is Craig Blunden, Chairman, CEO of Provident Financial Holdings. On the call with me is Donavon Ternes, our President, Chief Operating and Chief Financial Officer. Before we begin, I have a brief administrative item to address. Our presentation today discusses the company's business outlook and will include forward-looking statements. Those statements include descriptions of management's plans, objectives or goals for future operations, products or services, forecasts of financial or other performance measures and statements about the company's general outlook for economic and business conditions. We also may make forward-looking statements during the question-and-answer period following management's presentation. These forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from those discussed today. Information on the risk factors that could cause actual results to differ from any forward-looking statement is available from the earnings release that was distributed earlier this morning, from the annual report on Form 10-K for the year ended June 30, 2014, from the Form 10-Qs that are filed subsequent to the Form 10-K. Forward-looking statements are effective only as of the date they are made, and the company assumes no obligation to update this information. To begin with, thank you for participating in our call. I hope that each of you has had an opportunity to review our earnings release, which describes the fourth quarter results. You will note, this is the fifth consecutive quarter where our community banking and mortgage banking businesses are both profitable, subsequent to the less favorable mortgage banking environment, which was developed approximately 2 years ago. We're pleased that in comparison to the same quarter last year, net interest income and fee income have both increased, our net interest margin has expanded and our efficiency ratio has improved. Our community banking business is capitalizing on more opportunities regarding loan originations and purchases, and continue to increase loans held for investment. For the 12 months ended June 30, 2015, loans held for investment grew at a 5% annualized rate, and preferred loans, a component of loans held for investment, grew at 13% annualized rate. However, we're disappointed with our fourth quarter held for investment volume, which fell short of our expectations and resulted in a sequential quarter decline in the outstanding balance of loans held for investment, the first decline in 7 consecutive quarters. During the quarter, we lost our loan origination opportunities of pricing and structure but chose not to compete on those. We lost because risk versus return did not meet our objective. We're committed to improving the growth rate and will allocate resources necessary to do so. Credit quality deteriorated a bit on a sequential-quarter basis, but after reviewing the specific loans, we did not detect a new trend developing; rather, the specific loans have been on our radar for some time, a few years, in most cases, but just recently deteriorated to the point of nonperforming status. Also, you will note that early-stage delinquencies fell to $1.3 million at June 30 from $4.4 million at March 31, suggesting that further near-term deterioration is unlikely. We recorded a negative provision of $104,000 from allowance for loan losses during the quarter ended June 30, 2015. Net recoveries were $116,000 for the June 2015 quarter, compared to net recoveries of $130,000 during the March 2015 quarter, and net recoveries are $159,000 during the December 2014 quarter. We are pleased with these credit quality results, even though we experienced the June 2014 deterioration. Mortgage banking FTE count in the June 2015 quarter was essentially unchanged from the March 2015 quarter. We currently employ 315 FTE at mortgage banking, down from the 316 FTE on March 31, 2015, and up from the 312 FTE employments at June 30, 2014. During the quarter, we decreased our origination staff by 11 professionals and increased our fulfillment staff by 10 professionals, largely to improve our efficiency and service levels. We will continue to adjust our business model, as we have done in the past, commensurate with changes in loan origination volumes. Volume of loans originated for sale in the fourth quarter of fiscal 2015 increased from the March 2015 sequential quarter, carried the large locked pipeline into the June 30 quarter from March 31, and were successful in converting the bulk of the locked pipeline to funded loan volume. Locked pipeline declined at June 30 compared with March 31, so it would not be surprising to see a decline in loans originated for sale during the September 2015 quarter. Although increased purchase volume may blunt to some degree, our expectation is for lower refinance volume. We believe we are well-positioned to capture our share of mortgage loan origination volume in the markets we serve. Our loan sale margin for the quarter ended June 30, 2015, improved to 139 basis points from the disappointing 125 basis points from the sequential quarter ending March 31, 2015. We experienced the transition to higher percentage of more profitable purchase activity and a lower percentage of less profitable refinance activity in comparison to the March 2015 quarter. Our net interest margin increased this quarter in comparison to March 2015 sequential quarter, primarily as a result of the special cash dividend received on the FHLB stock during the June 2015 quarter. More pronounced was the year-over-year improvement in the net interest margin, which increased by 24 basis points, and was the result of our efforts to redeploy cash balances to loans held for investment and loans held for sale. These efforts, coupled with the increase in total earning assets, resulted in a 16% increase in net interest income from the June 2015 quarter in comparison to the June 2014 quarter. Our short-term strategy for balance sheet management is unchanged from the last quarter. We believe that releveraging the balance sheet is essential. For the foreseeable future, we believe that maintaining a significant cushion above the regulatory capital ratios of 8% for Tier 1 leverage, 9.5% for common equity Tier 1 and 13% total risk-based that is critical, and we're confident we will be able to do so. We currently exceed each of these ratios by a wide margin, demonstrating we have the capital to execute on our business plan and capital management goals. Additionally, in the June 2015 quarter, we repurchased approximately 188,000 shares of common stock. And we continue to believe that executing on stock repurchases is a wise use of capital in the current environment. Additionally, last week, we announced a quarterly cash dividend of $0.12 per share, with the distribution scheduled for September 1, 2015. We encourage everyone to review our June 30 Investor Presentation posted on our website. You will find that we included slides regarding financial metrics, community banking, mortgage banking, asset quality and capital management, which we believe will give you additional insight on our strong financial foundation, supporting the future growth of the company. We will now entertain any questions you may have regarding our financial results. Thank you.

[Operator Instructions] Our first question will come from the line of from Brian Zabora of KBW.

There's a question on the competition on loans side, are you seeing any abatement of the competition? Are they continuing into the third quarter or the calendar third quarter? And how does the loan pipeline look for the held for investment side?

Brian, this is Donavon. The one piece of relief we're seeing today in comparison to the June quarter is in pricing. You'll note that the tenure has backed up a little bit from where the lows were in the June 2015 quarter. And as a result, pricing has become much better from our perspective as it relates to kind of an absolute low that will end up putting a multifamily or commercial real estate loan on our books. So that's improved. Structure is -- of the loan is still very competitive. We have larger lenders doing interest-only loans in that product type. We have lenders who will forego personal guarantees from some of the sponsors or all of the sponsors in the particular loan. So I think structure remains very competitive. I think pricing has become a bit more favorable to us.

Okay. And then also, you had a gain on other real estate owned, was that -- was there one credit that was a major contributor or were these several credits that you've ended up selling for a gain?

There was one specific commercial real estate property. It was a dental office prior to our taking it back in foreclosure. And in fact, there were junior liens against it. So they were wiped out for the foreclosure sales. There was a good piece of equity in there for us when we ended up selling it essentially to another dentist, who is going to be opening an office there.

Our next question will come from the line of Lucy Webster of Compass Point.

I wanted to touch base on your loan sale margins. From what we were seeing, they are up for the month of July over the sort of June 30 quarter. And I was wondering if that syncs with what you guys are seeing in the market? Or are you seeing sort of longer-term expectations that you may have?

I think we've always described our loan sale margin in a range, and we typically refer to the loan sale margin of the last 6 quarters in our investor presentation. 125 basis points in the March quarter was the low of that range, and 159 basis points in the Q4 '14 quarter was the high of that range. Our expectation is that we will see our loan sale margin come in, in that range for the September quarter as well.

Our next question comes from the line of Tim Coffey of FIG Partners.

When we look at the portfolio of loans held for investment, did you see any kind -- extraordinary paydowns or payoffs this quarter?

No. In fact, I think, payoffs for the quarter -- this year, for the June quarter, were actually down from payoffs in the June quarter of last year. It's in our earnings release, but my recollection is it's something like $30 million in the June quarter of this year and it was something like $40 million in the June quarter of last year. So we've actually seen payoffs actually come in a bit, or decline a bit, in comparison to last year.

Okay. And the second question -- if you look into mortgage market, your expectations for the Mortgage business in the second half of calendar 2015, how do you think it will be different or similar to what you saw in the second half of calendar '14?

What's your forecast of interest rates?

That seems to be the prevailing backdrop at this point?

Sure. I think the issue becomes the balance between purchase money activity and refinance activity. And we even saw in the June quarter that our refinance activity declined a percentage of total volume, but our total volume actually went up because purchase money activity did increase to some degree. In fact, just anecdotally, it's not a number that we publish. And in fact, we don't describe it typically. But the June -- the month of June was the highest purchase money month that we had over the past 18 months. And it's probably even more -- even longer than that, but that was the information I received from our mortgage banker when we were talking about it. So the way we think about the back half is we think refinance volume will decline, but we think purchase money activity will increase. And I think that's very similar to what the MBA has come out with in their most recent revision to forecasts. In fact, they expect volume in total for '15 to be above their original forecast, and they've increased their volume for fiscal -- for calendar '16 as well. And they've troughed it up to an increase in purchase money activity.

Okay. And how is home affordability in the foreclosure mortgage business?

It's not getting better, especially along the coast, as you're probably aware. It's becoming less affordable. However, it does help us in some of the other areas that we have mortgage offices because it drives the buyers, certainly, inland and we can serve them very well. So -- but the numbers have really turned around from 2008 to now.

Yes, and I think, obviously, interest rates rising will hurt affordability to some degree. And then maybe a larger component of that for us is the fact that home prices have appreciated so much in the California markets. Both of which drive affordability down, however, affordability is still better today than it was in the peak, prior to this credit cycle. And -- so much of it will be dictated by what employment growth looks like and what general economic activity looks like because I do think there's some pent-up demand with respect to purchase. And frankly, a little blip up in interest rates may actually get people off the dime to purchase homes.

And the last question in queue at this time comes from the line of Tim O'Brien of Sandler O'Neill Partners. Tim O’Brien: So comp costs, salary and benefit costs were up a little bit here in this last quarter relative to the trailing quarter. Can you give a little color on some of the influences there?

The largest influence was with respect to loan origination volume -- held for sale loan origination volume. That was up in comparison to the prior sequential quarter. And as a result, our comp costs were up as well. Now when I'm looking at it from a sequential-quarter basis, overall, operating expenses were essentially flat to the March quarter, but they were up significantly in comparison to the June quarter and that was more related to the volume as well. Tim O’Brien: And then occupancy dripped it down a bit, was there anything you guys did, either -- did you get some lease relief or did you close an office, or why was that?

I would have to look -- yes, I would have to look specifically, but I don't recall an office closing or anything of that nature. We could have had leasehold improvements being fully depreciated in a particular office or something of that nature, which could have allowed that cost to drift down a bit, but I think it was a relatively small number. Tim O’Brien: And then, also -- it looked like, from a credit standpoint, there was a meaningful uptick in nonperforming loans in your single-family residential, is that right?

Yes, there were -- when we look at the NPAs, and we'll drill down specifically to understand why NPAs increased, it was all in the loan portfolio. And I think there were 5 new net SFRs that went to nonperforming status. We drilled down, we looked that each of those, there was no specific trend with respect to the reasons. One was a relatively recent production, I think, within the last 18 months or so. In that particular case, it was a divorce and so they're selling the home. And then the others were all relatively older from an origination standpoint, and it ran the gamut. We had one that was a TDR that had gone back to note status, that got into trouble and is going to end up walking from the property. We had another incident where the borrower was essentially fully leveraged with the first, second on the property. He had a job offer else well. So he simply vacated the property and moved, and we're going through the foreclosure on that. In each case though, we don't expect large losses to occur relative to those 5 new SFRs that became nonperforming during the quarter. Tim O’Brien: Are those properties in California?

Yes. Tim O’Brien: Near Riverside?

Not necessarily. There was one in Northern California, in the Bay Area, that was the divorce situation. The others, I don't specifically recall what the geography was. Even by geography, I didn't notice a trend. Tim O’Brien: And then last question. I think you alluded to this in the press release, Craig, about being reinvigorating or -- you didn't used that word, but on the commercial banking, within your commercial banking business, maybe doing some hiring or something or revitalizing that or taking a run at it -- running out the gate in the first year. Can you give a little bit of color, Craig, about prospects for generating preferred loans here on a go-forward basis, and what you guys want to try to accomplish here in the new year?

Sure. We've been looking for new commercial loan officers and have been interviewing and starting to hire some more, which will give us, again, some increased present in our marketplaces to add more portfolio loans in the preferred loan area.

Yes. At the end of the day, it gets down to the success of your originators with respect to how successful you may be in origination volume. And it is relatively competitive out there. And one of the things we're going to end up doing is putting on new hires in that area to originate more volume for us. Tim O’Brien: Can you give us kind of footings on that? Like, at the end of the fiscal year, what were your production? How big -- what was the size of your production staff for preferred lending, so that next quarter we can see how things settled out -- successful you were in the -- on the hiring process? Would that be all right to get from you?

You're looking for a net number of how many more originators? Is that what you're looking for? Tim O’Brien: Yes. Did you add any originators this quarter? What it -- how many originators did you end the year with?

I don't have a specific number for you. But we ended the June quarter with the same number of originators that we ended the March quarter with. Since the end of the June quarter, we have hired 1 new originator, primarily in the construction loan area and he started -- in fact, Monday of last week was his first day. But we've had many more interviews with respect to others. And we anticipate that finding that right person maybe a bit difficult, nonetheless, throughout the remainder of our -- this fiscal year, fiscal '16, we're interested in putting more originators onboard. Tim O’Brien: And one last question, and you mentioned this in the narrative. Interest-only loans on -- you talked about walking away from some deals where the competition was offering interest-only loans on -- was it Commercial Real Estate or multi or both, Craig?

Yes. That was both. Tim O’Brien: So can you talk a little bit about -- and that -- and whoever is doing that, they're not kind of an incidental participant -- they are major competitor and market shareholder in those spaces in Southern California. Is it meaningful or is this kind of...

These are meaningful players. These are large lenders. They're not community banks, necessarily. But some of the larger lenders are able to do that. And the dilemma with that is these larger lenders have come down market. And prior to the credit cycle, we didn't see these lenders in the $1 million to $5 million loan space. But those lenders are active in that space now. And because their loan size is so small relative to what they generally do, they have been able to loosen underwriting a bit. Tim O’Brien: So what kind of rate can you get? Just generalize there, what kind of rate can you get on a multi-interest-only loans? And once the lock -- what's the fixed period on that loan? How -- what's the structure of a loan that you've seen out there that you think is attractive to a borrower and where they're getting traction?

They will price up for the interest-only nature. They will, in fact, they'll price up as well for the release of guarantors. And that will price up 25 to 50 basis points. But we've seen 10--year interest-only structures where it will balloon in 10 years. Tim O’Brien: And are they advertising pricing on that, like you can get this at 4%, something like that?

Yes, I mean, we see the pricing typically on their rate sheets, but they're not advertising that in the Los Angeles Times, if you will. Tim O’Brien: That's not been actively marketed, but it's a viable product that their production staff is used -- making headway with?

Correct. That's the way to think about it. Their production staff has the ability to generate that type of production. Tim O’Brien: Is this new -- is this a recent kind of occurrence or has it been around for a few quarters?

The interest-only is newer, although, we've heard about it in other markets, but that's kind of a newer thing that we've been seeing.

There are no further questions in queue at this time.

I want to thank everyone for joining us on our conference call, and look forward to speaking to all of you again at our next quarter call. Thank you.

Ladies and gentlemen, that does conclude our conference call for today. On behalf of today's panel, we'd like to thank you for participation in today's fourth quarter earnings teleconference call, and thank you for using AT&T. Have a wonderful day. You may now disconnect.