Provident Financial Holdings, Inc. (PROV) Q4 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Provident Financial Holdings Fourth Quarter Earnings Conference Call. [Operator Instructions]. As a reminder, today's conference is being recorded. And I would now like to turn the conference over to our host, Mr. Craig Blunden. Please go ahead, sir.

Thank you. Good morning, everyone. This is Craig Blunden, Chairman and CEO of Provident Financial Holdings. And 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 yesterday, from the annual report on Form 10-K for the year ended June 30, 2017, and from the Form 10-Qs that are filed subsequent to Form 10-K. Forward-looking statements are effective only as of the date they're 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 our fourth quarter results. I'd like to begin this morning by highlighting the results in our community banking business. Over the course of the last year, our net interest margin has expanded. Core deposits continue to grow. Credit quality remains strong, though our loan growth has been below our expectations as a result of significant prepayments. In the most recent quarter, the community banking staff originated and purchased $44 million of loans held for investment, an increase from the $29 million in the prior sequential quarter. And single-family loans originated for the portfolio from mortgage banking division increased to $27 million in the June 2018 quarter from $21 million in the prior sequential quarter. During the quarter, we also experienced $64.6 million of loan principal payments and payoffs, which is up from the $43.2 million in the March 2018 quarter and still tempering the growth rate of loans held for investment. Additionally, we estimate that the increase in acceleration of amortization of net deferred loan costs associated with the higher loan payoffs in the June quarter, in comparison to the average of previous 5 quarters, increased our net interest margin by approximately 2 basis points this quarter. For the 12 months ended June 30, 2018, loans held for investment were essentially unchanged; and preferred loans, a component of loans held for investment, grew at a 1% rate. However, for the 6 months ended June 30, 2018, loans held for investment increased by approximately 4% annualized; and preferred loans, a component of loans held for investment, grew at a 5% annualized rate. We're encouraged by recent activity regarding preferred loans and the outlook for single-family adjustable rate originations from our mortgage banking division. We believe the rise of mortgage interest rates will result in future opportunities to accelerate the growth of our loan portfolio by adding adjustable rate SFR loans. We're very pleased with the credit quality, and you will note that the early stage delinquencies are approximately $805,000 at June 30, 2018, and very low from an entire credit cycle perspective. In fact, nonperforming assets remain at very low levels and are now just $7 million, which is down from $9.6 million at June 30, 2017, a 27% decline during the course of the year. We experienced a small net recovery of $43,000 during the quarter end at June 30, 2018, compared to a modest net charge-off of $39,000 from the March 2018 quarter and a modest net recovery of $23,000 during the December 2017 quarter. As a result of very low early stage delinquencies, the low level of nonperforming assets and the modest net charge-off fiscal year, we recorded $189,000 negative provision in the June 2018 quarter. We are pleased with these credit quality results. Our net interest margin expanded by 13 basis points for the fiscal year ended June 30, 2018, compared to the same period last year as a result of 11 basis point increase in the average yield of total interest-earning assets and a 2 basis point decrease in the cost of interest-bearing liabilities. It should be noted that our deposit cost of funds is unchanged at June 30, 2018, compared to June 30, 2017. Over the course of fiscal 2018, we've been able to hold the line on the cost of core deposits while increasing the balance of core deposits and decreasing the balance of time deposits. And it's also noteworthy that our net interest margin expanded to 3.28% from the June 2018 quarter, the highest level in many years. We're still adjusting our mortgage banking business model to respond to a generally very challenging mortgage banking environment. We currently employ 173 FTE in mortgage banking, down from the 200 FTE employed on March 31, 2018. During the quarter, we reduced our origination staff by 3 professionals while our fulfillment staff declined by 24 professionals. These adjustments are more pronounced from the December 31, 2016, when we first started reducing our origination capacity commensurate with changes in market opportunity. Since then, our origination staff has declined by 33%, and our fulfillment staff has declined by 49%, for a total reduction of 43% in the mortgage banking division. We, like our competitors, are responding to less favorable environment by taking capacity out of our platform. It is currently unclear when sufficient capacity will be removed from the industry to allow mortgage banking to return to more profitable operations. New mortgage loan applications increased slightly in the June 2018 quarter from the prior sequential quarter. But based on current information, we expect volumes in the September 2018 quarter to be similar to the June 2018 quarter and significantly lower than the September 2017 quarter. The loan sale margin for the quarter ended June 30, 2018, deteriorated from prior sequential quarter toward the lower end of the range, and pricing pressure remains a concern throughout the industry. Market participants are pricing more aggressively in an effort to maintain market share. We will continue to adjust our business model and FTE count as we have in the past, commensurate with changes in market opportunities and the mortgage banking operating environment. During the past 18 months, we reduced capacity to more closely align operations to the current opportunities in the market, which reflect an uptick in purchase money activity with a significant decline in refinance activity. We have reduced mortgage banking operating expenses by approximately 35% this quarter in comparison to the same quarter last year, a combination of fixed cost and variable cost savings. Additionally, we're in process of converting our wholesale branches to new loan origination system that will be much more efficient for a more convenient operations when fully implemented. Retail branches have all been converted or moving quickly to a paperless environment, which will streamline the application process and underwriting and funding functions for our customers, third-party service providers and employees. We expect to decommission our legacy solution by November 30, and many of the duplicative costs have already been eliminated. Our short-term strategy for balance sheet management is unchanged from last quarter. We believe that releveraging the balance sheet with prudent loan growth -- portfolio growth is the best course of action. For the foreseeable future, we believe that maintaining a significant cushion above the regulatory cap ratios of 8% for Tier 1 leverage and 13% total risk base is wise and are confident we'll be able to do so. We currently exceed each of these ratios by a significant margin, demonstrating that we have the capital to execute on our business plan and capital management goals. Additionally, in the June 2018 quarter, we repurchased approximately 39,000 shares of our common stock. And we continue to believe that executing on stock repurchases is a wise use of capital in the current environment. Over the course of the past year, we've executed substantial returns of capital to shareholders in the form of cash dividends and stock repurchases. We encourage everyone to review our June 30 investor presentation posted on our website. You will find that we've 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]. And our first question today comes from the line of Brian Zabora with Hovde Group.

One question on funding. You've done a great job of keeping deposit costs flat over the last year or so despite all the rate increases. Your deposit ratio -- loan deposit ratio has been inching up a bit. Just kind of just tell us about funding. And maybe are we getting to -- closer to the point where we may see some deposit cost increases?

Brian, it's Donavon. Sure. I think the longer we go with interest rates increasing, the more pressure there will be on us to respond with respect to our deposit costs. We provide a great deal of information in the SEC filings with respect to a GAAP analysis as it relates to repricing of assets and liabilities. And I think even if we were to see a beginning in the rise to deposit costs, it does not necessarily preclude us from increasing net interest margin because our assets are repricing upward as well. Although potentially, the pace of the increase to the margin may decline to some degree. The other point I would like to make with respect to funding costs, we have a great deal of wholesale capacity, if you will, in that we have very little in the way of brokerage CDs. We have a great deal of capacity with the Federal Home Loan Bank of San Francisco as it relates to borrowing from them. And so it's conceivable for us that we could execute on wholesale funding strategies while not disrupting our retail deposits in such a way that increase those retail deposits very quickly as rates go up. So I think we have a lot of levers that we can pull, but we do note your question or your concern with respect to the question of deposit costs because I think the industry itself is feeling that pressure. And we've been more disciplined than many, given where we're at in our balance sheet strategy.

That's great. And then just a question on the capital side. Your EPS is down this quarter, and you had a bit lower buybacks this quarter. Should we look at that as kind of the trend potentially? Or is there -- just any updated thoughts around the buyback and how you're looking at capital.

I don't think anything has changed with respect to that. You will notice that for the fiscal year, we executed approximately a 5% share repurchase over the course of the year. The board reauthorized or completed another 5% plan. I think it was in April of '17, which was contingent upon the completion of the -- or April of '18, which was contingent upon the June '17 completion of that plan. That has now been accomplished. So we have dry powder with respect to repurchase activity, and I don't think anything has changed materially there.

And we do have a question from the line of Tim O'Brien with Sandler O'Neill.

Did you guys find any ARM loans that you're going to hold for investment this quarter?

Yes. In fact, those numbers have increased, Tim. We have a slide in our investor deck. It's on Slide 7. We picked up $27 million from mortgage banking division this quarter, which is the second-highest origination volume from them in the 6-quarter horizon that we have on that slide. So we do believe that there will be more single-family adjustable rate opportunity out of the mortgage banking division into our held-for-investment portfolio.

So Q4 fiscal year '17 was the last -- was -- it's the highest since then, just looking at the slide.

Yes. Looking at the slide, that's correct. If you see, we had $31 million originated from the mortgage banking division in Q4 of '17. We had $27 million Q4 of '18.

And then can you characterize those loans? What kind of structure they have on them?

Sure. Our portfolio programs in mortgage banking are primarily 5/1 and 7/1 ARMs. They're all conforming. They have relatively conservative underwriting characteristics. If I were to characterize the rates today, we are in the very low 4s with respect to that production volume, kind of blended between 5/1s and 7/1s.

And FICOs on those, average FICOs.

Yes, again, we have a slide in the slide deck that will show that. It's Slide 13 in the upper left. You'll see that 2018 year-to-date balances, on average, the weighted average FICO of those loans is 739. And weighted average LTV was 71%.

And just as far as those loans are concerned, that you will portfolio, are -- where are the -- are there any constraints on where the property is geographically situated?

Well, we have primary and tertiary markets, of course. But -- and we have origination volume all over the state of California. But really, they're kind of urban centers, if you will, as well as suburban communities outside of the urban centers that we're originating from.

And you said the majority of those loans are conforming in size?

Yes. There might be some that jumbo conforming [indiscernible]. But there's also some jumbo in there, but it's pretty evenly split.

And as Craig characterized qualitatively, that opportunity looks to be increasing, improving, expanding potentially here, kind of given the nature of what you're seeing in the market.

Yes, I think that's a fair statement.

Yes, as interest rates rise, absolutely.

And then did you guys purchase any commercial real estate loans or multi loans this quarter?

We did. We purchased approximately $10.4 million of multifamily this quarter. So that would have been denoted on that Slide 7 as part of the $44 million from the CRE group.

Okay, I see that. And do you have a weighted average yield number calculated on the loans that you guys added this quarter of the new loans to the book?

Well, we do, but we don't disclose. The best thing to do is look at Slide 8 perhaps on the investor presentation. What you'll end up seeing is the June 30 [indiscernible] compared on a year-over-year basis, and then the weighted average interest portfolios.

[Operator Instructions]. And we do have a question from the line of Tim Coffey with FIG Partners.

So how should we be thinking about the tax rate end of the calendar 3Q? Because you are on that fiscal year, and I'm wondering what changes might occur this next quarter.

Sure. It's a good question. We had a blended rate essentially from January 1 through June 30, '18. That blended rate on a combined statutory basis was 35.9%. Beginning July 1, 2018, or our new fiscal year, our blended combined statutory tax rate will be 29.6%. So obviously, there are discrete items that will go in there on an ongoing basis, but that's the blended statutory. So we will finally see the full impact of the tax cut that was moved into law earlier this year.

Okay. So will this -- ex out the discrete items, going with 29.5%, 29.6% is a good number to use?

Yes. 29.6% is a good number to use. That's the combined statutory tax rate, both federal and state. And then discrete items can either move that a little bit higher or a little bit lower depending upon the items that come through.

Okay. And then my second question has to do with the loan sale margin and the expectations or how we should look at it this next quarter. Because given what the data you provided on the pipeline, it suggests that you could be more competitive on pricing. But yet, we're also getting into one of the seasonally strong periods for mortgage banking loan. The originations don't necessarily need to be as competitive. So how should we think about the loan sale margin over the next quarter?

Well, I think, yes, I think we're in a very competitive environment irrespective the seasonality associated with the environment. We're seeing mortgage banking opportunities lower in today's market than last year at this time. In fact, the California Association of REALTORS President came out and was talking about the June sales figures. And I'm going quote him here. He said, "California's housing market underperformed again despite an increase in active listings for the third straight month. The lackluster spring home buying season could be a sign of waning buyer interest as endlessly rising home prices and buyer fatigue adversely affected pent-up demand." So I think California is a very competitive environment, and I think that flows through to the pricing models that our competitors use. And so I would expect tough pricing again. We would argue probably at the lower end of our range.

[Operator Instructions]. At this time, it does appear there are no further questions from the phone. Clients, please continue.

Thank you. In that case, I'd like to thank everyone for participating today. And I look forward to having our conference call next quarter. Thank you.

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