Provident Financial Holdings, Inc. (PROV) Q3 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the third quarter earnings call. [Operator Instructions]. As a reminder, this conference is being recorded today. It's now my pleasure to turn the conference over to our host, Chairman and CEO, 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. We do hope that all of you and your families are doing well, staying safe during this health and economic crisis.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, objective or goals for future operations, products or services, forecast 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, 2019, and from the Form 10-Qs and other SEC filings that are filed subsequent to the Form 10-K. Forward-looking statements are effective only as of 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 our third quarter results. In the most recent quarter, we originated and purchased $28.8 million of loans held for investment, a decrease from the $81.6 million in the prior sequential quarter. During the quarter, we also experienced $55.7 million of loan principal prepayments and payoffs, which is down from the $65.2 million in the December 2019 quarter but still tempering the growth rate of loans held for investment.In the March 2020 quarter, there were 2 loan purchase packages from different sellers that we did not sell. Unfortunately, we could not complete our due diligence on individual loans consistent with our underwriting requirements, and we could not obtain satisfactory protections in the whole loan sale and servicing agreement. Additionally, we canceled another long purchase package scheduled for an April settlement for the same reason. It's very difficult to get comfortable purchasing loans from others in the current environment.For the three months ended March 31, 2020, loan shelter investment decreased by approximately 3% in comparison to December 31, 2019, with declines in all loan categories. New loan production is uncertain for California lenders because of the sheltered home constraint and the difficulty in obtaining certain underwriting documents such as verification of employment and IRS tax transcripts, among others.We are very pleased with the current credit quality, and you will note that early-stage delinquency balances were $2.8 million at March 31, 2020. In addition, nonperforming assets remain at very low levels and are just $3.6 million, which is down from the $6.1 million at March 31, 2019, a 41% decline during the course of the year. However, the recent situation regarding the pandemic will certainly have negative implications for future credit quality although it is far from certain what those implications may be. We are currently working with our borrowers to provide payment forbearance of up to 6 months. The forbearance amount will be due and payable in full as a balloon payment at the end of the loan term or sooner if the loan becomes due and payable in full at an earlier date. We believe our forbearance plan will meet the broad criteria promulgated by the CARES Act, the Interagency Regulatory Guidance and clarifying statements from the Financial Accounting Standards Board and the Securities and Exchange Commission.As a result, we anticipate we will qualify for the favorable provision guided in the guidance. Although at the close of business on April 24, we have filled the approximately 99 single-family forbearance requests by number or $46.2 million by dollar amount and approximately 89 multifamily commercial real estate and business loan requests by number or $64.9 million by dollar amount. For single-family, we have processed approximately 13 eligible requests, 3 ineligible requests and 2 withdrawn requests. Additionally, for multifamily, commercial real estate and business loans, we have processed approximately 2 eligible requests, 10 ineligible requests and 9 withdrawn requests. You could tell from the numbers that we saw many requests to process but we anticipate we will be completed by mid-May.We recorded an $874,000 loan loss provision in the March 2020 quarter, primarily due to a qualitative component established in our allowance for loan loss methodology.All right. In response to the pandemic, which has negatively impacted the current economic environment, you will note that we remain on the incurred loss model and have not adopted CECL. This means that our allowance methodology cannot be reasonably compared to CECL adopters. I also wish to refer you to Slide 13 of our investor presentation, specifically Footnote 5 of the commercial real estate table. The footnote describes the composition of our commercial real estate secured loan portfolio and the balances that may be considered higher risk than the current environment.Our net interest margin compressed by 23 basis points for the quarter ended March 31, 2020, compared to the same quarter last year as a result of a 22 basis point decrease in the average yield on total interest earning assets and a 1 basis point increase in the cost of total interest-bearing liabilities. Our average cost of deposits decreased by 3 basis points to 36 basis points for the quarter ended March 31, 2020, compared to the same quarter last year, highlighting the strength and value of our deposit franchise. The 3.3% net interest margin this quarter was negatively impacted by approximately 8 basis points as a result of the increase in amortization of the net deferred loan costs associated with the loan payoffs in the March quarter in comparison to the average net deferred loan cost amortization of the previous 5 quarters. Our noninterest expenses have declined significantly as a result of scaling back our operations regarding the origination of sale of old single-family mortgage loans.Notably, our FTE count on March 31, 2020, was 183 compared to 298 FTE on the same date last year, and we have 10 fewer loan production offices and 1 less retail banking center in comparison to the same time last year. As a result, operating expenses declined approximately $7.5 million in the current quarter compared to approximately $13 million in the same quarter last year. However, it should be noted that we incurred approximately $1.6 million of onetime costs in the March 2019 quarter of last year associated with the scaling back of the origination of saleable single-family loans.Additionally, on a sequential quarter basis, operating expenses declined by approximately 1 basis point as a result of the declines in salaries and employee benefits and occupancy expenses, partially offset by increases in equipment and professional expenses. Our short-term strategy for balance sheet management is unchanged from last quarter. We believe that releveraging the balance sheet with prudent loan portfolio growth is the best course of action but executing on that strategy in the current environment may prove very difficult.We exceed well-capitalized capital ratios by a significant margin, allowing for us to execute on our business plan and capital management goals without complications. We believe that maintaining our cash dividend is very important to shareholders and doing so takes priority over buyback activity. Nonetheless, we repurchased approximately 47,000 shares of common stock in the March 2020 quarter but wish to emphasize that safeguarding capital is becoming increasingly important in the current environment and is the wisest course of action until we can get better clarity on the current economic landscape.We encourage everyone to review our March 31 investor presentation posted on our website. You will find that we included slides regarding financial metrics, 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 comes from the line of Tim Coffey with Janney.

So Craig, the difficulty you described in evaluating loan packages during the quarter, what does that kind of translate into expectations for loan growth this year?

Well, it definitely slowed our expectations, Tim, and not knowing how long we're going to be in this situation mainly with the issues, not only with, how do we underwrite these properly with companies closed down and issues with getting documentation, IRS and so on but also then what possible forbearance may occur immediately with those loans that we would purchase in a loan pool as an example. So it's really hard to say, knowing that people are going to be -- other lenders are going to be having these requests for forbearance now into the near future. Donavon, do you have anything to add?

Yes. I would kind of reiterate Craig's comments in that we would expect it to be lower than what we've been able to accomplish in the first 6 months of the fiscal. But things are changing very rapidly. For instance, I understand yesterday, the IRS announced that they've reopened their income verification portals, although they are very backlogged with respect to putting out the information on income verifications from tax returns and like. But that's a positive and that will move forward.And then I think the other thing is we described not being able to obtain satisfactory provisions in the whole loan sale and servicing agreements. I think that will change as well as sellers understand that buyers are going to be reluctant as a result of, again, the current situation to purchase loans without some protections surrounding forbearance. And one point of clarity there, yesterday or perhaps it was the prior day, we finalized an agreement to purchase a package of loans this quarter from another lender. And indeed, the other lender had agreed to give us some protections in the agreement with respect to forbearance requests.So I think the market is responding with respect to the current environment, and we will see changes being made that will satisfy market participants, us being one of them, but it's going to be slow to develop. So this will have, I think, negative implications in the short term with respect to purchase packages, but ultimately, it should shake out to become more routine.

Okay. That's great color. And then what are you seeing with potential for refinancing away in your existing loan portfolio, given that there are lower rates but this situation is incredibly unique?

Well, I think, Tim, we're expecting it would slow down from where it was when these refis were really happening in January and February, closing in March. I would expect everybody is going to be slowed down on that. And in fact, the whole system got jammed up with refis, which was slowing down the process of closing those applications in the first place. So again, I think that's just another part of this market. Even though rates are at historic lows, it's going to mean there will be a bit fewer refis at least in the near term.

Okay. And then if you look at the other side of your interest expenses, do you have CDs maturing the next couple of quarters?

Don, if you want to get that.

Yes. Tim, yes, of course, we do. In fact, in our 10-Q, you'll see a GAAP analysis, which we'll describe the incremental CDs that are repricing. So if you refer to the December Form 10-Q, you'll be able to see where it is, and when we file the March 10-Q, you'll see where it is. And indeed, rates are coming down on CDs across the board, by market participants, and we are able to lower our deposit rates on CDs, and we will get some incremental benefit in lowering deposit costs as a result of that.Additionally, I want to add that with respect to transaction accounts, we are also seeing that market participants are lowering money market account rates, checking account rates, transaction accounts. And even though we're at a very low base with respect to our cost of deposits, we think we will get some relief in that area as well as we go down the time line here. So we are going to see, I believe, our deposit costs, and overall, our funding costs come down, but they may not reprice downward as quickly as some others who may be in a higher percentage of CDs or had a higher percentage of money market accounts at higher rates, et cetera.

Okay. And are you participating in the Paycheck Protection Program?

No. No, Tim. We're not an SBA lender. We didn't have the staff, the software, understand the reporting and working with the SBA. So we have been referring our customers who have called us to nonbank lenders, SBA lenders that have been able to help them apply in that program. And honestly, after watching how smoothly it's gone, I'm glad we're not participating at this time.

No. Absolutely. That makes sense. And then the pullback on the buyback program, is that off the table for the rest of this year? Or is it something that you'll revisit as we go through the rest of this year or the rest of whatever we're going through?

Well, I'm sure we'll revisit it, number one, and we'll look at it closely as the market changes, so we'll see. Donavon, do you want to add to that?

Yes. I think the biggest thing there is we've not necessarily said that our buyback program is off the table at this time. What we've described in the prepared remarks is that we want additional clarity with respect to the current economic situation, how quickly businesses open, how quickly we get back to a new normal, if you will. And then secondarily, we want more clarity within the context of our own balance sheet and what the current economic environment may mean with respect to loan losses, our preparation for loan losses through provisioning to the allowance and the like.So I don't want to describe that it is off the table. I do think it is fair to describe that we are pulling back a little bit to understand where we currently are, which may mean not as much activity in June without the current economic situation. But there still could be some activity depending upon the clarity and comfort we get.

[Operator Instructions]. I do have a question at this time from Matthew Clark with Piper Sandler.

Just on the reserve build this quarter, given that you're not under CECL, that's kind of a point in time as of 3/31, I believe, and given the deterioration we've seen in the economy in April, is it fair to assume that we might see a bigger step-up in reserves here this coming quarter or not necessarily?

Donavon, you want to do that?

Tim or Matt, I think it's too soon to tell at this point in time. I certainly believe that there is an implication with respect to the current economic environment on what potentially could occur with respect to loan losses. Obviously, that's why we provisioned in the March quarter. We may come to the same conclusion in the June quarter. But the difference for us between March and June is that we will have a better handle on the number of borrowers that we have placed in a forbearance program, and there will be more granularity around that, which will give us some additional clarity.I think our reserve build was about 13% by dollar, by about 16% as a coverage ratio against loans, which is, I think, right in the ballpark of where non-CECL institutions have come in. So I think the verdict is out. I think there is perhaps an implication for additional reserves in the June quarter through provisioning. But really, it's very difficult to ascertain on April 29 what that situation may look like at June 30 when we're closing our books for the fiscal year. And again, the difference between the incurred loss model, that's really based upon current losses to determine where that reserve should be. It's not the CECL model, which is the future losses through the terms of the individual loans, which is a much different calculation. So it's very possible that there will be additional provisioning and reserve build, but we don't know what those implications are until we get further down the time line.

Understood. And then just in the multifamily portfolio, it looks like you guys provided some good detail in the -- for the commercial real estate portfolio in terms of some of the breakdown there. But in the multifamily piece, is there any of that exposure that might have a retail component to it? Or is it tried and true?

Yes. If it's in that multifamily table on Slide 13, those are pure multifamily. There wouldn't necessarily be a retail component. If it is mixed-use such as commercial and residential or retail and office or something of that, it would be in the commercial real estate table. So the multifamily table is really straight multifamily.

Okay. And then on the non-purchasing, the self-originated loan production, I guess, how are you thinking about opportunities right now? Are you tightening standards across the board or certain segments? I just want to get a sense for how you're thinking about kind of self-originated type of loan production?

Sure, Matt. We have tightened standards a bit with respect to single-family. I think all portfolio lenders have probably done so. But not so much that we don't -- that we think we've essentially tightened ourselves out of the market. But we have tightened a bit. The issue though is really how quickly we can process applications through, giving -- or given the underwriting requirements that we have with respect to verifying income, employment, et cetera, et cetera. So it's going to be slow but we think there's opportunity there because on the other hand, the secondary market is kind of frozen. We're not hearing that there is much of a jumbo fixed market right now, for instance, because there's no liquidity for those that are originating and selling.And as a result of that, we think there's perhaps some opportunity with respect to our ARM products, provided we can price appropriately and provided we can fulfill the expectations of building a pipeline with respect to underwriting and closing loans. We also think there's opportunity in multifamily and commercial real estate and the like. Perhaps there might be even more opportunity there than in single-family because it seems like that's a more liquid market almost than single-family. So we certainly think we can continue to originate but it is going to be difficult in the current environment until some of these things normalize.

Understood. And then last one for me, just on the margin outlook. Your loan yields came down quite a bit. It sounds like there was a little bit of an unusual item or activity in there with the deferred fees. But wondered also if there might have been something unusual in the securities yields as well. I'm just trying to get a sense for the potential margin pressure going forward.

Okay. You're right to point out the net deferred costs, which were higher than kind of a normalized 5-quarter look back. And that impacted us by about 8 basis points in the March quarter. Conversely, in the December quarter, we had lower deferred loan cost amortization than the prior 5-quarter look back, and that augmented the loan yield in the December quarter by approximately 7 basis points. So there's about 15 basis points of play in the difference between the December 31 net interest margin and the March 31 net interest margin.And we can't forecast what that may look like in any given quarter. Although if we do experience lower prepayments as we think may occur as a result of bottlenecks in funding new loans, we would expect that there would be fewer loan payoffs, which then mean fewer net deferred loan costs being amortized into the income statement. So we think that could be a net positive. Other than that though, we do have an adjustable rate loan portfolio, and it adjusts based upon the new indices. And the new -- or the indices are well below where they were. And as a result, until we hit floors or until we hit caps, we will be reducing net interest margin as these loan portfolios adjust.

[Operator Instructions]. I have no one in queue at this time.

All right. Well, I want to thank everyone for participating in our quarterly conference call and look forward to speaking to you next quarter. Thank you.

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