Provident Financial Holdings, Inc. (PROV) Q2 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Second Quarter Earnings Release. [Operator Instructions] As a reminder, today's call is being recorded. Now, starting off, we have your host, Craig Blunden. Please go ahead.

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, 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, 2011, and from the Form 10-Qs that are filed subsequent to the Form 10-K. Forward-looking statements are effective only as of date that they are made, and the company assumes no obligation to update this information. We want to thank you for participating in our call. I hope each of you has had an opportunity to review our earnings release, which describes our second-quarter results. The major components influencing our current financial results were unchanged, credit quality and mortgage banking. Credit quality continues to improve. Total nonperforming assets on December 31, 2011 decreased to $39.3 million, a 61% decline from what appears to be the peak of $100.7 million on December 31, 2009. We recorded a $1.1 million provision for loan losses during the quarter ended December 31, 2011, while net charge offs were $2.9 million, which was similar to the $2.8 million in the September 2011 quarter but significantly lower than the net charge-offs of $4.8 million in the June 2011 quarter and the $5.1 million in the March 2011 quarter. We're pleased that loans in the 30 to 89 days delinquent category remain manageable and have declined substantially from prior year levels. As we have described in the past, improving credit quality will be inconsistent and irregular. Performance is tied to general economic conditions and while our outlook regarding credit quality continues to improve, we believe that high unemployment rates and slow economic growth may last through much of 2012, keeping our nonperforming assets elevated. It's important to note though that this quarter marks the eighth consecutive quarter where asset quality has improved and the delinquencies in our multifamily and our commercial real estate loan portfolios have remained very low. We continue to believe that the mortgage banking environment remains favorable and provides us an excellent opportunity to enhance earnings. We have been investing in the business primarily by hiring additional personnel. We employed 290 FTE in mortgage banking on December 31, 2011, and we'll remain vigilant in monitoring the operating environments so we can adjust our model and as we have done in the past, commensurate with changes in loan origination volumes. Additionally, it is worth noting that 2011 has required an adjustment to new regulatory requirements that shocked the Mortgage market to some degree. We've dealt with the S.A.F.E. Act in January 2011, compensation changes in April, mortgage origination registration, which was required by July, and the implementation of lower conforming loan limits at the end of September. Each item was difficult for market participants to absorb and we believe resulted in lower loan origination volume. Additionally, we have witnessed the fallout from the quickly changing business environment, the announcements that Bank of America exited the correspondent channel and MetLife ceased operations in its mortgage banking unit. Disruption caused the remaining market participants who purchase our loans to reevaluate their pricing models which compressed our loan sale margin. Over time, we believe we can capitalize on this market turmoil by attracting talented personnel and providing consistent, uninterrupted customer service. And once stability returns, we would expect the mortgage market to become more transparent to market participants resulting in more stabilized volume and loan sale margins. The volume of loans originated for sale in the Second Quarter of Fiscal 2012 increased slightly from the same quarter last year, and increased significantly from the September 2012 sequential quarter levels. Applications remained elevated in December 2011 quarter resulting in a robust locked pipeline for the start of our third quarter of fiscal 2012, which suggests that the volume of loans originated for sale on the Third Quarter of Fiscal 2012 may be similar to current quarter levels. The loan sale margin for the quarter ended December 31, 2011, remained at the lower end of the range that we have come to expect and similar to the September 2011 quarter. Over time, lower mortgage rates are favorable for our business but short-term volatility increases our hedging costs, which generates market turmoil. And the exit of major mortgage purchasers reduces our pricing power. Overall though, loan sale execution remains favorable with very liquid markets for agency conforming loans and we're working very hard to increase our loan sale margins to more profitable levels. In addition, to improving the guarded view of credit quality and our positive outlook on mortgage banking, there have been other developments regarding operating results. For instance, during the quarter, originated and purchased, a total of $90 million from multifamily and commercial real estate loans to augment loans held for investment and allocated additional resources to the commercial real estate loan platform for the goal of increasing loan production for our portfolio. Additionally, our operating expenses have increased as a result of hiring additional mortgage banking personnel. We expect the investment we're making in the retail mortgage banking channel to pay off in the near-term as we increase the percentage of retail originations to total origination. We continue to maintain higher liquidity balances in response to the uncertain operating environment, we're less concerned with doing so today than at this time last year. This is another reason we're expanding our multifamily and commercial real estate capability. Additionally, we continue to invest in our retail deposit franchise resulting in higher core deposit balances as demonstrated by our announcement to open our 15th full-service branch. The net interest margin improved this quarter because liquidity was redeployed to a higher average balance of loans held for sale. Nonetheless, the key takeaways with respect to our second quarter results for the favorable credit quality trends and the investment we're making in mortgage banking has been a near-term drag to profitability. Our short-term strategy for balance sheet management is unchanged from last quarter. We do not believe de-leveraging the balance sheet is required but we recognize that loan demand is weak. It may be difficult to generate a sufficient volume of loans held from investment to replace payoff. Nonetheless, we're investing our multifamily commercial real estate platform to be able to take advantage of loan opportunities as they arise. For the foreseeable future, we believe that maintaining regulatory capital ratio is above 9% core and 12% total risk based is critical. We're confident we will be able to do so. Additionally, in the December 2011 quarter, we repurchased approximately 263,000 shares of common stock. We continue to believe that executing our stock repurchase plan is a wise use of capital in the current low growth environment. We recognize -- we encourage everyone to review our December 31 investor presentation posted in our website. You'll find that we included Slides regarding asset quality and mortgage banking, which we believe will give you additional information on the credit risk embedded in our loan portfolio and favorable mortgage banking fundamentals. We will now entertain any questions you may have regarding our financial results. Thank you. Kevin?

[Operator Instructions] First question is from the line of Don Worthington, Raymond James.

Just a couple of things, I notice you've got, I think, $60 million of FHLB advances maturing over the next 6 months, do you expect those to roll off at maturity?

Don, this is Donavon. Our current plan depending upon what loan demand may be with respect to multifamily and commercial would be to let them roll off and not replace them. On the other hand, if we were able to gin up some growth with respect to our loan portfolio, some of them may be replaced with longer-term advances in this pretty low interest rate environment.

Okay. And then any outlook on the margin? It was up pretty good this quarter and do you expect further expansion over the next couple of quarters?

I think the margin this quarter is at the top end of the range. What you saw during the quarter was re-deployment of cash into the loans held for sale line. Loans held for sale increased substantially in the quarter in comparison to the sequential quarter in September. And that was really the result of the market disruption because the exit of BofA and the beginning of the exit of MetLife in the correspondent channels. As well as the fact that rates really came down in the December quarter and a great deal of new origination volume occurred and it just slowed everything down. And so it was held or it increased our held for sale, and as a result, we redeployed that cash and got a better margin. [indiscernible] that has to be the top of the range.

And then in terms of the properties taken into REO in the quarter, were those primarily single-family homes?

Yes, they were.

And I guess my last question, have you had an examination by the OCC yet?

No, we have not. We would expect, possibly Spring, but we've had no notification at this time.

The next question is from the line of Jason Stewart, Compass Point.

My question is high level and we've seen on a national level, a pretty broad increase in sentiment around builders and construction and as it relates to your footprint and your localities, are you seeing any improvement from September to today? Is there any marked change in the way people are viewing things on the construction side of things?

I don't think so from our region. We're seeing some construction in -- along the coast in Orange County and in San Diego County. But even so, it's at pretty low levels. And there's been a bit of a commercial construction starting up near Ontario Airport on 1 or 2 small warehouses but that's about it, as far as I've seen.

Next question is from Tim Coffey, FIG Partners.

So the first question I've got is kind of on the differences I was seeing in the loan sale margin and the origination activity, it seems that origination activities have grown in the past 4 quarters pretty well but the margins on the loan sale seems to be coming down. Is that a new trend or do you think it's the function of the exiting of BofA and MetLife in the market that caused disruption?

I think it's a difficult question to answer right now. With respect to it being a permanent trend or not. Certainly, I believe the disruption that occurred is a result of the exit of a couple of large players in the market caused our pricing power to diminish at the same time that volumes increased. But that's not to suggest that the existing or remaining players in the market aren't committed to the market, and won't be gearing up to increase their market share relative to that volume, which would then suggest that margins would improve again. From our perspective, we look at the margin we've had the last 2 quarters at the lower end of the range. Perhaps the range is that 110 basis point level, maybe the 150 basis point level. So it's right close to the bottom but I think as everything settles down, as transparency kind of comes back in, as market participants, large market participants gear up to potentially take greater market share because of the exit of others, I think margins could improve. If they don't, we obviously will have to make some changes to try to make certain we increase the profitability in that particular business unit. But on the other hand, it's still ginning up very nice earnings for us and we anticipate that the low rate environment will continue to provide us that opportunity.

And as a follow-on question for the low rate environment, the difference that we saw among originations in terms of refinance versus purchase activity, would you anticipate seeing lower refinancing going forward?

I think so, Tim, at these levels. Refinances, as you saw, our numbers are certainly up some. Although when you compare us to the MBA numbers, we're still consistently low on refinances and higher on purchases, which again I think is a function of that strong retail network that we have today.

And then, have your outlook -- looking at the loan purchases, has your wish list changed at all or do you still anticipate doing some more of the income-producing commercial real estate properties?

When we look at originating for our portfolio, our preferred loans to originated are multifamily and commercial real estate. And that's not going to change, I believe, anytime soon. It's simply a very competitive market and part of competing in that market is putting the right talent on board. We recently hired an originator in Northern California, where we had a much smaller presence in the past, and we think he's going to open up some markets and some opportunities for us with respect to that -- those loan types.

And then my final question, as you look at kind of the market for buyers of your OREO, has that market changed in the most recent quarter compared to recent quarters?

No I don't think so, Tim. I mean, once we get control of the property, get it cleaned up and get in on the market, they're turning pretty quickly. There's lags some months or depending on where the month is in the quarter, we'll pretty well sell out of what we have available and we're getting more in. It does take time to get those people out of the property. So you'll see some variation there. But once they're available, they're moving pretty quickly.

Next question is from the line of Tim O'Brien, Sandler O'Neill. Tim O’Brien: Is the TDR opportunity universe run its course fairly well, is there much left to do there?

I think we -- I have to remember but I think there was 4 in the December quarter that we restructured, which is a very small number in comparison to a year ago or 2 years ago. So to some degree, I would suggest that you're accurate. Much of our portfolio has already run its course, with respect to TDR opportunities. But I also think much of it is tied to economic conditions and if we were to see deterioration in general economic conditions, I think there would be others that would be contacting us for potential restructure. So right now, it looks like it has run its course in large part but that doesn't mean that it won't change a quarter or two down the road.

Tim, what we've seen too is as modification requests continue to lessen significantly, we have had some increases in short sale request. So, that's obviously, again, as Donavon was mentioning, a function of economic environment. Tim O’Brien: Speaking to the economic environment or about that, there's discussion about housing price pressure again. I know that kind of the area that you guys have, your existing portfolio locator and in the kinds of loans that are made there, are you concerned about housing price pressure here affecting your book in 2012? Just leave it at that.

I don't think so. I mean, I've read many of the articles that have come out with respect to the Case-Shiller numbers and yes, they're suggesting housing price pressure but they're suggesting it in the low single digits. In other words, 1% or 2% or 3% or 5% decline in prices. Well, that's a very small decline in prices in comparison to where we've been 3 and 2 years ago. So I don't know that, that will dictate more default activity because those are pretty small declines in values.

And you have to remember too, our portfolio is pretty well spread out all over the State. So it's not just focused right here in the Inland area. Tim O’Brien: There is the pressure on housings markets. Actually, its focused all over the State.

Well, I guess you're right. It depends, though. I mean, we see a lot less pressure along the Coast, still, than we do Inland. Tim O’Brien: Seems like some of the higher-end markets are suffering a bit more than they were before, and there are higher default rates in staff at least, we're seeing up here in North Cal?

That could be the case but if you look at the average loan size of our single family portfolio, I think it's around $350,000 or something of that nature. So, we don't have a lot of high-end loans in our portfolio. Tim O’Brien: Switching gears real quickly. With these rates, at the rate environment where it is, these extraordinary low rates, is it possible you guys would consider portfolio-ing non-agency? Is there an opportunity to generate some non-agency single-family loans this year that would fit on your portfolio that would make sense? Is there any scenario that might make that work given the rate environment we're in?

Tim, listening to your prior question about prices, yes, we've been considering this now for probably I don't know, 9 months or more but until we see some stability on the higher end, which is what you mean by non-agency, right, jumbo? It just -- why would you take the risk if you're not certain of the value? Tim O’Brien: So you're suspicious there and rightfully so, probably?

At the moment, yes, but it's something -- you're right. Looking forward, I think there is opportunity there. It's just when is the right time to do it? Tim O’Brien: And then just last question, as far as investment on the CapEx investment this year, broad brush can you just give us some sense of directionally what that might mean for overhead cost as far as how big are these -- you're just going to chip away at growth it's not going to be -- have a meaningful impact on overhead costs I guess, probably going forward, you guys are going to remain cautious there, is that right?

That's fair. I mean, we've announced for instance a new brand in La Quinta that we expect to open call it late May, mid-June, somewhere in that time frame. And that will obviously, gin up a bit more in operating expenses. We've described that we've been adding mortgage bankers. We're up to 290 FTE in that division now. A year ago, we had 250 FTE in that division. So that has increased operating expenses. But there's no major initiative that we see that would increase operating expenses so significantly that it becomes abnormally high, if you will. Tim O’Brien: Okay. But what do you think the cost is to open that branch, to get it up and operational and running?

We don't describe that publicly for competitive reasons. I will tell you this, it was an existing branch of another institution that failed about 3 years ago or so. And so most of the tenant improvements, we will use. We're not going to have to put a lot of money into it. And indeed, lease rates today are much less than they were 3 or 4 years ago, the last time we opened a branch. So branch costs today are much less expensive than they were and this particular location is a bit less than normal because it's an existing facility or bank branch.

[Operator Instructions] And at this time, we have no further questions in queue.

All right. Well, I appreciate everyone joining our call and I look forward to speaking with you all at our next quarterly conference call. Thank you.

Thank you. Ladies and gentlemen, that does conclude your conference. We do thank you for joining while using AT&T Executive Teleconference. You may now disconnect. Have a good day.