Provident Financial Holdings, Inc. (PROV) Q2 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, we'd like to thank you for standing by, and welcome to the second quarter earnings release teleconference call. [Operator Instructions] As a reminder, today's conference call will be recorded. I would now like to turn the conference over to your host and your facilitator, as well as your Chairman and CEO, Mr. Craig Blunden. Please go ahead, sir.

Thanks, Steven. 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, 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, 2012, and 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'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 second quarter results. Credit quality is improving and we continue to believe further improvement is likely but at a slower pace. Total nonperforming assets on December 31, 2012, were $26.8 million, a 73% decline from what appears to be the peak of $100.7 million on December 31, 2009. We recorded a $23,000 provision for loan losses during the quarter ended December 31, 2012, while net charge-offs were $1.6 million, which was lower than the $1.9 million in the September 2012 quarter and to the net charge offs of $2.9 million in the December 2011 quarter. As we've discussed in the past, improving credit quality, going forward, will be inconsistent and irregular. Our performance is closely 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 2013, keeping our nonperforming assets elevated. It is important to note, though, that the delinquencies in charge-offs in our multi-family commercial real estate portfolios have remained very low throughout the poor credit cycle the past few years. Unfortunately, the single-family portfolio did not perform as well during the same period. Note though that many positive articles have recently been written about the state of the single-family housing markets. We are cautiously optimistic that we have -- may have found the bottom. We continue to believe that the mortgage banking environment remains favorable and provides us an excellent opportunity to enhance earnings. We've been investing in the business, primarily by hiring additional personnel. We had 368 FTE in mortgage banking on December 31, 2012, but we'll remain vigilant in monitoring the operating environment so we can adjust our model, as we have done in the past, commensurate with changes in loan origination volumes. We have recently slowed the pace of mortgage banking's new hires but we'll continue to look for new retail mortgage banking branch opportunities. The volume of loans originate for sales in the second quarter of fiscal 2013 increased significantly from the same quarter last year and from the September 2012 sequential quarter levels. New applications remained at elevated levels for December 2012 quarter, resulting in a robust locked pipeline for the start of our third quarter of fiscal 2013 when compared to the same quarter of fiscal 2012, suggesting a higher volume of loans originated for sale in the March 2013 quarter in comparison to the March 2012 quarter. The loan sale margin for the quarter ended December 31, 2012, deteriorated from the prior sequential quarter but remains at the higher end of the range in comparison to the prior 6 sequential quarters. Overall, loans sale execution remains favorable with very liquid markets for agency performing loans. We're working diligently to maintain our loan sale margins at these more profitable levels. You will note that the recourse provision for loans sold that are subject to repurchase increased to approximately $1.3 million in the December 2012 quarter as a result of reaching a global settlement with the bank's largest legacy loan investor. We determined it was in the bank's best interest to negotiate the settlement with this investor because we believe it will significantly reduce future repurchase claims and the liability uncertainties surrounding legacy loans sales volume. In addition to our improving the guarded view of credit quality and our positive outlook on mortgage banking, there have been other developments regarding our operating results. For example, during the second quarter, we originated and purchased a total of $26 million of primarily multi-family and commercial real estate loans to augment loans held for investment. Additionally, while operating expenses have increased as a result of hiring additional mortgage banking personnel, our efficiency ratio has improved to 58%, demonstrating that the increases in revenue generated from the investment mortgage banking is outpacing the increases in operating expenses. Simply said, the investment is paying off. We continue to maintain higher liquidity balances in response to uncertain operating environment but are less concerned we're doing so today than this time last year, which is another reason we're expanding our multi-family and commercial real estate capabilities. Additionally, we continue to invest in our retail deposit franchise, resulting in higher core deposit balances as demonstrated by opening our 15th full-service branch in the June 2012 quarter. Net interest margin decreased by 12 basis points this quarter in comparison to the same quarter last year because of higher liquidity balances. And last, the key takeaways with respect to our second quarter results are the improving credit quality trends and the returns we are now realizing from the investment we made in the mortgage banking business during fiscal 2012. Our short-term strategy for balance sheet management is unchanged from last year. We do not believe deleveraging the balance sheet is required. We recognize that loan demand is weak and it may be difficult to generate a sufficient volume of loans held for investment to replace pay off. Nonetheless, we're investing in our multi-family and commercial real estate loan platform to take advantage of loan opportunities as they arise. For the foreseeable future, we believe that maintaining regulatory capital ratios above 9% for Tier 1 Leverage and 12% total risk base is critical and we're confident we'll be able to do so. Additionally, in the December 2012 quarter, we repurchased approximately 94,000 shares of common stock. We continue to believe that executing on our stock repurchase plan is a wise use of capital in the current low growth environment. We also raised our quarterly cash dividend by 40% to $0.07 per share, the first of which will be distributed to shareholders on March 5, 2013. We encourage everyone to review our December 31 investor presentation posted to 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 home portfolio and favorable mortgage banking fundamentals. We will now entertain any questions that you may have regarding our financial results. Thank you. Stephen?

[Operator Instructions] Our first question will come from the line of Mr. Jason Stewart of Compass Point.

Two questions. One, on the cash balances. How should we think about the cash balances moving directionally and then if you can give us a magnitude with mortgage production going forward?

Jason, this is Donavon. I think there are a couple of things to think about with respect to cash balances. The first and overriding consideration is that those cash balances are available to fund our mortgage banking activity. And to the extent that loans held for sale increase or decrease, we will have an increase or decrease, a corresponding increase or decrease in the cash balances as you probably are thinking about our investment at a nominal interest rate. The second thing to consider with respect to those cash balances is that we have essentially some significant advances maturing from the Federal Home Loan Bank that gets approximately $75 million over the course of the next year or less. And we are probably going to be using the cash balances to pay down those advances at least until such time that we see our ability to increase origination of loans held for investment that requires us to go out and perhaps look at longer-term funding out of Federal Home Loan Bank. So -- and I guess the last thing I would suggest is that we're not interested in investing in fixed income securities with the liquidity we have on our balance sheet because of what we believe to be the excessive interest rate risk associated with doing so.

And then you said you were cautiously optimistic about the outlook. I was wondering if you could offer any specific comments about the outlook for single-family, real estate markets and multi-family in your market?

Certainly on the single-family side, we do see improvement. We do see rises in prices, especially on the low-end. We're starting to see a lot more activity in the jumbo side of at least pricewise of the real estate market where those homes that didn't sell for a number of years are starting to sell. And we also believe that there's going to be more secondary outlets for single-family. On the multi-family side, we're just not -- still not seeing a lot of volume out there and what volume there is, is aggressively being price down by those institutions. They do have a lot of cash and don't have other business lines.

I guess, with respect to mortgage banking, a couple of other things I would point out, Craig touched on it. This mortgage banking environment today is far different than it was in the prior boom’s cycle in that none of it is really related to jumbo production. And the reason it's not related to jumbo production is because the securitization markets for jumbo just aren't there yet. Now we're going to see proposed rules coming out with respect to securitization hold back. I think CFPB, as suggested, is coming out early this year. That will put some foundation or layering in the market with respect to what can be done there. And ultimately, I think there's a great deal of pent-up demand particularly if we see home prices rise. There are some borrowers who have been locked out of the market because of high LTVs. We'll be able to reenter the market at lower interest rates. So I think there's pent-up demand there. And we've spoken about Redwood Trust in the past as kind of being the one organization that has done a lot of jumbo securitization. They continue to do so but there's also been recent rumblings of other conduits and aggregators that are going to enter that market. And so if we see the liquidity build, we think there's some good volume that can be had in jumbo. And then obviously, the purchase money activity, California is relatively strong. If you read some of the data quick information results for instance with respect to volume and with respect to prices. And then third, which we really don't understand yet, there's been some talk by the administration that there could be an expansion of HARP 2.0 to those loans that may not currently be serviced by the GSEs. And they have HARP 2.0 as expanded in that way. There would be a number of additional borrowers that would be eligible for refinance that are currently underwater. So mortgage banking is going to change, I think, in 2013 as a result of what ultimately occurs from these items that I've mentioned. And I think we're in a very good position to take advantage of that.

Okay. Actually, 2 more follow-ups based on your comments, Donavon and Craig. One, if you could give us an idea of how much business you're doing through the HARP program. And then two, when you talk about originating and selling to a securitization outlet on the jumbo side, is there the potential to sell to a balance sheet aggregator rather than an aggregator that's only securitizing?

As far as the percentage that we're doing out of that program, currently, that would be 0. We're just not -- we haven't been servicing those loans for years. We've sold this production for a long time, servicing released. And so haven't anticipated. So when you see our numbers, that's all about any of those government programs.

With respect to jumbo and sending jumbo to other aggregators or held for investment, yes, there's -- every once in a while, we'll see some information, hey, can you send us 10 million jumbo package, can you do this? That's just very difficult for us to operate in that window because we need flow capabilities with respect to anything that we do. We can't necessarily be subject to an investor who is simply looking for $10 million, it's just not worth our time. It has to be an investor who's looking for flow production from us so we know that we're originating into a program as our pipelines build.

And the balance sheet -- investors in the past few years, of course, have been the major banks. They've been originating their own product for their own portfolio and have not been accepting product or priced it so that we can't really originate it and deliver it to them.

Our next question will come from the line of Mr. Don Worthington of Raymond James.

One question on the margin, not the gain on sales spread, but just your margin on loans. It's been pretty stable, would you expect that to continue?

Don, the one thing with respect to our net interest margin that sometimes gets bought [ph] is the fact that our held-for-sale portfolio can move up or down quite significantly depending upon volume and depending upon flows to the secondary market. So for instance, the deterioration you saw in net interest margin year-over-year, not sequential quarter but year-over-year, was largely the result of last year at this time, our held for sale balances were significantly higher than our held for sale balances through this December's quarter. And as a result, we have more cash on hand, liquidity invested at fed funds yield, if you will, and that brought down the net interest margin. Now with respect to what we're seeing at least kind of the -- our held for investment, margins are still under pressure. They're under pressure because we've lowered deposit costs aggressively. We still have a little ways to go, perhaps, with respect to deposit costs. And certainly FHLB advances as they mature are going to bring down our overall cost of funds. But the reality is the bulk of our loans have repriced themselves into their adjustable period and as a result, those margins have come down significantly because the adjustable period in the loan has come down quicker than what we've been able to do with respect to our funding costs. So I think the range that you see over the past 6, 7, 8 quarters, I think they maintained if you think about a low and a high but it might ultimately come down or tick down a bit that range from what the highs were as a result of the held for investment pressures.

Okay. And then are you seeing any shift in your mortgage banking activity towards purchase from refi or are those percentages kind of holding up what they've been in recent quarters?

Well, we actually have a slide in our investor presentation on that, Don, and the one thing that we described to everybody who speaks to us about it, we're getting our fair share of refinance activity. And in fact, it went up to 68% of total origination volume in the December quarter. That's up from 62% in September. That's up from 50% in June, 56% in March of last year. But those percentages are lower than the industry in general. I think MBA puts out statistics that suggest, perhaps, 80% of all loan volume being generated today is refinance. The reason ours is lower is not because we're not taking them but it's because what we've done through this cycle is expand our retail origination production capabilities and retail will capture more purchase money activity than wholesale will. And as a result, coupled with the California geographies essentially the housing markets coming back quite nicely, we've been able to maintain pretty significant purchase money activity.

Don, the other thing is a factor here and you probably right about it is the supply of homes for sale is pretty low. Couple reasons, of course, there's a lot fewer foreclosures than there were in prior years. And there's still people holding back their homes waiting for prices to rise before they put them on the market again. And so it's a real battle for every purchase and the complaints I hear not, of course, just from our people but from realtors in general in the markets we're in, there's just not a good supply of homes for sale.

And last question in queue at this time is coming from the line of Mr. Tim Coffey of FIG Partners.

Craig and Don, I have a question about capital management here. So in the last 2 years, we've seen 3 dividend increases and an ongoing share repurchase program. So my question is, as investors start to think about the stock, should they be cognizant of this? It seems like active approach to capital management by the company?

Yes. Clearly, we've talked about the possibility of growing the back in the last few years and it's been difficult. And yet, we're making a lot of money though mortgage banking, which, of course, is raising our capital levels. So we're very cognizant of that and the board is as well and that's why we've been actively doing the repurchase programs and increasing the dividend. Trying to keep pace and we'll continue to do that as long as we don't have the opportunity to grow the bank as fast as we'd like. Does that kind of hit it?

It does, it does. You have any thoughts about acquiring anybody? Reinvesting in the business that way?

I don't know that we would talk about that on the conference call, Tim.

I'm not looking for specifics. I'm just talking about in general as a way -- as an additionally way to manage the capital.

Yes, but there's a lot of competition even on that front. We look at, for instance, acquiring loan portfolios. And when you start looking at the pricing metrics of loan portfolios, there's a great deal of sticker shock and premium risk associated with those transactions. So organic growth with respect to origination volume and held for investment seems to be the way to go. And I think our approach with respect to capital management has been sound because we balance that against what we feel our organic growth opportunities are. And we manage that through, obviously, as you point out, increasing cash dividends and repurchasing stock. I guess the one caution I would throw out is that our stock price is now trading above book value and it's no longer a no-brainer decision, if you will, with respect to repurchasing our stock in comparison to when we are trading below book value. So if I would describe capital management, perhaps the needle is moving a little bit more toward cash dividend and away from stock repurchases but I think both will remain tools that the bank will use.

And then following Don's question about the refinance activity within the portfolio end of calendar 4Q, was some of that trying to accelerate the refinance before year end? Or is there some kind of seasonality in there related to something related to the Fiscal Cliff concerns?

I suppose there could have been. But we typically see that the December quarter is a rush to get loans closed before year end just kind of as a natural thing in the market. And then unfortunately because of the holidays, there's an extended period of time off typically by many of the sales professionals, if you will. And so the pipeline doesn't get replenished at the same pace that the fundings occur. So a lot of the pipeline comes down, which then means from a seasonality standpoint, March typically becomes lower funding volume quarter than December. Again, I would simply point out however, that this year, our locked pipeline at December 31 is higher than our locked pipeline at December 31 of last year, which suggest to me that our funding volume for March of this year will be higher than what it was for March of last year. So I don't know that there was necessarily this rush out of the ordinary to get loans funded for the December quarter.

Yes. The only time we've seen rushes, Tim, is when there's been a change in some program maybe on the loan amount, maximum loan amount you can deliver, something like that changes. We have seen those periods of time where you do see a quick rush before a cutoff date. We haven't seen that in the last year or more.

Okay, okay. And, Don or Craig, you provided the numbers on your full-time equivalents in the profit mortgage banking unit and think you said for quarter end it was 368?

Yes.

Okay. Do you have those equivalent numbers for the previous 3 quarters?

Yes. September, we were at 349; June, we were at 336; March, we were at 316; and December of last year, we were at 291.

Okay. And then you also said, if I had to grab my notes, that you were slowing the pace of new hiring in the mortgage banking unit. Was that right?

I think as you think about our mortgage banking unit, our back-office staffing has kind of caught up with our origination or originator staffing in the volume. So now, it becomes more of a strategic decision, if you will, if we find a group of originators with the possibility of opening a branch office in a location we're not currently at. We would probably consider bringing them on and their back office staff, if you will. For a while, we were bringing on originators more quickly than were bringing on back-office and we had to continually keep up with that. So I think that's what we referred to when we think about slowing the pace.

We have another question in queue from the line of Mr. Tim O'Brien of Sandler O'Neill. Tim O’Brien: My first question, the global settlement recourse provision dollars. From the press release, it sounds like that payout takes place subsequent to reporting earnings yesterday. So in the next couple of days before the end of January?

That's our expectation but we're still finalizing all of the terms of the agreement. But for December 31 purposes, we determined that it was more likely than not to occur. As a result, we accrued sufficient resources to completely fund that global settlement. Tim O’Brien: So the final terms are not financial, they're more legal?

Right, yes. Tim O’Brien: Okay, great. That's how you could come up with the dollar amount that you provided?

Right, yes. Tim O’Brien: And as of today, since we're only a few days up from the end of a month, we're still on track, you think, for getting that done here before the end of the month?

Yes, I think that's a fair assessment. Tim O’Brien: Okay, great. And then, Donavon, you talked a little bit about proposed rules, regulations on securitization of non-agencies?

The QRM. Tim O’Brien: Yes, the QRM. Do you -- is there anything in particular watching out for there and once those rules are announced from a competitive standpoint, do you guys have a plan in place that's going to allow you to, I don't know, engage differently in the marketplace or are you more likely to give some time and pause and see how the market responds and then react after that?

I think the biggest issue is that once the QRM are proposed and defined, liquidity will enter the market in that more aggregators and conduits who want to begin to securitize. Is the 5% retention going to be the number and if that 5% retention is the number, is there an exemption from it as a result of the underwriting terms that is being used to generate the loans. So once that dust settles, it seems to me that liquidity will start coming back into the market and once liquidity starts coming back into the market, then origination volume will naturally increase. Tim O’Brien: You're fully ready to go at that point, I guess, is the way to look at it?

Correct. Yes, we're ready now. We've got the staffing. We just have to have the programs.

It's another program on the rate sheet is all. Tim O’Brien: Yes. You've talked about those new programs on rate sheets before in the past, Craig. The $26 million in multi and what was it? Non-agency? I didn't catch that. Did you guys purchase some loans this quarter? Is that right?

When we described it in our earnings release, we can pick up a loan or 2 or 3 so we always put it -- the bulk of it is organic originations, our originations. And then additionally, you're going to see, I think, there was $2 million of single-family that we took out of the mortgage division and put in the held for investment. That's coupled with, I think, about $3 million that we did in the prior quarter. So we've done about $5 million in the first 6 months out of TBM into the portfolio. So it's primarily multi-family and commercial with a little sprinkling of single-family. Tim O’Brien: Got it. And then to characterize kind of the jumbo opportunity from a different standpoint, historically, have margins for jumbo sales been higher in the past and would you anticipate that, that would probably carry even in this new environment?

Historically, nonconforming has a premium to conforming but the rules are kind of changing now. I would expect to see a potential differentiation and perhaps some better margins in jumbo. But we'll just have to see how the dust settles on that. Tim O’Brien: And then last question. As far as kind of the purchase seasons, there's some seasonality to home purchasing in California. And, Craig, you mentioned this point about a lack of inventory, it's backwards looking in terms of what happened, the experience from 2012, I would assume, your purchased channels, do you get a sense in talking to your folks that, that is going to be a significant hindrance to purchase originations here for the 2013 sales season in California?

Well, we're hopeful that it won't be a hindrance, Tim. And as values continue to firm up and they are, I believe there will be more properties put on the market. It's just not as easy, let's say, as when you have lots of foreclosures dumped into the marketplace and there's a lot of activity and scurrying around for a couple of years like there was for the realtors in many of our communities. But not -- it's hard to call but as long as prices keep doing what they've been doing, I think there'll be more activity and more purchases available in our market places. Tim O’Brien: So for example, relative to last year that would logically make sense, I guess?

Yes, I think so, yes.

Absolutely, absolutely. I mean, again, you look at the statistics in California. And I think from a geography standpoint, we have an advantage to other parts perhaps. Sales activities been rising and prices have been rising essentially throughout all of 2012. And the more that, that continues, the more available homes or the more activity will occur naturally as a result of those higher prices, more people will be able to get out from under if that's what they want to do.

Another thing that I think indicates that prices are strengthening is that we're -- we have been seeing in the last year now more single-family construction going on, especially along the coast in the different counties from San Diego, Orange County and so on that we didn't see it for years. And they wouldn't be building those if they couldn't sell them, number one, and from what I understand and talking to sales reps on tracks, they're selling very well because there hasn't been a lot built, as you know, in the last 5 years. So again, to me, that indicates that there's strength in the prices in the marketplace. Tim O’Brien: One last quick question. Fallout ration trend. Is that the trend we're seeing, which is a decline in the fallout ratio and is there something cyclical to that given, I guess, improvement in the economy, does that ratio generally come down?

It's more refi.

It's more interest rate sensitive in that if refis are more interest-rate sensitive, number one. And then if rates rise while you have a locked pipeline that you're working, more of those loans will fund because they're not able to get a better rate elsewhere. So really, that's what's going on there. It's not a seasonality thing. It's really dependent upon what the rate of your locked portfolio is in comparison to current market rates, which are 2 or 3 week or 4 weeks later from that locked application and if rates came up, you're going to fund more on those loans.

And certainly the high percentage of refi's being in that pipeline because they don't have the fund. Refi's aren't like a purchase that have a drop dead date on a sale. That adds that additional dimension.

And there are no further questions in queue at this time, sir.

Well, I'd like to thank everyone for participating on our quarterly conference call. And I look forward to meeting with you all again next quarter. Thank you.

Ladies and gentlemen, that does concludes our conference call for today. In behalf of today's panel, I'd like to thank you for your participation in today's call and thank you for using AT&T. Have a wonderful day. You may now disconnect.