Provident Financial Holdings, Inc. (PROV) Q2 2016 Earnings Report, Transcript and Summary

Ladies and gentlemen, think you for standing by. Welcome to the second quarter earnings call. [Operator Instructions] As a reminder, this conference is being recorded. I'd now like to turn the conference over to Mr. Blunden, Chairman and CEO. 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, 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, 2015, and from the Form 10-Q that was 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 our second quarter results. You will note that our mortgage banking business suffered a pretax loss as a result of a less favorable mortgage banking environment. The volume of loans originated for sale in the second quarter of fiscal 2016 decreased significantly from the same quarter last year and from the September 2015 sequential quarter. New applications were weaker in the December 2015 quarter as a result of higher mortgage rates, seasonality and newly implemented regulatory disclosures. The newly implemented regulatory disclosures commonly referred to as TRID had a more pronounced negative impact on our wholesale channel because, in many cases, the mortgage brokers' regulatory disclosures were inconsistent with our TRID disclosures, and required significantly more time for training and implementation. Additionally, we began the third quarter of fiscal 2016 with a lower locked pipeline suggesting a lower volume of loans originated for sale for the foreseeable future when compared to the volume of the prior 12 months. The loan sale margin for the quarter ended December 31, 2015, decreased from the prior sequential quarter and has reverted to approximately the midpoint of the range for the past 6 quarters. Overall, loan sale execution was unfavorable for the quarter, as competitors priced at unsustainably low levels to keep the volumes up and interest rate volatility resulted in significantly higher hedging cost because of the basic risk between underlying hedging instruments and the cash markets. Additionally, newly implemented regulatory disclosures slowed the loan closing process by 1 weak or so, also increasing the hedging costs, since the hedges were required from longer a period. We're working diligently to rationalize our pricing models, but it's always difficult to recover from irrational pricing, since the mortgage banking industry has too much origination capacity for the current demand given the decline in loan originations volume. The mortgage banking FTE count in December 2015 quarter decreased from the September 2015 quarter, and we currently employ 317 FTE and mortgage banking, down from the 320 FTE employed on September 30, 2015. During the quarter, we decreased our origination staff by 1 professional and decreased the fulfillment staff by 2 professionals. We will continue to adjust our business model and FTE count as we have done in the past to commensurate with changes in origination volumes. And given our current results, we lack more aggressively regarding these adjustments. In the mortgage banking business -- I'm sorry. In the community banking business, we increased loans originated and purchase for investments $45 million from $30 million in the prior sequential quarter, which hold, again, an annualized growth rate of 4% for loans held for investment. During the quarter, we also experienced $37.7 million of loan principal payments and payoffs, which is down from the $45.8 million in the September, 2015 quarter, also contributing to the improved growth rate. For the 12 months ended December 31, 2015, loans held for investment totaled a 2% annual rate, which is somewhat disappointing, but preferred loans, a component of loans held for investment, grew at 11% annualized rate. Preparing [indiscernible] for the growth rate of preferred loans balance is changing. Composition of loans held for investment has been the long term goal. Preferred loans are now 58% of loans held for investment and the percentage of loan given for single family loans or loans held for investment has declined significantly from historical highs. Credit quality improved on a sequential quarter basis, and you'll notice that early stage delinquencies fell to $522,000 at December 31, 2015, from $1.2 million at September 30, from $1.3 million at June 30, and from $4.4 million at March 31, suggesting that meaningful near-term deterioration is unlikely. In fact, total classified assets have fallen to their lowest level in many quarters and are now $26 million, which is a very manageable level. We recorded a negative provision of $362,000 from the allowance from loan losses during the quarter ended December 31, 2015. Net recoveries were $96,000 for December 2015 quarter compared to net recoveries of $348,000 during the September 2015 quarter, and net recoveries of $116,000 during the June 2015 quarter. We are pleased with these credit quality results. Our net interest margin decreased this quarter when compared to September 2015 sequential quarter, primarily as a result of the increase in our average cash balance and the decrease in our average balance of loans held for sale. This change in composition resulted in a compressed net interest margin and is directly correlated to mortgage banking originations volume, which declined from last quarter and can be very volatile from one period to the next. Our short-term strategy for balance sheet management is unchanged from last quarter. We believe that releveraging the balance sheet is essential. For the foreseeable future, we believe that maintaining a significant cushion above regulatory capital ratios of 8% for Tier 1 leverage, 9.5% for common equity Tier 1 and 13% total risk-based is critical and we're confident we'll be able to do so. We currently exceed each of these ratios by a wide margin, demonstrating that we have the capital to execute on our business plan and capital management goals. Additionally, in the December 2015 quarter, we repurchased approximately 91,000 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. Additionally, yesterday we announced a quarterly cash dividend of $0.12 per share with the distribution scheduled for March 8, 2016. We encourage everyone to review our December 31 investor presentation posted on our website. You'll 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] And we have a question from the line of Allyson Boyd with KBW.

This is actually Fred Cannon. I just had a question -- number of the mortgage companies have pointed to the new CFPB rules and terms of disclosures as the reason for weaker mortgage banking volumes in the fourth quarter, just saying that it would push it to the first. Was that an issue at all for you during the quarter?

Fred, this is Donovan. I think there is a distinction with respect to that depending upon the channels. The wholesale channel was impacted significantly more than the retail channel. So those mortgage bankers who have a significant contribution from the wholesale channel, I believe experienced more in the way of problems. But overall, while I do think it -- depressed volumes for the December quarter, I think the larger reason for the depressed volumes was the rise in interest rates during that quarter. If you recall, I think the 10-year bond got as high as 2.30%, 2.31%, 2.33% and it took mortgage rates above that, that seems like a magic 4% level for conventional 30-year fixed. Today, the 10-year is at 2.03% and indeed mortgage rates are now below that 4% number. So I think about the December quarter, I think the larger component with respect to depressed volumes was the rise in mortgage interest rates. I think there is some seasonality thrown in there as a result of the holidays, which is typical in the December quarter. And then I think, you are right, there were some issues with respect to the TRID requirements, particularly with respect to the wholesale channel.

And I should know this, but can you remind me of your channel mix.

We're about 50-50 -- about -- little bit less than 50% wholesale.

Okay. And then, since the beginning of the year, have you seen any increase in your pipeline as a result of mortgage rates coming down? Have you seen anything yet?

Yes, we are seeing an uptick in origination volume in new applications, particularly as it relates to the months of November and December. And again, I think the large reason for that is, everybody is kind of getting back to work after the holidays, but more probably having to do with 30-year fixed rate again being below 4%. In fact, I think the MBA the last 2 weeks, they put out a weekly new application volume number. The release this morning suggesting last week's applications were up 8%, just about 9%. And I think the release last week dealing with the prior week release suggested new applications were up 11%.

That's all very helpful. And -- I'm sorry, I should also know this. What's your current mix between the refi and purchase?

We do have that on Slide 14 of the Investor deck. Refinance is approximately 4% or 47% and purchase activity was 53% in the December quarter.

And next we will go to the line of Tim Coffey with FIG Partners.

Craig, so far this year I assume your company has gotten used to obviously doing TRID [indiscernible] documentation. Have you seen any kind of resolution in vendor software to alleviate some of those -- some of that log jam?

Some, but I don't think the industry or all of us have worked our way all the way through that, Tim. I still see delays, especially with third parties and not just wholesale brokers, but escrow companies and title companies are all struggling. There are some sending documents back and forth that aren't correct, which again is delaying the closure of the loan and influences --the leaps that were loss and the hedging and all of that. That still seems to be going on, it's just not as bad as it was last quarter.

Does that mean the -- that weak delay has started to shorten?

Well -- yes, I think ultimately it has started to shorten, but I think what has gotten lost with the whole TRID issue, the lenders are now responsible for the closing disclosures that go to the borrowers. In the past, the escrow companies or title companies were responsible for those closing disclosures. And I think the entire industry was caught a little bit off guard with respect to the amount of change that was actually occurring beyond just the program requirements, the software changes and the like. And so there's been a good bit of training that has been occurring amongst the industry participants, and literally, it's from escrow companies, title companies, the wholesale brokers to loan officers, you name it, everybody is now facing a different process and as a result, it's getting better. And so I would expect those delays are shortened. But nonetheless, we're still seeing some of it.

Okay. In terms of pricing in the market from your competitors, has that pressure started to alleviate?

I think that if you think about our loan sale margin and, in particular, if you look at the slide deck and think about what our last 4 quarters have been. The range of our loan sale margins on a quarterly basis is 125 basis points on the low end. They are 165 basis points on the high end. I think when volume conditions are better, we get closer to the 165 basis points, and wherein competitor pressures are there, I think we'll be closer to the 125 basis points.

Okay. And then on origination volume. Do you see that lower on a year-over-year basis through the next 4 quarters? Or do you think -- was the comments about the loss pipeline leading to lower production just kind of as you see the loss pipeline today?

Tim, we see the loss pipeline today. Again, we have a slide in the deck that describes where our starting point is. But I think it's meaningful to describe to our investors and analysts that our starting point is at the lowest point of the last 6 quarters. It doesn't mean that the entire volume for the industry will be down this calendar, it simply means that the industry, because I don't think we're unlike the industry, I think the industry itself is starting from a lower point. I think the mortgage banking association or the realtors association, well I think they both came out with higher mortgage volumes for calendar '16 in comparison to calendar '15.

Next we'll go to the line of Tim O'Brien with Sandler O'Neill. Tim O’Brien: So question on mortgage sales volumes. Following up on what Fred asked you guys, got you talking about, as far as CFPB rules and TRID and such like that, and relative to that cost of the hedge this quarter, is that going to be elevated for -- until efficient processing comes back to you guys -- until you get that dialed in with you wholesalers? Are those costs just going to run higher for the next few quarters?

Well, they will run higher as long as we start -- or the application to close and sale runs longer. So as long as the cycle runs longer than it historically has, the hedge has to be out there longer and it exposes us to greater costs. I don't think that, that is a huge meaningful part of our loan sale margin. I think competitor pressures are a larger part of that. But it is a part of it, and I think it will run a little bit higher until we can discrete the disclosures more efficient through the system. Tim O’Brien: And then can you quantify how much of the new loans you guys put on this quarter were purchased?

Yes. We had $45 million of purchase and originations from our CRE area, $12.7 million of that was purchased. And then additionally, the PBM area contributed, I think it's about $8 million of single family. So the total origination in purchase volume for the quarter in the held for investment was just over $52 million. Tim O’Brien: And then your kind of -- your dedicated bankers to your core banking unit. Does that FTE number stayed static through the quarter?

We actually increased, I believe, by 1 in the CRE group. Tim O’Brien: And what's the count there?

See I don't have that, Tim, and frankly, we generally don't disclose it. Tim O’Brien: And then do you have any -- my sense is you probably don't have any branch planning initiatives either to open or consolidate branches this year. Is that correct?

Actually, we announced 2 items in December. We have 1 consolidation of our branch -- of our 2 branch locations in Moreno Valley. We're closing 1 office in Moreno Valley, consolidating it with our other office in Moreno Valley. And I believe that will be completed on March 31 of this year. And then, we also announced that we will be opening a new home office across the street from our headquarters. But we have to build that out, and so that probably won't occur it’s not an expansion per se, but what it does do is allow us to create a real corporate headquarters, where we don't have a branch on the first floor and allows us to consolidate some other leases that we have in the city, and move some personnel into our headquarter location. Tim O’Brien: And given the lease environment, given demand for real estate office space and such, do you expect reduction in lease cost for the bank, once you get through the other side of this process? Or are your costs are going to go higher just due to space needs?

Actually, I think our cost will go lower if we are able to consolidate some of our existing leases and personnel in the headquarters. And we exit that lease in Moreno Valley where we're consolidating branch offices. But in each case, with respect to the Form 8-K that we filed on those events or decisions, we described the cost saves as immaterial. Tim O’Brien: And then last question just regard to purchase housing market in Southern California, from the perspective of business that you can capture their specifically. How is that shaping up and what are you thinking here for the new calendar year?

It looks, Tim, like more product is finally coming into the market now in Southern California. You might have read -- this past year there were periods of time when realtors had really very little product to sell. And we have seen an increase since the holidays and with more products on. And that looks to me like that's going to continue this year. And interest rates still are pretty low, which I think will help those sales. It'd be interesting to see what the rest of the economy does, however. Tim O’Brien: You're talking about new housing or is it existing housing that's coming to market?

I'm talking about mainly existing housing. Although we're still seeing some build out of new construction, there has -- there has been a problem, though, completing some phases of tracks and if there is just few workers available to complete the homes. So it's really slowing down the delivery of new home construction at least in Southern California. Tim O’Brien: I wonder where those workers are.

They all went back to Mexico a while back, 6 years ago.

Or they are in San Francisco working on the Transit building.

[Operator Instructions]

If there are no further questions. I would like to thank everyone for joining us on our second quarter fiscal 2016 conference call, and look forward to speaking with you next quarter. Thank you.

Ladies and gentlemen this conference will be made available for replay after 11:00 a.m. Pacific today through February 3, at midnight. You may access the replay system at any time by dialing 1 (800) 475-6701 and entering the access code 384428. That does conclude our conference for today. Thank you for your participation. You may now disconnect.