Provident Financial Holdings, Inc. (PROV) Q3 2016 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to Provident Financial's Third Quarter Earnings Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to turn the conference over to Mr. Craig 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, 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, 2015, 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. We hope that each of you has had an opportunity to review our earnings release, which describes our third quarter results. You will note that our mortgage banking business reversed course, and we realized a pretax profit as a result of a somewhat more favorable mortgage banking environment. New applications were stronger in the March 2016 quarter as a result of lower mortgage rates and a reasonable start to the spring buying season. The increase in applications had a pronounced favorable impact on our locked pipeline, suggesting a higher volume of loans originated for sale for the foreseeable future when compared to the volume of the prior 6 months. Loan sale margin for the quarter ended March 31, 2016, increased from the prior sequential quarter and has moved to the upper end of the range for the past 6 quarters. Overall, loan execution -- sale execution was favorable for the quarter as we were able to price at better levels, given the decline in mortgage rates during the March 2016 quarter. The mortgage banking FTE count in the March 2016 quarter decreased from the December 2015 quarter, and we currently employ 306 FTE in mortgage banking, down from the 317 FTE employed on December 31, 2015. During the quarter, we decreased our origination staff by 5 professionals and decreased our fulfillment staff by 6 professionals. We will continue to adjust our business model and FTE count as we have in the past, commensurate with changes of loan origination volumes, and given our current results, we'll act more proactively regarding those adjustments. In the community banking business, loans originated and purchased for investment declined to $35 million from the $45 million in the prior sequential quarter, resulting in a small decline in loans held for investment. During the quarter, we also experienced $56.3 million of loan principal payments and payoffs, which is up from the $37.7 million in the December 2015 quarter, also contributing to the small decline in loans held for investment. For the 12 months ended March 31, 2016, loans held for investment decreased by 2%, which is disappointing, but preferred loans, a component of loans held for investment, grew at a 5% rate. We're pleased with the growth rate of preferred loan balances since changing the composition of loans held for investment has been a long-term goal. Preferred loans now are at 58% of loans held for investment, and the percentage of lower yields on single-family loans to loans held for investment has declined significantly from historical highs. Credit quality improved on a sequential-quarter basis, and you will note that early stage delinquencies fell to $1.5 million at March 31, 2016, from $4.4 million at March 31, 2015, 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 at $23 million, which is a very manageable level. We recorded a negative provision of $694,000 from the allowance for loan losses during the quarter ended March 31, 2016. Net recoveries were $126,000 for the March 2016 quarter compared to net recoveries of $96,000 during December 2015 quarter, net recoveries of $348,000 during the September 2015 quarter and net recoveries of $116,000 during the June 2015 quarter. We're pleased with these credit quality results. Our net interest margin increased this quarter in comparison to the 2015 sequential quarter, primarily as a result of the decrease in our average cash balance and the increase on our average balance of loans held for sale. This change in composition resulted in an expanded net interest margin and is correlated to mortgage banking loan origination volume. Our short-term strategy for balance sheet management is unchanged from the last quarter. We believe that releveraging the balance sheet is essential. For the foreseeable future, we believe that maintaining a significant cushion above our regulatory capitals: 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 that. 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 March 2016 quarter, we repurchased approximately 206,000 shares of our common stock, and we continue to believe that executing on stock repurchases is a wise choice -- or 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 June 7, 2016. We encourage everyone to review our March 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. Paul?

[Operator Instructions] Our first question is from Fred Cannon with KBW.

Just a couple. On the deposit side, I wanted to find out if you've seen any upward pressure on deposit costs in any way, given we did see the Fed lease increase rates once.

No, Fred, not at this point. We've seen no pressure on rates.

Okay, great. And then perhaps a little bit more color on the mortgage banking situation. I -- the first quarter obviously was low rates. We saw ideally some refi activity pick up. And then you did mention that the spring selling season looks relatively favorable. Can we kind of expect as we go into the second quarter, with rates remaining relatively modest, that the purchase market should start picking up, and we can hopefully expect a little bit even better volumes in the second quarter going into the spring selling market and then into the summer?

Yes, Fred. This is Donavon. I think that's a fair view or a fair or reasonable assumption. Even when we look at the March 31 quarterly results with the downtick in interest rates and the pickup in refinance activity, our total refinance activity was only 48% of our total volume, up a little bit from the December quarter, up a little bit from the September quarter, but significantly less than the same quarter last year. March of last year, our refinance volume was 68% of total volume. So when we think about the locked pipeline and what we think might occur in the June quarter, we think the purchase money volume or purchase transaction volume will be far more significant to us and others in the business relative to total volume.

Oh, great. That's actually very helpful. And I have to admit, I'm not -- I'm somewhat new to the story, so this question probably shows a bit of my ignorance. But could you give me a little bit more detail on kind of what's going on with the retained portfolio on the balance sheet? Do you continue to see prepayments of the balance sheet being somewhat elevated? Or what you're currently -- in terms of origination, what you're putting on the balance sheet? And what kind of growth we might expect there?

Sure. With respect to prepayments, they are elevated. In fact, the numbers for the first 9 months of this fiscal for us reflect prepayments of approximately $140 million in comparison to the first 9 months of last fiscal quarter at $102 million. So those prepayments are resulting in less growth than what we would like to see. As it relates to the origination volume and what we're actually seeing, our primary focus has been on multi-family, commercial real estate and a little bit of construction. We continue to desire to grow those portfolios. We've been adding to origination staff to help do so. But really, the story with respect to portfolio loan declines is the result of our single-family balances. If you look at what has occurred in our single-family portfolio, it has declined significantly in comparison to this time last year, for instance, and that's the result of lower interest rate. And then when we think about portfolio production in single-family, first of all, we don't put on 30-year fixed-rate loans. And the primary vehicle being used by borrowers stays 30-year fixed. And as a result, the opportunity in single-family is less today than if you think about a prior cycle perhaps, given where interest rates are and the preference by borrowers to put fixed-rate loans or to have fixed-rate loans.

And in terms of what you do put on the balance sheet in terms of single-family, you put on hybrid 3/1, 5/1, 7/1s primarily? Or do you do 15-year fixed on the balance sheet too?

No, you nailed that right on. Those are the types of hybrids we put on, not 15-year.

Okay, great. And then just finally, I mean, credit quality continues to be stellar. And I would imagine that with the fairly strong Southern California economy and real estate values continuing to percolate up, there's no reason to -- there's no kind of near-term sign that there's any shift in credit quality. Is that fair?

Yes, I think that's fair. And the portfolio has performed very well essentially over the last 3 years. When we look at total classified assets at the $23 million level, that's the lowest number it's been since before the credit crisis.

And we have a question from Tim Coffey with FIG Partners.

Kind of get an idea of what your expectations are, where your thoughts on where the loan sale margin could go from here compared to the comments that it's upper end of the range as well as that you could see more purchase activity in this next couple of quarters.

I think, we always guide toward the range that you see in our investor presentation, and that range is 125 basis points to 165 basis points. I do think that the purchased money activity helps that margin. But additionally, just the pure volume increase also helps that margin. People aren't slashing prices, if you will, to keep the volume up. So the fact that we've had kind of an increase in refinance activity as well as entering the spring buying season, both of those are favorable with respect to the loan sale margins.

Okay, great. And then kind of turning the page to kind of what you're keeping on portfolio. You've had nice growth in the multi-family product last 8, 10 quarters. It's now about 50% of your total portfolio loans. Is this -- I mean, can you kind of give me kind of your thoughts on where you see that product going in terms of loan composition as well as kind of what you're seeing in the marketplace for multi-family right now?

Well, multi-family is a very competitive market. We continue to keep our -- what we believe fairly robust credit quality standards. And to the extent that we are not loosening our underwriting standards, I expect to see the same type of volume on a go-forward basis, unless for some reason there's a hiccup in the market. The more interesting parts of CRE for us are nonmulti-family. We've had a small decline in that portfolio on a year-over-year basis, and it just doesn't seem like we've gained enough traction there. Additionally, our construction loans are starting to come on better than what they have over the last year as well, so I would expect construction lending to go up from here. But construction as a total part of the entire portfolio is still going to be relatively insignificant. So the big drivers of CRE will hopefully continue to be multi-family and more so in pure commercial real estate as well.

And as a follow-up on the construction product, is that mostly for residential?

We've done some multi-family as well. We've looked at some commercial projects as well. But year-over-year, the volume has doubled in the first 9 months of this year versus the first 9 months of last fiscal year. But it's still a small number, and we hope to essentially double that number again, which will still not be meaningful to the total footings, but it will start to become more meaningful as we go down the time line.

A question from Tim O'Brien with Sandler O'Neill. Tim O’Brien: So Craig, you alluded qualitatively that you're going to be a little bit quicker to react to market conditions in the mortgage business. Did I hear that right?

No, I think we try to react quickly. Things move fast sometimes depending on where interest rates are going, as you know, but there's always that decision point of when you pull the trigger on reining in and using fewer staff. Tim O’Brien: So coming into the second quarter with higher purchase outlook, some optimism there, my sense is probably you've made adjustments for the near term anyway, unless there is a significant change in the rate environment. Is that a fair assumption?

Yes, I think that's fair. You allude to the origination volume, and it's demonstrated on one of the slides in our investor presentation. Our gross locked pipeline at the end of March was $226 million. It essentially hasn't been that large since the March quarter of last year. So there has been a pickup from the September and December quarters and even from the June quarter of last year, and we would expect that, that would continue, provided interest rates remain at these levels. Tim O’Brien: And then changing gears. Donavon, in the past, you've talked about managing the ALLL kind of in a range that -- of, like, call it 105 basis points to 120, something along those lines. Is that prior guidance still viable here kind of given how strong credit quality is in the book now? Or do you think you guys have a little more latitude to right size the ALLL relative to the loans that you have invested in?

Yes, I think the range is probably lower today than it was a year ago because credit quality has improved so well. I think previously, we've suggested 100 basis points to 125 basis points. 125 basis points seems unreasonably high for a range, particularly since we're at 101 basis points right now. So if I were to think about a range on a go-forward basis, yes, we're probably in the 90 basis point to 115 basis point range, something of that nature. Again, provided credit quality remains as good as it currently is or ostensibly even gets better, which I think it could probably do over the course of the next year. Tim O’Brien: Great, that's great color. And then last question, can you talk a little bit about -- you had a really nice improvement in the margin this quarter. And obviously, a good chunk of that, I think, was related to mortgage loans funded that remain on the books and that you guys collected interest on relative to last quarter higher cash balances. What's your view on -- does that normalize lower probably from here? And what's your kind of outlook for your ability to support the margin here through the end of the calendar year and into next year, kind of given the rate environment we're in?

There's no doubt that our net interest margin is impacted by the total loans held for sale. And to the extent total loans held for sale on average are higher than they were, we will be able to improve that net interest margin. But additionally, you'll see with respect to our net interest margin, we're beginning to deploy some cash into investment securities. It's not a significant or meaningful number yet. It is only because we started at such a low number. I think we had $15 million and now we're up to $33 million or $30 million or thereabouts, so we doubled it. But it's still a relatively small number relative to the total balance sheet. And so I think there could be some support there as well as we move cash off the balance sheet, put it into relatively very short duration investment securities, where we're looking for those cash flows to be returned over the course of the next 2, 2.5, 3 years to hopefully reinvest at higher rates in the event the Fed were to move interest rates higher. So I think there's 2 areas of support. Held for sale is the primary area, but additionally, repositioning our cash and liquidity into investment securities is another area of support. Tim O’Brien: And then last question. You guys closed a branch this -- in the first quarter, right? Or consolidated one?

Yes, we consolidated. Tim O’Brien: Are the cost savings from that reflected in 1Q results fully? Or are we going to see a little bit of savings reflected in the second calendar quarter?

There are no cost saves in the March 31 quarter. In fact, we're winding that branch down after we move. We obviously have to return it to vanilla shell [ph], and so there's a few expenses. And I think -- I believe the lease goes through June 30 as well, so there won't be meaningful or material difference in the June quarter relative to that branch. And then ultimately, once the lease does roll off or once it is returned to the owner, it's such a small number that there's not a meaningful impact to operating expenses anyway. Tim O’Brien: Any additional rationalization that might be headed this way beyond this particular branch?

Not with respect to branch consolidation. But we are doing some things around our home office. We're actually moving our home office branch, which is also in our headquarters building, to a new site essentially across the street. That will free up some space at the headquarters building, which will allow us to collapse some leases for fulfillment and support staff perhaps into this headquarters building. But that's a really long time or a medium term, if you will. That's going to take us a year, 1.5, 2 years to complete everything.

At this time, there are no further questions in queue.

All right. We look forward to presenting our next quarter's results at our next conference call. We thank you all for joining today, and that's the end of our call. Thank you.

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