Provident Financial Holdings, Inc. (PROV) Q2 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session; instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Craig Blunden. Please go ahead, sir.

Thank you and 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 last Friday and the Annual Report on Form 10-K for the year ended June 30, 2016, 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 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 demonstrated mixed results this quarter with improving loan sale margin below lower origination volume. New applications declined in the December 2016 quarter as a result of higher mortgage rates. The weakness in the applications resulted in the lowest lock pipeline of the past six quarters, down by approximately 50% from the September 2016 quarter suggesting lower volume of loans originated for sale for the foreseeable future, when compared to the volumes of December 2016 and September 2016 quarters. The loan sale margin for the quarter ended December 31, 2016 increased from the prior sequential quarter and has moved to the middle of the range. Overall, we were pleased with the loan sale execution for the quarter as we experienced less volatility in loan servicing premiums in the cash markets. The mortgage banking FTE count on December 31, 2016 decreased from September 30 2016, and we currently employ 306 FTE in mortgage banking, down from the 308 FTE employed on September 30, 2016. During the quarter, we decreased our origination staff by two professionals, while our fulfillment staff was unchanged. We will continue to adjust our business model and FTE count as we have in the past, commensurate with changes in market opportunities and the mortgage banking operating environment. In the community banking business, loans originated and purchased for investment increased slightly to $48 million from the $47 million in the prior sequential quarter. During the quarter, we experienced $54.7 million of principal loan payments and payoffs which is up from the $50.5 million in the September 2016 quarter and still tempering the growth rate of loans held for investment. Nonetheless, for the 12 months ended December 31, 2016 loans held for investment increased by approximately 7% a moderate pace of growth, while preferred loans, a component of loans held for investment grew at a 17% rate. We're pleased at the growth rate of the preferred loan balance since changing the composition of loans held for investment has been a long-term goal. Preferred loans are now 64% of loans held for investment and the percentage of single-family loans has declined significantly from historical highs. However, I'd like to point out that the single-family loan balance increased this quarter for the first time in many quarters because of the rise in mortgage interest rates has resulted in an increase in adjustable rate originations and purchase opportunities. We welcome this change in adjustable rates single-family market conditions and believe it will result in future opportunities to grow our loan portfolio. We're very pleased with credit quality and you'll note that early stage delinquencies declined slightly to $1.3 million at December 31, 2016 from $1.4 million at September 30, 2016 suggesting that meaningful near-term deterioration is unlikely. In fact, total classified assets remained at very low levels and are now $21.2 million, which is very manageable. The credit quality activity resulted in a negative provision of $350,000 for the quarter ended December 31, 2016. Net recoveries were $16,0000 for the December 2016 quarter compared to net recoveries of $205,000 during the September 2016 quarter, and net recoveries of $1.1 million during the June 2016 quarter. We are pleased with these credit quality results. Our net interest margin was essentially unchanged in comparison to the 2016 sequential quarter, just one basis point higher, as a result of very similar average balances and rates for the major components of the balance sheet in comparison to the prior sequential quarter. Our short-term strategy for balance sheet management is unchanged from last quarter. We believe that re-leveraging the balance sheet with prudent loan portfolio growth is the best course of action. 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 base is essential and we're confident we'll be able to do so. We currently exceed each of those ratios by a significant margin, demonstrating that we have the capital to execute on our business plan and capital management goals. Additionally, in the December 2016 quarter, we repurchased approximately 86,000 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, last week we announced a quarterly cash dividend of $0.13 per share with the distribution scheduled for March 08, 2017. We encourage everyone to review our December 31, Investor Presentation posted on our website. You will find that we've 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] Our first question comes from the line of Tim Coffey with FIG Partners. Please go ahead.

Thank you, good morning gentlemen.

Good morning.

Good morning.

Craig, I heard the baseline of your comments about the mortgage business right now. Do you see kind of 2Q rebounding potentially?

I think there is a good chance Q2 will start increasing. It is – well, you know it is the time of the year when we would expect once we get past the holidays and through January that business will start picking up, at least that's what's happened traditionally. Yes, the one wild card with respect to thinking about where the March quarter or the June quarter may go is where refinance rates go. We would expect a decline in refinance volume in comparison to what they were at this time last year. However, we also expect that there might be an increase in purchase money volume as it relates to this time last year, although I am not certain that the increase in purchase money volume would necessarily offset the decline in refinance volume. So you know that overall we think we have an opportunity here, but it is also possible that we would see origination volume decline.

And if we do kind of see that change in mix within the origination activity, what would that mean for your margin, would it, the loan sales margin could that strengthen?

Well, generally when there is a great deal of competition for fewer loans, there will be those that are pricing down their loan sale margins to keep their origination activity higher. And so I think one could expect the loan sale margins as well to come under pressure. However, for us when we think about what has occurred with all our loan sale margin primarily as a result of selling our servicing release in the cash markets, the servicing release premium declined in the September 2016 quarter, so July, August, September and that SRP margin or component actually increased in October, November, and December quarter, which improved our loan sale margin and it increased because the value servicing went up as a result of a rise in interest rates, so depending upon how you execute on your servicing, we execute by selling it into the cash markets. In comparison to those who execute on servicing by retaining it in the portfolio where they are modeling their mark, that could be one favorable component in the loan sale margin as we think about where we are in the business cycle for mortgage banking, so I think that's a positive component, but I also think that market pressures and the competitive nature of the market is a negative component.

So do you think it is too early to tell or do you think that it could fluctuate just within a tight range?

I think it is too early to tell because ultimately it would be determined by loan sale margin or by loan sale volume. And if we see volume come down significantly, I would expect some compression in the loan sale margin for the industry as a result of what the competitor pressures are. But that may or may not affect us in the same way because at the same time if that origination volume is declining as a result of rising interest rates, the value of the servicing released premiums or the SRPs are going to go up.

Okay, understood. And then if I kind of look at your net interest margin because your loans held for sale are part of the average loan balance calculation every quarter, would you anticipate your margins to come under a little bit of pressure if the average loan balances decline due to lower mortgage banking activity?

Yes. If you think about loans held for sale being on our books at call it the high 3% and if that balance is declining and as a result of lower loan origination volume, it is going to turn into cash and as a result of it turning into cash, we will be redeploying it either into our own held for investment activity or investment securities for cash balances, and if it is in investment securities and cash balances, it would be at lower absolute rates than if it were in loans held for sale.

And then kind of the opposite side of that is, what do you see in the market in terms of opportunities to purchase some of the preferred loans?

We're seeing about the same opportunity with respect to preferred loans that you know I think there is some originators in the market that are selling their portfolios as a result of concentration, and so we're seeing those packages whether or not we can execute on them as function of price, some we can execute on others we cannot. But I do want to point out another thing that has occurred, we purchased for the first time in many quarters about $9.5 million single-family portfolio, adjustable-rate with seasoning they were 51 [ph] arms originally and now it is seasoning there, it was something less to the repricing stage or repricing characteristic. And what we're seeing there as interest rates rise we think that adjustable rate probably would come more into favor for some of the borrowers or applicants and that's the result arm production may increase and that ultimately means more opportunities by us or from the market with respect to putting single family on our books which we've been doing but not at a tremendous amount because we sell fixed rate and we don’t want to keep adjustable rate. So for the quarter we originated about $18 million single-family arms and we purchased another $9.5 million of seasoned multi at our single-family arms and those two components together actually resulted in the higher single-family portfolio at the end of the quarter in contrast to the September 30th bounce.

Okay, well those are my questions. Thank you very much for the color.

Our next question comes from the line of Fred Cannon, KBW. Please go ahead.

Oh, thanks, and thanks for the color on the mortgage business. I want to ask you about your deposit sensitivity as rates begin to rise and what you're seeing in terms of your need to raise deposit rates, some second fed rate high and also your expectations for deposit baiters moving forward?

No we haven’t seen tremendous pressure in our markets with respect to deposit rates. There are a few players in our markets that have seen, they have more need than others and so we've seen their rates increase over there, but by and large I think there has been relatively good deposit rate and discipline by our competitors in our markets. The other thing that for us specifically, so we think about where our cash balances are and where our cash balances may go as a result of lower loans held for sale balances, we aren’t necessarily going to see the same lien without others in our markets may seem with respect to deposit balances. So our view is that we can essentially lag the market to some degree with respect to increasing our deposit rates. And so, I think there could be some pressure depending upon how quickly our competitors move, but I think there is less pressure on us specifically in comparison to other competitors as it relates to what our balance sheet looks like and what it may look like it helps our sale balances go down.

Great. That makes a lot of sense and then regarding kind of related to that, you just discussed about how an rising rate environment we tend to see consumer demand pick up for variable rate in hybrid loans relative to fixed rate loans. If we do see that and you can see some reasonable growth in that, would we – should we think that we would just see the cash balances redeploy to support those loans or would we see the balance sheet actually grow?

Initially you would see redeployment of growing cash balances to the extent held for sale generally with those cash balances, but over time that loans held for sale balances go into become stable relative to the market opportunity we have and then we would no longer be spending on cash balances. As a result of that, you could see total assets increase as a result of redeployment into held for investment loans.

All right. And then you don’t have any constraint on growing your balance sheet if you did see that type of environment do you?

There is no constraint other than our own internal goals credit quality and capital ratio goals et cetera.

Great and then I know you guys have purchased the variable rate production, is there lot of competition for those loans in the marketplace or do you feel like there is a pretty good opportunity as we see demand pick up for hybrid?

Well I think there is an opportunity as the origination market changes, I would expect that there would be more hybrid arms available and whether or not then those hybrid arms come to market in secondary sales is a different question, but certainly we've seen hybrid arm packages and as a result of that, that is something we're going to continue to look at.

Great, well this is very helpful; I think that's all my questions.

Thanks.

[Operator Instructions] Our next question is from Tim O’Brien, Sandler O’Neill. Please go ahead.

Hi good morning everyone. It's actually Alex Morse on for Tim.

Hello Alex.

Good morning. I appreciate the color you guys provided on the single family purchase during the quarter. If I missed I apologize; did you provide the dollar amount of the other loan purchases during the quarter and the mix?

I hate it, but we purchased $16.9 million of multifamily as well.

16.9 got it and kind of heading into the New Year, is there any kind of qualitative or even quantitative color you could provide on how the preferred loan pipeline has changed over call it the past three or six or 12 months?

I don’t think we it has changed per se, I think the competition with respect to multifamily and commercial real estate loans is still very significant and as a result of that there is significant competitive pressure. I would however describe and it seems maybe the last six months more than last 12 months, it seems that there are more competitors that are describing that their multifamily in commercial real estate balancing are getting concentrated to the point where they’re inclined to slow the grow rates in those portfolios. And to be extent that they are interested in slowing the grow rate in those portfolios, it creates more opportunity for us if we think about the entire origination environment. So, still very competitive and there is good demand with respect to that product and the second is market with respect to that products still demonstrates there is a good demand and that’s a result which we are able to be competitive.

Sure, that’s helpful. You mentioned earlier regarding the pricing has been appropriate or at least you are seeking out purchases for pools that though the pricing makes sense. Are you also seeing credit standards that are up to what you would like to put on that balance sheet or is it harder to find opportunities where the credit I mean matches the profile what you want?

We've always had difficulty with respect to credit profile. We look at a number of packages. We are very quick to throw loans out and specific packages that we may have negotiated. And so, the packages themselves in our view with respect to credit quality are probably the same than they were say 12 months ago and it gets down to discipline in our review and we underwriting at the loans themselves with respect to what we’re willing to put into the portfolio. And we don’t deviate from our own origination standards and if these individual loans don’t meet those standards, whether it is single family or multifamily, we are not reluctant to throw a loan out of our particular code.

Sure. that’s – I appreciate that color and just lastly from me given the rise in rates that we saw the back half of the quarter, has there been any change in pay off and pay down activity so far in this calendar first quarter of the year kind of relative to the - an uptick in principle payments you saw in the December quarter?

I think it’s too new to rate. The December quarter was pretty healthy, we had about $55 million from that or roughly $55 million approximately and I think its two new with to rate with respect to the March quarter, although I think there is an expectation by us and others that as in mortgage interest rates rise, refinance activity will decline and as a result prepayment will come down.

Very helpful, thanks for answering all my questions.

Thank you.

And at this time there are no other questions in queue.

If there are no other questions for us this time, we look forward to speaking with all of you at our next quarterly conference call. Thank you.