Ladies and gentlemen, thank you very much for standing by, and welcome to the first quarter earnings conference call. [Operator Instructions] As a reminder, this conference is being recorded. And I would now like to turn the conference over to our Chairman and CEO, Mr. Craig Blunden. Please go ahead.

Thank you, Colin. 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, forecasts 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, 2017, and from the Form 10-Qs that were filed subsequent to the Form 10-K. Forward-looking statements are effective only as of the date they're made and that 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 first quarter results. I'd like to begin this morning by highlighting the results in our community banking business. Over the course of the last year, our net interest margin expanded. Our loan growth has been consistent. Core deposits have continued to grow, and credit quality remained strong. In the most recent quarter, the loans originated and purchased for investment decreased to $20 million from $43 million in the prior…

[Operator Instructions] We'll go to the line of Brian Zabora with the HOVD (sic) [ Hovde ] Group.

Just, first, a question on the new system that you're planning to deploy next year with the mortgage operations. Should there -- is there going to be any type of near-term expenses as far as investments? And then going forward, will there be savings or just more efficiency kind of a processing-type reduction in expenses?

At the current point in time, we're absorbing a little bit more by way of expenses in that we are in the process of implementing the new system which has a cost component to it, of course. But additionally, we're maintaining our existing system until such time we can sunset it and move into the new system. So we would expect once the new system is implemented that we will have some cost saves by sunsetting our old or existing system. And then additionally, once we implement the new system and become more proficient in its use, we would expect to be able to bring out some efficiencies with respect to the actual processing of loans, potentially moving to a paperless environment over time. So there are some pickups with respect to operating efficiencies, even after the new system is implemented. But as with new -- any new system, you have to become more proficient at it as we go down the time line.

Understood. All right. And then a very modest charge-off here this quarter. Are the -- do you think the recoveries you've kind of captured the majority of it? Or is there still potential recoveries down the road here?

There are still potential recoveries down the road, Brian. It just turned out that this quarter, the particular loans that had deteriorated have some charge-offs attached, and we didn't have sufficient recoveries of existing deteriorated loans to offset those charge-offs. But when we look at our nonperforming loans, there are a number of them that -- I'll use an old term, that are essentially performing nonperformers. And at some point, they're going to pay off through refinance or sale of a property or something of that nature, and we have specific reserves attached to them or charge-offs attached to them that will come back through as a credit to the allowance, which may then allow for some future negative provision through the income statement. That's why we were careful to point out, we don't believe this charge-off trend is a new trend. We just think it's an anomaly with respect to the particular quarter.

And next we will go to the line of Tim O'Brien with Sandler O'Neill + Partners. Tim O’Brien: So did you guys accrue any -- Zabora asked a great question about the system cost and savings, and I couldn't have framed it better myself, but I'll try, one more shot at an answer. Did you guys have any costs associated with that system ramp-up this quarter? And if you did, can you quantify it?

Yes, we did, because we are paying obviously a maintenance fee as we're using the system, but it is a very immaterial number at this point with respect to the third-party [ service providers ]. Costs are really embedded in our operating expense lines with respect to soft costs associated to those employees that are charged with implementing the new system. So... Tim O’Brien: It's a pretty big project, too, right? No, I mean, it's going to take a lot of man-hours. And it's a big deal, right?

Yes. It's a very big project, and it's something that we expect will be very helpful to us in the future. But because it's such a good -- big project, it takes a little bit of time. So we're going to bring out efficiencies as a result of this conversion. [indiscernible], however, is going to be sometime in the future. Tim O’Brien: Do you guys have any intention to, I don't know, identify those costs kind of as a breakout so that we can look at them as maybe perhaps a non-core item since it's initiative-driven kind of one-off stuff? Is that something that -- and also so that we can kind of look at the core numbers on a go-forward basis. Is that something that you guys have thought about doing?

Well, we thought about it. But at this point, really, it's kind of an immaterial number relative to the core number. Tim O’Brien: I mean, on a go-forward basis?

Yes. On a go-forward, at some point. If we can quantify it and if we feel it's material, we would obviously disclose it. But what I think one of the truisms with respect to new operating system implementation is that the efficiencies that get rolled out of it get rolled out of it over time, and we don't quite know what that timing is because it's going to be contingent upon our ability to learn the system as quickly as we learn it to roll out those efficiencies as we go through the time line. So it's very difficult to suggest or describe in any meaningful way at this point until you become more familiar with it. Tim O’Brien: Given the scope -- but you do have a sense of what the scope and scale of the project is going to be, obviously, going in, right?

Sure. We have things like -- we know when our old system is costing us on an ongoing basis. We have a projection of what we believe the new system will cost us once it is fully implemented, but the difference between those 2 numbers are not necessarily material or largely material. The efficiencies are really where it's at with respect to wringing out the costs that are embedded because our old system can't do things like paperless, and we haven't even really scratched the surface on determining how we're going to be implementing any of that. So as we move off of one system to another, the costs are going to be basically the same. And it's only going to be through changes in our processes that the new system gives us the capability to complete, we'll we wring out those efficiencies.

Is there a milestone kind of like the first milestone? I don't know what it might be, where you go live or you get the infrastructure, the hardware infrastructure or whatever in place? Or what kind of -- give us a milestone that you might tell us you've the reached some point down the road? What -- which -- what would be the near-term milestone that we can -- that you're going to use to judge progress?

Right now, we're in the middle of training our staff. So much of the software -- well, all of the hardware and much of the software has already been completed and implemented. It's now a question of training our staff with respect to the use of the software. And then that staff has to go back to their particular branches and train all of the personnel in those branches. So the first series of milestones with respect to implementing the hardware has been completed. Implementing the software, that has been completed. We're now in the training stage with respect to our staffing, and we think we're going to be taking applications or generating applications off of the new system in the first quarter of calendar '18. So the March of '18 quarter, we may actually have applications that are still residing on the old system and applications that will begin to be taken onto the new system, and then all applications will go to the new system at some point, we think, in the first 6 months of 2018. And then all of the applications will roll off of the old system with the same timing, and the old system will be sunset. Tim O’Brien: So the goal -- do you guys have a goal to get it done in your current fiscal year? Or is it -- I mean...

Yes. It's current fiscal year. So by June 30 of '18, we believe we'll be fully implemented with respect to the new loan system and off of the old loan system. But we may not have all of the processes changed that our new loan system will allow us to change. Tim O’Brien: I have one other question for you, and that is was there anything nonrecurring as far -- that boosted earning asset yield this quarter? I saw loan yields were up to 4.03% from 3.92% sequentially. Did you guys get anything? Was there any onetime items, prepay, penalties, anything like that and that number that augmented the interest income out of that or that came from the loan?

It was a pretty normalized number where there are going to be, for instance, some [ deteriorated ] loans that have paid off that we might have recovered full interest on but not material enough where we pointed out, as we did in, I think, of June quarter of last year, when we have a large recovery from a particular bad loan. And so every quarter, we will have that occur. So I think you can think of the net interest income, the net interest margin and the yield on loans as being a normalized number with respect to the quarter in comparison to prior quarters. Tim O’Brien: And that increase in loan yield sequentially is a reflection of -- is it more due to, I don't know, adjustable rate benefit? Or is it more due to the addition of new fundings at higher yields?

It's a combination of both. But I would point out that when you look at the loan yield, for instance, on our single-family portfolio, the single-family portfolio is largely fully adjustable, except for those loans that have gone on the books within the last year or so. And our single-family loan portfolio yield went from 3.73% at September 30, '16 to 4.07% at September 30 of '17. And that's largely -- that component is largely the result of our existing adjustable portfolio adjusting upwards. When you think about the loan yield in multifamily, it actually went down a few basis points in comparison to last year. And that's the result of new loans coming on and existing adjustable loans adjusting up, not adjusting up enough to offset the new loans coming on.

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

So, Craig, you talked about some of the competition going on in large banking spaces, competitors try to maintain market share. What kind of impact do you anticipate that could have on the gain-on-sale margin sales the next 2 quarters?

That's a tough one. I don't know. One thing, the volumes were off is low for everybody, and that impacts a lot. So what happens with applications and sales of homes has a lot to do down in the future with that happens with margins. My crystal ball looks cloudy because the last 6 months, we expected volumes to be better than the [ world ] during what would normally be the time [indiscernible]. And this year, we saw less activity.

Yes. I think when we describe margins, we always refer to the margins in our investment or in our mortgage banking slide, and we think about it within the context of a range. And so 124 basis points this quarter set a new low in the range. The previous low was 125 basis points. So the range that we've experienced is 124 basis points to 158 basis points over the course of the last 6 quarters. I think as we enter the next 6 months, particularly as it relates to seasonality or the impact of seasonality as well, we're going to be at the lower end of the range with respect to loan sale margins, I believe, because there's still probably too much capacity in the industry with respect to market demand. And competitors will protect their market share quite fiercely, I believe, and that's going to impact margin into the downside.

Right. And we typically see a lower margin in 4Q just because of that seasonality, right?

Not always. It's -- if I think about our second quarter of last year, I see we had 139 basis point margin, which is kind of right in the middle of the range. The March quarter of last year, we had 158 basis point margin. That was at the high end of the range. So it's not necessarily the seasonality itself that drives the margin compression, but I do think seasonality will play a role this year more so than perhaps it did last year because we're entering that period and seasonality with production volumes being much lower than they were a year ago at this time.

Okay. And then shifting focus over the portfolio of held-for-investment loans. You kind of talked about competition here. When a loan gets into the pipeline, are you seeing the fallout ratio increase or decrease recently?

Recently, we've seen our fallout increase on commercial real estate and multifamily loans. And the reason we're seeing the increase on our multifamily and commercial, what I'm hearing from our originators, is not necessarily with respect to our pricing or our terms. It's with respect to the loan dollars we're willing to lend in comparison to what the market is willing to lend on that same property. And I think the reason that we're seeing that difference between what we're willing to do and what others may be willing to do, we stress every one of the loans that we are underwriting on a current basis. We're stressing them with respect to the cap rates, and we have minimum requirements that I won't share, obviously, for competitive reasons. But we stress on cap rate, and we have minimums. And those loans at the time of underwriting have to meet that minimum cap rate. And then secondarily, we stress with respect to net operating income, which could be a combination of lower rents, meaning the market has declined with respect to rents that particular properties can command or increasing interest rates because primarily these loans are adjustable rate at some point in the future. The primary product is a 5-1 hybrid or a 5/1 ARM. And so we're stressing, both on cap rate and on net interest -- or net operating income for the property. And as a result of that stressing, we will oftentimes come up with lower loan dollars to lend on those multifamily and commercial properties in comparison to what some others may be doing.

And just kind of a follow-up to my question. The loans that you're looking at and stressing the way that you are that are that are better than falling out of the pipeline, the geographic location of those, is there any difference between, say, what you're seeing in Orange County versus what you're seeing in Inland Empire?

No. I don't know that that's necessarily an issue or at least I haven't noticed a geography that seems to have a buyer fallout ratio than another geography. Although admittedly, I've not asked our originators that question. Perhaps they would have some color on it. But I've not seen that as a pattern per se.

Okay. So the overall market is essentially behaving the same way?

Yes. It seems that -- at least in California because we don't [ need ] to deal in California. But on Slide 13 of our investor presentation, you can see where our weighted average LTVs are with respect to multifamily and commercial real estate. For the year-to-date, so for 9 months, 3 calendar quarters in 2017, weighted average LTV of our newly originated multifamily loans that are still in our portfolio is 52%. For commercial real estate, the weighted average interest rate -- or I'm sorry, the weighted average LTV of the newly originated loans in calendar '17 is 41%. Those are very low LTVs, and those LTVs are low as a result of us not being able to get to the loan dollars that the borrower may request as a result of our stressing the loan for our underwriting process.

[Operator Instructions]

There are no further questions. I'd like to thank everyone for participating in our quarterly conference call and look forward to talking to all of you next quarter. Thank you.

And ladies and gentlemen, once again, thank you very much for your participation on today's call. That does conclude our conference for today. The call will be available for replay, and you may now disconnect.