Provident Financial Holdings Inc (PROV) 2006 Q2 法說會逐字稿

Good morning, good afternoon, welcome to the Provident Financial Holdings second quarter 2006 earnings release. [OPERATOR INSTRUCTIONS] Here with our opening remarks is Provident Financial Holdings' Chairman and Chief Executive Officer, Mr. Craig Blunden. Please go ahead, sir.

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 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 make 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 is available from the earnings release that was distributed yesterday and from the annual report on Form 10K as amended for the year ended June 30, 2005. Forward-looking statements are effective only as of the date that 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 yesterday's earnings release, which describes our second quarter results. This morning, I will update you on current trends in our mortgage banking business and community banking business. First, our mortgage banking division originated $400 million of loans this quarter, a decrease of 15% from the $472 million of loans originated during the quarter ended September 30, 2005. Of this total, $99 million or 25% was originated for our portfolio during the quarter, down slightly from the quarter ended September 30, 2005. The loan sale margin for this quarter was 110 basis points, a decline from 123 basis points in the quarter ended September 30, 2005.

We believe that our loan sale margin declined from the last quarter as a result of a more competitive environment and a high percentage of refinance volume, which generally, is less profitable. Refinance activity was 51% of loan origination volume, down from 55% in the quarter ended September 30, 2005. But significantly higher than the 37% in the same quarter last year. In our view, the mortgage banking environment has become much more competitive in the last 90 days or so because of higher interest rates, lower affordability and more conservative underwriting standards, resulting in shrinking volume.

At the same time, Wall Street firms and conduits have been quoting tighter pricing spreads. Ultimately, this may lead to a shakeout of marginally profitable competitors. But in the meantime, many of these competitors are reducing their profit margins, which leads to tighter pricing spreads. We do not expect this highly competitive environment to change anytime soon. As a result of our near term outlook for business and the lower mortgage banking volume in the second quarter, in January, we trimmed the FTE count in our mortgage banking division to 153 FTE's. A 10% decrease from our peak in November when we employed 170 FTE's in the division.

The majority of these reductions were made in support staff, which have been reduced to 102 FTE's from 115 FTE's in November. This will result in a 7% decline in fixed salary expense for the division, which we will begin to realize in February. We will continue to monitor this area closely and respond to changes in mortgage banking volume very quickly. We continue to be encouraged by the results of our community banking business and the opportunities that are available. For the quarter ended December 1, 2005, community banking grew to 75% of pretax income, a significant achievement in our effort to reduce the percentage of income derived from mortgage banking.

These efforts stem from our belief that community banking income is rewarded with a higher price to earnings multiple than mortgage banking income. Therefore, we continue to focus on growing community banking income at a faster rate than mortgage banking income.Although we continue to believe that both operating segments provide long term opportunities for our Company. We continue to experience a highly competitive deposit market and depositors continue to switch from money market accounts to certificates of deposit. During the quarter, we did not compete with the aggressive deposit pricing offered by some of our competitors. And as a result, deposits declined by $18 million on a sequential quarter basis.

In the near term, given the highly competitive environment and rising short term interest rates, our cost of deposits will likely increase at a faster rate than we experienced in fiscal 2005. Noninterest expenses decreased during the current quarter in comparison to last year, primarily as a result of a decline in the variable expenses related to lower loan production volume. Partially offset by the expense associated with stock option expensing and lease expense on new loan production offices. We continue to deploy sound capital management strategies for the benefit of all shareholders. We continue to believe that favored use of capital is to prudent growth of the Company. But to the extent we are unable to grow as quickly or as carefully we envision, sound capital management strategies, including share repurchases, will be employed.

During the quarter, we repurchased approximately 169,000 shares of common stock. And at an average cost of $27.25 per share, a significant increase to the number of shares repurchased in comparison to recent prior quarters. Finally, I'd like to update you on the current conditions in the Southern California real estate market. According to a January 18 news release from Data Quick Information Systems, home sales volume at December 2005 declined by 4.5% from last year, falling to the lowest level in four years. Although, the median price paid for a Southern California home in December increased by 13% from a year ago level.

Data Quick notes that the strongest markets by the number of sales and price appreciation are in the Inland Empire and the weakest markets are in San Diego County. For example, the year-over-year increase in the median price was 29% for San Bernardino County and 5% for San Diego County. Data Quick cautions that the frenzied part of the current real estate cycle is behind us and that mid-market and entry level homes are selling well, but the move-up in prestige markets are leveling off.

Additionally, Data Quick points out, that indicators of market distress are still largely absent and foreclosure activity is edging up from its bottom, but is still low. Before I open the call to questions, I wish to advise you that we have posted an investor presentation in the Investor Relations section of our Website, which you can review at your convenience. We will now entertain any questions that you may have regarding our financial results. Thank you.

Yes, sir, indeed. [ OPERATOR INSTRUCTIONS ] And representing FIG Partners, our first question, we go to the line of Christopher Marinac. Please go ahead, sir.

Thank you and I guess good morning to you. I wanted to ask you about the interest rate environment and to what extent do you think that the cost of funds and the positive that you experienced, when it only went up slightly, was that an anomaly this last quarter or do you think that can continue given the strategies you have in place?

Good morning, Chris, this is Donovan. Our net interest margin expanded partly because we did not compete aggressively with many of the more competitive rate payors in our deposit markets. That was the result, to some degree, of not growing the balance sheet as much as we would have liked. Our origination volume for the quarter was below what we essentially wanted. It was still decent volume but we had capacity to do more. So therefore, we weren't really pressured to respond with high deposit pricing to gather those deposits. Nor long term do we think that that's a good strategy, if you will, to build good customer relationships.

So, to the degree that we're able to respond with growth or grow our balance sheet, which is our favorite use of capital, we will be forced to respond to some of the competitive pricing pressures that we see in the market, build our deposit base and fund that growth. So with respect to whether or not our net interest margin can continue to expand, the answer is yes. But on the other hand, the longer the flatness of the yield curve or even an inverted yield curve exists, the more difficult it would -- it will become. Although, I also don't see any reason why it has to compress significantly from where it currently is since we've anchored a great deal of our balance sheet growth over the past three years with long term advances at relatively favored rates.

Great. That's helpful, Donovan. And I guess is to your last point, there's nothing significant coming due or in the immediate future, if I remember correctly, from your schedule?

That's correct. The schedule is accurate. So, you can see what's going on pretty easily with respect to what we have coming due.

Great. And then Craig or Donavon, I wanted to ask you about kind of where you see the loan to value shaking out, whether it be in the residential or even on the commercial side, within the multi-family and other commercial loans that you are involved with?

On loan to value, Chris, certainly we're getting some pressure from the regulators in their new directive to look carefully at both loan products that we offer and the real estate environment that we're in right now. I know they're concerned and of course, we've been a bit careful in, I think, the loan to values and our underwriting criteria for loans that we put on our portfolio. And of course, sold the ones that don't meet our requirements into the secondary market. So, at this point we're still seeing some price appreciation in the market. Certainly, as Donavon -- or as the data came out of Data Quick, certainly doing better in our area than other parts of Southern California. So, what we're doing is we're having our underwriters look at particular deals depending on where they're located and what the price range is of the property and then being a bit more conservative on the higher end in other county locations.

Great. Is there any threshold that you observe, you use multi-family as an example, that the regulators sort of get uneasy about? Or that you have internal thresholds?

Well, from the standpoint of LTV?

Correct.

The LTV issue to some degree is a nonissue in that sector because it's kind of driven by debt coverage ratios.

Right.

And what we've found, given the cap rates, the debt cover -- or the LTV's are actually not that high. It becomes more difficult to qualify these things from a debt cover ratio perspective. And for the longest time you hear many lenders probably suggest standards in the neighborhood of 1.15 income to debt before they'll end up putting those deals on their books. I would suggest on our underwriting, that's probably the most aggressive, generally speaking, where we will do those deals.

We've been concerned about cap rates now for a year or better on many commercial properties, especially multi-family. And we think they're at the bottom and have been at the bottom for quite a while. And there's only one other direction for cap rates to go and that's up, which will certainly effect values in the future.

In fact, everybody has noted that we sold a commercial office building in the second quarter. And one of the drivers of that decision were where current cap rates are and what we felt the future would hold for future cap rates. It seems to me that where cap rates were and are, it doesn't get much lower -- or it doesn't get much better if you're a seller.

In fact, that particular transaction was the lowest cap rate that a commercial class A office building had ever been sold at in our region.

And cap rates can still go up this year on many a property, even if the short term money market rates stop going up, they would be independent of one another.

Yes.

That's true.

Great. Thank you very much, guys. Very helpful.

Thanks, Chris.

Thank you, Mr. Marinac. And next we go to the line of Richard [Firie], representing Delphi Management. Please go ahead.

Yes, hello. I was just looking at the income statement. It looks as though if you back out that real estate you sold, the earnings were flat or even down a little bit. I'm wondering if this represents something -- some sort of a trend and what you're doing to try to grow the earnings again?

Yes, if you back out the gain on the sale of real estate, which we've suggested attributed approximately $0.53 --

Right.

Our earnings were 70. And if you graph that, for the last six or so, that's about where we've been earning. So, what we are facing is a decline in our mortgage banking revenues as a result of the competitive pressures there, the lower volumes there. And to some degree, the strategy we've designed is working in that our community banking revenues are picking up the slack as those mortgage banking revenues go away. But ultimately, whether -- for instance, at one time our mortgage banking revenues had gone away, you would have seen declining earnings, perhaps but for the fact of us implementing the strategy.

You've done a pretty good job of growing your earnings in the face of this in the past. I know some of your other gains on sale were down. I'm wondering if you feel confident about growing your earnings at 10% or so going forward? Or is the environment just too tough to do that?

It's a difficult environment and we don't essentially forecast earnings. But I think absolutely, we can grow earnings. It's going to be dependent upon whether or not we're able to grow our balance sheet. And whether or not we're able to find the loans that we want to put on our balance sheet. Both in the preferred loan group, which is down in the second quarter from many quarters, we did about 52 million in that group for the quarter and that's down significantly. We've been in the $80 million range in that group. And then the mortgage banking volume was down, we only picked up 99 million of volume in single family. So that, coupled with what the prepayment are in our balance sheet, will dictate whether or not we're able to grow the balance sheet, which will then ultimately drive earnings growth. It is clear that the environment, at least in the second quarter, was more difficult than in the past. But that doesn't mean that it won't be -- or better as we go through the rest of our fiscal year.

It's really hard to forecast volumes. So certainly at this point, after the last quarter, it does appear to be more difficult than it was in the quarters prior to that.

Yes, do you feel that you have to sit down as senior management and come up with some sort of plan to combat this? Or is it not that serious?

Well look, one of the things that we've stated, our first goal is to grow the bank and grow the balance sheet and invest in the Inland Empire. And continue to be an integral part of the growth in the Inland Empire. But to the extent that we can't grow like we want, we have other options such as repurchasing stock to keep the leverage in the balance sheet. And it's no coincidence that you saw, for instance, the large number of shares that we repurchased in the second quarter. We didn't grow the balance sheet and again, we had a large gain on sale from the sale of real estate, which contributed a great deal of capital. Essentially deleveraging the balance sheet a little bit, more than what we would really like. There are alternatives.

But certainly, you asked about are we getting together to plan on how to find more business, absolutely. But it's not a critical issue. It's just, I think, normal course of business.

Right. You guys had a recovery on your provision for loan losses. You obviously are growing loans. I wonder, what the outlook is for that going forward? Are you going to be provisioning each quarter? I know you're well-reserved, but --?

The answer is yes if the loan portfolio grows. We use a matrix that is dependent upon the balance of loans outstanding -- the total balance of loans outstanding and then incremental increases in reserves on specific loans that, for some reason, have become a classified loan. And as those balances move up and down the scale, if you will, it may require additions or in this quarter, for the first time I think I can recall, a small recovery. And that was because the loan portfolio didn't grow as much as perhaps we would have liked on an absolute basis. And additionally, we actually had improvement in some of our criticized assets and in our asset quality. Therefore, requiring a smaller overall loan loss reserve.

And one last thing, what percent of your loans are interest-only right now?

We don't disclose the number, but let me describe what's happening in the market. Particularly in Southern California, there are reports out from some of the conduits as well as the Wall Street firms that buy mortgages, that perhaps 60%, 65% of the mortgages being originated in the Southern California market are either interest-only or option ARM's, which can be interest-only. So, the volume that we're generating will reflect what is occurring in the market. And then additionally, if you look at what happens to payoffs, which are older loans that may not have been interest-onlies, those are going away as they're prepaying and they're being replaced with loans that are interest-only. So, the number is -- it's not a small number but it's nothing in our view to be concerned with in that our underwriting is sound. And in fact, in the last quarter we put out in our Q some loans that we sold out of our portfolio that were interest-only that we didn't feel met an underwriting standard that we were comfortable with. And that will give you an idea of what the current underwriting standards are with respect to what is going on -- or going into the portfolio today.

Okay, thank you very much.

Thank you.

And thank you, sir. [ OPERATOR INSTRUCTIONS ] Next in queue we have James Abbott with Friedman Billings and Ramsey. Please go ahead.

A couple of quick questions. Could you tell us what the -- you mentioned the support staff, the fixed support staff cost in the mortgage banking unit, I believe is what you were referring to, was expected to be down about 7%. Do you have approximately the dollar amount on that?

It's approximately $40,000 a month in salary and benefit savings.

Okay. Thank you. That will help me quantify what 7% is. Also, another question on the gain on sale of the conforming product. Is it softening, stable? And if you -- I don't know if you can characterize it or maybe for competitive reasons you don't want to. But I'm trying to get a sense as to the range of that? And then as a piggyback question on that, what's your outlook on the amount of conforming that you might be doing going forward within 10%, 80% of the production, 70%, 60%, that type of thing?

Well, James, it -- if you give me an interest rate forecast, I could help you out a lot more. Certainly if the 10-year stays down and people continue to be concerned about where their payments are going on interest-only loans, re-fies, then, will increase and we'll do more fixed rate business, which then has lower gain on sale characteristics to it. Where that number is moving to, I don't know. It's -- we've already mentioned that the number is off from last year. But I can't -- I don't have a feeling and I haven't heard from our mortgage banking group or our head of secondary marketing that they're concerned that this number is going to be going lower than it has. But again, that goes back to what is the mix that we have each quarter of the conforming-type loans, fixed-rate loans, against the Alt. A and other products and second trustees that we have a higher gain on sale on.

And additionally, as we've stated in our prepared comments, the environment is still very competitive. And just as on the deposit side, gathering deposits are very expensive right now given what some irrational deposit -- irrational companies in our view are paying for them. The same thing can be said to some degree with respect to mortgage banking. And the other thing is as we're looking at this, you analyze mortgage banking from the standpoint of, well, if I cut my profit margin by 10 basis points, will I then generate sufficient new volume over and above what it cost me to cut the 10 basis points out of the profit margin in such a way that I'm actually generating more revenue or income. That's what our competitors are doing. And so that's driving pricing down, from a competitive standpoint, to borrowers. And on the flip side of that, some of the underwriting concerns that have been raised because of the nontraditional products that are out there and the regulatory guidance that has been given, has actually produced smaller pricing spreads from the conduits and the Wall Street firms that buy our loans. So, we're getting squeezed from both sides. And that will be an issue for us but whether that's going to be 90 basis points of gain on sale margin or 120, is very difficult to determine.

One of the things we're trying to do to offset this, James, is back to the balance of products. We're getting pretty aggressive on our second trustee product because we still think there's a lot of low fixed rate loans -- first trustees that are out there that people won't touch. And when they do need cash, then they go to a second P.D. and that's really a real profitmaker for us. So, we're pretty aggressive in going out and looking for those loans right now. And additionally, in the competition area, I'm getting calls regularly of mortgage companies that are for sale. That people are trying to get out of the business while they can still make some money selling their companies. So, I'm starting to see that really accelerate, which means that some of these players are going to be disappearing from the marketplace.

What's -- have you seen some sales and what pricing -- you may not be prepared for this kind of question but what sort of pricing are these companies getting or asking?

Well, I haven't seen any that have closed, at least none have been published, so, I don't know. And the pricing, they're looking at a couple times what they think is their book value. And I haven't even seen them priced at some earnings multiples. So, they don't seem to be pricing themselves like a financial institution would. And in fact, I don't go any further to tell them that we're not interested. So, I don't even get into the details.

Okay. I was just curious as to what they're seeking. Okay. And so just to recap on the loan spreads -- I'm not sure that you touched on -- you mentioned 80 basis points and 120 basis points, but that was sort of a range of gain on sales type of outlook. is the 80 basis -- if you did 100% conforming stuff, assuming again, that the yield curve would remain flat, which obviously you're going to do some of your all-day product with any point in time, but just on the conforming product -- you're probably -- is it close to 80 basis points, plus or minus a little bit?

It's lower than that. We would say conforming fixed rate stuff is probably in the neighborhood of 50, 65, 60 basis points gain on sale margin.

Okay. And then the all-day stuff really depends, I guess. But have you seen a significant compression there?

It has come in. But it's not come in too much. We've seen pricing and it varies. There's some hedging issues that go on, as a result of when we actually hedge, how the hedge performs, etc., that ultimately lead to that gain on sale. But we're probably in the 125 to 150 range of gain on sale margin on that product.

Okay. That's very helpful. So, it is primarily a mix shift during the quarter rather than a compression of the rate itself?

Well, it's both, though. It's both of those issues. We did experience a poor execution on our gain on sale of our all-day product. We also shifted or had a 51% in refinance activity, which is, again, a big number and lower profitability.

We saw some real pricing squeeze right before year-end, James, where the conduits just kind of cut everything off and if you really wanted to get a price then, it was not good. So -- and I'm not quite sure -- maybe they made their targets already, for their bonuses. I don't know. And they wanted to delay stuff for the year after but December really was not good execution at all.

I've heard that, actually, from some of the other mortgage lenders that we cover here. Okay. That's very helpful to go into that level of detail. Thank you. And last -- I think the last question that I had is on the cost of CD's, new issue CD's. It seems like the average cost of CD's on your balance sheet right now is 3.50, roughly, 3.52. What are you predominantly issuing CD's at today in your market?

Well, we're out there with an option CD or an option deposit, we call it, that gives the depositor a right to call it early, essentially, if they want. It's a 12-month CD with a six-month option and that is priced at 4%. We're publishing that, so we're not giving away any trade secrets, if you will. That's a 4% APY. We also have a 36-month CD and an 18-month CD and those rates are obviously a little bit higher than the 4. Now, some of our competitors are out there in the 450 basis points or 4.5% on one-year CD's. In fact, I saw one competitor over the weekend -- it was very close to 5. I actually made note of it. It was approaching 5% on a one-year CD.

I heard of another bank doing that, actually, or a little start-up bank and other banks that were in that community, all went and took some of their institutional money and tried to deposit it and they were successful. [ laughter ] Maybe you want to try that! I don't know. Might be accretive to some of your -- some of the yields on your security portfolios or something.

Yes.

There you go.

Alright, well, I think actually -- and do you have any comments on volumes as the progression went from month-to-month? Just out of curiosity? I know that you said you cut some staffing in November. Did the volume begin to wain in October and you cut quickly in November or --?

Actually, we cut the staffing in January.

Oh, I'm sorry.

We began the quarter with actually relatively healthy, strong pipeline. We did $400 million in mortgage banking, which is down from where we were but that's still not a bad number. That's still a pretty good number. It's just down from where we were. But by the end of the quarter we had kind of funded out some of our pipeline. And we began this year with lower pipelines than what we were accustomed to and the question always becomes; Will the volumes come back? Because as you know, all the realtors -- the business kind of shuts down for three, four weeks toward the end of December. And people don't seem to start getting back into the offices and generating business until mid-January, third week of January or so. And so we frankly, took a look at things and determined that we could make this change without effecting our delivery or our timing to our wholesale brokers who still perform. And so took the opportunity to make the change.

James, I think when you talk about timing, November was slower than we expected. December was slow like it always is. So, it just seemed to start a month early this year. And again, we're just being careful and watching where volumes go from now.

Okay, any severance costs, by the way, that we should expect in the January -- or the March quarter, rather?

It won't be material.

Okay. All right, thank you again for your time.

Thank you.

And thank you Mr. Abbott. And with that Mr. Blunden, Mr. Ternes, we have no further questions. I'll turn the call back to you.

All right. Well, thanks -- I'd like to thank everyone for joining us today on our conference call and we look forward to talking with you again at our next quarter.

And ladies and gentlemen, your host is making today's conference available for digitized replay. It is for one week, starting at 12:30 p.m. Pacific Standard Time January 25 all the way through 11:59 p.m. January 31. To access AT&T's executive replay service, please dial (800)475-6701 and at the voice prompt, enter today's conference I.D. of 813150. And with that, we'd like to thank you very much for your participation. Now, that does conclude the call for this second quarter 2006. And with that, you may now disconnect.