Provident Financial Holdings Inc (PROV) 2006 Q3 法說會逐字稿

Welcome to the third quarter earnings release conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to your host, Mr. Craig Blunden. Please go ahead.

Thank you, Stacy. 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 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 is available from the earnings release that was distributed yesterday and from the annual report on form 10-K as amended for the year June 30, 2005. 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 yesterday's earnings release which describes our third 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 $292 million of loans this quarter, a decrease of 27% from the $400 million of loans originated during the quarter ended December 31, 2005. Of this total 42 million, or 14%, was originated for our portfolio during the quarter, down significantly from the quarter ended December 31, 2005. The loan sale margin for this quarter was 101 basis points, a decline from 110 basis points in the quarter ended December 31, 2005. We believe that our loan sale margin declined from 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 53% of loan origination volume, up from 51% in the quarter ended December 31, 2005, but significantly higher than the 40% in the same quarter last year.

During our conference call last quarter I noted that the mortgage banking environment had become much more competitive because of higher interest rates, rising real estate prices resulting in lower affordability, and more conservative underwriting standards. Additionally, Wall Street firms and conduits were quoting tighter pricing levels. These circumstances did not change this quarter and were exaggerated because the March 31 quarter is generally considered the slowest quarter of any given year. Although the month of March was stronger than January or February, both in terms of volume and loan sale margin, we do not expect this highly competitive environment to change in the short-term. As a result of our near-term outlook for the business and lower mortgage banking volume in the third quarter of our fiscal year, we reduced the FTE count in our mortgage banking division to 129 FTEs, a 24% decrease from our peak in November 2005 when we employed 170 FTE's in the division. A majority of the reductions were made in support staff, which had been reduced to 87 FTEs from 115 FTE's in November of 2005. This action resulted in an 18% decline in fixed salary expense for the division.

To help boost loan volumes, in April we acquired a retail loan production office in Vista, California. This is consistent with our strategy of attracting top producing originators and opening loan production offices around them. In this particular case, the team of eight professionals, with a history of extraordinary results, determined that Provident Bank Mortgage was an attractive strategic fit. We're pleased that they have joined us and look forward to their contribution. In summary, we're not satisfied with our mortgage banking results this quarter and are working diligently to make the necessary changes that will lead to improved profitability. We continue to be encouraged by the results of our community banking business and the opportunities that are available. For the quarter ended March 31, 2006, our net interest margin expanded to 300 basis points, boosted by a higher percentage of loans to total earning assets and higher percentage of preferred loans to total loans.

During the quarter we originated and purchased $94 million of preferred loans, one of the strongest quarters in our history. The growth in loans held for investment was primarily funded by the decline in investment securities and the decline in receivable from sale of loans resulting in a more profitable earning assets composition. We continue to experience a highly competitive deposit market and depositors continue to switch from money market accounts to certificates of deposit as a result of higher short-term interest rates. During the quarter ended March 31, 2006, we did not compete with the aggressive deposit pricing offered by some of our competitors and, as a result, deposits declined by $13 million on a sequential quarter basis. In the near-term, given the highly competitive environment and rising short-term interest rates, we anticipate that our cost of deposits will increase at a faster rate than we experienced in fiscal 2005. Non-interest expense increased slightly during the current quarter compared to the same quarter last year, primarily as a result of stock option expensing.

Also during the current quarter the provision for loan losses was higher than the same period last year, largely the result of preferred loan growth. We continue to deploy sound capital management strategies for the benefit of all shareholders. And we continue to believe that the favored use of capital is prudent growth of the Company. But to the extent we're unable to grow as quickly or as carefully as we envision, sound capital management strategies, including share repurchases, will be employed. During the quarter we repurchased approximately 22,000 shares of common stock at an average cost of $29.36 per share. Finally I would like to update you on the current conditions in the southern California real estate market. According to an April 18 news release from Data Quick Information Systems, a median price paid for southern California home passed the $500,000 level in March, 2006 for the first time as sales continued to decline, the result of higher mortgage interest rates and a real estate cycle that has passed its frenzied phase. A news release also noted that sales have declined on a year-over-year basis the last 21 months and are currently at 2001 levels.

Riverside County was the only county in southern California to register an increase in sales, rising 6% from the March 2005 sales level. The news release went on to say that the indicators of market distress are largely absent and that 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 you may have regarding our financial results. Thank you. Stacy.

[OPERATOR INSTRUCTIONS] Our first question is from the line of James Abbott. Please go ahead.

Good morning.

Good morning.

A few questions here. One of the questions is on the purchase or origination of the preferred loans. I was wondering if you could breakout what the purchased amount of those were as opposed to just the origination amount?

Good morning, James, this is Donavon. In the quarter we purchased approximately 53 million of preferred loans. They were primarily multi-family. And the activity occurred in March. Therefore the benefit of the net interest income was not realized the fourth quarter, although we did establish the loan loss reserves attributable to that particular grouping of loans.

Okay, thank you. And you mentioned the benefit was of net interest, were they bought at the end of the quarter, then?

Right around the middle of March.

Middle of March. Can you say what the coupons were on those loans?

Well, we don't break those out. You will see in the earnings release, we have a section described purchased loans serviced by others. If you compare that to March of last year, you'll see that that increased by approximately 50 million. And the loan yields in that group went from 612 to 693. If you were to look at that for the December or in comparison to the December 31 earnings release, you will get a sense of what that was.

True, but they probably wouldn't be embedded for the whole quarter. Would you characterize them as five-year fixed rate product type?

They were a mixture of twelve mat and five year fixed. There were some three by one as well.

Okay. And I am just trying to get a sense as to what the pricing is on such loans in the market right now. Would you say that it is in excess of 7%?

They are in the high 6's.

Okay. Okay. And then another question on the high margin versus low margin product, which is in your slide show presentation, are you seeing some of the bigger all day lending companies continuing to push down and get more involved in the space? Is it more competitive? Is it difficult to get the gain on sale spreads? Another way to ask the question is is the compression in the gain on sales spread due somewhat to mixed shift compared to the prior quarter or is it due solely to competitive pressures?

They're linked, James. In fact, in the space, what we're seeing is not only are A lenders moving down into the all day space, we're seeing subprime lenders move up into the all day space. And that has led to a great deal of competitive pressure. But the other point that you raised with respect to the mix is right on as well. If you look at, in that particular slide presentation, 179 million of high margin products out of that that was sold and 71 million of low margin products, the 71 million of low margin products was replicated in December's quarter. Yet the high margin products moved down from 230 million in the December quarter. So it is actually a combination of both. Now, one bit of color, and we eluded to it in our prepared text, March was a better month both in terms of volume and in terms of loan sale margin. And it seems that we're entering the better part of the season, if you will, And that mortgage banking or the volumes are coming back from where they were certainly in January and February.

And also, James, we are seeing a number of the firms added to the over capacity in the marketplace starting to disappear, finally, through basically some of them going broke and others phasing out of the business and slimming their operations down and not trying to compete on volume and thus driving the prices down in the marketplace.

Okay. Fantastic. I will step back for now and leave some other questions if nobody else asks them, I will be back at the end.

Okay.

Thank you. We have a question from the line of Christopher Marinac. Please go ahead.

Hi, guys. Good afternoon. Wanted to ask about the LTV's you're seeing on multi-family and also in general just overall credit profile that's happening around you, by the loans you're doing plus what you're seeing in the market.

Sure. One of the things, as you look at income producing loans, the LTV's are actually relatively low, historically speaking, given some of the cap rates that are still out there. It is not uncommon to see a multifamily loan come in at a 65% LTV given the cap rates being used and given the income being spun off to ultimately get to the loan amounts. So the LTV's aren't necessarily the issue right now as we see the credit risk in the portfolio. The issue becomes what ultimately can rents do over time to support the values of the properties.

As it pertains to some of the loans that you see, are you uncomfortable with deals being done around you or any color there?

Certainly the pricing still seems to be pretty aggressive, although I would suggest that the pricing today is perhaps not as aggressive as it was last year at this time. In fact, we're seeing more products. We look to purchase loans for an extended period of time historically, and at times we were just unable to price them in such a way that we felt it made sense for us. That is changing a little bit. We are now seeing more packages that seems to be more reasonably priced relative to our appetite and what we're willing to do, which suggests to me that competitively it is a little less competitive on pricing.

I had a follow-up question about the deposits and deposits sort of mix overtime. I know that you mentioned in the text yesterday about the money markets rolling off and checking going up. How much of that is influenced by your campaigns or is that simply customer preferences in your market?

Certainly it is influenced by our campaigns. For instance, there are a number of competitors around us that have relatively high yield money market accounts. We had originated a number of deposits at what one time was a high yield money market account, but we've not necessarily increased our money market rates in such a way as to compete with those higher yielding money market accounts from our competitors. Rather, we've come out with some CD programs, 12, 18, and 36 month programs where we're still retaining the customer, rolling them into those programs rather than money market.

Great. I guess the last question, back to the gain on sale margin discussion. If you went back, several years back to where it was the last cycle maybe in the late 90's or 2000, where would this margin have been and I guess I'm just trying to get a sense of how much further downside there just could be theoretically on sale margin.

One of the nuances there is what we're doing now versus what we were doing then. We were more of an A lender in our mortgage banking area back in that cycle. And A quality fixed rate, it is not uncommon to see margin, loan sale margins of 40, 45, 50, 55 basis points. That's essentially one of the reasons we've moved away from those product lines given where those pricing levels were. To compare us to ourselves, even back in that cycle, I think is not necessarily the way to think about it. One can suggest we're at 101 basis points of margin this quarter, although in the third month of that quarter, the margins were better. It depends upon how competitive and what goes on out there. But we could break the 100 basis point level absolutely, although that's not what we're currently seeing. We're currently seeing margins a little bit better than that.

That's helpful, guys. Thank you so much.

Thank you.

[OPERATOR INSTRUCTIONS] We have a follow-up question from the line of James Abbott. Please go ahead.

Okay. I will follow-up with a couple of other questions. On the provision expense, maybe, Donavon, if you can walk me through that. It seemed really quite high on a relative basis, unless there is some stuff that I am not seeing on the balance sheet. It sounded like you're classified loans or the watch list or whatever you call it may have increased a little bit or a lot. I don't know. Maybe you can give us some additional insight there.

Sure. Actually in the earnings release we did describe that. But our classified list did increase in comparison to the December 31st quarter. However, of the 1.3 million that we established, I attribute approximately 860,000 to the growth, primarily in the preferred loan group, and then the remaining 441,000 or so attributable to the increase in the classifieds. I haven't looked at it specifically right now, but I think it went up by about 4.4 million or something of that nature.

The classified went up about 4.4 million?

Yes, I believe that was the number.

Say again how much you provisioned for that specific increase?

Total classified assets increased 4.4 million to 11.3 million. And that was about 440,000 of the 1.3 million of loan loss reserve.

Okay. And I guess maybe the disconnect is, then, the amount that you're provisioning for the preferred loans grew 63 million. So if you divide one by the other, it is about 1.4% reserves to incremental loans, incremental reserves to incremental loans?

What we do, we have A LL matrix, and as loans move on our balance sheet or off our balance sheet, for that matter, such as single-family loans declining, those reserves will move up or down. But your analysis of the growth in that particular loan group versus the 860,000 that I am attributing to that loan growth is relatively close to the matrix that we use with respect to the reserves that we establish. There is a couple of different buckets for multi-family. We have a less than 36 unit bucket with a particular reserve. And we have a more than 37 unit with another reserve. The more than 37 unit is a little bit higher than the less than or 36 or less unit.

Okay. So that still seems actually -- are these higher quality properties or are they low quality properties? We haven't really seen multifamily losses in years, and not to say that it won't happen, but even at the worst part of the cycle it was really only about 100 basis points of charge-offs.

Historically, I think you'd almost have to go back 15 years or so to see the excessive credit quality deterioration in that sector. And we've looked at some of our historical losses back that far. Ultimately we've chosen our matrix to populate the factors in our matrix based upon historical loss experience as well as perhaps what might be coming.

This is not a quality issue, James. There is no difference in our underwriting standards for these loans as other multifamily that we have looked at in the past and booked. So that's not the issue.

I guess if your point is are we over reserving for these loans in comparison to others, or others of our peer, I would argue that our loss reserve policy is a little bit tighter than many that I have seen.

I won't fault you for that because that will come back to help you in a year or two or three. I am convinced of that. Okay, I just wanted to get some sense as to -- because I just couldn't make the math work. I was using maybe 75 basis points on incremental multifamily loans at the higher end of the range, especially considering the credit cycle and the loan to values and whatnot that we're seeing in the industry. Nevertheless, I appreciate the color on that. And then anything in the non-interest expense line item that is nonrecurring or can you give us a sense as to what a run rate might be in the second quarter? I know you don't generally provide earnings guidance, but With the layoffs and whatnot?

I can give you a number with respect to the layoffs. And I want to make clear that the numbers we're talking about does not include the acquisition of those eight employees in the Vista branch, which have really come online in April. But with respect to the expense reductions that we had in our reorg, the two reorgs we had during the quarter in mortgage banking, the approximate monthly salary expense savings is $93,000. That does not include any ancillary benefit expense, costs, et cetera. That's just a straight salary line.

The other thing I would like to point out, and it is in our earnings release in the income statement, if you look at our salaries and employee benefits and if you consider on a nine-month basis and you compare it year-over-year for the first nine months of this year in comparison to last year, we're down by 394,000 in that line item. But what that doesn't show, in comparison to last year, is that 284,000 of stock option expense was recorded this year because we adopted FAS 123-R on July 1st, which was not there last year. So if I adjust for that number, our salaries and employee benefits are down $678,000 fiscal year-to-date through the first nine months. For the quarter, the March 31st quarter, that adjusted number is 285,000. And I get there because the number in the income statement is down by 184 and our stock option expense for the quarter was 101,000.

Add the two together and it is $285,000. You can start to see the impact of some of the action that we've had. And for the quarter, remember, we've not realized the full benefit of that action. The first action took place around mid January, the second action took place around mid-February. There are some severance costs associated with those actions. So really we didn't get the full benefit of those actions this quarter.

And the severance costs were how much approximately?

We're not going to disclose those numbers, but suffice it to say that even if we took the action let's say January 15th or February 15th in these particular cases, there are going to be severance costs that follow us. I would argue that as of March 31st all of those costs have been realized.

Okay. Okay. And then any thoughts on the margin? Obviously it was really nice to see the margin come up a lot and I was wondering if you anticipate continued balance sheet changes that would allow it to push up further. Or if you anticipate that the, particularly the receivables from sale of loans, if that might increase, which would adversely impact the margin, I guess, in the next quarter.

You're asking kind of two questions. First of all, this quarter we were fortunate to be able to really impact one of our stated goals, which is to cycle out of our high percentage of single-family in our loans held for investment portfolio. And we've gotten our preferred group up to 32% now from essentially 28% over the course of the last year, let's say. We funded that growth essentially by reducing the receivable from sale of loans on our warehouse line of the activity in mortgage banking, as well as a reduction in investment securities. So those two factors, which we spelled out in the text, really gave us a better quality of earnings or a better asset quality mix, lower investment securities to total earning assets, higher loans to total earning assets, and then a higher percentage of higher yielding loans to total loans. We're going to continue that.

We've stated for an extended period of time that we would like to see those numbers maybe 40, 45% in the preferred loan group. And to the extent we can get there, in our view it will only help our margin. Now, if we see opportunity to grow the balance sheet, even in a lower margin single-family product, ultimately to get financial leverage on the balance sheet, I think that's what we will do. And it is difficult to determine whether or not we're going to be able to accomplish that because that's going to be dependent upon what loan volumes do in the industry. Okay. Thank you again.

Thank you. We have a question from the line of Ross Haberman. Please go ahead.

Good morning, gentlemen, how are you?

Good morning.

I want to ask about the buyback. What's your general -- I guess as the mortgage volume shrinks, I am just curious how you're looking at the buyback, vis-a-vis the shrinking volume business. As it shrinks are you inclined to buy more? How are you looking at that?

Well, Ross, we certainly thing there is an opportunity from a couple issues. Number one is the capital levels have risen, as you noticed. And certainly as the volumes have dropped that does give us more opportunity to buyback. You may notice that in the first few months of this year our stock ran up, quickly.

Right.

Of course in the last day or two it's come back a bit, as you've also noted.

Right.

Certainly there will be more opportunities, we think, for us to continue our buyback period as we come out of our quiet period.

The issue there, in my view, is really one of financial leverage. We have a stated goal of growing the bank and we think that that's the best thing long-term to do for our shareholders. But to the extent that we can't accomplish that goal as well as we would like, because of market forces, the second way you put financial leverage in is to reduce your capital.

You might remember that part of the reason why our capital bumped up so quickly was the sale of that building.

Correct. That was about a year ago or so?

It was just December. It was just five months ago.

And I was wondering, do you have any other plans -- I know you made mention of, I guess, you're going to have a loan office in Fullerton. Any other loan offices or branches planned for '06?

Actually we closed the office in Fullerton recently.

Okay.

We may consolidate some other operations, but we opened -- .

In Vista, was it.

In Vista, which is in north county of San Diego. And it was an existing ongoing operation that was a branch of another firm, so it is not a start-up per se. And of course, as we can, what we like to do is add more producers to our existing offices rather than add new offices. But, as we find high producers, like we did in Vista very recently, we'll go ahead and open an office. So that's the only plan we have. We don't have a plan where we're going to say open three offices in the next year. We do not have a plan like that for mortgage banking.

Okay. Thank you.

You're welcome.

Thank you. We have a follow-up question from the line of Christopher Marinac. Please go ahead.

I was just looking at the savings rates and I am just curious why savings rates are down the last year-over-year, let alone just the last 90 days. Is that an area that you could tweak to get additional money in?

I am sorry, Chris, the savings accounts?

Yes, I am just looking at the basis points you're paying on savings accounts.

Well, certainly it is an area -- now, let me back up. In our grouping of savings accounts we have a group of money market look alike accounts. They're essentially money market accounts, so a large part of the balances in those accounts are money market accounts. And as I've said, we've not aggressively competed with the rates that are out there for money market accounts at this stage, because we've transitioned our customers into CD's. It seems to me that if we wanted to be aggressive in that area, given what competitive market rates are for money market accounts, we would be in the 450-basis point neighborhood. So to think that we could add accounts at 2% in this environment in that particular savings account grouping, I don't think would necessarily work. We would have to compete more aggressively.

I follow. And the balance sheet is also not growing. If it were, you could behave differently.

Right, correct.

With prepayments and other cash flows off investments and so on, we haven't needed to be as aggressive in savings, but that could change.

Do you think that your margins, having said that, Craig, is distorted either up or down at today's level of 3%?

I think what you see is a margin based upon a somewhat restructured balance sheet than you saw this time last year. This time last year, or even in June, the June numbers are handy in our earnings release. You saw a receivable from sale of loans at 168 million. That number today is 76 million. Additionally, you saw investment securities, it looks like about 232 million, and today investment securities are 190 million. And the increase occurred in loans held for investment, which as it turns out is primarily in the preferred loan group. So to some degree we're undertaking a restructuring of the balance sheet which is what we wanted to accomplish. We've just not done it in one fell swoop in a quarter by selling off assets at a loss or something of that nature.

But certainly, I see what you're headed for on deposit rate. Certainly if we needed a lot more cash to fund some growth, it would cost us more today than it has in the past, because we've been able to not be aggressive in deposit rates so far. If you look at the cost, 11th district cost of funds currently and then look back at in comparing our costs, including borrowings, we're significantly below today's 11th district by almost 60 basis points below.

I guess the hope is if you grew the balance sheet you would have greater asset yields in there, so that would hopefully counteract that to some extent.

Certainly, yes.

Great. Thank you for the help very much.

Thank you. [OPERATOR INSTRUCTIONS] At this time there are no questions in queue.

Thank you, Stacy. I appreciate it. I thank all of you for attending our conference call and we look forward to speaking with you next quarter.

Thank you, ladies and gentlemen. This conference will be available for replay after 12:30 p.m. today running through April 28th till midnight. You may access the AT&T replay system at anytime by dialing 1-800-475-6701 and enter the access code of 825120. Those numbers again, 1-800-475-6701, access code 825120. That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.