Provident Financial Holdings Inc (PROV) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Provident third quarter earnings release call. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded. I would now like to turn the conference over to Chairman and Chief Executive Officer, Craig Blunden. Please go ahead.

Thank you, Marla. Good morning, everyone. This is Craig Blunden, Chairman and CEO of Provident Financial Holdings; and on the call with me is Donavan 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 from any forward-looking statements is available from the earnings release that was distributed yesterday and from the annual report on Form 10-K for the year ended June 30, 2006. 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 $331 million of loans during the third quarter ended March 31, 2007. A decrease from the $389 million of loans originated during the quarter ended December 31, 2006. Of this total $37 million or 11% was originated for our portfolio during the quarter in comparison to $79 million or 20% during the quarter ended December 31, 2006. The loan sale margin for the quarter was 71 basis points, a decrease from 100 basis points in the quarter ended December 31, 2006. The decline in the loan sale margin is primarily the result of fewer investors offering materially lower prices for Alt A product. We believe investors are re-evaluating their comfort level with Alt A product given the recent problems in the subprime sector and a concern that those problems may also eventually affect the market of higher quality mortgages.

It should be noted that we did not have any difficulty in selling the product we originated during the quarter, but we did sell at materially lower prices. Ultimately, we believe that demand for Alt A product will return, but the underwriting standards will tighten considerably. Therefore we have responded with tighter underwriting standards which mirror investor demand. During our conference calls of the last few quarters I have noted that the mortgage banking environment has become much more competitive because of lower funding volumes. It was worse this quarter as a result of the well publicized collapse of the subprime loan market. The disruption in the secondary market was extensive, and somewhat overwhelming. Investors were tightening underwriting standards on all products from one day to the next and bidding significantly lower prices on loan pools irrespective of quality if they were bidding at all.

Many originators were caught up in the turmoil and had to make uncomfortable decisions about selling their product at very low prices or placing the product in their portfolio. We chose to sell the product despite the pricing. There is very little that an originator can do in the short-term to mitigate the impact of such a dysfunctional secondary market except to trust that the short-term panic will subside and to plan for the immediate term. We have done so by increasing a number of production staff in an effort to stabilize our volume, by decreasing the number of support staff, and consolidating certain back office operations in an effort to lower our operating expenses, and most recently by increasing our pricing to improve our loan sale margin.

As a result of these actions, the number and mix of employees in mortgage banking continues to change. Currently we have 155 full time employees in the division, 67 are production staff, and 88 are support staff. This compares favorably to December 31, 2006, when we employed 162 full time employees with 59 production staff and 103 support staff. Lowering the ratio of support staff to production staff creates a more efficient operation and reduces the cost of originating each loan. My update regarding mortgage banking would not be complete without describing the increase we have experienced in loan repurchases.

During the quarter ended March 31, 2007, we repurchased $4.5 million of loans from investors and were unable to sell another $1.4 million of loans resulting in a specific loan loss provision of approximately $352,000 on these loans. In the quarter ended December 31, 2006, we repurchased $2.6 million of loans and were unable to sell $940,000 of loans resulting in a $349,000 specific loan loss provision, and in the quarter ended September 30, 2006, we repurchased $1.3 million of loans which resulted in a $47,000 specific loan loss provision. The total for fiscal 2007 through March 31, is $8.4 million of repurchases and $2.4 million of loans that we were unable to sell to investors. Resulting in a specific loan loss provision of approximately $748,000. This is a significant increase from fiscal 2006 where the impact of loan repurchases for the entire fiscal year was $106,000 loans, specific loan loss provision.

It should be noted that so far this fiscal year we have recovered $91,000 of specific loan loss provision and for fiscal 2006 we recovered $65,000 of specific loan loss provision. Therefore, the pre-tax impact to the income statement is approximately $657,000 in fiscal 2007 compared to $41,000 in fiscal 2006. The nonperforming assets generated as a result of this year-to-date repurchase activity is described in yesterday's earnings release at 13 single family loans repurchased from investors. Additionally, one of the three single-family REO properties was a result of a repurchase. We believe that the costs we will experience as a result of this activity have been fully reserved. This quarter was the first quarter in many for our mortgage banking business was unprofitable.

The combination of fewer Alt A investors, maturely lower Alt A prices and a significant increase in the number of loan purchases -- repurchases proved to be too difficult to overcome for the quarter. However, I have confidence in our ability to adapt to the challenging environment and believe that we can make the changes necessary to become profitable. Those changes may be in the form of a different product mix, still tighter underwriting standards, a reduction to our operating expenses, or a combination of these and other changes. However, it is also true that a shakeout of the weaker irrational competitors needs to occur since there appears to be too much capacity in the business. We continue to be encouraged by the results for our Community Banking business and the opportunities that are available in the Inland Empire.

On January 3, 2007, we opened our 13th branch, La Sierra and are please to do report the deposit growth in La Sierra's first 90 days has exceeded two of the prior three de novo branches that we have opened in the last few years. Deposit growth was not limited to La Sierra as we grew deposits by approximately $56 million. The sequential quarter growth occurred in core deposits by approximately $8 million and to a much larger degree in time deposits which grew by approximately $48 million.

During the quarter we began to compete a bit more aggressively with our time deposit interest rates that are still priced below our overnight borrowing costs. The proceeds were largely used to reduce borrowings which declined by approximately $53 million. Deposit growth and lower borrowings during the quarter in conjunction with preferred loan growth upwardly repricing adjustable rate mortgages in our portfolio and a decline in investment securities resulted in relatively stable net interest margin for the quarter. Given the shape of the yield curve we will continue to change the compositional loan portfolio by favoring preferred loan growth over single-family loan growth or investment securities growth. Deposit growth of course is always at the top of our list and will continue to receive a great deal of our attention.

Last quarter we established a $2.5 million specific loan loss reserve on 23 individual construction loans in a single-family construction project located in Coachella, California. There is very little progress to report at this time with respect to this matter except to advise you that we have filed lawsuits alleging loan fraud by the 23 individual borrowers, and this representation fraud by the mortgage loan broker and misuse of funds fraud by the contractor. Although we are pursuing all legal remedies available to us, it is far from certain the amount if any that will be recovered. Additionally, given the number of parties involved, the complexity of the transaction and probable fraud we do not believe this matter will be resolved very quickly.

In yesterday's earnings release we disclosed that the loan loss provision for the quarter was approximately $1.2 million. There were three primary components leading to the provision, first the growth in preferred loans required a provision of approximately $126,000. Second, the increase in nonperforming loans required a provision of approximately $361,000. And, third, the increase in classified assets required a provision of approximately $698,000. Please note that the loan repurchases I discussed earlier are included in these totals.

We are working diligently to resolve our nonperforming assets and to prevent more from occurring. We continue to deploy sound capital management strategies and maintain that the best use of our capital is prudent growth of the Company but to the extent we're unable to grow as quickly or as carefully as we envision, stock repurchases will be employed. During the quarter we repurchased approximately 194,000 squares of common stock at an average cost of $27.62 per share.

Finally, I would like to update you on the current conditions in the Southern California real estate market. According to an April 12, news release from DataQuick information systems. March's median price paid for a Southern California home declined by 2% from February of this year and increased by 4.6% from March of last year. Sales however remained at a ten-year low.

In a subsequent news release that DataQuick distributed on April 16, they noted that the number of default notices sent to California homeowners in the January to March quarter increased to its highest level in almost ten years as a result of flat appreciation, slow sales, and post teaser rate mortgage resets. I would characterize the DataQuick information as mixed. On the one hand, we have stable to slightly increasing home prices, and on the other hand we have much slower home sales and a higher level of homeowner defaults. I believe we're in the early to middle stages of the frequently debated real estate correction. If I am correct, credit quality costs will return to more normalized levels from historically low levels that we experienced in the past several years. Our direct experience supports this view.

Before I open the call to questions I wish to advise you we have posted an investor presentation in 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.

(OPERATOR INSTRUCTIONS) Our first question will come from the line of [Logan Alexander] with FIG Partners. Please go ahead.

Good morning. I have a couple of questions, and first of all, looking at the noninterest expense you had a little bit of an increase compared to the December 31, quarter. I was just wondering what are your thoughts on the going rate for the rest of the year and any kind of seasonal expenses that were included this quarter that we should know about?

Good morning. This is Donavan Ternes. With respect to comparing to sequential quarter, we had a couple of things go on in our third quarter in comparison to the second quarter. First of all, we did two reorganizations in our mortgage banking business. Each time we do so there are severance costs, there are accrued vacations and the like that are required to be paid, and that was part of it.

Secondarily, in comparison to the second quarter when we begin the third quarter, it is really the first calendar quarter of the year, is really the first calendar quarter of the year, and many of our employees who are higher paid employees who have capped out of their tax obligations in the employment pieces or the employer pieces of those tax obligations go up in the first calendar or the first -- yes, calendar quarter. Other than that, there is nothing unusual if you will. Expenses increased a bit. Also when you compare it to the second quarter, in the second quarter, given what our financial results were, management had reversed all bonuses associated with accrued bonuses for year-to-date numbers.

Okay. Great. That was helpful. Also, regarding the loan sale fees, there was again looking at the linked quarter comparison, is it fair to say that most of the decline in the gain on sale of loans was related to the lower -- to the lower margin or did you -- was there lesser sales volume as well?

Well, no, with respect to the decline in gain on sale, the largest component was the lower margins. We went down by approximately 30% to 71 basis points from 100 basis points. I think if you look at volume as well, we did describe in Mr. Blunden's prepared comments that total volume of originations went down from 389 million to 331 million linked quarter, but even so we put fewer of those loans in portfolio. Therefore those loans that were sold while it declined from the second quarter, it was not as significant as the difference between 389 and 331. Literally the reason for the lower gain on sale margin is related to the decline -- or the reason for the lower gain on sale is the decline in the loan sale margin primarily.

Right. And what are your expectations going forward for the kind of -- I mean both volume and margin do you see any meaningful improvement happening by the end of the calendar 2007 or do you see them more kind of tank at these levels.

I think there is a couple of things going on with respect to Alt A product in particular. First of all, in this past quarter or in the quarter we're talking about there was significant dysfunction as it relates to what was going on in subprime, and speculation that it was going to creep into Alt A. As a result, it was very difficult to receive a bid of comparison value in prior periods if you will, even though we were originating with underwriting standards that were a little bit tighter, but the fact remained that during the quarter these underwriting standards kept getting tighter and tighter, almost on a daily basis, so you almost couldn't keep up with the tightening underwriting standard as it was related to what was being originated so that when you ended up putting a package out for sale, you would get hit for a particular piece of the underwriting in the package that you were originating two weeks before and that was fine in the market, so I think it was an issue with respect to that. We have seen so far through April that that has been less frequent. We think that the bulk of the underwriting changes that the purchasers of Alt A have implemented have all been implemented, and we are seeing a little bit better execution.

The second part of your question is with respect to volume. Naturally as a result of tightened underwriting standards even if demand remains the same, we will see lower volume because fewer people by definition will qualify for some of these mortgages that are currently being underwritten. Long-term this is actually a good thing for the market. On the short-term it does present an interesting challenge for us because not only are we underwriting to tougher standards which potentially could lead to a little bit lower volume, I won't say significantly lower volume, I will say a little bit lower volume given our experience to date, but we are seeing pricing that doesn't approach pricing of last year, for instance, so as a result we have to work on our origination model to make certain what we're doing can be done on a profitable basis.

And the other wild card on this is what the regulators and Congress want to do with some of these loan products. If you read Angela Mosellos comments from Country Write recently he is concerned that an over reaction in the products that we've been offering in the marketplace could seriously impact the future of the mortgage levels that we'll see this year just as they over reacted years ago with the junk bond business, so we're real concerned about what we're going to hear from our regulators as far as products we're allowed to offer in the future, and that's really unknown at this time.

Okay. Thank you. And a couple other questions I have. It looks like you had a pretty decent growth in preferred loans this quarter. Was -- is that what you expect to see during the rest of the year or was that more or less seasonal?

No, I don't believe it was seasonal. There is no reason to believe if that part of the marketplace stays steady which it hasn't and still is, that we should still expect those types of volumes in the future because I do not believe it is seasonal.

And lastly, you mentioned that of the repurchases you charged off about $352,000 this quarter, is that -- did I write this number correctly?

Yes, you have that number correct, but I just want to correct, it wasn't charged off. We established a specific loan--.

Okay. Yes.

-- on those, and let me briefly give you what we do on that. We are literally getting new appraisals on these properties to develop our fair market value analysis to determine what those numbers should be. So that's on current appraisals, current market. It includes sales costs. It includes expenses associated with improving property if it is a trash property, let's say, and so we believe or are relatively confident that the number we established as a SVA or specific valuation is indeed representative of the property's current market value.

Okay. What were the net charge-off during the quarter?

We've not released that number, but it is actually an immaterial number, I believe, but relative to the whole -- the actual charge-off number is going to be a relatively small number when you see it in the 10-Q.

Okay.

They've not worked their way through the system to the point where it is a charge-off.

Okay. Okay. Well, thank you so much.

Thank you.

(OPERATOR INSTRUCTIONS) There are no additional questions at this time, gentlemen. Please continue.

Well, if there are no further questions, I want to thank everyone for joining our quarterly conference call, and we look forward to reporting to you again next quarter. Thank you.

Ladies and gentlemen, this conference will be available for replay after 12:30 p.m. Pacific time today running through May 2, 2007, at Midnight. You may access the AT&T Teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 869379. That number again is 1-800-475-6701 and entering the access code 869379. That does conclude our conference for today. Thank you for your participation, and for using the AT&T Executive Teleconference. You may now disconnect.