Provident Financial Holdings Inc (PROV) 2007 Q4 法說會逐字稿

Welcome to the Provident fourth quarter earnings release conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Mr. Craig Blunden. Please go ahead, sir.

Good morning, everyone. This is Craig Blunden, Chairman and CEO of Provident Financial Holdings and with me on the call is Donavan Ternes, our Chief Financial Officer. Our presentation today discusses the company's business outlook and will include forward-looking statements. Those statements include descriptions of management's goals, 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. We hope that each of you has had an opportunity to review yesterday's earnings release, which describes our fourth 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 $228 million of loans during the fourth quarter, a significant decrease from the $331 million of loans originated during the quarter ended March 31, 2007. Of this total, $39 million or 17% was originated for our portfolio during the quarter ended June 30, 2007, in comparison to $37 million or 11% during the quarter ended March 31, 2007. There are a number of factors contributing to the decline in loan volume. All of them well documented in the financial press, but the important point is that we believe, based on current market conditions that the lower loan volumes will be with us for the foreseeable future.

The loan sale margin for the quarter was 31 basis points, a decrease from 71 basis points in the quarter ended March 31, 2007. The decline in the average loan sale margin is primarily the result of a $423,000 lower cost of mark adjustment on unsalable loans that were moved to loans held for investment, six single family loans sold at a $415,000 loss, a $90,000 loss on derivative financial statements consistent with FAS 133 and a $62,000 reserve provision for loans sold that are subject to early payment, default repurchase. These items reduced the loan sale margin by approximately 54 basis points. Additionally, the mortgage banking environment remains volatile and (inaudible) which has further eroded loan sale prices.

During our conference calls for the last few quarters, I've noted that the mortgage banking environment has become very challenging. This quarter was no different, even worse, and the deterioration sparked by the collapse of the subprime loan market has been made worse by the final guidance on subprime mortgage lending issued by the banking regulators, although the guidance is long overdue. Also contributing to the deterioration was the rating downgrades of mortgage-backed bonds by the rating agencies. These downgrades have caused a liquidity concern in the secondary market and loan sale execution has and will suffer as a result.

It is clear that we're in a significant mortgage banking correction and as a result we have had to make adjustments to the number and mix of employees in the mortgage banking division. Currently, we have 129 full-time equivalent employees in the division, 66 are production staff, and 63 are support staff. This is the fewest number of employees in the division since February 2004 when we employed 124.

During the quarter ended June 30, 2007, we repurchased $6.2 million of loans and REO from investors, resulting in a specific loan loss provision or charge-off of approximately $230,000. In the quarter ended March 31, 2007, we repurchased $4.5 million in loans, resulting in a $260,000 specific loan loss provision. The total for the year ended June 30, 2007, our fiscal year end, was $14.6 million of repurchases, resulting in specific loan loss provisions or charge-offs of approximately $886,000. This is a significant increase from fiscal 2006, where the net impact of loan repurchases for the entire fiscal year was a $41,000 specific loan loss provision. This quarter was the second consecutive quarter where our mortgage banking business was unprofitable.

The combination of fewer Alt A investors, materially lower Alt A prices, a significant increase in the number of loan repurchases, and the (inaudible) secondary market reduced our earnings for mortgage banking during the quarter. It is apparent that additional changes are necessary and we will be diligent in making them. Those changes may be in the form of a different product mix, further tightening of our underwriting standards, a further reduction in our operating expenses, or a combination of these and other changes. We will continue to invest our community banking business and are excited by the long-term opportunities that are available in the Inland Empire.

For the quarter end June 30, 2007, deposit growth was approximately $16 million. The sequential quarter growth occurred in time deposits which grew by approximately $31 million, partially offset by declining core deposits. We're competing a bit more aggressively with our time deposit interest rates, but our time deposits are still priced below our cost of overnight borrowings. The proceeds from deposit growth and the sequential quarter decline in total assets was used to reduce borrowings, which declined by approximately $134 million between March 31, 2007, and June 30, 2007.

During the quarter ended December 31, 2006, we established a $2.5 million specific loan loss provision on 23 individual construction loans in a single family construction project located in Coachella, California. We increased the specific loan loss provision by $161,000 in the quarter ended June 30, 2007 to a total of $2.6 million for the project. There is very little progress to report at this time with respect to this matter, except to advise you that we're in the discovery phase of litigation. We're pursuing all legal remedies available to us, but 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 earning release, we disclosed that we had a loan loss recovery for the quarter of approximately $490,000. There were two primary factors leading to the recovery. The first was the $41.2 million quarter sequential quarter decline in loans held for investment and the second was the $6.2 million decline in classified assets. Of course, the impact of these two factors was partially offset by the increase in nonperforming assets, which required higher loan loss reserves.

We continue to deploy sound capital management strategies and maintain that the best use of our capital is the prudent growth of the Company, but to the extent we're unable to grow as quickly or as carefully as we envision, share repurchases will be employed. During the quarter we purchased approximately 168,000 shares of our common stock at an average cost of $24.79 per share.

Finally, I would like to update you on the current conditions in the Southern California real estate market. According to a July 17, news release from DataQuick information systems, the median price paid for a Southern California home in June declined by 0.6% from May of this year, but increased by 2.4% from June of last year. Real estate sales, however, were at a 14-year low. Marshall Prentice, DataQuick President said, and I quote, "we're probably pretty close to the floor level of buying and selling, meaning that most of the activity is basic and not discretionary. Today's buyers and sellers really need to move for one reason or another, not because they want a guest room or a bigger yard. The exception seems to be the high end markets, most of which are doing pretty well", end quote.

In subsequent news release DataQuick distributed on July 24, they noted that the number of default notices sent to California homeowners in April to June quarter increased to its highest level in over a decade, the result of flat or falling prices, anemic sales, and a housing market struggling with the excesses of the 2004, 2005 home buying frenzy. 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.

(OPERATOR INSTRUCTIONS) Our first question comes from James Abbott. Please go ahead.

Hi, good morning.

Good morning, James.

I was wondering if you could give us a sense as to what is salable today and what is not salable? I know that you repurchased some, obviously, and mentioned that you were not able to sell others types. So maybe if you can update us on what, it seems to be a moving target on a day by day basis, but can you give us a sense?

James, that's true. It is a moving target. Certainly one of the toughest things to sell are second trust deeds today. That was a market that at one point in the past few years has been our most profitable product as we sold those to investors and didn't put them on our balance sheet. That's pretty much a huge item right now and then secondarily, of course, as we discussed in the call already, Alt A prices and margins have been compressed as well. They are still salable and we're getting forward commitments on individual loans as we move forward, so we don't try to bulk up loans as we used to do in the past with the market being so uncertain today.

James, this is Donavan. One of the other characteristics or dual characteristics of some of the loans that are more difficult to sell are 100% CLTVs or combined loan to values and stated income. Stated incomes can still be originated and sold, but the secondary market has or is really requiring that the borrowers are coming in with some type of downstroke or some type of equity. And so if you do a 90% CLTV stated income, that can get done, but it seems like anything over 90, while it can still be originated and sold, the pricing of that product is such that I'm not so certain it's profitable to do so.

Okay. Okay. Any -- from a FICO score perspective, are you seeing any differentiation there, or is it just -- how would you characterize the subprime -- market's appetite for subprime versus prime versus the middle of the pack?

Well, everything is moving to tighter standards, including FICO. So if you have a 750 FICO borrower, you are obviously able to get them into a less restricted product, if you will. If we consider anything less than 620 or really the classic definition of subprime, it is very difficult to sell, although there are still buyers out there, they're just interested in more equity and specific locations, for instance. And they're interested in the appraisals that are coming in with respect to that type of product. And we're seeing a pinch in Alt A as well. I think Countrywide and IndyMac have both announced and they're large Alt A lenders and buyers and they've announced tightening underwriting standards.

James, something else that we're seeing now, is the seconds are going away. We're seeing a lot more mortgage insurance come into play for the higher LTV loans, which I think is a good thing. and of course the agency market is strengthening as well. The issue there is though the spreads are not nearly as good when you talk about agency paper today. Don't have the same spreads that you had previously in Alt A.

Okay. Second question and then I'll step back, but is there a common thread of the types of loans that you repurchase during the quarter?

Sure.

Or is it all of the above that we just talked about?

Well, it is, but it's high loan to value, stated income, and second trustees.

And when we consider those types, they might be in combination with each other, so there is risk layering involved. And when we dig into the file, I would argue that a large percentage of them are really fraud-related products.

Okay, interesting. There's probably some follow-up questions there, but I'll step back for the moment. Thanks.

Okay.

Thank you. Our next question comes from the line of Christopher Marinac. Please go ahead.

Thanks, guys. Just to continue James' questions, I probably have some similar ones, which are, can you remind us, how much of your production in past quarters and years was coming from stated income as well as the second trustees, as well as just general Alt A?

Well, I don't know that I have specific percentages to give you, Chris. What I would describe is that our volume declining to $228 million from $330 odd million last sequential quarter really is a function of the tightened underwriting standards which is eliminating the stated income, high CLTV product. And so you can get a sense that a large percentage of our volume was being underwritten to that criteria, which was being purchased by the secondary market. Second, trustee volume -- with respect to those loans that we were originating and selling, a good percentage of those loans had second trustees. I don't know that it was 70%, but it would not shock me to go in and do the research and see 40 to 50% of our origination volume carrying a second trustee that was ultimately originated in tandem and sold.

Okay, very well. Then from a perspective of the NPAs, the 20 million that you have here, how much of that is related to the issue that we've known about that you added more provision to and is there any other new NPAs this quarter above and beyond those?

Actually I've got somewhat of a breakdown. This 19.7 million or roughly the 20 million of NPAs, 7.6 million of that comes from our loans held for investment portfolio, which is also inclusive of the REO that essentially we foreclosed on from the portfolio. So roughly 46 basis points, $7.6 million of that came out of that portfolio.

With respect to the Coachella construction loan fraud transaction, $2.4 million of our nonperformers came from that or roughly 15 basis points and then with respect to repurchase and REO activity as a result of the repurchases, a total of 9.5 million or 58 basis points came about as a result of repurchase in REO and then we have a couple hundred thousand or 1 basis point in other product types. So you can see that roughly half of the activity has come out of repurchase activity in our mortgage banking operation.

The one thing we should describe is what we believe is happening there given the tighter underwriting standards. If you think about how the subprime meltdown occurred in the first calendar quarter this year, tighter underwriting standards were really implemented January, February, and to a large degree, March. Maybe a little bit tighter in April. And if we consider that early payment defaults are 90 to 120 day or three-month or four-month first payments, if you will, or those payments in those first four months and then you give a little bit of time to the servicer to notify everybody, you can really see that EPDs are running about six months behind the production cycle. And if we've tightened underwriting at the end of March, let's say, early April, we would expect to see significantly less repurchase activity toward the four calendar quarter of this year or October, November, December if those tighter standards are really impacting it, which we believe it will.

Okay. I guess as a follow-up to my other question about the level of the types of loans you are doing in the past, if I go back a couple years when you were doing 475 million total productions, back in fall of '05, how much at that time, just ballpark, would have been in some of these same product? Would you have had a different mix then than you were doing earlier in 2007?

Well, the mix did change in '07 because we really started seeing some of the issues occur in the fourth calendar quarter, our second fiscal quarter of '06. So the November, December time period and the mix really started changing out then in our third quarter or the March 31, quarter. In comparison to those prior years that you're referring to where we had over $400 million and the other thing that is occurring, we can talk about our specific production with respect to Alt A products, which was and could have been stated income, high CLTV product.

But even outside of that product with respect to our particular institution, as you start tightening these underwriting standards, you are taking a huge universe of prospective borrowers off the table because they're no longer able to qualify under more restrictive or traditional underwriting guidelines. And what we're seeing in reaction to that in the secondary market is volumes going down significantly from the standpoint of origination volume and then from the standpoint of what these participants are actually going to purchase, they're really scrutinizing these loans. It's getting to the point where we will actually send some of these loans on an individual loan basis to the ultimate investor so that he'll qualify and approve the loan kind of simultaneous to our underwriting of that loan to the borrower.

Okay. Then last question, just on the core banking business, what would you say the core banking margin is there today when you exit out the mortgage business and is the deposit composition likely to change? Does it get any lower on the core side than it has?

I think the decline in core deposits is quite simply a function of what the yield curve is doing on the short end. Literally, the CD deposit pricing is such that you can pick up a local newspaper and find anywhere from a one-month to a 12-month CD rate between 5% and 5.5%, let's say. So the question becomes when do you introduce a money market product, for instance, that would compete with that CD rate, and I think the answer is you do so when you believe the fed is getting ready to lower short-term interest rates. Until such time that you believe that to be the case, you really actually only accelerate your cannibalization out of money market into noncore products, like CDs, if you compete aggressively with the money market product, and we've not done so. As a result, we've really seen deterioration in core deposits. And I don't think that changes until the Federal Reserve responds with respect to short-term interest rates.

So essentially, if I can paraphrase what you're saying, is that you would rather have CDs than money market accounts given the same interest rate?

Sure. Well, because what you could do, of course, is jack up all your money market rates, which then increases your cost of funds even faster than if you just offer CDs at this point if time, because you still have those individuals that will hang in there at the lower money market rates. So why would you cannibalize those -- or really move them up all at once by raising those rates to keep them when you know that a number of them will stay at the old rate.

Okay, great. Thank you very much for your questions.

Thank you. (OPERATOR INSTRUCTIONS) And there are no further questions in queue. Please continue.

Well, if there's no further questions, I would like to thank everyone for participating in our quarterly conference call and we look forward to speaking with you next quarter. Thank you.

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