Provident Financial Holdings Inc (PROV) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. And welcome to the Provident second quarter earnings 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, Chairman and CEO, Craig Blunden. Please go ahead.

Thank you, Brad. Good morning, everyone, this is Craig Blunden, Chairman and CEO of Provident Financial Holdings. 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 from any forward-looking statement is available from the earnings release that was distributed yesterday and from the annual report on the Form 10-K for the year ended June 30, 2007. 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, community banking business, and local real estate market. First of all, the quarter ended December 31, 2007 was another difficult quarter for our mortgage banking business.

During the quarter, we completed the reorganization announced early in the quarter by closing five loan production offices and reducing our staffing levels. Our mortgage banking operations are now conducted from two wholesale loan offices, Pleasanton and Rancho Cucamonga, and two retail loan production offices, Glendora and Riverside. Additionally we have reduced our staffing levels in the mortgage banking division to 81 full-time equivalent employees at December 31, 2007, with 43 production staff and 38 support staff. This is down 51% from our peak employment in the division in November, 2006, when we employed 164 full-time equivalent employees. We will continue to monitor the mortgage banking correction and are prepared to make additional changes that may become necessary.

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. There were two positive developments for the quarter regarding mortgage banking. During the quarter ended December 31, 2007, we repurchased $2.1 million of loan and REO from investors resulting in a specific loan loss provision, or charge-off, of approximately $158,000. This is higher than the quarter ended September 30, 2007, when we repurchased $1.7 million of loans and REO from investors, resulting in a specific loan loss provision, or charge-off, of approximately $164,000, but a significant decline from the two prior sequential quarters. In the quarter ended June 30, 2007, we repurchased $6.2 million of loan and REO from investors, resulting in a specific loan loss provision, or charge-off, of approximately $367,000, and in the quarter ended March 31, 2007, we repurchased $4.5 million of loans resulting in a $282,000 specific loan loss provision. or charge-off.

Since underwriting standards have tightened considerably during the past 10 months or so, loan repurchases have fallen considerably and should continue to fall. In addition to the repurchased loans I've just described, for the 12 months ended December 31, 2007, we originated $12.6 million of loans that we could not sell to investors, which were reclassified as held for investment but required LOCOM adjustments of approximately $635,000. The most recent such loan was reclassified on September 30, 2007 and $1.9 million of these loans have been paid in full subsequent to their reclassification. The second positive development in mortgage banking was the increase in our loan sale margin, which improved to 109 basis points. This is significantly higher than the prior three sequential quarters, where our loan sale margin was 11 basis points, 31 basis points, and 71 basis points respectively.

Non-conforming loan products are still relatively illiquid, keeping the loan volumes depressed, and while it is too soon to conclude that the mortgage banking environment will become more favorable any time soon, recent Federal Reserve actions and Washington's purposed economic stimulus package, which increases the conforming loan limit, could restore non-conforming liquidity in the secondary mortgage market. We continue to invest in our community banking business and are encouraged by the long-term opportunities that are available in the Inland Empire. We look forward to opening our two newest branches in calendar 2008, one in Moreno Valley and the other in Beaumont]. Doing so will enhance our ability to grow deposit market share in our existing geographic footprint. Although no opening dates have been established, we currently expect Moreno Valley to open this summer and Beaumont to open this fall.

For the quarter ended December 31, 2007, deposits declined by approximately $6 million. The sequential quarter decline occurred in timed deposits, which fell by approximately $10 million, partially offset by increasing core deposits of $4 million. We decided to compete less aggressively with interest rates on our timed deposit products, although the FOMC action beginning in September has generally resulted in lower timed deposit rates by competitors, except for the large mortgage bankers who have thrift charters. FHLB advanced rates are significantly cheaper than timed deposits, resulting in our decision to fund sequential quarter balance sheet growth with approximately $42 million of new FHLB advances. Core deposit growth in conjunction with the preferred loan growth and upwardly repricing adjustable rate mortgages in our loans held for investment portfolio resulted in a sequential quarter net interest margin expansion.

We believe that a steeper yield curve, and lower short-term rates, should work to our advantage in 2008 since our balance sheet is slightly liability sensitive. If the FOMC continues to cut interest rates, our net interest margin expansion may accelerate. There's some progress to report regarding the fraudulent construction loans located in Coachella, California. As we discussed during last quarter's conference call, we have had a few settlement discussions with certain individual borrowers. Earlier this month we executed our first settlement with one of the borrowers, which resulted in a cash payment and us receiving the deed for the undeveloped lot. We expect a few more borrowers to settle with us in the next few months but the settlement amounts are not expected to result in a material recovery of the specific valuation allowances previously established.

We continue to pursue all legal remedies available to us and have filed criminal complaints with law enforcement agencies, but is far from certain the amounts 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 we have recorded a loan loss provision for the quarter of approximately $2.1 million. There were three primary factors contributing to the provision. The first was the $9.5 million sequential quarter increase of loans classified in the special mention and substandard category. The second was the $28.6 million sequential quarter growth of loans held for investment. And the third was the additional loan loss provisions required on previously classified loans as a result of the continued deterioration in real estate collateral values.

We continue to deploy sound capital management strategies and maintain the best use of our capital as a prudent growth for the Company. But to the extent that we are unable to grow as quickly or as carefully with the asset mix we envision, share repurchases will be employed. During the quarter we repurchased approximately 36,000 shares of our common stock at an average cost of $19.24 per share. The decline in the number of shares repurchased in comparison to recent prior quarters reflects our sensitivity to maintaining prudent capital ratios in an environment where credit losses are increasing significantly from historically low levels. Finally, I would like to update you on the current conditions in the Southern California real estate market. According to the January 15th news release from DataQuick Information System, the medium price paid for a Southern California home in December, 2007 declined by 2.4% from November, 2007 and declined by 13.3% from December, 2006.

More significantly, real estate sales plunged 45.3% from December, 2006. Marshall Prentice, DataQuick President, said, quote, looks like anybody who can is waiting this thing out, which of course means that the activity we're seeing right now is largely stressed and atypical, end quote. He went on to say, quote, we're in the midst of turbulence and we don't -- won't know what really has been going on until things have settled down and we can look back, end quote. Before I open the call to questions, I wish to advise you 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. Brad.

Thank you. (OPERATOR INSTRUCTIONS) One moment, please. I do have a question from the line of Tim Caulfield. Please go ahead.

Good morning, guys, how you doing?

Good morning, Tim.

I know you just said that the balance sheet has become a little more liability sensitive. But I was wondering what -- if you had any idea of what would happen to the margin with 125 basis point cut like we're seeing right now?

Tim, I haven't modeled what that will do specifically. But you'll find on the last page of our earnings release, just on our advances we have in overnight $27 million or something plus $27 million maturing. And then additionally, in the six months or less category, we have $190 million maturing in FHLB advances. Those advances are in the low fours, 418, 420. In each of those cases, we believe we'll be able to replace those advances in the low threes, so perhaps 100 basis points decline on 217, 218 million of liability cost over the next six months. Additionally, with respect to deposits that are maturing, while we don't put it into the earnings release, if you look back to the September 30 Q, and in fact if you wait until our December 31st Q, you're going to find that much of what we were doing with respect to CD deposit gathering was short-term in nature, 12 months or less, and so there's a great deal of CDs that are coming due over the course of calendar '08.

But certainly significant amounts in the next six months for this fiscal quarter that will significantly impact what we're paying for them. They're going to reprice down. So I think as we look at our margin and we had two basis points of sequential quarter expansion and that comes after, I think, three basis points of sequential quarter expansion in the prior quarter's period, it seems to me, since these cuts have occurred by the Fed in our second quarter by a significant amount, we're going to accelerate the expansion to our net interest margin.

Okay. And then the other question I had was with regards to the credit buckets, it looks like the level of (inaudible) substandard have returned to -- obviously comes a little bit higher than the third quarter but more in line with what we saw I guess two quarters ago. Do you have any other -- anything else you can tell me about that? Do you expect those numbers to come down? Do you expect them to increase or stay the same?

I think with respect to credit quality, there's no question that we're in a stressed environment. And we breakdown and you can compare where our credit quality is with respect to non-performers, in fact, even with respect to criticized or special mention assets. They are up, but the pace of the increase seems to have slowed down to some degree. Additionally, with respect to our single family loans that are in our portfolio, they are primarily interest only loans. They are not option ARM loans. And that's significant because the payment shock associated with an interest only loan when it comes up for its repricing, its first repricing, second repricing or wherever it is in its term, is going to be significantly less than a payment shock associated with an option ARM. And indeed, the bulk of our single family loans are written off of six month LIBOR and many of them, or the bulk of them, are at a 275 margin.

So when you start looking at six month LIBOR of 315 and you look at a 275 margin, you've got a 590 interest rate on those today. I think that comes down as we go down the time line in calendar '08 because I think six month LIBOR is going to come down in a response to Fed action. And so the payment shock associated with 590 when the loan has already been in the low to mid-fives is substantially less than what you're going to see in option ARMs that are being recast because they've hit the neg AMP. And so I think that's a significant difference. So when you look at our credit quality trends, we're in a stressed environment. If we see a recession, that's obviously going to result in job losses. We're in territory where it takes two incomes to make many of these mortgage payments, so we're going to have our normal credit quality concerns given the environment, but I don't think we're going to have the credit quality concerns with respect to the instrument itself that our borrowers are in, in comparison to option ARM lenders.

Okay.

And Tim, you might have noticed also our comment on loans that were modified in the last --

Yes, I did see that.

It was a pretty low number and I think part of the reasons are what Donavon just talked about and what we were seeing then were loans were adjusting from the low to mid-fives up to the high sevens and with that index falling so quickly, in the next few months they'll be in the sixes instead, or low sixes, so that's going to be a lot less payment shock.

Sure. More manageable. All right. Gentlemen, those are all my questions. Thank you.

Thank you.

(OPERATOR INSTRUCTIONS) We have a question from the line of Ross Haberman, please go ahead.

How are you, gentlemen?

Good.

I got on late, I apologize. Could you repeat, if you did, sort of your assessment of how soft you see residential demand, I guess, for the balance of this year and how much originations in '08 do you see volume down compared to last year?

Sure. Certainly the sales market part and the percentage we talked about in our presentation indicate that it's going to be way off this year. What may happen, though, is refinances will start to increase because of the Fed action.

Right.

And if the Freddie Mac, Fannie Mae limit gets raised substantially, that will significantly impact more activity for refinances also. Probably the one qualifier in all of that is the appraisal part of it. Some of these borrowers, many of the borrowers in the marketplace in the last few years have over encumbered their properties with first and second. With values coming down it's going to be tougher to refinance those properties. So some of them are going to be stuck.

I mentioned earlier about the modifications I've been looking at and in a number of cases it's not a problem for a number of our borrowers to take the increased payment. The ones that have a problem have other issues like divorce, loss of job, the types of things that really worked out of the marketplace the last really five plus years because values were going up so quickly. If they had a problem paying the loan, they just sold the house. Well, today, can't sell the house. So that will increase some problem loans and we're seeing that right now in our delinquency rates and increased foreclosures, remembering that we started from almost zero a year ago.

Right.

So what I see is the possibility of increasing volumes in the next few quarters over the last few quarters, because of increased refinance activity, but not from the sales of homes.

And the level of those -- of that increased volume will not be levels of volume that we saw in calendar '06, for instance, which was kind of at the peak of the market with respect to volume.

Right. Volume started falling off in the second calendar quarter of '07 substantially.

Will the re-fi business, if it does -- it will, because I'm hearing that from everyone, if you get it from your business, will that hurt the margin or the spread because you're going to have higher mortgages on your books re-fi down?

Well, it will hurt it within the context of -- they probably re-fi into a lower rate than they would have been had they not re-fied in the first place. It won't within the context of, I think, our liability side of the balance sheet is going to reprice down relatively quickly over the next year or calendar 12 months as a result of what our maturities are in FHLB advances and CDs.

Right, I saw that. Okay.

And again, we will have some loans that are adjusting upward and many of those loans won't be able to be re-fied because of issues with value, yet they're still making the payments.

So the ones which are going to go up are not subprime or anything like that and they can afford to pay the higher rates.

They're not subprime but they can afford to pay the higher rates. We didn't do subprime loans or if we did any, we didn't do them on purpose. We certainly did a lot of all A lending, which is stressed because of other types of loan products in the marketplace, which, I don't know if you caught Donavon's earlier comments about option ARMs.

Yes, I did.

And the other major factor with respect to our single family loan portfolio, because they are interest only in a falling interest rate environment, it is not a foregone conclusion that they will be repricing up from their current interest rates significantly enough to have a payment shock that they're not able to absorb. And indeed, the longer we go where Fed action or Fed bias is a lowering of interest rates and with LIBOR now finally coming down with some semblance of tracking to treasury, if you will, these borrowers right now are adjusting into the high fives, primarily, low sixes in some case and they're already in the low fives to mid-fives. So I think that protects the portfolio to some degree, other than for other stress-related issues that borrowers might go through, such as divorce, job loss, et cetera.

Got it. Okay. Thank you guys, best of luck.

Thanks, Ross.

([OPERATOR INSTRUCTIONS) Speakers, there are no further questions from the phone lines at this time. Please continue.

Well, if there are no further questions, I'd like to thank everybody for joining us on our quarterly conference call and look forward to speaking with you all next quarter. Thank you.

Ladies and gentlemen, this conference will be available for replay after 11:30 a.m. today and running through February 1st 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 903947. International participants dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844, with an access code of 903947. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.