Provident Financial Holdings Inc (PROV) 2010 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Provident Financial Holdings conference call. (Operator Instructions). With that being said, I'll turn the conference over to Mr. Craig Blunden. Please go ahead, sir.

Thank you, John. 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 Operating and 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 from the annual report on Form 10-K for the year ended June 30, 2009 and from the Form 10-Q that were filed subsequent to the Form 10-K. 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 our earnings release, which describes our fourth quarter results. The major components influencing our current financial results are unchanged, mortgage banking and credit quality. We are pleased with both this quarter since our mortgage banking results and credit quality improved from last quarter. As we have previously discussed, we expect quarterly results to remain choppy, as we endure the current credit quality cycle, which, by the way, is compounded by our mortgage banking business, which can be unpredictable.

As I said, overall, we are pleased with our mortgage banking results. The increase in loans originated for sale in the fourth quarter was result of the lower interest rate environment. The uptick in real estate values and sales activity, and fewer competitors in the business. Refinance volume held up pretty well and it does not currently appear likely that the Federal Reserve will change its current monetary policy of supporting lower interest rates any time soon, which is described in the recently released minutes from their meetings and public comments and testimony from Chairman Bernanke. We ended the fourth quarter with a comparatively large locked pipeline, suggesting that next quarter's loan origination volume will remain consistent with current quarter levels.

One potential concern for mortgage banking stems from the removal of emergency action by the US Treasury, Federal Reserve and Congress in response to the credit crisis, which resulted in the ancillary benefit of significantly lower mortgage interest rates. On March 31, 2010, purchases of mortgage backed securities and agency debt instruments were stopped and the Federal Home Buyer tax credit for qualified home purchases expired on April 30, 2010. To date, we have not seen a significant rise in mortgage interest rates. And while some reports describe that home purchase activity has declined as a result of the tax credit expiration, it is too soon to determine the long-term impact to the mortgage and housing markets as emergency actions are removed.

Also, the loan sale margin improved from March 31, 2010 quarter, but will remain volatile as we continue to reserve the loan repurchases and intermittently change our investor loan sales mix to mitigate liquidity and capital risk by delivering more loans to the GSEs when required, which settle their loan purchases much more quickly than private investors, but to the detriment of our loan sale margin. Nevertheless, we shall continue to believe that the mortgage banking environment remains favorable and provides us an excellent opportunity to augment earnings. However, we must remain vigilant to be able to recognize when the environment begins to change, so we can adjust our operating model commensurate with lower loan origination volume.

Credit quality improved during the quarter. Total nonperforming assets on June 30, 2010 decreased to $73.5 million, a 27% decline from what appears to be the peak of $100.7 million on December 31, 2009. We did not record a provision for loan losses during the quarter ended June 30, 2010, while net charge-offs were $7.4 million, a bit higher than the net charge-offs of $6.8 million in the March 31, 2010 quarter, but lower than the net charge-offs of $9.6 million in the June 30, 2009 quarter. During the quarter, 42 new REOs were acquired, while 40 REOs were sold, resulting in a net gain of $650,000 at their disposition. The net gain at time of disposition supports our view that we're identifying any losses early in the loan deterioration process.

One nuance that everyone should understand regarding the foreclosure process relates to the new California state laws delaying foreclosure until certain borrower notice requirements have been met. The laws have simply led to delays, but will not have a significant impact on the total number of foreclosures since we are complying with the new requirement and the foreclosures in process will occur in due course. We remain committed to quickly identifying any problem loans within the portfolio and to timely record any losses we may experience on those problem loans, and to quickly dispose of the resultant REO.

Our bias regarding credit quality is somewhat improved, given our most recent credit quality experience, but we continue to believe that poor economic conditions, such as higher unemployment rates and muted economic growth may last through much of 2010, keeping nonperforming assets elevated. However, it is important to note that this quarter marks the second consecutive quarter where asset quality improved.

In addition to our positive outlook on mortgage banking and somewhat improved view of credit quality, there have been other developments regarding operating results. For instance, our operating expenses have increased as a result of hiring additional mortgage banking personnel to accommodate the opportunity we see in mortgage banking. We monitor operating expenses very closely and will be quick to make adjustments if necessary, should loan origination volume begin to decline.

We continue to maintain higher liquidity balances in response to the uncertain operating environment, although doing so has reduced our net interest income. We continue to invest in our retail deposit franchise, resulting in an increasing core deposit. Additionally, our net interest margin has expanded for the third consecutive quarter. Nonetheless, the key take-aways with respect to our fourth quarter results are the favorable quality, credit quality trends and the opportunities we see in mortgage banking.

Our short-term strategy for balance sheet management is unchanged from last quarter. We believe that maintaining capital ratios at their current levels is critical, but we will allow an increase in loans held for sale to accommodate mortgage banking, while we reduce other balance sheet components, if necessary, to maintain the core capital and total risk-based capital ratios above 8% and 12% respectively.

I encourage everyone to review our June 30 investor presentation posted to our website. You will find that we included slides regarding asset quality and mortgage banking, which we believe will give you additional information on the credit risks embedded in our loan portfolio, and the favorable mortgage banking fundamental.

We will now entertain any questions you may have regarding our financial results. Thank you. John?

(Operator Instructions). First we'll go to the line of Tim O'Brien with Sandler O'Neill. Please go ahead.

Good morning, gentlemen.

Good morning, Tim.

Good morning, Tim.

Just starting out, can you tell me when your examination is coming up?

We haven't been notified yet, Tim, but I would expect that it would be in our second fiscal quarter or the fourth calendar quarter, maybe into the first of the new year.

Okay, thanks. And then, Craig, you alluded to this execution of your deposit strategy and investment in that. Can you provide a little bit more color on what that funding goes towards? Are you hiring now? Or what are you doing there to bring down your deposit costs?

Well, on the retail banking side, no, we're not hiring more. And we haven't opened any more branches. But with disruptions in the marketplace, with institutions that have failed, Tim, most recently Arrowhead Central Credit Union, which at one point was the largest in our region, that's given us the opportunity to pick up more core accounts. So we're just doing a lot more marketing with our existing offices and focusing on transaction accounts versus CDs. And if you notice in the financials, you see that we allowed quite a bit of runoff out of CDs. Now, of course, some of that did end up in money market accounts.

Is that a trend that you expect to carry into the second half of this year?

That's certainly a trend that is our plan to carry on into this year. You probably also noticed in the past year we've paid off Federal home loan advances, which has given us more room on the balance sheet to expand deposits.

One of the things historically, Tim, when rates are low, there are quite a few depositors who rather than pick off a CD at these rates and extend out their maturities, they are just as satisfied to stay in money market accounts. And so you get this transition from CDs to money market. We noticed that in the last interest rate cycle as well and as a result, core deposits or transaction accounts get goosed to some degree, as you think about that transition. Now, from our perspective, it's terrific because that CD customer was core banking relationship anyway and we're maintaining that relationship.

And so, other -- the asset side of the balance sheet being equal that you're going to have stable, generally more stable yields there, we could see some continued margin support and margin strength here.

Yes, I think that's fair. I think you have to look to the schedules that we've provided. For instance, Federal home loan bank advances, there's about $48 million that mature over the next six months. The weighted average cost of those advances is 5.22%. I think a current five-year advance from the Federal Home Loan Bank is just over 2%. So we will certainly have the opportunity to roll those costs down as we are thinking about interest rate risk management.

One other thing that you kind of touched on is what we're doing with the balance sheet and while we do describe ourselves as flat or maybe slightly deleveraging the balance sheet, it's important to note that we're -- we don't envision that we will be delevering at the pace that we've been delevering over the past couple of years. So, we like the balance sheet around this $1.4 billion area. That means that we might see increased lending and loans held for investment as payoffs occur in those portfolios. And certainly if the credit quality trends continue to improve, we would expect that profitability would be building capital ratios as well supporting these stout ratios that we wish to maintain.

And then last question, on the provisioning front, that zero provision, is that simply you taking advantage of what you viewed as excess reserves, based on your credit outlook or your credit situation in the second quarter and on a go-forward basis? Is that the sign of a trend there that you feel that you've got ample reserves for the next couple of quarters possibly unless there's something that pops up as a surprise? Or was that kind of a true-up exception and you're going to continue to throw a little bit into the allowance going forward here?

Yes, everything is relative to our actual loan loss experience. We have a process in place. We review it on an ongoing monthly and quarterly basis, and depending upon when our actual experience is and what is reflected in asset quality will dictate what it is that we do with reserves. It turns out that this quarter, no reserves were necessary. But I think we would be foolish to suggest that in future quarters, you are to expect zero reserves. It's simply a function of what is occurring with respect to nonperformers.

And then additionally, one of the things I mentioned is if we are not delevering as we have done in the past, we are not freeing up reserves out of that delevering component of the balance sheet. So if we are maintaining loans held for investment where they are, that suggests that we may have reserves for new production coming on to replace old production going off, depending upon the mix or the type of loan rolling off versus coming on.

Well, thanks for the help.

Okay.

And next in queue, we'll go to the line of Tim Coffey with FIG Partners. Please go ahead.

Good morning, Craig. Good morning, Donavon.

Good morning, Tim.

The question, Craig, you mentioned in your comments about potential change in the mix of buyers of your mortgages. Do you anticipate the GSEs becoming bigger buyers?

No, no, not really. Again, it's just a function of the amount of loans that we're putting through the system and us trying to control, our balance sheet and our asset levels that with the kind of volumes we're bumping up against right now and our investors being just as busy as we are, that it does impact the settlements of those loans and to try to keep our balance sheet about where it is now, if we have to at certain points during the quarter, we'll deliver some loans to the GSEs, even though the execution is poor. So that's what it is, Tim. But again, that's the only reason.

Okay. Rates, margin rates have been -- seems like they have been low for a while now. Do you think that you've tapped all the potential buyers or people thinking about refinancing at this point? Or do you think there's still more out there?

No, I think there's more out there. Again, there's -- people have had different issues either with their balance of their loan or their job change or their credit score some things have changed. And actually what I've seen is some people have actually got to the point where their balances have gone down some of the values have gone up slightly, and it's allowed them to actually do a refinance. But, no, I think there's -- and I think there's a group of people who are so unsure about whether or not they qualify, they just haven't jumped in yet. So that's as far as REFIs. But, our focus is really on sales, not refis. And that's why we've been building the retail part of our mortgage banking operation that have great contacts with realtors in our region and honestly, if you look at the numbers that we've shown, you'll see that we have a much higher percentage of sales versus refis or maybe another way to put that is our REFI percentage is much lower than the general marketplace, when you look at the numbers that have been released by MBA.

The one thing that I would point out as just to kind of reinforce what Craig is saying, in the June quarter, 32% of our volume was refinanced volume, and that's actually down from 43% in the March quarter and 50% in the December quarter, yet I believe interest rates were lower in the May-June time period than in March and December. And now as we enter the new quarter or the September quarter of 2010, we find that rates are even lower. That would argue well for mortgage origination volume, because we're not turning refinance volumes away. It simply hasn't been a focus with respect to our retail mortgage banking function. But as rates come down, we are naturally going to get more refinance volume, and that should help us keep volume levels elevated.

Okay. Sounds like your loan losses are -- do you have -- an idea of what you think a normalized reserve level is for the Company based on its credit risks?

Well, I don't think that there's an answer to that really. I think historically if you look at banks and thrifts and you look at loan loss reserve levels, you're probably in the 100-basis point to 150 basis point range.

At the most, yes.

In good economic times. While I think we're quite a ways away from really good economic times, and as a result, I think loan loss reserve or allowance ratios will continue to be elevated, not just for our own portfolio, but for the industry in general. And frankly, I think that that's probably healthy for those of us that are going through the cycle.

Okay, okay. I know we talked about this last quarter, but do you still feel comfortable with, having charge-offs greater than provision expense on a quarterly basis?

Well, we don't look at it within that context. Anyway, I know analysts, such as yourselves, love to look at that number. But we don't enter a quarter and say to ourselves, our charge-offs are X and so our reserves should be X. We look at our loans held for investment portfolio. We look at our loan loss experience that is developing as we go down the time line, and we try to build our allowances through provisioning such that we have sufficient allowances available. I think what that means is in some quarters, the provision will be higher than the charge-off. In other quarters, like this quarter, the provision will be lower than the charge-off. I think it has to be directionally consistent with what is actually happening in nonperformers. So we've had two successive quarters now, or consecutive quarters of declining nonperformers, and I feel absolutely comfortable with respect to what we've done in provisioning and what our allowance looks like consistent with loans held for investment and our actual loan loss experience.

Okay. Craig, it looks like the Company has had three really good quarters and results are a lot less choppy. Are there any thoughts about perhaps starting to pay a dividend?

I don't -- that discussion has not come up. You mean more than the $0.01 dividend?

Yes.

No. To be honest, this has been a turnaround in the last two quarters, but looking, looking out at the future, near future at least, I think things still have a chance to be choppy. Maybe not as choppy as it was, but, no, I think we're very cognizant of building, our capital ratios and this isn't the time, I don't think at least at this moment, to be increasing a dividend payout.

And here's the other thing. We just had regulatory reform legislation passed and signed. And there's a provision in there with respect to the regulators setting capital levels. Or at least changing them from current levels. So I think there's some uncertainty with respect to that legislation, what the regulators might do. And we absolutely don't want to find ourselves a year from now bumping up a new -- against a new higher capital requirement, when we could have prevented doing so by being a bit more conservative with respect to our balance sheet activity and with respect to dividend policy.

Okay. Fair enough. Those are all my questions. Thank you very much.

Okay, Tim. Thanks.

And next we'll go to the line of Jason Stewart with Compass Point. Please go ahead.

Good morning, and good quarter. My question is on the OTS's increase on the capital requirements for some of the loans. Could you give us a little bit more color as to what that discussion was like and what the thought process was there?

Sure. As you know, the OTS is our primary regulator. And they have the ability through various regulation to consider loans held for investment, consider the risks contained in loans held for investment, particularly within the context of what our loan loss experience is, and we've said and described that a riskier component of the portfolio is single-family stated income. They believe that a riskier component of the portfolio is interest-only single-family. And as a result, when they were considering these matters, they spoke with us and determined that perhaps we should allocate those loan types into the higher risk buckets with respect to risk-based capital requirements. We had that discussion. We agreed to do so.

From our perspective, it wasn't meaningful within the context of core capital ratios, because it didn't impact core capital ratios. It brought down our total risk based and our tier one risk based, but they are still very healthy levels of risk based capital. And essentially it provides additional support in the form of capital on top of loan loss allowances against those portfolios. So, in a sense, it's a more conservative posture obviously and stands with respect to future loan losses and what might actually occur in our capital ratios as a result of that.

And I'm guessing this was something that was industry-wide, or was this something unique and there was a catalyst for them doing this with you only?

Well, I think as they look at each institution and look at the different characteristics that are inherent in a loan portfolio, whether it's commercial real estate or whatever, is the significant piece of a portfolio, at that point, they do suggest that there's more risk and that adjustments need to be made. But it really varies, institution to institution based on their portfolio.

Okay. I guess I will never appreciate the rhyme or reason for regulators and the timing, but I thought maybe I would ask the question at least to get some perspective. The only other question I had was on the product mix that you were offering on the mortgage banking side. Has that changed or evolved over the last year or couple quarters? Or has it pretty much been your typical product mix?

The product mix has been the same for the past, I don't know, probably six quarters at least once the industry changed and got away from interest-only, stated income, option arms, and all of that stuff and went purely to Freddie, Fannie conforming and HFA/VA and that's what we've been doing and that's 100% of our product line and has been and that's what we're selling 100% of today.

Okay. I have one last question. I know this is probably a little bit too soon to be talking about, just like it sounds like a dividend increase is. But with capital where it is, loan balances, and the assets maybe stabilizing, what sign post should we look for either for capital actions like dividend increases or stock buybacks, or for loan growth? Is there something that we should be focused on that might give us some insight as to when you're thinking that's appropriate?

I think you have to look at what nonperforming, performers or credit quality is doing. We have two consecutive quarters of improvement. Perhaps that's the beginning of a trend, but I still think there are risks out there with respect to the general economic conditions in, where our loan portfolio is held. And as a result, I think we're approaching the near time or the near term a bit cautiously. But if you -- if we continue to see improvement in credit quality, I think that you can start thinking along the lines of increased lending from loans held for investment basis to make certain that we're simply not building cash to maintain these total assets where they are. We're actually deploying that cash into loans held for investment. So, that's probably the primary driver. And that obviously works its way into our capital ratios because if we don't have loan loss provisioning or elevated loan loss provisioning to build an allowance, we obviously then have earnings which go into capital and will increase our ratios.

Okay. Thank you, gentlemen. Good quarter.

Thank you.

And gentlemen, there are no further questions in queue.

Alright. If there are no further questions, I would like to thank everyone for participating in our quarterly conference call and look forward to speaking to you all again at our next call at the end of our next quarter. Thank you.

Ladies and gentlemen, that does conclude your conference. Thank you for your participation. You may now disconnect.