Provident Financial Holdings Inc (PROV) 2011 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the first-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 and instructions will be given at the time. (Operator Instructions) Also as a reminder, today's teleconference is being recorded.

At this time we will turn the conference call over to your host, Chairman and CEO, Mr. Craig Blunden.

Good morning, everyone. This is Craig Blunden, Chairman and CEO of Provident Financial Holdings. 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, 2010, and from the Form 10-Qs that are 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 first-quarter results. The major components influencing our current financial results are unchanged, mortgage banking and credit quality.

We are particularly pleased with our mortgage banking results. The increase in loans originated for sale in the first quarter of our financial year was a result of the lower interest rate environment, the uptick in real estate values and sales activity, fewer competitors at the business, and the strategic decision to invest in our mortgage banking operations during the last 18 months or so. Additionally, the refinance volume accelerated 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.

We ended the first quarter with a comparatively large locked pipeline suggesting that next quarter's loan origination volume will remain similar to current quarter levels.

The loan sale margin improved from the June 30, 2010, quarter but will remain volatile as we continue to reserve for loan repurchases and intermittently changed 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.

We continue to believe that the mortgage banking environment remains favorable and provides us excellent opportunity to augment earnings. We have been investing in the business primarily by hiring additional personnel, but we will remain vigilant regarding the operating environment so we can adjust our model, as we have done in the past, commensurate with lower loan origination volumes.

Credit quality slightly improved during the quarter and at a slower pace than recent prior sequential quarters. Total non-performing assets on September 30, 2010, decreased to $72.7 million, a 28% decline from what appears to be the peak of $100.7 million on December 31, 2009. We recorded a small provision for loan losses during the quarter ended September 30, 2010, whilst net charge-offs were $5.3 million lower than the net charge-offs of $7.3 million in the June 30, 2010, quarter but higher than the net charge-offs of $4.6 million in the September 30, 2009, quarter.

I believe future improvements in credit quality will be inconsistent because performance is so closely tied to general economic conditions, although our outlook regarding credit quality has improved given the most recent developments and performance. Even so we continue to believe that the poor economic conditions, such as higher unemployment rates and muted economic growth, may last through the first half of 2011 keeping non-performing assets elevated. It is important to note, though, that this quarter marks the third consecutive quarter where asset quality has improved.

In addition to our positive outlook on mortgage banking and improved view of credit quality there have been other developments regarding our operating results. For instance, our operating expenses have increased as a result of hiring additional mortgage banking personnel, but we are seeing the payoff in improving efficiency ratio because revenues are outpacing expenses. We monitor operating expenses very closely and will be quick to make adjustments, if necessary, should loan origination volumes 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. Additionally, we continue to invest in our retail deposit franchise resulting in increases in core deposits. Nonetheless, the key take aways with respect to our first-quarter results are the favorable credit quality trends and the opportunities we see in mortgage banking.

Our short-term strategy for balance sheet management is unchanged from last quarter and we do not believe significant deleveraging of the balance sheet is required. 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.

Before I open the call to questions I would like to spend a few minutes describing our foreclosure documentation and loan sale procedures in light of the industry debate leading to moratoriums, legal uncertainty, and elevated scrutiny.

First, when we foreclose on real estate collateralizing a defaulted mortgage loan in our loans held for investment or loan service for others portfolio we are doing so with the original promissory note and deed of trust. It is very rare that we rely on a loss note affidavit because we retain the original collateral instruments in our loan vault. In fact, our most recent filing of a loss note affidavit during a foreclosure proceeding was in 1998.

When we foreclose it is abundantly clear to all parties concerned that we have the legal standing to proceed and I cannot remember a situation where our documents, process, or legal standing has been challenged by a court.

Regarding loans that we originated for sale, which by the way are primarily sold on a servicing release basis, clear ownership is conveyed to the investor by endorsing the original notes in favor of the investor, transferring the servicing to a new servicer consistent with the investor instruction, communicating the servicing transfer to the borrower as required by regulation, and shipping the original loan files and collateral instruments to the investor contemporaneous with receiving cash proceeds from the sale of the loan.

Additionally, we registered a change of ownership in MERS as required by the contractual terms of the loan sale agreements, but do not believe that doing so clouds ownership since the steps described previously have also been taken. It should also be noted that we do not originate or sponsor the mortgage-backed security for many of these loans will eventually reside.

Also, as a side note, we retain an image copy of the entire loan file and collateral instruments as an abundance of caution in the event questions arise that can only be answered by reviewing the loan file.

I encourage everyone to review our September 30 investor presentation posted to our website. You will find that we have 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 fundamentals.

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

(Operator Instructions) Brett Scheiner, SBR Capital Markets.

Good to see the progress on the credit trend. Just a quick question; it looks like transaction account balances have been flat since the March quarter. Any color on improving the deposit mix going forward and what initiatives you might have there?

Hi, Brett; it's Donovan. Really the issue gets down to one of need to some degree for us.

As you know, we haven't been growing the balance sheet so we have been competing less aggressively on rate. Although we continue to compete quite aggressively for transaction accounts or core deposits, moving the needle in total deposits with checking accounts is very, very difficult because the balances are relatively small in comparison to a CD, for instance.

Okay.

So that is essentially what the deal is. And should we determine we have an interest and wish to compete more aggressively I think we can move the needle substantially in deposits.

Certainly. And doing so would you be able to prepay some of the higher-cost borrowings or are you comfortable with the cost of funds right now?

No, we are not ever comfortable with our cost of funds. We are always trying to lower that. I think we are going to see that that naturally occurs.

In the next six months we have something on the order -- I want to get to my note to make sure I have got it. We have something on the order of $93 million maturing with the Federal Home Loan Bank at a rate of 4.56%. To the extent we pay it off and we don't replace it that is obviously going to drop our weighted average cost of funds. If we determine that we wish to replace that advance on a longer-term basis, FHLB advance rates are very competitive and certainly lower than that which would also reduce our cost of funds.

Okay, that is very helpful. And then just one other question. We are one month into the quarter. It looked like the locked pipeline looked pretty good in the slide deck. Can you talk about quarter-to-date gain on sale margin or volumes?

First of all, the best place to look to get some clarity with respect to our next quarter's volume is the slide deck where we describe our locked pipeline. And you will see that the locked pipeline at September 30 was the largest over the prior six quarters that we have on the slide deck. That suggests that we can replicate the volumes that we have seen in the September quarter.

Of course, that is always dictated by what interest rates are doing because additionally you will see that refinance activity increased (technical difficulty) percent of that volume and refinance activity is very interest rate sensitive. So we think we can replicate that volume, first of all, provided interest rates remain where they are currently.

With respect to the loan sale margin, the thing I would suggest there, and we are not the only ones, when the industry is inundated with loan applications, as the industry was in the September quarter, everybody in order to control the volume that is coming in the door to make certain service levels do not decline is able to price their product up a bit. And as a result, when you price your product up a bit your loan sale margin is going to be higher.

The reverse, by the way, is true. When loan volumes begin to decline everybody is competing for that business and will cut their margins a bit in order to retain it. So we had the good fortune this quarter of having refinance volume come in quite substantially and then additionally that volume was such and the competitive pressures are less that we were able to price up a bit on that volume.

Okay, that is very helpful. Thanks again, guys.

Tim Coffey, FIG Partners.

Morning, Craig. Morning, Donavon. Donavon or rather Craig, as you look at your mortgage banking operation do you get the feeling that you are fully staffed at this point or could you be adding more FTEs?

Well, I know that we are working people to death in the last couple of months, which you can't do forever. And if these volumes maintain at these high levels I would guess that we would probably have to hire a few more people, but other than that it's hard for me to say.

Okay. And then in terms of geography, where are your larger mortgage banking activities taking place? Have you thought about expanding outside of those areas?

There is a couple of things I think to keep in mind there. We are very familiar with the California markets, both Southern California and Northern California, through our Pleasanton operation. And to leave the state of California it seems to me is not an insurmountable task, but on the other hand is that really something we want to do?

It's something that we can consider. It's something we have kicked around in the past but there has been plenty of business in California for us.

And we have had opportunities, actually, in a couple of other Western states that have been offered to us. But again, as I mentioned, our volumes are at the levels where I think the last thing we want to do is add on a new group and have to try to train them when everybody is already busier than they know what to do.

Okay, okay. Then Donavon, give me a general idea here, as we talk about liquidity on the balance sheet what is the best way to look at liquidity? Is it in terms of assets, in terms of loans held for sale, in terms of the locked pipeline? What kind of color can you give me there?

Well, there is a couple of things driving liquidity. Perhaps the most significant is the inter-agency guidance that came out by the regulators that specifically suggested that institutions pay closer attention to their levels of liquidity. We have obviously been doing so for an extended period of time.

And I think on a balance sheet of about $1.4 billion or so you will see that we have got about $100 million of liquidity with a fully-funded loans held for sale, if you will. So to the extent loans held for sale declines from the levels that we saw at September 30 I would argue that cash liquidity would increase and vice versa. If loans held for sale go up a bit, I think cash liquidity comes down a bit.

The real question with respect to liquidity is where it is that we determine we should invest it. And at this point in time we are quite uncomfortable with putting it on treasuries or agency debt instruments or mortgage-backed securities, for instance, as a result of the interest rate environment we are in.

I am not certain where interest rates are going. It sounds like a quantitative easing, too, is coming down the pipe which would suggest longer-term rates come down perhaps. But at some point interest rates are going up and the last thing we want after dealing with the credit cycle that we have dealt with is find ourselves with an interest rate risk management issue.

Okay. That makes sense. And then, Craig, any thoughts on increasing the dividend?

No. Something we haven't discussed at this point. It seems like it's still a bit early in the cycle to be discussing it.

All right. Thank you very much, those are all my questions.

Jason Stewart, Compass Point.

Good morning and great quarter. I have two questions. One, could you just give us just a little bit of color or commentary on the broader economic environment that you are seeing in your footprint? And then two, maybe some idea as to what signposts we should be looking for, whether it be economic or capital or liquidity-driven signposts in order to make you more enthusiastic about expanding the balance sheet?

Sure, let's start with the economic environment, at least in the inland area here in Southern California. What we have been seeing really in the last nine months or so is job creation on the private sector, some pretty good job growth actually. However, offsetting that what we have also seen as a loss of jobs in the public sector from state agencies, county and local governments.

As you might remember, during the early parts of this cycle they were still increasing staff. That is no longer true with the budgetary problems they have.

We have got an election coming up. Sacramento has been gridlocked now for quite a while, maybe actually something will get done up there that will be helpful in the future. I am not going to bet on it.

So we think it's still an extended issue with these unemployment levels remaining close to where they are, maybe coming down a bit, but there is still pressure for the public agencies to unload more staff. So that is kind of what is happening out here.

We can -- we really see economic growth. I can see it in one way just in the container traffic coming through the ports of Long Beach and LA that actually flow through Riverside here going throughout the rest of the country delivering goods. The traffic in the last 90 days has increased tremendously.

We can't hardly get across railroad crossings around here anymore. For the past couple years trains disappeared for the reason that the ports were really dead and products were not being imported into them. So there is some positive news out there, but there is still a lot of caution because of what is going on the public side.

With respect to the balance sheet and balance sheet growth, I think at this point in time we are not necessarily interested in extensive growth in the balance sheet. I think the $1.4 billion mark is probably a good guidepost with respect to where we want to keep the balance sheet.

The one caveat or the one change, though, that I think you might see as we go down the timeline here, we have been running off our loan portfolio. And in fact, we have not been replacing those loans with new origination volume to increase or to maintain the level of loans held for investment.

I think rather than letting those loans run off, turn to cash, and essentially build our cash balances, we might be more inclined to begin to look to make some origination volume for our loans held for investment portfolio.

So I think balance sheet will remain flat, let's say. We are not taking it down as we have done in the past year or so and I think cash balances, perhaps, could begin to remain flat. And to the extent we have loan payoffs or regular amortization of principle we can begin to reinvest that and replace it.

I guess a further comment might be just on capital and what has been happening with BASEL and so on. Our regulators, I think if you listen to them the last couple of years, haven't really indicated what proper capital levels should be in this environment. They have just always said more capital.

We are trying to get comfort with the capital levels that we are at now; the bank being at and around 9.25% core capital. You know the rules; the old 5% disappeared quite a while ago. We think the minimum is probably 8%, although it's not set anywhere out in writing, but we get that sense from what we read and certainly actions against other institutions and the capital levels they are requiring those institutions to get to.

So, again, we are just trying to get comfortable with the capital levels, where we are, to see when growth can really occur.

And then the only follow-up to that is in addition to what the absolute, well-capitalized levels may become as a result of BASEL III, which are obviously going up, there has been some discussion among regulators that those become minimum levels with respect to kind of a basic bank. And that a bank running higher risk activities would be expected to maintain capital ratio something above that.

Well, we have a mortgage banking operation and we know that that is considered to be a higher risk activity than a regular community bank, let's say. And as a result I think we would have some additional requirement tacked on to the regular well-capitalized levels whatever they may be.

Okay. I appreciate the answers and great quarter. Thank you.

(Operator Instructions) Tim O'Brien, Sandler O'Neill.

Good morning. Have you guys had any contact with the OCC regarding transfer into regulatory coverage over there? And can you give any color on outlook there of how that might change the way you are regulated?

Sure. About two weeks ago I was back in Boston at the American Bankers Association board meeting, an annual meeting, and I was invited to a very small breakfast with the head of OTS, senior members of OCC, FDIC, and the Fed; basically eight bankers and six regulators. And that was one of the topics that we discussed.

Then in the afternoon there was a panel of the senior OCC and the number two from OTS sitting there talking about how they saw this merger going and how it would affect institutions and allowed us to ask questions. One of the questions I asked was is there something we should be preparing to do today that we are not doing to make sure that we are ready for OCC taking over supervision.

They say there is not. We don't need to change our charter. We don't need to change the way we are doing business. Our reporting will change over time. They can't give us a date of when they might move off the TFR. They are not sure what they are going to be doing with the interest rate modeling that OTS does.

Anyway, honestly, the answers we are getting is it's supposed to be pretty seamless. They are going to be mixing examiners with the OTS examiner in charge still leading the exams in the next couple of years and mixing OCC examiners in with the OTS examiners. So, again, it will have consistency and examiners that we have known in the past actually running the exams for us.

But there is still a lot of unknowns. Now I think the staff of OTS has more issues out there than the institutions do today.

Was there any perception or was there any discussion of capital requirement changes or some difference of view on the OCC side relative to the OTS side regarding the nature of thrift lending and risk and capital needs?

I asked that question at the breakfast meeting and I got, number one, no indication as usual of what capital levels might be proper in the future. But, no, I didn't get an indication that we would be treated differently with capital levels because of the real estate portfolios and/or activities like mortgage banking, no.

One thing in other comments that have come out from the OCC is that they regulate many banks that look very similar to thrifts right now with respect to balance sheet composition. As you know, community banks are quite active in real estate lending and many times other than the name of the bank at the top of the page you really couldn't discern a difference in the composition of their balance sheet to a thrift.

So I think they feel that they have some experience, and perhaps rightly so, with respect to the composition of what a thrift balance sheet looks like. Certainly there are going to be OTS examiners that are very active and involved in supervision on a go-forward basis. So our expectation is that there won't be significant changes, although there will obviously be some. We just don't know everything at this point.

One last kind of follow on to that. Did they give any indication of how they might ultimately provide guidance to you guys so that you can kind of settle your capital planning on a go-forward basis? Did they give you some thoughts of -- is it going to be interagency guidance that, broadly speaking, encompasses the thrifts that get rolled up into OCC or are they going to specifically address capital issues regarding thrifts that come over?

Did they give -- did anybody ask about that or approach it like that? Or what are you looking for I guess entering 2011 from any guidance perspective so that you guys can make capital plans, capital use plans?

Well, you know, we have been looking for guidance from OTS in the last year or so and we are not getting it other than the basic more capital. I have discussed and I discussed in this meeting how difficult it is when you start doing your planning, strategic plans for the next one to three years. How can you do that if you don't have better guidance on capital levels?

They said they understood the question but they didn't answer it or give me guidance as to when they might.

And I think one of the problems that they have, to be fair to them perhaps, is BASEL III is out there and I think they are going to have to consider what BASEL III ends up looking like. Then from there perhaps interagency guidance from the various regulators at that time to make to layer on top of BASEL III for certain risk characteristics.

That is the sense we are getting but it's just too soon to call. I don't think they know necessarily.

But you are right; it's the most frustrating part of running our business today is not having that guidance in our planning for the future.

It sounds like you guys are well positioned regardless and that it might be -- better frustration than despondency I think. It also sounds like you are going to continue to approach this prudently from a capital preservation standpoint going forward until some clarity comes from those sources, from regulatory sources.

Rather than talk about raising dividends and sending a signal that way, you guys are going to continue on the same path that you have been on for a while. Am I right there?

Well, certainly for the near term, absolutely you are right. Certainly the economy has a piece of that as well so absolutely.

Switching gears really quickly, you talk about the idea that you guys are open for business to originate loans for portfolio or possibly add loans or maintain your balance sheet at $1.4 billion. A little pushback, I would argue that if it's more profitable and it doesn't hurt your long-term prospects to allow the balance sheet to continue to shrink, then that is something worth considering.

And then the other thing is is it reasonable to think that there is even loan demand that is non-agency related out there. Like where would the best prospects for adding loans come from? Would it be from jumbo?

No, I think the best prospects would be a multi-family. There is some really good performing multi-family packages out there right now, some even at a discount, that I think when you talk about long-term strategies for margin growth, rather than just living off fee income that makes a lot more sense to us.

Sure, there is probably some jumbo business but honestly the jumbo side of the market is still so unsettled price wise and volume wise. You could do refis but I don't have a sense yet that we actually know what the true jumbo loans, let's say $1 million plus, what the true value is today. I think values are still coming down in that sector of the single-family real estate market. Certainly in southern California inland.

What would be the ideal kind of multi-family loan that you guys would be most interested in putting on your books at this point in time from a structure standpoint?

Well, in the past, and we have had very good success with it, we generally do a five-year or three-year fixed that rolls into an adjustable period subsequent to the fixed period. So a hybrid ARM product. Generally has a 25-year amortization and many have a 10-year balloon.

In some cases we will do a full 25-year [amp] so it's a full 25-year loan. In other cases we have done a few full 30-year loans. So I think the structure can be anywhere from a 10-year balloon to a full 30-year amort and I think it's probably a hybrid product.

And I think today you can really get better cap rates and debt service coverages, you can demand that in the marketplace to make it a more conservative product. So we would be stress testing the cash flows on those loans, which we did in the past and why our multi-family portfolio has been performing so well.

Then loan size, we have always liked to look at loans from $0.5 million to $1.5 million, $2 million -- not huge deals. But that part of the market has been very good for us in the past and performs well where the smaller numbers when you have like less than 10 units or these huge projects seem to have more problems.

And is it reasonable to think that we can see some volume this quarter come out of that?

I think this quarter is a little early for that. You have listened to our calls of the past few quarters, probably more than the past few, and this is the first time we are kind of talking about making replacing some of the run-off in our loans held for investment. There is always a lead time required to essentially reengage in that market.

So this quarter is probably a bit too soon, but it is certainly -- our financial condition is certainly in a position where this is something on our plate and something we need to consider. As we go through the fiscal year I think you will begin to see some activity.

Appreciate it. Thanks, I will step back. Very helpful.

At this time we have no additional questions in queue. Please continue.

All right. Well, if there are no additional questions, I would like to thank everyone for joining our conference call. We look forward to speaking with you next quarter. Thank you.

Thank you. Ladies and gentlemen, this conference will be available for replay after 11 a.m. Pacific Time today through November 4, 2010, at midnight. You may access the AT&T Teleconference replay system at any time by dialing 800-475-6701 and entering the access code of 175813. Once again that telephone number is 800-475-6701 using the access code of 175813.

That does conclude our conference call for today. We do thank you for your participation. You may now disconnect.