Provident Financial Holdings Inc (PROV) 2017 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the third quarter earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to turn the conference over your host, Mr. Craig Blunden. Please go ahead.

Thank you. Good morning, everyone. This is Craig Blunden, Chairman and CEO of Provident Financial Holdings. And on the call with me is Donavon Ternes, our President, 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 include forward-looking statements. Those statements include descriptions of management's plans, objectives or goals for future operations, products or services, forecast of financial or other performance measures and statements about the company's general outlook for economic and business conditions. We may also 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, 2016, 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 on our call. I hope that each of you has had an opportunity to review our earnings release, which describes our third quarter results. You will note that our mortgage banking business demonstrated mixed results this quarter, with an improving loan sale margin but a lower origination volume. New applications declined in the March 2017 quarter as a result of higher mortgage rates. The weakness in applications resulted in a lower locked pipeline when compared to March 31, 2016, quarter end but a somewhat higher locked pipeline when compared to the December 31, 2016, quarter end. As a result, based on current information, we would expect volumes to increase in the June 2017 quarter in comparison to the volume of the March 2017 quarter but not to the level of the June 2016 quarter last year. Additionally, the June quarter of every year typically includes increased activity as a result of the traditional spring buying season.

The loan sale margin for the quarter ended March 21, 2017, increased from the prior sequential quarter and has moved to the top of the range.

Overall, we were pleased with the loan sale execution for the quarter, as we experienced less volatility in loan servicing premiums and the cash markets.

The mortgage banking FTE account on March 31, 2017, decreased from December 31, 2016; and we currently employ 282 FTE in mortgage banking, down from the 306 FTE employed on December 31, 2016. During the quarter, we increased our origination staff by 5 professionals, while our fulfillment staff declined by 29 professionals. We'll continue to adjust our business model and FTE count as we have in the past commensurate with changes in market opportunities and the mortgage banking operating environment.

I would also like to describe a few additional changes in mortgage banking during the quarter. In early February, we had the opportunity to hire a retail mortgage banking group who operate in markets in the Central Coast of California, a new market for us. We are comfortable with executing on strategic expansion of this nature even during the current mortgage banking environment because selective expansion in more profitable retail channel is difficult to execute in any environment. This type of opportunity does not come along that often. At the same time, we closed 2 retail mortgage banking offices during the quarter, Westlake Village and Elk Grove. Westlake Village has been a marginal performer that we chose to close given the poor environment. In Elk Grove, we lost a small group of that office to a competitor.

In the mortgage banking -- in the community banking business, loans originated and purchased for investment decreased to $39 million from the $48 million in the prior sequential quarter, but single-family loans originated per portfolio from the mortgage banking division increased to $19 million in the March 2017 quarter from $16 million in the prior sequential quarter.

During the quarter, we also experienced $46.2 million of loan principal payments and payoffs, which is down from the $54.7 million in the December 2016 quarter and still tempering the growth rate of loans held for investment. Nonetheless, for the 12 months ended March 31, 2017, loans held for investment increased by approximately 9%, a moderate pace of growth. But preferred loans, a component of loans held for investment, grew at a 19% rate. We're pleased with the growth rate of preferred loan balances since changing the composition of loans held for investment as a long-term goal. Preferred loans are now 64% of loans held for investment, and the percentage of single-family loans has declined significantly from historical high. However, I would like to point out that the single-family portfolio balance increased for the second consecutive quarter because of the rise in mortgage interest rates has resulted in an increase in adjustable rate originations and purchase opportunities. We welcome this change in adjustable-rate single-family market conditions and believe it will result in future opportunities to grow our loan portfolio.

We are very pleased with credit quality, and you will note that early stage delinquencies declined to $978,000 at March 31, 2017, from $1.3 million at December 31, 2016, suggesting that meaningful near-term deterioration is unlikely. In fact, total criticized and classified assets remaining at very low levels are now just $18.7 million, which is very manageable.

The credit quality activity resulted in a negative provision of $165,000 for the quarter ended March 31, 2017. Net recoveries were $49,000 for March 2017 quarter compared to net recoveries of $16,000 from the December 2016 quarter and net recoveries of $205,000 during the September 2016 quarter. We're pleased with these credit quality results.

Our net interest margin compressed by 9 basis points in comparison to the December 2016 sequential quarter as a result of higher interest-earning deposit balances during the quarter in comparison to the prior sequential quarter. The increase in interest-earning deposit balances was a result of a lower average balance of loans held for sale.

Our short-term strategy for balance sheet management is unchanged from last quarter. We believe that releveraging the balance sheet with prudent loan portfolio growth is the best course of action. For the foreseeable future, we believe that maintaining a significant cushion above the regulatory capital ratios of 8% for Tier 1 leverage, 9.5% for common equity Tier 1 and 13% total risk based is essential, and we're confident we will be able to do so. We currently exceed each of those ratios by a significant margin, demonstrating that we have the capital to execute on our business plan and capital management goals.

Additionally, in the March 2017 quarter, we repurchased approximately 90,000 shares of our common stock and continue to believe that executing on stock repurchases is a wise use of capital in the current environment.

We encourage everyone to review our March 31 investor presentation posted on our website. You will find that we include slides regarding financial metrics, community banking, mortgage banking, asset quality and capital management, which we believe will give you additional insight on our strong financial foundation supporting future growth of the company.

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

(Operator Instructions) Our first question is from Brian Zabora with Hovde Group.

So first question on expenses. Given the new group that you just hired and then still kind of you're rightsizing for just the environment, how -- any sense of how we can look at expenses going forward, either maybe the efficiency ratio kind of target or anything -- maybe a dollar amount that you could provide?

We really don't provide color of that nature given the volatility of that business. What we do describe is that our business model and our ultimately FTE count has to change relative to the mortgage banking environment that we're in. In the March quarter, it was somewhat complicated with respect to what we did in the change of the business model because we picked up the new group in Atascadero. But if you think about the new group we described, I think, in our press release at that time that there were approximately 23 FTE that came on board. In addition with the color we gave today in Craig's comments, we did noted a decline of approximately 24 personnel from December 31 to March 31. So if we combine those 2 numbers, we had a reduction in force in the mortgage banking business of approximately 47 FTE during the March quarter, which was approximately 15% of the workforce outside of what we did in Atascadero. The other thing I'd like to note with respect to Atascadero, we obviously didn't pick that group up with a pipeline. So that group has essentially spent the first 2 or 3 months with us growing their pipeline and getting it to a position where indeed they'll begin funding volume for us. We expect that they're right at the cusp of profitability based upon the numbers that we've seen through March 31 from that group and then as well some of the activity we've seen in April. So we still think that, that execution of that strategic acquisition was wise, particularly because it was retail banking or a retail channel and a group that -- or a market that we were not currently serving. So we think that acquisition will be additive to earnings in that division essentially beginning in the June quarter.

Great. That's really helpful. And then a question on deposit costs. So you've done a nice job over the last year of bringing down deposit costs, mix shifting, increasing some of those lower-costing deposit accounts. How -- some background of how you've been able to be successful in doing that and just could that continue to occur?

Well, I think -- we can't take all of the credit because I think the industry -- or at least our competitors are a bit more disciplined than what we've seen in the past with respect to activity in deposit gathering and competitive pressures. Additionally as well, when you think about what the FOMC has done, they increased one time and then 2 quick times. So we've had 3 25 basis point increases but over a relatively long period of time that has not given the consumer the idea that interest rates are going up tremendously in a short period of time. Having said that, we've also been very disciplined. And the pressure on our balance sheet is a little bit different than others, again because as interest rates increase and as our held-for-sale balances decline it automatically increases our cash positions. So we're not funding -- or there's a significant percentage of our balance sheet that is being funded on a short-term basis and not on a long-term basis. So as we think about liquidity and the like, we're not pressured in a rising rate environment like many are because we have assets turning to cash much more quickly. As a result of that, we could essentially be slow to match competitors when they do begin to raise rates.

Our next question is from Tim O'Brien with Sandler O'Neill.

Do you guys have any stock options that are impacted by that accounting rule change down the road?

So we've not gone through the calculation at this point. We adopt on July 1, so the impact will be in the September 30 quarter. As it relates to the March quarter, we did have disqualifying dispositions of exercised incentive stock options. And as a result, it created a tax benefit. So the tax benefit that was created in the March quarter was normal activity, if you will, of existing stock options. Unfortunately, our pretax earnings were lower than they've been in prior quarters. So the disqualifying disposition of those ISOs and the tax benefit created was a larger -- or had a larger impact, which drove our tax rate down in the March quarter. So when we adopt with respect to the new accounting provision, we will have an impact in September or in the July 1 or September 30 quarter. We just haven't done the calculations around it yet.

And then the baseline cost of having the Atascadero group in place, that was fully realized -- that was only partially realized because they came on in early February. So we haven't had a full quarter run rate of kind of their base cost hit the P&L yet, right?

Well, yes, as it relates to production impact as well as their loss impact. There are also fixed expenses associated with bringing the group on that are also transitionary, so we expect that those fixed costs will be dissipated in the [December] as well in comparison to the March quarter. So when we kind of look at that group all in, you obviously look at first 3 (inaudible) would probably be unprofitable as a branch, retail branch for us. But after that time, we would expect profitability coming out of that retail branch.

And then it looks to me like you guys have had recoveries for about the past 9 or 10 quarters straight, net interest -- net charge-off, recoveries on previously charge-off loans. Any color on that, Donavon? Is that going to -- is that just a gift -- is that a perpetuity, Donavon, for Provident?

Well, I don't know that it's in perpetuity. But if you remember, we have a number of loans that have been previously charged off. And in some cases, they're essentially paying current, but they're on a cost basis. So we can't recognize the income until the previously charged-off amounts are essentially cared for. And that populates recoveries back into the allowance, which then allows us to analyze that on quarter end whether or not we need the provision. There is still a group of loans out there in those buckets. And as a result of that and with no other deterioration in the portfolio to speak of, yes, it wouldn't surprise me for recoveries to go on for another year or so, provided the real estate market doesn't reverse its trend. Because even if we have a loan that somehow gets into trouble with the collateral value has only gone up, and we really don't experience losses on current deterioration with respect to the loans that get into a poor position.

And then last question. Do you expect -- is your outlook for -- how much in loans -- this is a 2-part question. Can you give me the number, Craig, on in-house underwritten loans that funded this quarter? Or drew -- were increased draws? I think you gave that earlier in the call, and I didn't -- wasn't able to get that jotted down.

Yes. It's $58 million.

Yes. That -- both purchases and originations were $58 million the March quarter. Originations and purchases in the second quarter was $63.4 million, and originations and purchases in the first quarter was $58.3 million. In the third quarter or the March quarter, we purchased $10 million -- approximately $10 million of single-family loans. And that was it with respect to purchases. The other origination volume, we had an increase in loans originated -- single-family loans originated for sale out of mortgage banking. That was approximately $19 million. And then we had multi family, commercial real estate and construction originated as well. So if you think about our quarterly run rate as it relates to origination and purchase volume for the held-for-investment portfolio, it's $60 million or so per quarter.

Kind of hanging in there?

Yes. It's hanging in there. We're seeing more opportunities in single family. We're seeing more packages, and many of these packages are adjustable rate. It's something that we can repackage and execute on.

How much in adjustable-rate held-for-investment single family did you guys -- Craig, you alluded to this that production -- that opportunities are -- you see more opportunities to underwrite single-family loans that you guys had actually -- that would fit in your held-for-investment portfolio. How much in production did you guys do this quarter?

It was $19 million, yes.

That's -- and you kept it all, obviously, right?

Yes.

That was for us, yes.

Great.

We also did some adjustable-rate loans that didn't meet our portfolio criteria from an underwriting perspective that we may have sold also. But the pipeline of adjustable-rate portfolio loans coming out of the mortgage banking division has been growing steadily since the rise in rates began, call it, November and December of last year.

Our next question is from Tim Coffey with FIG Partners.

Can you guys kind of provide some color on production this last quarter as it relates to kind of the March period versus the 2 previous months? Did it get better? Was it about the same?

No. The March quarter picked up -- or I'm sorry, the March month picked up as we went through the quarter, so January was pretty slow. February was a little better, and March was a little better still. And I think that had to do with the typical spring buying season, people coming out of the holidays and pipelines beginning to build. It is telling if you look at our investor presentation, the volume funded in the March quarter shifted considerably in mix. We went to 62% of the volume in purchase money activity and 38% of the volume in refinance activity. In the December quarter, it was 55% refinanced, 45% purchased. So I think the purchase market is still pretty good. In fact, I think the numbers I've seen by the MBA, California realtors and others suggest that purchase activity has actually grown in the March quarter in comparison to December and maybe even year-over-year. I can't remember that specifically, but maybe even year-over-year. Our volume decline is really the result of refinance activity declining, which can be pegged to interest rates. Maybe the more interesting question is whether or not inventories will actually rise. We've been talking 2 years about inventories being below normal, and we still hear that from our contacts in the industry. There is not the same degree of housing turnover that there once was as a result of either the move-up or move-down markets. And so inventory is low. Supply is low. And as a result, that actually compresses purchase money activity as well.

Okay. So those 2 combinations, the lower turnover and the lower refi volume, kind of underpin your thesis that production in next quarter could be somewhat less than we saw in the year-ago quarter, correct?

Yes. I think the June quarter of last year was -- is probably going to be a stronger quarter than the June quarter of this year, but I would expect our June quarter of this year to do better than we did in December quarter or the March quarter.

Okay, okay. And then kind of the changes you've made in the staff in the mortgage bank, if you can kind of put that in context. Is -- are you appropriately staff if originations become -- are less than your expectations? Or would you have to make more adjustments to mortgage banking staffing levels?

I think we would have to make more adjustments if we didn't see origination volume come back from where we were in the December or March quarters. But again, we've already essentially completed a 15% reduction in force in the March quarter when we extract out the Atascadero group that we picked up. But we're very -- it's very difficult to make that decision in the backing without having some type of forecast with respect to where we think origination volumes are going to go.

Yes, that's helpful. It's very helpful. And then kind of -- you talked about the pricing on what you're seeing from loan purchases in the market as it relates to single-family residential. Have you seen any improvements in pricing of loans that's in the market for CRE or multifamily?

Everybody's still pretty proud of their multifamily production in particular, so we didn't execute a purchase in the March quarter. We executed purchases in multifamily in the December and September quarter. We just couldn't put anything together in the March quarter. And we see packages, and we look at it. But we're cautious with respect to multifamily, in particular. That seems still to be a pretty toppy market when we start thinking about cap rates and the like. So part of it I suppose is that our credit culture is a little bit tighter than some. There are packages out there and available. They might have declined a bit just because interest rates from just a pure level have gone up. But it still typically trades at a premium.

Our next question comes from Fred Cannon of KBW.

Great. Just had a few kind of follow-up questions. Could you give me a little color on the type of variable-rate loans that you're originating now and you've seen the market shift to? Is it 3/1, 5/1, 7/1? Just curious what the...

They're mostly 5/1s for the most part, and there's an occasional 7/1. Yes, there's an occasional 3/1, but it seems like the 5/1 probably is most popular.

Okay. And it seems to be priced best relative to what consumer is looking for?

Well, we price it best relative to what the consumer is looking for. I know we could get more volume in 7/1 and 10/1 if we're willing to take the interest rate risk. But when we look at what competitors are pricing 7/1 and 10/1 products, we're just not comfortable in pricing or meeting competitors with respect to those prices.

Great. And on the net interest margin, I mean, I would suspect that we would see -- continue to see some moderate pressure going forward. I mean, deposit pricing remains pretty constrained. But given the structure of your balance sheet, even that much has increased in deposit costs, it all should put some pressure on the net interest margin. Am I thinking about that correct?

Well, one thing we like to point out are the number of the loans or the dollar amount of loans in our portfolio that are repricing in less than 1 year. It's a significant percentage of the portfolio. So we think net interest margin without the complication of the loans-held-for-sale balance, if you will, could actually expand. In other words, we think we're asset sensitive on the pure balance sheet. What complicates our balance sheet is the held-for-sale balance. If we deployed out a larger percentage of that cash in the held for sale because our pipelines are growing, our held-for-sale balances are growing, volume is growing, we wouldn't have seen the compression we saw this quarter with respect to net interest margin. So I think as we think about the June and September quarters or the next 6 months, we would expect mortgage banking volumes to recover from the December and March quarter levels, which means held-for-sale balances should go up, which means we're redeploying out of cash in the held for sale actually supporting our margin.

Okay, great. That's very helpful. I can see how that held for sale will change. And finally, just as a follow-up on the expense question from Brian Zabora. Your efficiency ratio the last 6 quarters in your slide deck has been in the kind of 80% to 90% range. Do you foresee sometime in the future where we might be able to get below that 80% to 90% range?

Well, yes. When mortgage banking, which is a significant composition of total revenues, is actually in a better position or a better environment. When -- if we were to look back 2, 3, 4 years, we had efficiency ratios below 70% when the mortgage banking unit was contributing a larger percentage when volumes were up. So the answer is yes. We can see better efficiency ratio levels at some point in the future, but it would not be without an improvement in the mortgage banking environment.

Right. Okay, yes. And it's fairly meaningful improvement from the current situation, correct?

Yes. Meaningful or us rightsizing the business into the current environment.

(Operator Instructions) And there are no further questions. Please continue.

Okay, Amy. We're going to go ahead and wish everyone a good year, and we look forward to speaking with you all at the next -- our next quarterly report. So thank you.

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