Provident Financial Holdings, Inc.
Q2 2019 Earnings Call Transcript

Published: 29 Jan 2019

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Second Quarter Earnings Call. [Operator Instructions]. As a reminder, today's call is being recorded. I would now like to turn the call over to your host, Craig Blunden. Please go ahead, sir.

[Craig Blunden:]

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 will 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 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, 2018, 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're 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 second quarter results. I would like to begin this morning by highlighting the results of our community banking business. Over the course of last year, our net interest margin has expanded, core deposits have been stable, credit quality remained strong, but our loan growth has been below our expectations as a result of significant prepayments and disciplined underwriting standards reducing loan origination volume. In the most recent quarter, the community banking and staff originated and purchased $15 million of loans held-for-investment, a decrease from the $21 million in the prior sequential quarter. And single family homes originated for the portfolio from the mortgage banking division increased to $24 million in the December 2018 quarter from $16 million in the prior sequential quarter. During the quarter, we also experienced $41.2 million of loan principal payments and payoffs, which is down from the $62.9 million in the September 2018 quarter, but still tempering the growth that rate of loans held-for-investment. Additionally, we estimate that the decrease and acceleration of amortization and net deferred loan costs associated with the lower loan payoffs in the December quarter in comparison to the average of previous five quarters improved our net interest margin by approximately one basis point this quarter. For the 12-months ended December 31, 2018, loans held-for-investment declined by approximately 1%, with the largest declines in multi-family and construction, partially offset by growth in commercial real estate loans. Competition for new loan production is intense and we will not chase loan production volume, but be much leasing our underwriting standards to do so. Clearly, some lenders have done so, given the overly competitive environment. We are very pleased with the credit quality even though but early stage delinquency balances were negligible at December 31, 2018, for the second consecutive quarter. In addition non-performing assets remain at very low levels and are now just $6.1 million which is down from $8.6 million at December 31, 2017, a 30% decline during the course of the year. We experienced a net recovery of $123,000 during the quarter ended December 31, 2018 compared to modest net recovery of $7,000 for the September 2018 quarter, and a net recovery of $43,000 during the June 2018 quarter. As a result with low levels of non-performing and classified assets and the net recovery for successful year-to-date, we recorded a $217,000 negative provision in December 2018 quarter. We are very pleased with these credit quality results. Our net interest margin expanded by 46 basis points for the quarter ended December 31, 2018, compared to the same quarter last year as a result of the 48 basis point increase in the average yields on total interest earning assets firstly offset by a two basis point increase in the cost of interest bearing liabilities. Should be noted that our average cost deposits increased by just two basis points for the quarter ended December 31, 2018, compared to the same quarter last year. The net interest margin is augmented by approximately 10 basis points this quarter with the recognition of interest income from two non-performing loans that were paid in full and the special cash dividend received from the Federal Home Loan Bank San Francisco stock. Over the course of the past 12 months, we have been able to hold the line on the cost of core deposits while maintaining the balance of core deposits and decreasing the balance of time deposits. Also note that our net interest margin expanded to 3.54% for the December 2018 quarter, the highest level in many years. We’re still adjusting our mortgage banking business model to respond to a generally more challenging mortgage banking environment. We currently employed 148 FTE in mortgage banking down from 169 FTE employed on September 30, 2018. During the quarter, we reduced our origination staff by four professionals while our performance staff declined by 17 professionals. The adjustments are more pronounced by December 31, 2016, when we first started reducing our origination capacity conventional exchanges and market opportunities. Since then our origination staff has declined by 40%, our performance staff has declined by 58%, for a total staff reduction of 52% in the mortgage banking division. Similar to the actions of our competitors responding to the less favorable environment by taking capacity out of our platform. New mortgage loan applications decreased in the December 2018 quarter from the prior sequential quarter, and based on current information, we would expect volumes in the March 2019 quarter to be lower from the December 2018 quarter and significantly lower than the March 2018 quarter. The loan sale margin for the quarter ended December 31, 2018, was similar to the prior sequential quarter remaining at the high-end of the range. We resisted the competitive pricing pressure recognizing that lower loan sale margins but not necessarily successfully offset the higher loan origination volumes. We will continue to do adjust our mortgage, our business model, and FTE calendar we have cut down in the past commensurate with changes and market opportunities and the mortgage banking operating environment. During the most recent quarter, we have reduced mortgage banking operating expenses by approximately 24% in comparison to the same quarter last year, combination of fixed cost and variable cost savings after adjusting for the litigation settlement expense recorded in last year's quarter. 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% return on leverage and 13% total risk base is wise and are confident that we'll be able to do so. We currently exceed each of these ratios by a significant margin, demonstrating we have the capital to execute on our business plan and capital management goals. Additionally, in the December 2018 quarter, we further delayed our stock repurchase activity, believing that we will have better opportunities to execute on these repurchases in future quarters. Nonetheless, over the course of the year, we have executed substantial returns of capital to shareholders in the form of cash dividends and stock repurchases. We encourage everyone to review our December 31st Investor Presentation posted on our website. You'll find that we’ve included 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 the future growth of the company. We'll now entertain any questions you may have regarding our financial results. Thank you. Kevin?

[Operator:]

Thank you. [Operator Instructions]. And we do have a question from the line of Tim O’Brien, Sandler O’Neill. Please go ahead.

[Tim O’Brien:]

So you talked about releveraging the balance sheet, is it -- you say short-term or long-term strategy, Craig? I need to catch that.

[Craig Blunden:]

Well, it’s worth a shift. It would be nice we've short-term but it's looking like long-term at the moment.

[Donavon Ternes:]

In the current environment with respect to what we would argue are more conservative underwriting standards there are many competitors and as a result of that, we are finding that competitive pressures on lower loan origination volumes. We know that from the loans that have gone elsewhere during the application process.

[Tim O’Brien:]

I mean your underwriting requirements have been consistent and that’s been a consistent headwind, I guess for you guys for far back as I can remember, so maybe it’s little more acute now with in the marketplace given similar remarks made by other bankers I have talked to. But is it looking out into the calendar year, do you anticipate being able to make some headway growing your balance sheet, growing loans and will that help you to continue to engage in the mortgage banking business, do you think?

[Craig Blunden:]

Well, I think you’re talking about two separate items. If you're thinking about balance sheet growth, we are really thinking about the community banking business, part of which is well single-family loan origination volume which is primarily adjustable rate with many applicants are not interested in. Although as interest rates have risen there has been more interest by applicants for adjustable rate loans and we will see that as single-family production volume has gone up a bit as a result of that. But if you're looking for speaking to the community bank as it relates to the competitive pressure on origination volume, I think we are seeing some lenders who have actually back off a bit with respect to being so competitive primarily on underwriting terms as a result of the concern with respect to whether or not we're long in the truth every time and the like and whether real estate volumes can really continue going up in the multi-family commercial real estate sector. So I think that will help some. And then another consideration is with respect to prepayments. So to the extent that interest rates have risen which they have and new loans are being originated on the higher interest rate then what maybe in the balance of portfolios across the universe of banks. There conceptually will be fewer loan payoffs that are occurring with respect to that loan -- with respect to those loan portfolios. Now we did see a decline in payoffs in the December quarter from the September quarter and the June quarter of 2018 which September or June was very high numbers and that could help us with respect to maintaining our balance in the portfolio. So it will continue to be a headwind, I think but I think that pressure might be -- it will be aided to some degree with respect to lenders backing off a little bit on aggressiveness and multi-family commercial and with respect to the loan payoffs declining as a result of the rising interest rates.

[Tim O’Brien:]

So talking about the mortgage banking business and looking at the slide deck in your lock pipeline, lock numbers do you had at year-end, are those just some of the lowest you recall seeing in the business?

[Donavon Ternes:]

Yes, they were certainly the lowest with respect to this cycle and remember that that mortgage business is somewhat cyclical as well with December quarter can still be a relatively decent quarter with respect to volumes. But as you work your way through the December quarter, you are essentially funding out of your pipeline because the pipeline doesn’t grow during the Holidays. And then as people come back in January that pipeline begins to build once again but not sufficient offset the decline from the prior quarter. So the March quarter can actually be a lower production volume quarter the entire year. So we would expect weaker volumes in the March quarter than what we saw in the December quarter and we’ve noted that whenever we described ourselves in a current quarter what we would expect, we point everybody back to the locked pipeline that we disclosed and to the locked -- to the extent the locked pipeline is low starting at a very low number, we would expect that that volume then doesn’t keep funded as much through the quarter.

[Tim O’Brien:]

It seems like it’s above 16% last year’s number and obviously historically that March production and March business has been historically seasonally low and but this just seems more acute than typical. I guess looking beyond that at the business, are there any signs, anything in the marketplace that looks promising from the standpoint of your mortgage banking business, you’re looking beyond the March quarter out into the Spring quarter and then into the summer time, anything in Southern California in the housing market that you find could help shot up the business and?

[Craig Blunden:]

Well, it’s hard to say if you think back year ago to what we were talking about, we were looking forward to spring and summer buying seasons except they didn’t happen. We were very quiet compared to the prior years. At this point, the market still seems slow, there is a lot more properties listed for sale, they don’t seem to be moving whether that’s because of the time of the year right now can’t say but we’re not doing or seeing a lot of activity from our real estate business, so with realtors. And so I hesitate we're going to have that strong spring buying season because at this point we just can’t see it.

[Donavon Ternes:]

And the other thing to think about at least in California which is where we conduct our business, so as the interest rates kept going up obviously the refinance volume has declined considerably. And even with rates having come down a bit from kind of the December quarter highs if you will, they are only up by about 40 basis points or so if you will on the third year fixed conforming. That doesn’t necessarily entice an existing borrower to go out and refinance their product. But coupled with that, is the fact that loan sales activity in California have come down to very low numbers. And if you read any data in California really across the entire state, home sales themselves are down as much as 20% on a year-over-year basis and maybe little more in other pockets, a little less in other pockets. But that’s kind of new in this part of the cycle in that not only as refinance volume down but also home sales are down even though inventory is up. And so that doesn’t necessarily suggest that the headwinds are going away anytime soon.

[Tim O’Brien:]

So with that, can you talk a little bit about your commitment to that line of business strategically at this juncture given kind of how poor the outlook is here at this point and how weak volumes have been from a cyclical standpoint and also kind of looking at your quarterly loss levels in that unit, what is your commitment stand relative to where it’s been historically?

[Craig Blunden:]

We just haven’t seen a cycle like this last this long, Tim, a downward cycle, it’s just really surprising and difficult for us to plan what we’re doing, we continue as we’ve noted, we have tried to right-size this thing but just seems like every quarter we’re still little behind on where the volumes are going. And then it's we would have never expected looking to have cycles if we would have been in this position today.

[Tim O’Brien:]

So are you at a point where you can continue to make incremental adjustments to the business that I guess just try to minimize losses in a low production environment?

[Craig Blunden:]

Even in the past, we’ve done some reductions and then 60 days later have to hire the people back. So unfortunately, but so that’s why I think there's a slight lag there, but yes we still can make incremental reductions to that point.

[Donavon Ternes:]

And additionally what you’ve seen if you look at those quarterly losses, essentially the changes that we have been making to reduce capacity and operating expenses have essentially stabilized the losses. So the losses aren’t giving anymore but they’re also not getting reduced, that's because the origination volume is going away as quick, a bit quicker than the changes that we can make. So the operating losses are stabilized, that’s not comforting per se but that’s what has occurred during this cycle.

[Tim O’Brien:]

I noticed that on the operating loss front that there has been some stability there and obviously the profitability of the community bank has offset, you guys have generally stayed profitable and that’s a credit to you given kind of this -- the situation in mortgage banking. One last question as far as launch sale margins are concerned, can you give any color I mean obviously there were some stability and that was a minor positive point of note for the quarter. Can you share any thoughts looking out about the landscape there, is it heading to the direction you don’t like as well kind of given -- given what’s going on in the March quarter or do you feel like that that number is okay and that’s where the market is kind of settled out at this juncture?

[Craig Blunden:]

I think we’re pretty disciplined with respect to our loan sale margin needs. We analyze that daily if you will and we change our pricing daily with respect to what the environment looks like. But I think that the takeaway with respect to where we’re at today in our margin in comparisons to the range that we describe in our Investor deck we are at the high-end of our loan sale margin. I think we will remain disciplined and possibly stay up at that higher end of the range because what we find is we can’t generate enough volume by lowering that loan sale margin to offset the lower margin. So it’s a balancing act between volume and margin, we’ve landed at the high-end of the range right now but that doesn’t mean that we would chase some additional volume that we saw that was really there and couldn't get paid towards that additional volume by lowering our margin. So it’s settled where it is right now, we’re going to be in that range, I would expect and maybe at the top end of that range.

[Operator:]

Thank you. Our next question is from the line of Kevin Swanson, Hovde Group. Please go ahead.

[Kevin Swanson:]

Maybe just one question kind of follow-up, have you guys seen any change in the overall level of non-bank competitors, I think maybe some commentary out of the few who have seen some consolidation, just curious if you’re seeing on that front?

[Craig Blunden:]

With respect to mortgage banking competitors?

[Kevin Swanson:]

Yes.

[Craig Blunden:]

Yes, I mean there are competitors that are non-bank competitors that maybe don't have the staying power that banker, a mortgage banker or true bank, community bank has. And so yes, we've also seen some of those pressures. Kind of another thing we’ve seen in this quarter at least from a few, those that are holding the servicing portfolio, they have not necessarily been able to market that servicing portfolio to offset the origination losses and in fact because interest rates have come down, pre-maintenance fees in their models have probably gone up that and they’ve actually had to mark those servicing portfolios down in some cases from the higher end of the servicing portfolio range. So that would also add pressure with respect to profitability for some of these non-bank competitors that hold tremendous amount of servicing.

[Kevin Swanson:]

Okay. And just curious on the kind of the business you guys are doing the mortgage banking, how is there a percentage on competition with these non-banks like do you all grow each loan, is it a couple of them, is it maybe one, maybe once in a while just kind of curious?

[Craig Blunden:]

It’s increasing that will be the best way to put it especially by the direct lenders, non-bank direct lenders.

[Donavon Ternes:]

And the other thing that we’re seeing, we’re QM lender, we are seeing many other non-bank lenders who have gone down the path of underwriting and credit standards getting into non-QM product that has increased some but there is a lot of talk around that right now. So I think we are going to see some of that occur as pressure or headwinds persist, you’ll see some lenders put down the credit curve and except used to underwriting standards in order to keep that volumes, that’s not something we’re interested in at this stage.

[Craig Blunden:]

And by the way we’ve seen that from bank competitors as well just not non-bank.

[Kevin Swanson:]

Okay. Yes, I guess that kind of leads me for my -- maybe my final question, obviously credit for you guys continues to steadily improve, are you guys seeing anything to suggest the cycle may return, I know you mentioned that it seems like maybe houses are staying on the market for a little bit longer, just curious what you’re seeing on that end?

[Craig Blunden:]

Well I don't -- no, I don’t think so, not at this point, but I think it’s -- a part of it is not interest rates of course it's price and prices are up significantly in most areas above even the peaks of 2007. So until people adjust their prices little more reasonably I think there is lot of people sitting on the headlines saying I don’t want to pay the top of the market and then see you guys pay down after I buy, so they are not just entering and that’s why I’m hearing from a number of realtors that I do business with.

[Donavon Ternes:]

Yes. And so yes there could be some soften -- well in fact we’re seeing it from the data, the rate of increase with price appreciation has gone down, it’s still up year-over-year but it’s up much lesser than it was a year ago and a year prior to that. So price appreciation has certainly come in with respect to the single-family space. With respect to multi-family and commercial we’re not seeing anything in particular in traditional lending, if you will. There might be some things in shared national credits or leverage lending that certainly if you read some of the OCC data or regulatory data, there are some weakness or some softness there. But in the fundamental, our bread and butter multi-family lending or commercial real estate lending, we’re not really seeing anything that would suggest what the top of the market that’s going to soon come in from where it currently is. Again I think we would probably argue the same point that be it a price appreciation in those markets will slow, but at the end of the day debt covers are still there, interest rates are still relatively low by historical standards and there just doesn't seem to be a lot of pressure if you will on core credits in those markets.

[Kevin Swanson:]

Great, that’s really helpful color. All my questions -- all my questions are answered. Thanks guys.

[Craig Blunden:]

Thank you.

[Operator:]

Thank you. [Operator Instructions]. At this time, we have no further questions in queue.

[Craig Blunden:]

If there are no further questions, I appreciate everyone’s participation in our call and I look forward to speaking with all of you again next quarter. Thank you.

[Operator:]

Thank you. Ladies and gentlemen that does conclude your conference. We do thank you for joining. You may now disconnect. Have a good day.