Provident Financial Holdings, Inc.
Q2 2018 Earnings Call Transcript

Published: 30 Jan 2018

[Operator:]

Ladies and gentlemen, thank you very much for standing by. And welcome to the Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given to you at that time. [Operator Instructions] Also as a reminder, this conference is being recorded. I'd now like to turn the conference over to our host, Mr. Craig Blunden. Please go ahead.

[Craig Blunden:]

Thank you and 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 and the Annual Report on Form 10-K for the year ended June 30, 2017, and for 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 second quarter results. I'd like to begin this morning by highlighting the results in our community banking business. Over the course of the last year, our net interest margin expanded, our loan growth has been consistent, core deposits continue to grow and credit quality remains strong. In the most recent quarter, loans originated and purchased for investment increased to $22 million from $20 million in the prior sequential quarter. And single-family loans originated for portfolio from the mortgage banking division decreased to $12 million in the December 2017 quarter from $25 million in the prior sequential quarter. Although the portfolio loan byline is down on a sequential quarter basis, this clearly suggests that this is a newly developing trend particularly since the December quarter is heavily influenced by the holidays. During the quarter, we also experienced $57.4 million of loan principal payments and pay offs, which is up from the $43.4 million in the September 2017 quarter and still tempering the growth rate of loans held for investment. Additionally, we estimate the increase and acceleration amortization net preferred loan cost associated with loan pay offs in December quarter in comparison to the September quarter reduced our net interest margin by approximately 7 basis points. For the 12 months ended December 31, 2017, loans held for investment increased by approximately 2% a reasonable pace of growth. But preferred loans, a component of loans held for investment grew at a 3% rate. We're somewhat disappointed with this growth rate for rolling NewStar underwriting standards which goes against our credit culture, flat burn incurrence by the outlook for single family adjust rate originations and purchase opportunities as a result of the rise in fixed mortgage interest rates and believe will result in future opportunities to accelerate the growth of our loan portfolio. We're very pleased with the credit quality and you'll note that early stage delinquencies are approximately $1.5 million at December 31, 2017, essentially unchanged from September 30, 2017, and very low from an entire credit cycle perspective. In fact, total criticized in classified assets remain at very low levels and are just $13.8 million, which is down from the $21.2 million at December 31, 2016, a 35% decline over the course of the year. We experienced a small recovery of $23,000 from the quarter ended December 31, 2017, compared to a modest net charge off of $145,000 for the September 2017 quarter and net recoveries of $141,000 during the June '17 quarter. As a result we recorded $11,000 negative provision in December 2017 quarter. We are pleased with these credit quality results. Our net interest margin expanded by 3 basis points for the six months ended December 31, 2017 compared to the same period last year as a result of a 2 basis point increase in average yield of total interest-earning assets and a 2 basis point decrease in the cost of interest-bearing liabilities. Should we note that our deposit cost declined by 4 basis points in the six months ended December 3, 2017, compared to the same period last year? Over the course of last year we've been able to hold the line on the cost of core deposits, while increasing the balance of core deposits and decreasing the balance of time deposits. You'll notice we're still adjusting our mortgage banking business model to respond to generally poor mortgage banking environment. We currently employed 212 FTE and mortgage banking, down from the 237 FTE employed on September 30, 2017. During the quarter, we reduced our origination staff by six professionals, while our fulfillment staff declined by 19 professionals. The adjustments are more pronounced for the calendar year from which period our origination staff declined 24% and our performance staff is delinked by 34% for a total reduction of 31% in the mortgage banking division. We like our competitors are responding to less favorable environment by taking capacity out of that platform. It is unclear to date when sufficient capacity will improve from the industry to allow mortgage banking originators to return to more profitable operations. New applications decreased in the December 2017 quarter and there was weakness in new application towards the end of the quarter consistent to the prior years, where new applications declined during the holidays. Based on current information we would expect volumes in the March 2018 quarter to be similar to volumes of December 2017 quarter, but more than the volumes of the March 2017 quarter last year. The loan tier margin for the quarter ended December 31, 2017 improved from the prior sequential and has climbed to the higher end of the range, but pricing pressure remains a concern throughout the industry. Our participants are pricing more aggressively in an effort to maintain market share. We will continue to adjust our business model and FTE count as we have in the past commensurate to changes in market opportunities in the mortgage banking operating environment. During the past 12 years, we've reduced capacity more closely aligned to the current opportunities in the market, which reflects uptick in purchase money activity, but a significant decline in refinance activity. Additionally, we are in the process of converting to a new loan origination system which will be much more efficient for our mortgage banking operations when fully implemented. The new system will allow us to move more quickly to a paperless environment and streamline the application process, underwriting and funding function for customers, third-party service providers and employees. We've converted all of our retail brands to the new system and we will be converting our wholesale brands over the next few months. As we saw, we expect to decommission our legacy system by June 30 and will no longer be absorbing the cost of operating this system. Our short term strategy for balance sheet management is unchanged from the last quarter. We believe that we're leveraging the balance sheet with proved loan portfolio growth with best course of action. For the foreseeable future, we believe that we maintaining a significant cushion above the regulatory capitals of 8% for tier 1 leverage and 13% total risk base is essential and we're confident we'll 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 December 2017 quarter, we repurchased approximately 141,000 shares of our common stock, and continue to believe that executing on our stock repurchases is a wise use of capital in the current environment. Over the course of the past year, we've executed substantial returns of capital to shareholders in the form of cash dividends and stock repurchases. Furthermore, we're generally pleased with the newly enacted tax legislation as it relates to lower corporate tax rates to all our future tax obligations of the company, thereby improving net income and supporting our ability to return capital to shareholders, employment cash dividends and stock repurchases. We encourage everyone to review our December 30 Investor Presentation posted on our website. You will 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 future growth of the company. We will now entertain any questions you may have regarding our financial results. Thank you.

[Operator:]

Thank you. [Operator Instructions] And we do a question from the line of Tim O'Brien - Sandler O'Neill & Partners. Please go ahead.

[Tim O'Brien:]

Good morning, guys.

[Craig Blunden:]

Good morning.

[Tim O'Brien:]

Hey Craig, could you explain again - you said the margin was down sequentially by 7 basis points due to lower amortization of - was it differed cost or - can you give that detail again?

[Donavon Ternes:]

Yeah. Tim, its Donavon. So the amortization of net differed loan costs were accelerated or are accelerated anytime a loan pays off. And in the December quarter the particular set or sub set of loans that paid off had net deferred loan cost associated with them that were approximately $200,000 more in the December quarter in comparison to the September quarter and when you annualize our $200,000 number to $800,000, that's above the 7 basis points decline in our net interest margin. We don't have control over which loans pay off obviously. But the growth volumes have net differed cost associated with them in contrast to net differed income and so depending upon which loans pay off and how much pays off in a given quarter, it can have an impact like it did this quarter with respect to the net interest margin.

[Tim O'Brien:]

And then getting back, you gave some detail about - so head for investment loan balances were down sequentially and you talked about the pay offs being elevated at 57.4 million. Can you give a little bit more color on what precipitated that or - it seems a bit unusual or it's a volatile extreme I guess. Can you give a little bit of color on what happened exactly there?

[Craig Blunden:]

Yeah, a lot of it is with respect to our origination volume in the first six months of this fiscal year in contrast to the last fiscal year with the decline in the number of purchases that we had. In the first six months of last year, we purchased $49.3 million of loans were held for investments. In the first six months of this year, we purchased $3.1 million. That $46 million difference in the amount of loans we purchased for investments really impacted the growth that we saw in our portfolio, of course, coupled with the larger amounts of pay offs in the December quarter in contrast to the December quarter last year.

[Tim O'Brien:]

Was there anything you can generalize or characterize? Any reason for the decline in purchases in those periods, was it pricing driven or is it structure driven or was it credit driven or is it - or is it any - or maybe it was a combination really, I don't know. Maybe there were fewer offerings which are left on the shelf to look at out there. What's that all about?

[Craig Blunden:]

So I think it's a combination of a number of factors. I think you probably - you found generally that the industry is posting lower growth with respect to their held for investment loan portfolios and as a result I think that helped taking some capacity out of the industry as it relates to purchase activity for those of us who purchased some loans. But on top of that we've all seen packages most recently, we've not been able to get better on the price of those loans, so we've not gotten into the underwriting per say, because we've not even obtained the loans filed or the package of loan files to underwrite. We've never been able to get better on price and I think that's a matter of price transparency as a result of raising more interest rates in the COE sector. We've seen that those rates have gone up, so I think that's kind of temporary. And then historically as well our credit marks might be a bit tighter than others. I think it's slightly the fact that it is and sometimes when you see those packages and individual loans associated with those packages, would not necessarily be together with respect to the credit quality of the portfolio.

[Tim O'Brien:]

And then is there a - what's the outlook or - purchase for loan offerings here on the market right now, is there been any improvement at the start of the year or this far end of the year? At the end of the first month of the calendar year, are you seeing any better flow there or is it pretty much static with what you experienced in the fourth quarter?

[Craig Blunden:]

It's similar to what we experienced in the fourth quarter. We've looked at a couple of packages already in January and the stumbling block has been priced. We've not been able to get together end price with respect to the packages. We did that calendar year where they were for probably 18 million or in January.

[Tim O'Brien:]

And that's just a reflection again in part to the general situation in the market, which is slower velocity or there's just less production going on, so these loans are more dear, so they're getting priced up sellers and who want more, form, is that a fair assessment?

[Craig Blunden:]

Yeah, I think that's a fair assessment. The real price we get let alone the [indiscernible] and while we may be willing to give up a better view because we are not originating the products, we are not going to hand that pretty non-sectional yield in product that it becomes a concern a year from now or two years from now. Again because both of these mortgages are probably five year fixed and if it's newly originated production is about five years, with respect to the interest rate, we expand each of those.

[Tim O'Brien:]

And then shifting gears really quickly, the legacy underwriting system that you guys are going to switch offline by June 30, what's the cost, the quarterly dollar cost of operating? Do you have some - can you characterize that? I know that it probably varies, but what's the range been quarter-to-quarter through a typical year? Can you characterize that at all? And how much - by extension, I just want to get to, how much is going to come out of overhead cost when that gets shut down?

[Craig Blunden:]

Right, so we are not prepared to talk about the specific class because we are still implementing. Here's what I would say however, we are carrying too long origination systems or too long operating systems on our books right now. And we are paying costs associated with both of those systems as we have been deploying a new system. Beginning in January of this year, the maintenance cost associated with the legacy system will come down by approximately 40,000 per month depending upon what we have to do between January 1 and June 30, with respect to the long term on that system. In other words, we still have to keep that system maintained with respect to all the regulatory parts and we'll continue to do so. But, right now we are paying for two systems, that one system is going to be declined price by about 40,000 a month between January 1 with respect to its maintenance because essentially they we're originating our new applications are moving on to the new system in our field. So, that's one bit of cost that comes out relatively soon. As it relates to July 1, we're really not prepared to talk about it. If we speak about it from a free conversion perspective, I think the actual cost associated with the new system won't be substantially different from what the costs were with respect to the old system, when you are simply on the old system. But, it will be different because we are not going to be paying for both of those as we will have total conversion by June 30 or so.

[Tim O'Brien:]

So, the benefit of the new system verses the old system is, probably - there's a probably compliance element to it and it's probably less cumbersome to operate, so it's a little bit more efficient there. But, other than that, the cost is going to be the same?

[Craig Blunden:]

Approximately from the hard cost perspective, but that's before deploying the new system capabilities which is essentially papers, applications from application the funding stage. Right now there's still a lot of paper being driven on our legacy system. So, there will be some benefits with respect to that. That also suggests the efficiencies with respect to processing and underwriting loan files or would be more easily deployed as it related to a particular office, maybe having some capacity to process a fund in another office site. Right now it's very cumbersome for those efficiencies to work out. Once we deploy the new system, it will be much less cumbersome. So, there are a number of benefits with the new system, both from our compliance regulatory perspective and it could be a new better system than what are old legacy system was. Which by the way, it's pretty much an in-house system. We had a core solution provider with respect to that system, but we also own the code. So we were programming that system for regulatory changes and the like and we had a staff on board that was able to do that, that will no longer be required on the new system since it's a hosted system rather than an in-house system.

[Tim O'Brien:]

And then quickly, Craig, you said that mortgage unit staff was down 31%, what was the period - what were the periods you were comparing?

[Craig Blunden:]

That's January 1through December 31, right, so calendar 2017.

[Tim O'Brien:]

2017 verses 2016?

[Craig Blunden:]

Yes.

[Tim O'Brien:]

Okay, and then last question, just one more follow-up back to the loan side. What was the driver behind the 57 points, can you give color on the 57. 4 million, that elevation in principle pay downs to payoffs, what was atypical about that versus what we would normally expect to see? Was it just that there was a roll in the tenure and rates were attractive and there was a bunch of refined pricing away that these guys moved away or may be some transactions that probably got sold what have you, if that was elevated there, what was it?

[Donavon Ternes:]

We really don't know Tim. I can't call that, you have lots of ideas there, may be some of them true. It's really no way to guess on pre-payments on this.

[Tim O'Brien:]

Okay, thanks for answering my questions.

[Donavon Ternes:]

Yes, thank you.

[Operator:]

[Operator Instructions] And there are no further questions in queue, please continue.

[Craig Blunden:]

Well if there are no further questions, we appreciate everyone joining us on our quarterly conference call and look forward to speaking with you next quarter. Thank you.

[Operator:]

Thank you ladies and gentlemen. This conference call will be available for replay starting today at 11 am and will run until February 6 at midnight. You may access the replay service by dialing 1-800-475-6701 and entering the access code of 443110. Those numbers again, 1-800-475-6701 and entering the access code of 443110. That does conclude your conference for today. Thank you very much for your participation and for using the AT&T executive teleconference. You may now disconnect.