Provident Financial Holdings, Inc.
Q3 2017 Earnings Call Transcript

Published: 29 Apr 2017

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Third 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 at that time. [Operator Instructions] 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 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, 2016, 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 third quarter results. You will note that our mortgage banking business demonstrated mixed results this quarter with an improving loan sale margin below lower origination volume. New applications declined in the March 2016 quarter as a result of higher mortgage rates. The weakness in applications resulted in the lowest lock pipeline when compared to March 31, 2016 quarter end, but is somewhat higher in lock pipeline when compared to 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, 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 a traditional spring buying season. The loan sale margin for the quarter ended March 31, 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 in the cash markets. The mortgage banking FTE count on March 31, 2017 decreased from December 31 2016, and we currently employ 288 FTE in mortgage banking, down from the 306 FTE employed on December 31, 2016. During the quarter, we decreased our origination staff by five professionals, while our fulfillment staff declined by 29 professionals. We will 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’d also like to describe new 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 the strategic expansion of this nature even during the current mortgage banking environment because selective expansion in the more profitable retail channel is difficult to execute in any environment. This type of opportunity does not come along at often. At the same time, we closed two retail mortgage banking offices during the quarter, Westlake Village and Elk Grove. Westlake Village has been a marginal performer that we choose to close given the poor environment. In Elk Grove, we lost a small group of that office to a competitor. In the community banking business, loans originated and purchased for investment increased to $39 million from the $48 million in the prior sequential quarter with single-family loans originated for 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 has 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 highs. However, I’d 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 rates single-family market conditions and believe it will result in future opportunities to grow our loan portfolio. We’re very pleased with credit quality and you’ll 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 group size in classified assets remain at very low levels and now just $18.7 million, which is very manageable. Credit quality activity resulted in a negative provision of $165,000 for the quarter ended March 31, 2017. Net recoveries were $49,000 for the March 2017 quarter compared to net recoveries of $16,000 during the December 2016 quarter, and net recoveries of $205,000 during the September 2016 quarter. We are 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 lower average balance of loans held at sale. Our short-term strategy for balance sheet management is unchanged from last quarter. We believe that re-leveraging 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 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 March 2017 quarter, we repurchased approximately 9,000 shares of our common stock, and continue to believe that executing on stock repurchases is a wise use of capital in this current environment. We encourage everyone to review our March 31 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. Amy?

[Operator:]

[Operator Instructions] Our first question is from Brian Zabora with Hovde Group. Please go ahead.

[Brian Zabora:]

Hi, good morning.

[Craig Blunden:]

Good morning.

[Donavon Ternes:]

Good morning.

[Brian Zabora:]

First question on expenses, given the new group that you just hired and then still kind of right sizing for the environment. Any sense of how we can look at expense going forward either maybe an efficient ratio kind of target or any maybe on a dollar map that you can provide?

[Craig Blunden:]

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 a 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 two 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 work force 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 two or three months with us growing their pipeline and getting into a position where indeed they will 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, that strategic acquisitions was wise particularly, because it was retail banking, or retail channel and a group that – or a market that we were not currently serving. So we think that acquisition will be added to earnings in that division essentially beginning in the June quarter.

[Brian Zabora:]

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

[Donavon Ternes:]

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 in competitive pressures Additionally, as well what do you think about what the FOMC has done, they increased one time and then two quick time. 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. And as a result of that, we could essentially be slow to match competitors when they do begin to raise rates.

[Brian Zabora:]

All right, great. Thanks for all the color and thank you for taking my questions.

[Donavon Ternes:]

Thank you.

[Operator:]

Our next question is from Tim O’Brien with Sandler O’Neill. Please go ahead.

[Timothy O’Brien:]

Good morning.

[Craig Blunden:]

Good morning, Tim.

[Donavon Ternes:]

Good morning.

[Timothy O’Brien:]

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

[Donavon Ternes:]

We’ve not gone through the calculation at this point, we adopt on July 1. So the impact would be in the September early quarter. As it relates to the March quarter,we did have disqualifying dispositions exercised instead of 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, the existing stock options. Unfortunately, our pre-tax 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 having 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 July 1 or September 30 quarter. We just haven’t done the calculations around it yet.

[Timothy O’Brien:]

Thank you. 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?

[Donavon Ternes:]

Yes, as it relates to production impact as well as their loss impact, there were also fixed expenses associated with bringing group on that are also transitionary. So we expect that those fixed costs will be dissipated in December as well in comparison to the March quarter. So when we kind of look at that group all in, we obviously look at virtually [Technical Difficulty] would probably be unprofitable as a branch – retail branch for us. But after that time, we would expect profitability coming out of that.

[Timothy O’Brien:]

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 charge – previously, we charged off loans. Any color on that, Donavon? Is that going to – is that just a gift? Is that a perpetuity, Donavon, for Provident?

[Donavon Ternes:]

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 quarter-end whether or not we need to provision. There are 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, the collateral value has only gone up. And we really don’t experience loses on current deterioration with respect to the loans that get into a core position.

[Timothy O’Brien:]

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

[Donavon Ternes:]

Yes, it’s $58 million.

[Craig Blunden:]

Yes, that – both purchases and originations were $58 million for 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 have 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 $60 million or so for the quarter.

[Timothy O’Brien:]

It’s kind of hanging in there?

[Craig Blunden:]

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

[Timothy O’Brien:]

How much an 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 do you guys do this quarter?

[Craig Blunden:]

It was $19 million, yes.

[Timothy O’Brien:]

That’s – and you kept it all, obviously, right?

[Craig Blunden:]

Yes, that was for us, yes.

[Timothy O’Brien:]

Great.

[Donavon Ternes:]

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 rates, portfolio loans coming out of the mortgage banking division has been growing steadily since the rise in the rates began, call it, November and December of last year.

[Timothy O’Brien:]

I could just go on, but I won’t. So I’ll cede the floor. Thanks for the color, guys.

[Donavon Ternes:]

Okay.

[Operator:]

Our next question is from Tim Coffey with FIG Partners. Please go ahead.

[Timothy Coffey:]

Hey, good morning, gentlemen.

[Craig Blunden:]

Good morning.

[Donavon Ternes:]

Good morning.

[Timothy Coffey:]

Can you guys kind of like provide some color on production this last quarter, as it relates to kind of the March period versus the two previous month, but it did get better, was it above the same?

[Donavon Ternes:]

No. The March quarter picked up – 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 has 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 paid to interest rates. Maybe the more interesting question is, whether or not inventories will actually rise. We’ve been talking two 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.

[Timothy Coffey:]

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

[Donavon Ternes:]

Yes, I think the June quarter of last year was – is probably going to be a strong – 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.

[Timothy Coffey:]

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 – or less than your expectations, or would you have to make more adjustments to mortgage banking staffing levels?

[Craig Blunden:]

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.

[Timothy Coffey:]

That’s helpful, it’s very helpful. And then kind of – you talked about the pricing on what you’ve seen from loan purchase 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 their CRE or multi-family?

[Craig Blunden:]

Everybody is still pretty proud of their multi-family production, in particular. So we didn’t execute a purchase in the March quarter. We executed purchases in multi-family in the December and the September quarter. But 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 multi-family, 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.

[Timothy Coffey:]

All right. Well, thank you, gentlemen. Those are my questions.

[Operator:]

Our next question comes from Fred Cannon of KBW. Please go ahead.

[Fred Cannon:]

Great. Thanks and thanks for your time and just have a few kind of follow-up questions. Could you give 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…?

[Donavon Ternes:]

They’re mostly 5/1s for the most part, and there’s is an occasional 7/1.

[Fred Cannon:]

Okay.

[Donavon Ternes:]

Yes, there’s an occasional 3/11, but it seems like the 5/1 profit is the is most popular.

[Fred Cannon:]

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

[Donavon Ternes:]

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 what we look at what competitors are pricing 7/1 and 10/1 products, we’re just not comfortable in pricing for leading competitors with respect to those prices.

[Fred Cannon:]

Great, thanks. 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 price remains pretty constrained. But given the structure of your balance sheet even much of the increase in deposit costs at all should put some pressure on the net interest margin. Am I thinking about that correct?

[Donavon Ternes:]

Well, one thing we would like to point out are the number of loans or the dollar amount of loans in our portfolio that are repricing in less than one 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 deploy 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 interest margin. So I think as we think about the June and September quarters, or the next six months, we would expect mortgage banking volumes to recover from the December and March quarter levels, which we held for sale balances should go up, which means we’re redeploying out of cash in the held for sale actually supporting our margins.

[Fred Cannon:]

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

[Craig Blunden:]

Yes. when mortgage banking, which is a significant composition of total revenues is actually in a better position or better environment. When we were to look back two, three, four 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.

[Fred Cannon:]

Right. Okay, yes, and fairly meaningful improvement in the current situation, correct?

[Craig Blunden:]

Yes, meaningful or as rightsizing the business into the current environment.

[Fred Cannon:]

Okay, great. Thanks again for your time. I appreciate it.

[Craig Blunden:]

Thanks, Fred.

[Operator:]

[Operator Instructions] And there are no further questions. Please continue.

[Craig Blunden:]

Okay. we’re going to go ahead and wish everyone a good year, and we look forward to speaking with you all at the next quarter review report. So thank you.

[Operator:]

Ladies and gentlemen, this conference will be available for replay after 11