Provident Financial Holdings, Inc.
Q4 2017 Earnings Call Transcript

Published: 26 Jul 2017

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the Fourth Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. 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. 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 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 this morning 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 four quarter results. I’d like to begin this morning by highlighting the strength in our community banking business. Over the course of the last year, our net interest margin has expanded, our loan growth has accelerated, core deposits continue to grow and credit quality remains strong. In the most recent quarter, loans originated and purchased for investment increased to $43 million from $39 million in the prior sequential quarter. And single-family loans originated for portfolio from the mortgage banking division increased to $31 million in the June 2017 quarter from $19 million in the prior sequential quarter. During the quarter, we also experienced $45.5 million of loan principal payments and pay off, which is down from the $46.2 million in the March 2017 quarter and still tempering the growth rate of loans held for investment. Nonetheless, for the 12 months ended June 30, 2017, loans held for investment increased by approximately 8% a reasonable pace of growth. But preferred loans, a component of loans held for investment grew at a more robust 13% rate. We’re pleased with the growth rate of preferred loan balances since changing the composition of loans for investment has a long-term goal. Preferred loans remained at approximately 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 third 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 are very low at approximately $1 million at June 30, 2017 similar to the balance at March 31, 2017, suggesting that meaningful near-term deterioration is unlikely. In fact, total criticized in classified assets remain at very low levels and are just $13.3 million, which is down from $12.9 million at June 30, 2016, a 39% decline over the course of the year. The credit quality improvement resulted in a negative provision of $377,000 for the quarter ended June 30, 2017. Net recoveries were $141,000 for the June 2017 quarter compared to net recoveries of $49,000 from the March 2017 quarter, and net recoveries of $16,000 during December 2016 quarter. We are pleased with these credit quality results. Our net interest margin expanded by 9 basis points in comparison to the March 2017 sequential quarter as a result of lower interest earning deposit balances during the quarter in comparison to the prior sequential quarter. The decrease in interest earning deposit balances was a result of redeployment of excess cash on loans held for investment and purchases of investment securities. You will note that our mortgage banking business demonstrated mix results this quarter, but improving in origination volume with somewhat lower loan sale margin. New applications increased in the June 2017 quarter as a result of the traditional home buying season that will be reduced by lower refinance activity. Additionally there was a weakness in new applications toward the end of the quarter result in a lower locked pipeline at June 30, 2017 when compared to the March 31, 2017 quarter end. Nonetheless, based on current information, we’d expect volume in the September 2017 quarter to be similar to the volumes of June 2017 quarter, but not to the level of the September 2016 quarter last year. Loan sale margin for the quarter ended June 30, 2017 decreased from the prior sequential quarter, but is still near the top of the range. Overall, we were pleased with the loan sale execution for the quarter since our loan sale margin held up pretty well against increased competitive pressures. We will continue to adjust the mortgage banking FTE count as a result of the poor mortgage banking environment. On June 30, 2017, the FTE count decreased from March 31 2017, and we currently employ 253 FTE in mortgage banking, down from the 282 FTE employed on March 31, 2017. During the quarter, we decreased our origination staff by five [ph] professionals, while our fulfillment staff declined by 10 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. During the past six months, we’ve reduced capacity to more closely align to the current opportunities in the market, which reflect an uptick in purchase money activity, but a significant decline in refinance activity. Additional, we are in the process of converting to a new loan origination system that will be much more efficient for our mortgage banking operations when fully up and running. The new system will allow us to move more quickly to a paperless environment and to streamline the application process, underwriting and funding function for customers, third-party service providers and employees. 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 capitals 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 June 2017 quarter, we repurchased approximately 190,000 shares of our common stock, and we continue to believe that executing on 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. We encourage everyone to review our June 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. Roxanne?

[Operator:]

[Operator Instructions] Our first question comes from the line of Brian Zabora with Hovde Group. Please go ahead.

[Brian Zabora:]

Thanks. Good morning.

[Craig Blunden:]

Good morning.

[Donavon Ternes:]

Good morning.

[Brian Zabora:]

First a question on the group of new lenders – Central Coast mortgage originators, were they fully up and running in the quarter or could we see some benefit of that [audio dip] this current quarter?

[Craig Blunden:]

I believe they were fully employed; ready to go and they actually started off pretty quickly surprisingly even better than we expected.

[Donavon Ternes:]

There might have been a little bit less activity in April since we brought them on in February, but when we think about May, certainly June, they were running essentially full-bore with respect to their opportunities and we would have [audio dip] maybe a little bit of lift in the September quarter from the June quarter from that branch, but not significantly so.

[Brian Zabora:]

And is that branch – did they provide you any kind of different types of originations, maybe more portfolioable or is it kind of just like the rest of the group?

[Donavon Ternes:]

The loan size are lower it seems in Central Coast and what we see in North and Southern California. So, there is really no distinction with respect to the programs that they originate into or whether it’s portfolio or not because we have portfolio requirements across the bank, if you will, but we do see a little bit of difference in the loan sizes, which frankly helps out to get in loan sale execution. They are a little bit smaller than Northern and Southern California.

[Brian Zabora:]

Great. Okay. And then just dialing back, it sounds like new system for your – paperless environment for your mortgage operation. When can we expect this to be kind of online and how do [audio dip] expenses, maybe will there be finite expenses and potential savings down the road?

[Craig Blunden:]

Really we are not looking to see those efficiencies until the back half of fiscal 2018, the system will be fully implemented until perhaps six months from now and then there is going to be ramp up period after that with respect to the operating efficiencies. So really this becomes kind of a fiscal 2018 project for us.

[Brian Zabora:]

Okay, great. All right. Those are the questions I have. Thank you so much.

[Craig Blunden:]

Thank you.

[Operator:]

Our next question comes from the line of Tim Coffey, FIG Partners. Please go ahead.

[Tim Coffey:]

Hi, good morning, gentlemen.

[Craig Blunden:]

Good morning.

[Donavon Ternes:]

Good morning.

[Tim Coffey:]

I haven’t seen the presentation yet for the end of the quarter, do you have the balance of closed loans or the June 30 quarter – I’m sorry – not closed, I mean, the locked pipeline, I’m sorry?

[Donavon Ternes:]

Yeah, the locked pipeline at June 30 was down a bit from where we were at March 31. Gross locked pipeline was $125 million, the net locked pipeline was approximately $93 million and the fallout ratio was down to 26%.

[Tim Coffey:]

That was actually leading to my next question Donavon is on the fallout ratio [indiscernible], are you seeing anything – was there anything that occurred late in the quarter that would make you or give you pause heading into the kind of the September 30 quarter?

[Donavon Ternes:]

Just that the locked pipeline was down a bit from where we were in the March quarter and down a bit from where we were – well, actually down a lot from where we were in the June 30 quarter from last year. With respect to fallout ratio, that’s actually declining because there is a higher percentage of purchase money activity in contrast to refinance activity. And so fallout ratio will naturally come down as a result of that. Really the big question as it relates to mortgage origination volume is not really even driven by interest rates per se as much as it is saleable inventory. There just aren’t as many purchase money transactions being done as there once were, relatively good environment as it relates to interest rates, relatively good economic environment as it relates to employment as it relates to wages, it just seems like there is some pent up demand that just isn’t getting that and we are seeing totally that perhaps that’s because the inventory just isn’t there. There are fewer people selling their homes today.

[Tim Coffey:]

Certainly. We have been hearing that from other mortgage lenders on the West Coast this quarter. As it relates to Provident, is that relatively in balance between purchase money and refi loans, is that creating headwinds to your gain on sale margin?

[Donavon Ternes:]

No, purchase money activity can actually be a little bit stronger than refinance activity as it relates to loan sale margin. So, that financially help loan sale margin a bit. Probably the more striking issue as it relates to loan sale margin is what competitors are doing with respect to their mortgage pricing to keep pipelines up, to keep funding volume up. In today’s environment, there is too much capacity in the industry. The industry will have to adjust I think to lower origination volumes and as that – as the industry adjust I think pressure on the margin – loan sale margin can increase.

[Tim Coffey:]

Okay. And speaking of excess pipeline capacity, obviously, you’ve made some change to the origination in the fulfillment staff this past quarter. Would you be willing to say that you will be looking at those numbers in future quarters?

[Craig Blunden:]

Yes.

[Tim Coffey:]

Okay.

[Craig Blunden:]

We will be tracking this very closely and making any adjustments that’s we’ve [indiscernible] in the future.

[Tim Coffey:]

And then just – Craig, a follow-up on your comments about capital. Obviously, you are above the ratios you are talking about based on press release. I mean do you feel comfortable enough with the capital levels as the board will be able to execute on that recently announced buyback authorization if they want to?

[Craig Blunden:]

Yes, yeah.

[Tim Coffey:]

Okay. All right. Thank you. Those were my questions.

[Operator:]

Our next question is from the line of Tim O’Brien, Sandler O'Neill + Partners. Please go ahead.

[Tim O’Brien:]

Good morning.

[Craig Blunden:]

Good morning, Tim.

[Donavon Ternes:]

Good morning, Tim.

[Tim O’Brien:]

Donavon, do you have the percentage of loans purchased relative to refi on a total dollar funded basis for this quarter versus last quarter versus a year ago quarter?

[Donavon Ternes:]

It’s going to be in the investor presentation, which will be posted this morning, if it’s not already posted.

[Tim O’Brien:]

Didn’t see it, but it’s coming – okay.

[Donavon Ternes:]

Yeah. For the Q4, it was – 37% was refinance, 63% was purchase activity, a year ago refinance was 48% and purchase activity was 52%.

[Tim O’Brien:]

And what about last quarter? Do you happen to have that or? I will get it from the –

[Donavon Ternes:]

I do. 38% refinance in the March quarter, 62% purchase. Very similar to this quarter.

[Tim O’Brien:]

Okay, great. And is there – as far as the upgrade of your underwriting software and platform, that initiative – have isolated or can you kind of describe what kind of additional cost might be accrued over the next 12 months as a result of that before the benefits kick in?

[Craig Blunden:]

We obviously have some internal estimates, but we don’t release them. At some point, we will be switching over to the new origination software loan operating system and we will be switching from our existing loan operating system. So all of those costs associated with the existing system will essentially go away. The new system will replace those costs, but probably for – maybe up to six months, we will be having duplicate costs associated with that.

[Tim O’Brien:]

And again those duplicate costs will start to materialize in the next quarter I guess? You know, three months out from when you go live or is it already – does it kind of start this quarter?

[Craig Blunden:]

Yeah, essentially, it will start in the September quarter. We saw a little bit of it in the June quarter, but very little, an immaterial number, but it will be little bit higher in the September and December quarters.

[Tim O’Brien:]

And then did you – I got the FTE numbers that you gave Craig with regard to the mortgage division, but you said originators were up 19 and fulfillment staff was down 10?

[Craig Blunden:]

Originators were down 19 and fulfillment was down by 10 [indiscernible].

[Tim O’Brien:]

Thank you. One word can make a difference.

[Craig Blunden:]

Yeah.

[Tim O’Brien:]

Yeah, because it wasn’t jibing with me. All right, I got it now. Did you guys – can you give me again the held for investment kind of preferred loan originations that – dollar amount that occurred this quarter?

[Donavon Ternes:]

Sure. The impact like what we’ve seen with respect to our originator report. So single-family for the quarter was $31 million, multifamily for the quarter $31 million, commercial real estate for the quarter was $4 million and construction loans were $5.8 million for a total of $71.5 million for the quarter. Additionally, repurchase $2.4 million of multifamily in the quarter.

[Tim O’Brien:]

Did you say $8.4 million?

[Donavon Ternes:]

$2.4 million.

[Tim O’Brien:]

Sorry. Okay, got it.

[Donavon Ternes:]

So, in aggregate $73.9 million, $74 million of loans originated for investment. And that was the strongest quarter this fiscal year and it was largely because single-family moved up to $31 million from $19 million, $18 million and $12 million in the prior sequential quarters.

[Tim O’Brien:]

And then payoffs were $45.5 million this quarter?

[Donavon Ternes:]

Correct, yeah.

[Tim O’Brien:]

Got it. And the single-family that you originated for investment – the hold for investment, that was – those were arms typically, what was the most popular product type there?

[Donavon Ternes:]

5-1 hybrid arm.

[Tim O’Brien:]

5-1 hybrid arm.

[Donavon Ternes:]

Yeah.

[Tim O’Brien:]

And then, Donavon talked about, I don’t know, weakness in the market due to fewer home listings, there is good demand, but fewer listing, can you characterize that relative to the year-ago season kind of – what are trends – how fewer listings are there this year relative to last year? Is there a way to compare the numbers there and then beyond that can you give some clarity as far as different primary markets that you guys underwrite into in California maybe some, I don’t know, Inland Empire, Greater LA, Orange County and then Northern California, something like that, could you talk a little bit about that?

[Craig Blunden:]

Sure, the biggest issue are – the biggest difference when we are comparing ourselves to last year, is that refinance activity was 48% of the volume in the fourth quarter of 2016 and it’s only 37% of volume this quarter. So that’s the largest single difference or driver with respect to origination volumes being lower this quarter in comparison to last quarter. And I think that’s probably true for the industry and certainly true for the West Coast or California. As it relates to purchase money activity, it’s very difficult to handle on that, you can [indiscernible] information out of California realtors, [indiscernible] information as it relates to that. But anecdotally what we are hearing is that, there seems to be pent up demand, but there is just not enough supply of homes to originate more purchase money activity right now. Generally, interest rates are okay, they are up from where they were, but are very low by historical standards. And if you are purchasing home, I think you are less sensitive to that interest rate and economic activity is pretty solid in California. So if you look at job growth or rate growth in California, it’s pretty sound. But we do have the markets that you describe. And so if you think about the markets that we are in, in Northern California, particularly in the Bay Area, they are very choppy markets with respect to prices. And we are starting to see a little bit of weakness in price increases year-over-year and month-to-month, which also suggest that those markets are choppy. Frankly, if we come off of 10% housing price increases year-over-year, that’s healthy. It seems to me. If it were 1% or 2%, I think that brings more buyers in and that allows for purchase money activity to occur. It’s less competitive than that with respect to pricing in Southern California generally, although many of the markets in Southern California as well are near their record highs, late 2006, early 2007, whatever you choose to be the record high time period. So they are kind of back to those levels again. And then Inland Empire, it’s as always much more affordable than anything closer to the coast. So, we see good demand in the Inland Empire, but ultimately the purchase money activity just isn’t occurring as it once was.

[Tim O’Brien:]

So, speaking of the Inland Empire, what about new listing or inventory homes available for sale that are out there? Are those numbers – has there been a lot of new homes brought to market by the builders, is that industry kind up and running and cranking along in the Inland Empire markets and the affordable markets, do they have plenty of lots or what’s the status of that or are they constrained like, I don’t know, Bay Area markets or LA metro markets, by lack of lots?

[Craig Blunden:]

I guess the short answer is no. We are not seeing a lot – we are seeing some building scattered around the Inland Empire, but nothing like we saw years ago in the early to mid 2000s, nothing like that.

[Donavon Ternes:]

I think the lenders are much more disciplined when it comes to projects. There is certainly plenty of lots available, we see projects where they were partially or fully developed lots pre-crisis that ended up not being developed. So we are looking at those, but it does seem like construction lenders are much more disciplined as they probably should be when things – back to pre-crisis and what was going on and certainly new suppliers coming on at increasing amounts, but again not like we once saw.

[Tim O’Brien:]

Are there labor constraint this year relative to last year for the builders, ever heard about that, is it – was labor market in the building trades a lot tighter this year than last year and is that keeping construction down at all?

[Craig Blunden:]

[indiscernible] last three years or so, I don’t know if it’s any tighter now, but it’s certainly – labor is certainly an issue for any type of construction, not only new homes, but some of the extensive remodels that are along the coast, we hear that – there is just a long way to projects completed.

[Tim O’Brien:]

Thanks for the color guys. Okay, one other question real quick Donavon, do you have the final dollar amount for that accrual for the litigation?

[Donavon Ternes:]

Yeah, I think it was in the earnings release, it was $1.02 million.

[Tim O’Brien:]

Okay, $1.02 million. I missed that. All right, thanks.

[Operator:]

[Operator Instructions] We have a question from the line of Fred Cannon, KBW. Please go ahead.

[Fred Cannon:]

Thanks and most of my questions have been answered. I was just wondering if you might provide a little bit of color on the deposits if you are starting to see some pricing pressure on the deposit side and what you are seeing in terms of competition there.

[Craig Blunden:]

We are starting to see a little bit of that. It hasn’t impacted us. Our deposit costs have been flat year-over-year linked quarter or sequential quarter. So, it hasn’t really impacted us. But we are beginning to see some lenders – banks that are being more aggressive with respect to their deposit rates. As we think about the Fed and what they might be doing, I think that does put a little bit of pressure on deposit rates, but by and large everybody has been pretty discipline, but there are a few players that are out there running specialty.

[Fred Cannon:]

And you haven’t seen any need to kind of up your CDs to match on the rates that you were starting to see?

[Craig Blunden:]

Not at the present time. There were a number of other levers that can be pulled with respect to that. We don’t want to sensitize our existing deposit holders. We have a great deal of capacity as it relates to brokered CDs if we wanted to go down that path. We have a great deal of capacity from the Federal Home Loan Bank in San Francisco, which we use for interest rate risk management purposes. So I think as we think about Provident and what we might do in response to deposit pressures, I don’t know that it is necessarily an immediate response to raise our retail CD rates.

[Fred Cannon:]

Great. Good news on funding. Appreciate the color. Thanks.

[Operator:]

And at this time, there are no other questions in queue.

[Craig Blunden:]

All right. Thank you. I’d like to thank everyone for joining us and look forward to having our conference call at the next quarter. So, at this point in time, the conference call is over.

[Operator:]

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