Provident Financial Holdings, Inc.
Q3 2015 Earnings Call Transcript

Published: 29 Apr 2015

[Operator:]

Welcome to the third quarter earnings call. [Operator Instructions] I'll now turn the conference over to Chairman and CEO, Craig Blunden. Please go ahead, sir.

[Craig Blunden:]

Thank you, Kathy. 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, forecasts 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 April 28, from the annual report on Form 10-K for the year ended June 30, 2014 and from 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 third quarter results. You will note that this is the fourth consecutive quarter where our community banking and mortgage banking businesses are both profitable, subsequent to the less favorable mortgage banking environment, which developed approximately 2 years ago. We're pleased that the actions we have taken to overcome the more challenging environment have resulted in our improving financial results. In fact, in comparison to the same quarter last year, net interest income and fee income have both increased, our net interest margin has expanded, and our efficiency ratio has improved. Our community banking business is capitalizing on more opportunities regarding loan originations and purchases, and we continue to increase loans held for investment. For the nine months ended March 31, 2015, loans held for investment grew to an 8% annualized rate. And preferred loans, a component of loans held for investment grew at a 16% annualized rate. Additionally we originated and purchased single-family, multi-family and commercial real estate loans during the quarter demonstrating the improved capabilities of our origination channels and new product offerings through our mortgage banking platform. For the seventh consecutive quarter loans held for investment have increased from the prior sequential quarters ending balance, although pace of growth has been volatile since an increase or decrease in loan prepayments can significantly alter the annualized growth rate. I would also like to point out during the quarter we purchase a $16.3 million multi-family loan package from another lender on a whole loan servicing-released basis, which is included in amounts described earlier. Credit quality continues to improve and we believe further improvement is likely. Total non-performing assets on March 31, 2015, were $13.7 million, the lowest level in many quarters. We recorded a negative provision of $111,000 from the allowance for loan losses during the quarter ended March 31, 2015. Net recoveries were a $130,000 for the March 2015 quarter compared to net recoveries of a $159,000 during the December 2014 quarter, and net charge-offs of $38,000 during the September 2014 quarter. We're very pleased with these credit quality results. We increased the mortgaged banking FTE account in the March 2015 quarter and currently employed 316 FTE in mortgage banking on March 31, 2015 up from 305 FTE on December 31, 2014 and up from the 296 FTE employee on March 31, 2014. During the quarter we increased our origination staff by one professional and increased our fulfillment staff by 10 professionals, largely in response to the increase level of refinanced activity. We will continue to adjust our business model, as we have done in the pasts commensurate with changes in loan origination volume. The volume loans originated for sale in the third quarter of fiscal 2015 increased from the December 2014 sequential quarter. New applications volume grew throughout the March 2015 quarter. And with the current levels of mortgage interest rates, we're optimistic about the volume in the June 2015 quarter as a result of increase in refinanced applications. We have seen a growing volume of loans originated for sales, since the March 2014 quarter last year, and some forecasters have revised upward estimates of calendar 2015 loan origination volume. We believe we're well-positioned to capture our share of improving the loan origination volume. The loan sale margins for the quarter ended March 31, 2015 was disappointing on a 125 basis points compared to a 140 basis points for the sequential quarter ended December 31, 2014. However the composition of origination volume has shifted to a higher percentage of less profitable refinanced activity. The increase in refinanced activity has also increased our early payoff premium refunds to purchasers of origination volume that has paid-off early. I should also add that the mortgage interest rate volatility increases hedging costs in the form of applicant renegotiations and fall out. These costs are higher because the refinance applicant has not required to close the transaction and can hold out for the best possible rate, but once again improved our efficiency ratio in the March 2015, primarily because the gain on sale of loans derived from elevated mortgage banking activities more than offset the higher variable compensation expenses. Our net interest margin increased this quarter in comparison to the December 2014 sequential quarter as a result of deploying cash balances, increased loans held for investment, and loans held for sale, which we see as an ongoing opportunity. We also executed $30 million of long-term advances, which will improve our overall asset liability position of a growing balance sheet. Our short-term strategy for balance sheet management is unchanged from the last quarter. We believe that releveraging the balance sheet is essential and we're investing in our multi-family, commercial real estate and construction loan platform to take advantage of loan opportunities as they arise and are much more open to single family loan products for the portfolio. For the foreseeable future, we believe that maintaining a significant cushion above the regulatory capital ratios of 7% for Tier 1 leverage, 8.5% for common equity Tier 1, and 12% total risk based is critical, and we're confident we will be able to do so. We currently exceed each of these ratios by a wide margin demonstrating that we have the capital to execute on our business plan and capital management goals. Additionally in the March 2015 quarter, we repurchased approximately 278,000 shares of common stock. And we continue to believe that executing on stock repurchases is a wise use of capital in the current environment. To that end, yesterday, we announced a new 5% stock repurchase plan to be implemented when the existing plan has been completed. Additionally, we increased our quarterly cash dividend by approximately 9% to $0.12 per share, but the first distribution is scheduled for June 9, 2015. We encourage everyone to review our March 31, Investor Presentation posted on our website. You will find we have 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 will now entertain any questions you may have regarding our financial results. Thank you. Kathy?

[Operator:]

[Operator Instructions] Our first question will come from Brian Zabora with KBW.

[Brian Zabora:]

A question on the pace of the buybacks. Your share price is getting a little closer to tangible book. If you're trailing above tangible book does that change the pace of buybacks at all?

[Donavon Ternes:]

Yes, it could, depending upon how high it gets relative to our book value. On the other hand, we believe our franchise value for the company is certainly north of book value, perhaps by a substantial number. So even if we were to repurchase that something above book value, we still think that that's accretive to franchise value. But you do raise an interesting point, and as a result I think the capital return strategies will change to some degree between the composition or mix of buyback versus cash dividends.

[Brian Zabora:]

And then on the expense side, how much of the expenses were related to calendar first quarter seasonal expenses. Could you give you a sense on that, because expenses came in a little bit better than I was expecting, given the fact of the stronger mortgage production in the quarter?

[Donavon Ternes:]

Really, the first quarter relative to the remainder of the calendar year are impacted by the employment taxes and alike, such that our high income wage earners are taxed before they hit their -- or were taxed on them before they hit their caps. But we don't describe or parse out what those implications are, but clearly the largest impact of operating expense increase in the March quarter was the result of increased variable compensation costs as a result of the higher mortgage banking funding volume.

[Operator:]

Our next question will come from Jason Stewart with Compass Point.

[Jason Stewart:]

One was on gain on sale margin. I mean we're generally tracking gain on sale to be a little bit lower so far in April versus the first calendar quarter. But rate volatility is substantially different, and I think you highlighted that implication in your comments. Could you just talk about maybe what you're seeing or thinking those two variables, how rate volatility was going to impact that gain on sale margins in 2Q or at the start of June quarter?

[Donavon Ternes:]

I think if we contrast the beginning of our June quarter versus the March quarter, the first thing I would highlight is that the 10-year treasury traded in a range of somewhere around 168 basis points at the low to maybe around 215 basis points at the high, as I recall, entering January. And given that wide range and given the fact that production volume for refinance activity accelerated during the quarter, the implications for fallout ratio as well as hedging costs were higher, it seems to me in the March quarter than what we are currently seeing in the April quarter. As you point out, I think the range has been much narrower on the 10-year treasury from the beginning of April until today, probably 10 basis points rather than perhaps the 50 basis points I described in the March quarter. And as a result, we would expect our hedging costs and fallout ratios to decline to some degree in the June quarter. If we think about our loan sale margin from a historical basis, particularly as it relates to the six quarters we described in our investor presentation, we have a range of 125 basis points this quarter on the low-end to 159 basis points on the high-end. I would argue that that range is still intact, depending upon the volatility of interest rates in any given period.

[Craig Blunden:]

And certainly on the mix of product and the amount of early pay-off penalties that we have, that happened with these quickly refinancing loans.

[Jason Stewart:]

And then I think that GSEs have actually finished all of their buybacks for 2013 and prior. And it seems like activity is significantly lower there, at lease for you it is. How are you thinking about that reserve and activity on buybacks going forward for newly originated loans?

[Donavon Ternes:]

We look at our activity on a quarterly basis, as we roll through a particular quarter to get a sense of whether or not our individual experience is elevated or not. And then we also look at what's occurring in the industry to understand whether or not we have increased risk to determine what that reserve should look like. At the end of the day, we're carrying $731,000 recourse reserve, from $711,000 and $712,000 in two prior sequential quarters. It seems to me we have to have a reserve there. And even if our direct experience does not necessarily support, the small amount of reserve, at some point you just can't fall below these small numbers of recourse reserve. So we're probably at the lower-end of the range, as I think about the dollar amount of recourse reserve, unless we were to begin to experience increased activity.

[Operator:]

We'll go next to Tim Coffey with FIG Partners.

[Tim Coffey:]

In relation to the package of loans that you bought this quarter, are you seeing opportunities to do that going forward, perhaps are more attractive than what you've seen in the past?

[Donavon Ternes:]

Yes. We've always had a history of purchasing loans primarily multifamily or commercial real estate, we even historically have done participations in construction loans alone, that's currently not in our game plan. It could potentially be in the future. But, yes, I think the market dynamic is changing a bit. In that, we're finally able to price the production volume or the purchase volume in a way that makes sense to us in contrast to our self-originated product. But secondarily we're seeing the quality of the packages meet our underwriting standards, and I think that's primarily because we're really looking at loans from other regulated financial institutions, not necessarily unregulated sellers. And I think there are also some concentration issues, as it relates to regulatory oversight and what some of these lenders have done over the past few years, such that they are finally to the point of a significant concentration, and they are looking to unload some of those concentrations.

[Tim Coffey:]

The yield on this package, specifically, what was it in relation to your portfolio loan yield about 3.87%?

[Donavon Ternes:]

It was a little bit lower than that when I factor in prepayments and the premium associated with the package, but it was not substantially lower than that. And in fact, it was relatively similar. It was even less of a difference relative to our current origination pricing. So it was a little bit thinner than our current production pricing and a little bit more, as it relates to the portfolio in general.

[Tim Coffey:]

Given those opportunities and the purchase market, which has been holding on to a little more liquidity than you otherwise would just to be able to take on those opportunities?

[Donavon Ternes:]

Liquidity is an interesting question for us, because we're such a large mortgage banker relative to our total balance sheet. And in fact you saw our balance sheet increase by about $100 million from the December quarter to the March quarter, and that is all directly related to the loans held for sale. So if you look at our balance sheet, we moved out of cash balances into loans held to sale. And in fact the volume activity was so significant, we ended up borrowing $90 million from the Federal Home Loan Bank during the quarter. $30 million of which was long-term in nature, and that's described in our earnings release on one of the tables in the exhibits. And $60 million of that was short-term funding specifically directed toward the loans held for sale balance. So what we think about liquidity, we're running kind of two things, we're running short-term liquidity models, as it relates to mortgage banking; and we're running longer-term liquidity models, as it relates to kind of the permanent balance sheet or the less volatile balance sheet with respect to balance. So if rates, for instance, were to go up and mortgage banking activity were to decline, that $300 million on our balance sheet of held for sales goes to $200 million or $150 million or something less than $300 and that turns into cash, which can then be redeployed into loans held for investment.

[Tim Coffey:]

And then Craig, in your prepared remarks you said you expected more improvements and credit quality going forward. Is there anything tangible that you anticipate near term, additional recoveries, decline in non-accrual loans?

[Craig Blunden:]

We just see the economy generally getting better, Tim. And some of these loans have been slow to improve, but we just noticed it's a gradual improvement in credit quality. I don't think we were trying to discuss anything significant, but just that with the economy improving, we see credit quality getting better.

[Operator:]

We now have a question from Tim O'Brien with Sandler O'Neill & Partners.

[Tim OBrien:]

Craig, you talked about the possibility of the prospect of booking res mortgage loans maybe for investment, finding some of that business. Were you able to underwrite and close any res mortgage loans that you're going to hold for investment this quarter?

[Craig Blunden:]

Yes, we had some. I think they're laid out in the chart presentation.

[Donavon Ternes:]

It's $8 million for the quarter.

[Craig Blunden:]

It's not much. And we actually have more room, because if you look over last few quarters, because of payoff for the single family loans with portfolio and new originations were actually down a bit in single family on the portfolio. So we certainly have more room. The biggest problem is in a fixed rate market, it's difficult to find a lot of loans that fit our criteria for the portfolio.

[Tim OBrien:]

And just out of curiosity, what kind of loans were those? I mean how are they structured?

[Donavon Ternes:]

They were 5/1 ARMS.

[Tim OBrien:]

And was there anything one-time in nature in P&L beyond the variable cost mortgage part of your business, and seasonal employment cost that you alluded to. Donavon, was there was anything else tucked in there?

[Donavon Ternes:]

No. It was a pretty straightforward quarter from the operating expense side, other than the increased salaries and benefits expense, because of variable compensation tied to mortgage banking volume.

[Tim OBrien:]

It looks like professional expenses were up just a smidge, is that seasonal?

[Donavon Ternes:]

It's not seasonal. We described a piece of litigation that we're involved in with respect to employment classification in the June 30 Form 10-K. We're still involved in that litigation. And as a result, there are a little bit elevated legal fees and legal expenses.

[Tim OBrien:]

And kind of given the status of that, is that likely to kind of stick around here or is that one-time in nature as far as this quarter is concerned or is it ongoing for a while?

[Donavon Ternes:]

It's ongoing, until ultimately the litigation is resolved.

[Operator:]

Gentlemen, we have no further questions. End of Q&A

[Craig Blunden:]

All right. Well, I want to thank everyone for joining us in our quarterly conference call, and look forward to speaking to everyone next quarter. Thank you.

[Operator:]

Thank you. And ladies and gentleman, this conference will be available for replay after 11