Provident Financial Holdings, Inc.
Q4 2008 Earnings Call Transcript

Published: 29 Jul 2008

[Operator:]

Welcome to the Provident fourth quarter earnings release. For now, phone participants are in a listen-only mode. An opportunity for your questions follows. Instructions will be given at that time. This conference is being recorded. Now to Chairman and CEO, Craig Blunden. Please go ahead sir.

[Craig Blunden:]

Thank you. Good morning, everyone. This is Craig Blunden, Chairman and CEO of Provident Financial Holdings. On the call with me is, Donavon Ternes, our 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 yesterday. And from the Annual Report on Form 10-K for the year ended June 30, 2007, as amended. 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 fourth quarter results. The operating environment for the industry remains difficult as a result of the weakening single-family housing market. The single-family housing correction has resulted in deteriorating credit quality and significantly lower mortgage banking volume, which are the principal reasons that our earnings have come under pressure. It is difficult to predict when a more favorable operating environment will return, so today I will describe some of the actions we have taken to mitigate the company's exposure to the current environment and provide some insight with respect to our fiscal 2009 outlook. As I look back on fiscal 2008, it's clear to me that much of our focus was on right sizing the mortgage banking business consistent with the current environment and aggressively dealing with credit quality deterioration in our loans held for investment portfolio. We dealt with mortgage banking issues, primarily in the first half of the fiscal year, and credit quality issues become more pronounced in the second half of the fiscal year. Specifically, in mortgage banking, we reduced our origination capacity and operating expenses by closing six loan production offices and reducing the number of employees by 45 in comparison to June 30, 2007, and by 80 employees from our peak mortgage banking employment in November, 2006. Tighter underwriting standards were adopted during the course of the fiscal year, and expertise in FHA/VA products was enhanced since a larger percentage of origination volume is being generated in those products. Credit quality declined through the fiscal year, but accelerated in the second half. We responded by increasing the loan loss provision each quarter, commensurate with the increase in non-performing assets. To date, the weakness has primarily been limited to single-family loans within our portfolio held for investment. While the family and commercial real estate loans are still performing quite well and our limited exposure to construction loans or single-family Option ARM loans has mitigated the overall credit deterioration of loans held for investment in comparison to many of our competitors who have single-family or construction loan exposure. Although we are not satisfied with our fiscal 2008 results, I believe we responded quickly and aggressively to the environment and will continue to do so. Our allowance for loan losses has increased to 1.4% of gross loans held for investment which is 2.4 times the fiscal 2008 charge-off rate of 0.58%. Additionally, our mortgage banking business has been right sized to current market origination volume expectations, and we have augmented our expertise to respond to a changing product mix. We currently believe that fiscal 2009 will also be challenging, and have prepared our business plan to preserve capital, and to maintain our strong regulatory capital ratios. We do not anticipate asset growth in the current environment and are prepared to shrink total assets by a modest percentage provided doing so does not hinder our efforts to build a deposit franchise. Although our fiscal 2009 outlook is guarded, we begin the fiscal year in a better position than the last fiscal year. Much of the heavy lifting regarding operating expense reductions have been completed, and we will realize the full year's benefit of those actions which were primarily implemented during the first six months of the last year. Additionally, we begin the year with a significantly higher net interest margin than last year, and a significantly steeper yield curve which historically is a favorable yield curve environment for thrift. We expect mortgage banking funding volumes to be similar to this past fiscal year, but also believe that the loan loss provisions and recourse provisions for mortgage banking will be lower as a result of fewer early payment default claims. Additionally, we believe loan sale margins will improve since many competitors exited or curtailed the mortgage banking operations. The wildcard for fiscal 2009 is credit quality. It's fair to say that Southern California real estate market is under significant stress, which will negatively impact many of our borrowers if they experience financial difficulty. I don't believe the real estate market will find its bottom in the near-term, therefore I believe our past six months of credit quality experience is the best information available to formulate an expectation for credit quality cost during fiscal 2009. I believe we have sufficient resources in the form of an allowance for loan losses and capital to withstand the expected credit quality costs, but those costs will depress earnings for the foreseeable future. We will remain diligent in growing our deposit franchise, and will open our newest branch on Iris Avenue in Moreno Valley, California next month. We have enjoyed tremendous support from the Moreno Valley community for over 30 years since opening our first branch there, and are excited that we have the opportunity to grow our deposit market share where we are so well known. In closing, I want everyone to understand that we recognize the difficulties arising from the current operating environment, and will take the steps necessary to mitigate the impact to Provident's shareholder and customers. In fact, we believe there will be opportunities for Provident as a result of this poor environment, and we intend to capitalize on those opportunities when the outlook improves. We will now entertain any questions that you may have regarding our financial results. Thank you. Gail?

[Operator:]

(Operator Instructions). We'll go to Tim Coffey with FIG Partners. Please go ahead.

[Tim Coffey:]

Good morning, guys. How are you?

[Craig Blunden:]

Good morning.

[Donavon Ternes:]

Good morning, Tim.

[Tim Coffey:]

The first question I have is the pricing on the mortgage sales. What was the cause of the average price being 20 basis points lower?

[Donavon Ternes:]

The reason that the loan sale margin declined to a negative 20 basis points for the quarter is largely the result of the recourse provisions that we recorded during the quarter, which run through that particular line item on our income statement. We recorded $1.27 million worth of recourse provision. And in fact, what we've done, although not in our earnings release but in our investor presentation, we completed or put a slide out there, the investor presentation is now available out on our website, describing what the actual loan sale margin was on a GAAP basis in the prior six quarters. And then we excluded the recourse provision from that loan sale margin to give the reader an opportunity to understand what, perhaps the fundamental loan sale margins look like without the recourse provision being run through that line item. And in fact, for the last quarter, without the recourse provision, our loan sale margin was 92 basis points, and in fact that increased from roughly 77 basis points without any recourse provision adjustment in the prior sequential quarter or the March quarter. So literally what we did or what occurs is the recourse provision runs through that line item. The fourth quarter recourse provision was larger than what we've experienced in the prior few quarters. And as a result, the loan sale margin was negative.

[Tim Coffey:]

Okay. Have you seen any of your competitors in the mortgage sale market starting to get a little more aggressive on their prices?

[Donavon Ternes:]

On the mortgage side itself?

[Tim Coffey:]

Yeah. What I'm trying to figure out is has any of that had any kind of impact on mortgage pricing?

[Donavon Ternes:]

Well, we're not seeing necessarily real aggressive pricing in the mortgage banking business. What we've seen is a dramatic shift in the product line. And by and large, the transactions that are being completed today, number one are purchase money transactions. And interestingly enough, we also have another slide in the investor presentation. 66% of our volume in the fourth quarter was purchase money activity. And then the bulk of that purchase money activity is FHA/VA product lines. Essentially because the FHA/VA have lower down payment requirements and quite frankly is providing liquidity into the secondary market. Fannie, Freddie are also providing some liquidity, but we've not seen it necessarily through aggressive pricing, if you will, through mortgage brokers or some of our other competitors when it comes to pricing to the street. So, by and large, we're not seeing huge competitive pressures in pricing of mortgage loans. Everything comes down to liquidity with respect to mortgage loans, and having investors in place to take your loan production.

[Tim Coffey:]

Okay. You provided some very good color on the non-performing categories and classified them, as you usually do. In light of what Craig has talked about the challenges for fiscal '09, can you provide any kind of color on where you see credit quality going in the market?

[Donavon Ternes:]

Well Craig mentioned in his prepared remarks that one can probably look at least for russ, for Provident. One can look at the last six months while credit quality costs and then extrapolate that out or annualized it if you will and that not necessarily be an unrealistic expectation with respect to our next fiscal year. And in fact if you were to do that because our credit quality cost accelerated through the four quarters, they were relatively benigned in the first quarter, and then grew through each of the subsequent quarters. So if you analyze those last two quarters, you're going to come up with a number that is larger than all of our costs in this past fiscal year. So I think the environment is still difficult with respect to the real estate market but, we're also seeing production and we're also seeing loans being made and, in fact, our mortgage banking volume was the highest volume all be it by small number of the prior two quarters. So perhaps we ended up seeing the bottom two quarters ago in that volume, and we are seeing activity and volumes increase marginally.

[Craig Blunden:]

Tim, you know, also that volume is made up when we talked about purchase volume, and it's mainly REOs and short sales from other institutions, that's really driving the purchase market right now in Southern California. So, the issue really is the economy for everybody and how long this is going to be drawn out and where unemployment's going because it didn't really matter how good the quality of your loan was, if somebody's lost their job, it's tough to make payments very long into the future because they blow through their reserves pretty fast. And issues we're seeing have nothing to do with payment amounts which you read about a lot in the newspaper. Well, mainly because of Option ARMS and adjustable loans, it really hasn't had anything to do with that. It's truly had the effect of a poor economy and lost jobs.

[Tim Coffey:]

Yeah. This next question will be a little difficult to answer. But do you have any kind of visibility on the inventory of REO or short sales in your market?

[Donavon Ternes:]

Own, I've read some statistics but I hate to quote them because I'd be stretching my memory to understand. But there is some data out there, either DataQuick or there is another service that describes that. And I think the number is over 50% of all volume is being driven by foreclosure or short sale activity. So the market and the price discovery in the market is literally being driven by the lenders, but again I don't want to refute the fact that we're actually seeing some sales and we can see that within the context of our own REO portfolio. When we get these back, the bulk of them sell relatively quickly if we price them right. And it might be a geography that's a little bit out of the area that ends up, sitting on our books for an extended period of time. So we are seeing activity in that regard. But it's largely driven by short sale and foreclosure. And there are some services that put that information out.

[Tim Coffey:]

Okay. All right. Those are all of my questions, thanks guys.

[Operator:]

(Operator Instructions). And we have no further questions in the queue at this time. Please continue. And we still have no questions in queue.

[Craig Blunden:]

Well, if there is no further questions, I'd like thank everyone for joining our conference call. And we look forward to speaking to you at our next conference call next quarter. Thank you.

[Operator:]

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