Provident Financial Holdings, Inc.
Q4 2013 Earnings Call Transcript

Published: 31 Jul 2013

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Provident Financial Holdings Fourth Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to turn the conference over to our host, Mr. Craig Blunden. Please go ahead, sir.

[Craig G. Blunden:]

Thank you. 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, from the annual report on Form 10-K for the year ended June 30, 2012, and 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 fourth quarter results. I'd also like to point out that the fiscal 2013 was a record year for Provident in terms of net income. We're pleased to have delivered those results to the shareholders. Credit quality is improving and we continue to believe further improvement is likely, but at a slower pace. Total nonperforming assets on June 30, 2013, were $24 million, a 76% decline from the peak of $100.7 million on December 31, 2009. We recorded a $1.5 million recovery from the allowance for loan losses during the quarter ended June 30, 2013, while net charge-offs were just $353,000, which was significantly lower than the $1.2 million in the March 2013 quarter and the net charge-offs of $4.8 million in the June 2012 quarter. As we have described in the past, improving credit quality going forward will be inconsistent and irregular. Our performance is closely tied to general economic conditions, and while our outlook regarding credit quality continues to improve, if high unemployment rates and slow economic growth continue through remainder of 2013, as we currently anticipate, our nonperforming assets will remain elevated. It is important to note though that the delinquencies and charge-offs in our multifamily and commercial real estate portfolios have remained very low throughout the poor credit cycle of past few years. Unfortunately, the single-family portfolio did not perform as well during the same period. We note though that many [indiscernible] approximately 15 months, suggesting that we found the bottom line [indiscernible] this has resulted in improving credit quality for the company. We continue to believe that the [indiscernible] environment remains favorable, although we recognize that the recent rise in [indiscernible]. We have been transitioning our business model to a more profitable retail production platform for some time, which produces the added benefit of a higher percentage of purchase money loans, and is more sustainable in a raising rate market than a wholesale production refinanced platform. We have been investing in the business primarily by hiring additional personnel. We had 387 FTE in mortgage banking on June 30, 2013, an increase from 370 FTE count in March 31, 2013, but we will remain vigilant in monitoring the operating environment so we can adjust our model, as we have done in the past, commensurate with changes in loan origination volumes. We have recently slowed the pace of mortgage banking new hires but continue to look for new retail mortgage banking branch opportunities. In fact, in June, we opened our newest in Westlake Village, California. The volume of loans originated for sale in the fourth quarter of fiscal 2013 increased significantly from the same quarter last year and from the March 2013 quarter, but is down from record levels in the December 2012 and September 2012 quarters. New applications were strong for the June 2013 quarter, resulting in a significant locked pipeline from the start of our first quarter of fiscal 2014, and similar in size when compared to the same quarter of fiscal 2012. Loan sale margin for the quarter ended June 30, 2013, increased from the prior sequential quarter and remains at the higher end of the historical range. Overall, loan sale execution remains favorable with very liquid markets for agency conforming loans, and we're working diligently to maintain our loan sale margins at these more profitable levels. In addition to our improving view of credit quality and our positive cautious outlook on mortgage banking, there have been other developments regarding our operating results. For example, during the fourth quarter, we originated and purchased a total of $27 million of primarily multi-family and commercial real estate loans to augment loans held for investment. And for the first time since reining in the business in 2006, we originated a single-family construction loan, which denotes our return to construction lending. Our initial goals for construction lending are modest, but we're prepared to expand our product offerings as we gain confidence in the region's economic recovery. To give you a sense for our past experience in construction lending, on June 30, 2005, we had a construction loan portfolio of $156 million. We chose to curtail the business in 2006 when we became uncomfortable with the construction market. We've retained our institutional knowledge and expertise through the retention of key personnel who were redeployed elsewhere during the subsequent years. Also, we have recently hired 4 additional commercial loan officers to help fulfill more aggressive loan origination goals for the commercial real estate division in fiscal 2014. Liquidity balances are higher than we would like, which is another reason we're expanding our multi-family commercial real estate construction loan capabilities. Our net interest margin decreased by 17 basis points this quarter in comparison to March 31, 2013, quarter because of higher liquidity balances. We have opportunities to expand our net interest margin in fiscal 2014 to current levels since we use available cash currently invested at nominal yields, pay off FHLB borrowing as they mature, grow loans held for investment portfolio with the newly originated loans at higher yield, and by realizing higher yield on loans held for sale given the recent rise in mortgage interest rates. Nonetheless, the key takeaways with respect to our fourth quarter results are the improving credit quality trends and returns we're now realizing from the investment we made in the mortgage banking business during fiscal 2012. Our short-term strategy for balance sheet management is unchanged from last quarter. We believe that releveraging the balance sheet is essential, but we also recognize loan demand is weak, not -- and maybe difficult to generate a sufficient volume of loans held for investment to replace payoff. Nonetheless, we're investing in our multi-family commercial real estate construction loan platform to take advantage of loan opportunities as they arise. For the foreseeable future, we believe that maintaining regulatory capital is above 9% for Tier 1 Leverage, and 12.5% total Risk-Based is critical, and we're confident we'll be able to do so. Although we have not completed a comprehensive analysis of the recently proposed Basel III requirements, we're confident that our existing capital base is comprised of the quality and quantity that we will need to fulfill Basel III requirements, while still being able to execute on our business plan and capital management goals. Additionally, in the June 2013 quarter, we repurchased approximately 123,000 shares of common stock. It may be we believe that executing on stock repurchases is a wise use of capital in the current low growth environment. Yesterday, we raised our quarterly cash dividend by 43% to $0.10 per share, the first of which will be distributed to shareholders on September 10, 2013. We encourage everyone to review our June 30 investor presentation posted on our website. You will find that we included slides regarding financial metrics, community banking, mortgage banking and asset quality, which we believe will give you additional insight on our record earnings for fiscal 2013 and the strong financial foundations supporting the future growth of the company. We will now entertain any questions that you may have regarding our financial results. Thank you. Brad?

[Operator:]

[Operator Instructions] Our first question today comes from the line of Jason Stewart with Compass Point.

[Jackie Earle:]

This is actually Jackie Earle on for Jason. First off, is the broad NOI strength we are seeing in California multi-family market making balance sheet lending opportunities more attractive today?

[Donavon P. Ternes:]

Yes. We think that there's opportunity in multi-family and commercial real estate. There's been some new construction activity bringing new supply to the market, primarily in multi-family. And as a result, we're confident in being able to potentially grow our origination volume such that we've been hiring new originators to help us do so.

[Jackie Earle:]

Okay. And I just had a follow-up. Were there any substantial differences between the Southern and Northern California markets?

[Donavon P. Ternes:]

I don't know if there are substantial differences. I think the Northern California market, at least along the coast, because of Silicon Valley and the effects of the technology sector, perhaps outperformed Southern California through the worst of the credit cycle. It certainly did with respect to single-family. And so I don't envision that there is a great deal of difference between the 2 markets today as it relates to opportunity. And in fact, we do have mortgage banking origination offices in Northern California. And we have also hired multi-family and commercial real estate lenders in Northern California as well. So we're originating for our held for investment portfolio in both Northern and Southern California markets today.

[Jackie Earle:]

Okay. And then one last quick one. What are current loan yields on preferred loans that you've seen?

[Donavon P. Ternes:]

If you're talking about multi-family, and the predominant product being offered is 5/1 hybrid with 30-year amortization, where they roll to fully adjustable in the 61st month, you're probably talking an A property in the high 3% range. And if you get into B or C properties, you're in the very low 4% range. Yes, CRE or commercial real estate other than multi-family, you're probably 25 to 50 basis points higher than the multi-family product line.

[Operator:]

And we do have a question from the line of Tim Coffey with FIG Partners.

[Timothy N. Coffey:]

Talking about liquidity, if I could follow up on that comment you made during your prepared remarks, Craig. Your cash and liquidity balances, I mean, are what, north of $200 million at this point. Just do you have any thought on -- to buying securities right now?

[Donavon P. Ternes:]

Of course, we've given it thought.

[Craig G. Blunden:]

We've been thinking about it for a while, Tim.

[Donavon P. Ternes:]

I think it's -- there's more opportunity perhaps with investment securities today than there were 3 months ago, and we've seen that as a result of the 10-year backing up to where it's been. But we still think we're probably in a rising rate market. We're not necessarily certain that, that's the appropriate -- or we're at the appropriate point in time where we should pull the trigger by levering up the balance sheet with investment securities, although that's certainly a possibility. Our preference is to pay down or use that cash with -- for FHLB advances. You see in our schedule that we have $50 million of advances maturing in the September quarter. So that, you called it a $200 million number, which is relatively close to what the average was for the period, $50 million of that is going to be used to pay down advances. And so I think that's where we create some opportunity with respect to net interest income by paying down those advances, and then secondarily by staffing up with respect to the loans held for investment, particularly in the preferred loan group.

[Craig G. Blunden:]

And I think, Tim, the mortgage banking earnings have given us really the chance to be a little more conservative, sit back and see when the best time is to buy those investment securities.

[Timothy N. Coffey:]

Yes, no doubt. I'm just trying to get a feeling of when you think your excess liquidity starts becoming a serious drag on your spread account.

[Craig G. Blunden:]

It already is. And it's obviously the reason why we want to crank up some production and use up that liquidity -- some of that liquidity, like Donavon said, for FHLB advances and to grow the balance sheet.

[Timothy N. Coffey:]

Okay. All right. Perfect. And then my other questions had to do on some of the mortgage business, right? It looked like that your average loan amount originate per FTE is starting to drift down. How much of a concern is that?

[Donavon P. Ternes:]

Well, it's obviously a concern because we're becoming less efficient. But I think it's a reality with respect to the current mortgage market. We've seen interest rates increase by maybe 100 basis points...

[Craig G. Blunden:]

Or more.

[Donavon P. Ternes:]

Or more from their absolute lows with respect to mortgage or 30-year fixed. As a result, I do think refinance activity will decline, and in fact, we've probably already seen some of that occur in June. I think that probably continues as we go through the remainder of this calendar year, and certainly, within the context of our fiscal year. So I think we have to manage our FTE count to the volume that we have today and our expectation of where volume will go, although -- and frankly, some of that is being managed just by the very fact that much of the compensation is tied to origination success or total volume. So then you start thinking about the support staff, underwriters, funders, processors and the like. And what we need to be careful of there, because we still have a very active purchase market, is not to detract from our ability to execute on loan applications quickly and efficiently such that we're able to retain that business and become a preference for realtors and the like with respect to their purchase money activity. But certainly, I think that, that's a concern. I think volume can be down by 10% to 15% as we go through the next fiscal year in comparison to where we've been this quarter. I think there's going to be some pressure on the loan sale margin as well as a result of volume pressure being there, people are going to start cutting their margins. And I think we have to respond to each of those things as we go through the timeline.

[Operator:]

And we do have a question from the line of Tim O'Brien with Sandler O'Neill + Partners.

[Timothy O'Brien:]

Craig, a question for you on the FTE headcount. You said 387 versus 370 last quarter, who did you hire? I mean not names, but I mean, what kind of staffing did you do?

[Craig G. Blunden:]

Well, as I mentioned, we've just opened a new office in Westlake Village. And we have some more people in a new area, Santa Barbara as well. So it's been those areas, mainly in Southern California.

[Timothy O'Brien:]

Mostly mortgage?

[Craig G. Blunden:]

Yes.

[Timothy O'Brien:]

All mortgage?

[Donavon P. Ternes:]

Well, yes. That headcount is for PBM, specifically the 387 versus 370. But in addition to that, we hired 4 new originators. I think it's a net 3 increase, the 4 new originators in our preferred loan platform for commercial real estate and multi-family.

[Timothy O'Brien:]

When were they hired?

[Donavon P. Ternes:]

They were hired toward the very end of June, into the beginning of July.

[Timothy O'Brien:]

Great. And a little color on that you said you did an -- a construction loan?

[Donavon P. Ternes:]

We did.

[Craig G. Blunden:]

Pretty exciting, isn't it, one loan?

[Timothy O'Brien:]

Okay. It all starts with the first step. So -- and that was -- can you just tell me a little bit about that? What kind of loan was it? Is it to a developer that's got a number of lots that they're going to build out or what's the -- what kind of loan was it?

[Craig G. Blunden:]

No, it's a owner-builder in Riverside. There were 4 lots. This is one of the 4 lots. We've gotten an application on one other, and we had a third application that we rejected. So it's just a start, a very small start. It's not a track or anything like that, but -- which we used to do years -- many years ago.

[Donavon P. Ternes:]

But I do think it's important to point out that we've increased our expectation with respect to that line of business. And although our goals are modest today, that's not to say they will be modest a year from now, depending upon what we see with respect to the real estate recovery and the general economic recovery. We think there's opportunity there. We've got experience with respect to that line of business, and quite frankly, we're now lending in that area, although again, I think it's modest at this point in time.

[Timothy O'Brien:]

So let me ask you this. As far as construction lending is concerned, what's the competitive landscape like for making a loan? I'm sure that you guys must be competitive in your pricing. So what's -- what can a lender expect in order to book a loan to a builder these days?

[Donavon P. Ternes:]

Well, it's really interesting. It's kind of all over the map. We're seeing things where we can tell that the developer had been holding off until the environment became better. And now, instead of doing a condo project, it's all of a sudden a multi-family project, for instance, that they're trying to build on. We've seen a few developers come in and request a small track lending in our area. And then we've seen the single-family activity where it's an owner-builder that we've had a few applications on. So we're kind of really new into it with respect to understanding completely where our competitors are, other than to know by the conversations we've held that there are fewer competitors than you would think that are doing construction loans right now. So we think there's opportunity there.

[Timothy O'Brien:]

And is it accretive to your loan yield to do these loans right now? Are they priced better than what your existing portfolio is yielding?

[Donavon P. Ternes:]

Yes. In fact, in the earnings release, in one of the tables, you'll see the one construction loan, and it was booked at a 6.25% yield.

[Timothy O'Brien:]

And that's not including any fees?

[Donavon P. Ternes:]

Correct.

[Timothy O'Brien:]

Yes. So that's not a bad loan, it sounds like to me. And as far as the other kinds of interest that you've suggested might be out there by builders, have you guys had applications for small track and for multi, and looked at those? And would you consider making -- funding those loans as well?

[Donavon P. Ternes:]

We'll consider funding them. We've not had a formal application from a developer/builder in -- but we've had conversations. And those conversations are ongoing.

[Timothy O'Brien:]

As far as -- just shifting gears real quickly. The back half of this year is concerned, what's your view on where Southern California and perhaps Northern California, if you want to include that, where the purchase market goes? There's some seasonality to what I would expect you to discuss, but what do you think is going on in the purchase market right now as we enter the second half?

[Donavon P. Ternes:]

I don't think that the backup in rates has necessarily detracted from the purchase market. I think it's certainly detracted from the refinance market. It still seems that there's a shortage of inventory, which are holding sales back to some degree. But we're also finding that maybe some of those larger real estate investors can't quite get the ROIs that they once were able to get with foreclosures and the like. So that might create some more inventory to be had by the individual purchasers. So I guess my sense of it is that there's no reason, based upon what I see today, that the purchase market activity will decline. And in fact, I think that purchase market activity can increase from here.

[Craig G. Blunden:]

Yes, Tim, when I spoke to some realtors in our area, what they've said is it's -- what it's affected most is price. In other words, where you would see all those negotiation prices kept going up and up, we've actually seen some price cuts on people with their properties, because clearly, with the higher interest rate, the payment's affected. And what that's done is it's moderated the quick increase in prices that we've seen in the last year or more, so which is not a bad thing if you get some stability in price levels rather than having prices continue to go up at the percentages we've seen.

[Timothy O'Brien:]

Are you seeing big builders reenter the market with new product? And do you guys feel like your strategy towards banking to purchase businesses can capture some of that business?

[Craig G. Blunden:]

Yes. We've seen it mainly along the coast in Southern California with large builders and projects. And we do have some of our originators that specifically are geared just to handle a new construction.

[Operator:]

And we do have a question from the line of Don Worthington with Raymond James.

[Donald Allen Worthington:]

On the tax rate in the quarter, was there some truing up for the year end that occurred in the fourth quarter?

[Donavon P. Ternes:]

Yes, there was. Typically, it will occur in the fourth quarter. We're truing up for everything that we can see, and we're running through our tax accountants and we're getting consensus with respect to where we need to be.

[Donald Allen Worthington:]

Okay. And then you mentioned the $50 million even advances maturing in the next quarter. What's the rate on that?

[Donavon P. Ternes:]

$50 million is on at 4.09%, so that's a nice pickup from Fed funds at a quarter. And I will say this as well. $25 million of that $50 million matured in the first 2 weeks of July. And that $25 million was on at 4.25%. So we picked up a 4% spread on $25 million very early in the quarter.

[Donald Allen Worthington:]

Okay, great. And I guess my last question, in terms of leveraging the capital, do you have opportunities to say more aggressively purchase loans for your own book and/or any M&A opportunities? I know in the past, you've said no there, but just looking at your current thinking.

[Donavon P. Ternes:]

I think with respect to purchasing loans, absolutely. And in fact, we did purchase a package of loans in the fourth quarter. It was multi-family production, about $12.8 million. And that's something that we always look at and have historically looked at as well. So I think from the levering with respect to purchasing held for investment product, that's absolutely something that we will consider. I'll let Craig answer the M&A question.

[Craig G. Blunden:]

No change, Don, on our answer on the M&A question. There's just not much left out here.

[Operator:]

[Operator Instructions]

[Craig G. Blunden:]

Well, if there's no other questions, I'd like to thank everyone for joining us on our fourth quarter earnings conference call. I look forward to speaking with you end of our next quarter. Thank you.

[Operator:]

And ladies and gentlemen, this conference will be available for replay today after 11 a.m. through August 7 at midnight. You may access the AT&T teleconference replay system at any time by dialing [phone] and entering the access code 298059. International participants may dial [phone], and again, entering the access code 298059. That does conclude our conference for today. Thank you for your participation and for using the AT&T Executive Teleconference Service. You may now disconnect.