Provident Financial Holdings, Inc.
Q1 2014 Earnings Call Transcript

Published: 30 Oct 2013

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the first quarter earnings release conference. [Operator Instructions] And as a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Craig Blunder -- Blunden. Please go ahead.

[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, 2013, and from 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 first quarter results. Credit quality continues to improve and we believe a further improvement is likely, but at a sluggish pace. Total nonperforming assets on September 30, 2013 were $21.7 million, a 78% decline from the peak of $100.7 million on December 31, 2009. We recorded a $942,000 recovery from the allowance for loan losses during the quarter ended September 30, 2013, while net charge-offs were $1.9 million, which includes a $1.2 million charge-off on 1 multifamily loan we were seeking to install a receiver to manage the property because the condition of the property is significantly deteriorated while under the borrower's control. Net charge-offs during September 2013 quarter were higher than the $353,000 in the June 2013 quarter and similar to the net charge-offs of $1.9 million in the September 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 the remainder of 2013, as we currently anticipate, our nonperforming assets will remain elevated. In contrast to recent prior quarters, we believe that the mortgage banking environment is less favorable today because the recent rise in mortgage rates has significantly reduced refinance activity. While we have been transitioning our business models for a more profitable retail production platform for some time, we are not immune to deteriorating market fundamentals. As a result, this is the first quarter since the March 2008 quarter in which we reduced the mortgage banking FTE count. We employed 358 FTE in mortgage banking on September 30, 2013, down from 387 at June 30, 2013. We'll continue to adjust our business model as we have done in the past, commensurate with changes in loan origination volumes. The volume of loans originated for sale in the first quarter of fiscal 2014 decreased significantly from the same quarter last year and from the June 2013 quarter. New applications were weaker in the September 2013 quarter, resulting in a lower locked pipeline for the start of our second quarter of fiscal 2014, suggesting a lower volume of loans originated for sale for the foreseeable future when compared to the record volumes during fiscal 2013. The loan sale margin for the quarter ended September 30, 2013, decreased from the prior sequential quarter and has reverted to the lower end of the historical range. Overall, loan sale execution was unfavorable for the quarter as competitors priced at unsustainably low levels to keep the volumes up, and interest rate volatility resulted in significantly higher hedging costs because of the basis risk between the underlying hedging instruments and the cash markets. Each of these factors contributed to the much lower loan sale margin. We're working diligently to rationalize our pricing models, but it will be a slow grind to fully recover from irrational pricing, since the mortgage banking industry has too much origination capacity for current demand, given the decline in refinance volume. In addition to our improving view of credit quality and our cautious outlook on mortgage banking, there have been other developments regarding our operating results. For example, during the first quarter, we originated and purchased a total of $38 million of primarily multifamily and commercial real estate loans to augment loans held for investment. And for the first time in many quarters, loans held for investment grew from the prior sequential quarter's ending balance. The new hires in our commercial real estate group I spoke of in last quarter's conference call are assisting us in working towards our more aggressive origination goals for fiscal 2014. Liquidity balances are higher than we would like, which is another reason why we're expanding our multifamily commercial real estate and construction loan capabilities. And while our net interest margin increased by 23 basis points this quarter in comparison to the June 30, 2013 quarter, we see additional opportunity in fiscal 2014 to increase our net interest margin as we use available cash currently invested at nominal yields to grow our loans held for investment portfolio with newly-originated loans at higher yields by realizing a higher yield on loans held for sale, given the recent rise in mortgage interest rates, and by paying off existing FHLB borrowings as they mature. 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 that loan demand is weaker than we would like, making it difficult to generate a sufficient volume of loans held for investment to replace payoffs. Nonetheless, we're investing in our multifamily, commercial real estate and construction loan platform to take advantage of loan opportunities as they arise. For the foreseeable future, we believe that maintaining regulatory cap ratios above the 9% for Tier 1 Leverage and 12.5% total risk-based is critical and I'm confident that 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 we need to fulfill the Basel III requirements, while still being able to execute on our business plan and capital management goals. Additionally in the September 2013 quarter, we repurchased approximately 190,000 shares of common stock. We continue to believe that executing on stock repurchases is a wise use of capital in the current low-growth environment. We encourage everyone to review our June -- I mean, sorry, our September 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 strong financial foundations supporting the future growth of the company. We will now entertain any questions you may have regarding our financial results. Thank you. Lisa?

[Operator:]

[Operator Instructions] Our first question comes from Don Worthington, Raymond James.

[Donald Allen Worthington:]

In terms of the reduction in the volumes that led to the decrease in the gain on sale, would you say that there's a lag between when you can right-size the expenses against the declining mortgage banking operation?

[Craig G. Blunden:]

Yes, there's always a lag, Don. You want to make sure you get a handle on whether those lower volumes will continue. And in fact, if you look back through a couple of cycles, we let people go and then hired them back 2 months later, which is a costly endeavor.

[Donald Allen Worthington:]

Yes, okay. And then in terms of the preferred lending, you did touch on in your comments, but any more specifics on how you can grow that maybe a little faster in terms of either adding lenders or purchasing loans?

[Donavon P. Ternes:]

Sure, Don, this is Donavon. We recently -- and in fact, we spoke of it in the last quarter's call in July, had added some originators in that group. And in fact, they're beginning to gain traction and build their pipelines, such that through their efforts, as well as those that had been on board, we're going to be able to increase that production volume. And in fact, if you look at the slides that we presented -- one of the slides we presented in our investor presentation, you'll see that, that has essentially been growing over the last 3, 4 quarters as we determined that the credit criteria was finally being met with respect to what we could do in the commercial real estate, multifamily and construction arenas, if you will. So through origination efforts, we're going to increase that volume. This quarter, we did not purchase any packages. We looked at packages of primarily multifamily. We didn't like either the pricing or the credit metrics, so we didn't execute on those that we looked at. But in the June quarter, we purchased a package that we did like. So through combination of both our internal origination efforts and purchase activity, we will be growing our origination volume in that area. We have more aggressive growth goals in fiscal '14. And in fact, that is the transition that we will be embarking on as we think mortgage becomes less profitable or less fulfilling with respect to our financial metrics than it was in the past couple of years.

[Operator:]

Our next question comes from Tim O'Brien, Sandler O'Neill + Partners.

[Timothy O'Brien:]

I'm Tim's brother. Question following up on Don's question regarding staffing. Are you -- any additional hires in the core banking unit this quarter? And also, are you in the hunt for -- to further augment that group?

[Donavon P. Ternes:]

Yes. We've met with people in some contiguous markets with respect to their origination capacity. We're always looking for originators to plug into that area. And we'll continue to do so. And as we're successful, we obviously will be able to increase our origination capabilities there.

[Craig G. Blunden:]

And partially, that may not always be an increase because as you work through originators, you find some that actually don't meet their goals and you move them out.

[Timothy O'Brien:]

It's a competitive marketplace too.

[Craig G. Blunden:]

Yes, it is.

[Timothy O'Brien:]

How many are in that unit right now, like what's your production staff from an FTE standpoint? Do you know that?

[Donavon P. Ternes:]

Well, we know that. We don't often give those numbers out for competitive reasons.

[Timothy O'Brien:]

Just thought I'd ask. Okay. And then another question is, are there any -- is there any chance you could put single-family residential mortgage, some product that's a hybrid product on the balance sheet in this market or is that still pie in the sky?

[Craig G. Blunden:]

The short answer is yes. But then the question is, what products will work in this interest rate environment even though rates are up a bit? The rates on some of these adjustables we're seeing, some of our competitors do, are really low for a longer term than maybe you want on the initial term.

[Donavon P. Ternes:]

And the answer is, we have a production machine. We could be -- pick a number. We did $3.5 billion last year in our fiscal year, primarily fixed-rate single-family, which we chose not to put on our books, which I think was a wise choice, monetizing the gains at the time rather than rolling them through net interest income and taking on the interest rate risk. So we do have a couple of programs that we're rolling out with respect to single-family portfolio programs through our mortgage banking offices. The dilemma becomes what those hybrid characteristics look like from a competitive landscape and what type of volumes we can really see, because literally, we're still in a 30-year fixed rate market even though rates have gone up.

[Timothy O'Brien:]

That's a reality. I got it. And any other growth initiatives or plans out there, either that you're working on for 2014 or that you will roll out in 2014 that you can share with us?

[Donavon P. Ternes:]

It's really a combination of what we've discussed. We've got more aggressive goals with respect to our preferred loan originations. We're staffing up to attain those goals. Essentially, the bulk of the portfolio, at some point, we're going to see that prepayments are going to slow down because the portfolio is essentially rolled into lower rates, if you will. And so the origination volumes that we are gearing up will actually lead to growth rather than simply replacing those that are prepaying. And then secondarily, the portfolio of products coming out of our mortgage banking division, we think in a rising rate market, the products that we prefer for portfolio, such as hybrid RM product, become more in favor with the consumer and will ultimately give us some growth opportunity.

[Timothy O'Brien:]

And then what about branching?

[Donavon P. Ternes:]

We're really not looking at any. We've got some contiguous -- kind of in our geography that we've looked at. We kind of have a rolling list of communities that we would like to be in. But there's no immediate plans for a new retail business banking branch at this stage. Our most recent one was La Quinta [ph]. That's been about 1.5 years, 2 years, something like that?

[Craig G. Blunden:]

1.5 years.

[Donavon P. Ternes:]

1.5 years or so.

[Craig G. Blunden:]

With the amount of cash that we have, the last thing we need is more cash.

[Operator:]

We have a question from Jackie Earle, Compass Point.

[Jackie Earle:]

First off, could you provide any color on where you are seeing incremental yields on loans originated for the balance sheet today?

[Donavon P. Ternes:]

Sure. We think about the multifamily sector, primarily the predominant product out there is a 5/1 hybrid. And we're seeing the range of 5/1, anywhere from 3.75% for the start rate up to 4.25%, maybe a little bit higher than 4.25%, depending upon the quality of the collateral and the characteristics of the borrower. With respect to commercial real estate, the range is probably from 4% to 4.5%. Again for the same reasons, again the primary product out there is 5/1 hybrid. And then with respect to single-family, if you're looking at a 5/1 or a 3/1 product, a 3/1 product is probably 3%. A 5/1 product is probably around 3.25% for the start rate.

[Jackie Earle:]

And then my second question, it seems like correspondent buyers are finally adjusting pricing for the new rate environment. When did this happen? Has it changed since quarter end?

[Donavon P. Ternes:]

Are you referring to the mortgage banking correspondents?

[Jackie Earle:]

Yes.

[Donavon P. Ternes:]

Literarily, when we saw the Fed begin to talk about tapering, which came toward the end of June, we began to see mortgage rates increase actually quite significantly from where they were. If we think about where rates are today in comparison to where they were at the beginning of June, let's say, we're probably up 100, 110, 115 basis points out of 30-year fixed rate loan. And so literally, the mortgage bankers were rolling through a locked pipeline that they had on their books at June 30, funding that pipeline out as they roll through July and the first part of August. And then their origination pipeline was -- or their originations were beginning to slow and the interest rates were significantly higher, really beginning right about the first part of July. And so we're really seeing that phenomenon in those mortgage bankers that give you their locked pipelines at period end, which we do in our investor presentation, you will see how much lower the locked pipeline is at September 30 than it was at June 30. So it was really throughout the quarter that everybody has been adjusting to the new rate environment and kind of rolling through the prior locked pipeline and funding it out and kind of getting into the new pipeline with the higher rates.

[Jackie Earle:]

Okay. Given lower rates, have you seen any improvements since the end of September?

[Donavon P. Ternes:]

Yes. As you've noted, the taper talk took the 10-year up into the -- pretty close to 3%. I don't know that we broke 3%, but it was very close to 3%. I think the 10-year right now is trading at around 2.5%. And so we've seen a retraction or a decline in origination rates of 25, 30 basis points, somewhere in there from where it was. And indeed, we've seen that in new application volume, but still the absolute rate today is significantly higher than it was just 4 months ago, 5 months ago.

[Jackie Earle:]

And my last question. Was the increase in the delinquent loans primarily due to seasonality? And what do you expect for the remainder of the year there?

[Donavon P. Ternes:]

It's just choppy. If you're looking at that 30- to 89-day bucket, I think we went back up over $1 million from something like around $400,000. And the prior quarter end, it was something -- it's kind of a choppy number, and it's very difficult to understand and I don't chock it up to seasonality or anything of the like. It's just kind of the way it flows through when it kind of comes up. I believe that the nonperformers will continue to come down. I don't believe that the pop in 30- to 89-day delinquents is a new trend for us to be concerned about. And I think it's just the choppiness.

[Operator:]

[Operator Instructions] We have a question from Tim Coffey, FIG Partners.

[Timothy N. Coffey:]

Craig and Don, do you have any comments about desire to expand the balance sheet? Have you given any thought or changed your mind, your approach to handling liquidity within average-earnings assets, because it still runs at a pretty high cliff? I think this quarter, it was 15% of your earning assets for either cash or equivalents.

[Donavon P. Ternes:]

If you're speaking of fixed income, we give that thought all the time. I guess what I would point out with respect to fixed income, when we saw rates pop toward the end of June, and you look at the marks that were on the investment security portfolios of those that were heavily invested in fixed income, you saw 20% the value markdowns with respect to that. So I'm glad we weren't in fixed income, if you will, prior to that spike in rates. And so today, I think it is -- it would be a better time to invest in fixed income than it was just 4 months ago. Do I think it's a peak time to invest? Probably not. I think everybody believes that interest rates are going to be rising. It's just a question of when. It seems that the Fed has backed away from taper talk. We'll get more color on that today, I suppose, which has kind of stabilized rates into their current area, but at some point, rates are going to rise. So the question becomes, do we give up some current earnings or future earnings, or should we increase current earnings and give up some future earnings? So that's what we wrestle with internally with respect to what we do with the liquidity we have on our balance sheet.

[Timothy N. Coffey:]

Right. My impression if you're thinking of that previously, was that you were content to hold the excess liquidity, given the earnings shift in the mortgage banking unit. Now that the mortgage banking unit seems to be slowing down, I'm trying to figure out if you've changed your -- you plan on changing your approach to liquidity on the balance sheet?

[Donavon P. Ternes:]

We look at that all the time and we debate amongst ourselves, and...

[Craig G. Blunden:]

Constantly.

[Donavon P. Ternes:]

Constantly. And I would, yes, argue that there's been more discussion recently than there was 6, 8, 12 months ago.

[Timothy N. Coffey:]

Okay. Do you see those discussions stopping anytime soon?

[Donavon P. Ternes:]

I'm just not going to forecast when we may or may not take some of that liquidity and invest it out in the mortgage-backs or something of that nature. But it's absolutely a lever that we could pull to increase net interest income in comparison to where we're currently at. But you take on a great deal of interest rate risk, as well as equity risk with respect to future marks, depending upon what happens with interest rates.

[Timothy N. Coffey:]

Right. There's no [indiscernible].

[Donavon P. Ternes:]

There's more pressure today.

[Timothy N. Coffey:]

Do you have any scheduled maturities coming up within the FHLB advances?

[Donavon P. Ternes:]

I think that schedule is in the earnings release. We don't have much -- we kind of roll through. There's a $5 million maturing in 3 months or less, and then we have $10 million maturing in 6 months to 1 year.

[Timothy N. Coffey:]

Okay. The fallout ratio, which means the net pipeline and the gross pipeline, I would have thought with the rise in interest rates, you might have seen the fallout ratio decline, but it looks like it went up. Was that a function of competition in the marketplace?

[Donavon P. Ternes:]

It could have been. It went up just a little bit. And I think it went up, what, 3%, from where it was? I don't view that as a significant increase, if you will. Really, when you look at the March, June and September quarters, the fallout ratio was in the 20s. When you look back historically a year ago, the fallout ratio was in the 30% range. So really I view that fallout ratio as being relatively low from a historical context.

[Timothy N. Coffey:]

But just directionally, all else equal, as rates rise, the fallout ratio should fall?

[Donavon P. Ternes:]

Yes.

[Craig G. Blunden:]

Yes.

[Donavon P. Ternes:]

And in fact, as the portfolio shifts to purchase money activity from refinance activity as a percentage of total volume, the fallout ratio will also fall, because people will close that loan, they're buying their home.

[Timothy N. Coffey:]

Okay. And then my final question is -- I might have missed it during your prepared comments, but the number of FTEs in the entire mortgage banking unit?

[Donavon P. Ternes:]

At September 30, that number was 358 FTE, which is down from 387 at June 30.

[Operator:]

We have no further questions at this time.

[Craig G. Blunden:]

All right. Well, I want to thank, everyone, for joining us on our first quarter conference call and look forward to meeting with you again next quarter. Thank you.

[Operator:]

Thank you. Ladies and gentlemen, this conference will be made available for replay after 11 a.m. today through November 7. You may access the AT&T Executive Replay system at any time by dialing 1 [phone] and entering the access code 306253. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.