Earnings Call Transcript - PROV Q2 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Provident Financial Second 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. And as a reminder, this conference is being recorded. I would now like to turn the conference over to our host Chairman and CEO, Craig Blunden. Please go ahead.

Craig Blunden, Chairman and CEO

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, 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, from the Annual Report on Form 10-K for the year ended June 30, 2021, and from the Form 10-Qs and other SEC filings 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 second quarter results. In the most recent quarter, we originated and purchased $65.3 million of loans held for investment, an increase from the $60.9 million in the prior sequential quarter. During the most recent quarter, we also experienced $72.5 million of loan principal payments and payoffs which is up from $53.9 million in the September 2021 quarter and still tempering the growth rate of loans held for investment. Currently, competition remains elevated for loan originations but it seems that many multifamily and commercial real estate borrowers are once again completing transactions as a result of better general economic conditions. For the most part, our underwriting requirements have returned to pre-pandemic criteria except for certain loan products such as retail and office commercial real estate, which remain a bit tighter. Additionally, our single-family and multifamily pipelines are similar in size to last quarter suggesting the March 2022 quarter will be similar to the volume we experienced this quarter. For the three months ended December 31, 2021 loans held for investment decreased by approximately 1% compared to September 30, 2021, the decreases in the multifamily and commercial real estate loan categories partly offset by growth in the single-family and construction loan categories. Current credit quality is holding up very well and you will note that there are just $3,000 of early stage delinquency balances at December 31, 2021. Additionally, non-performing assets decreased substantially to just $2.8 million, which is down from the $6.6 million on September 30, 2021. Please note that the decline in non-performing assets was primarily the result of forbearance loans previously downgraded to Troubled Debt Restructuring non-accrual status that were subsequently upgraded to performing status given their satisfactory payment performance and compliance with the terms of their forbearance. As of December 31, 2021, there were no loans in forbearance. Previously, on March 31, 2021, we ended new requests pursuant to our forbearance program. As a result, forbearance loans ran their course as provided in their individual forbearance agreements and are now primarily classified as performing loans with a few remaining in Troubled Debt Restructuring non-performing status. We recorded a $1.1 million negative provision for loan losses in the December 2021 quarter. The allowance for loan losses to gross loans held for investment decreased to 77 basis points on December 31, from 86 basis points on September 30. You will note that we remain on the incurred loss model and have not adopted Current Expected Credit Losses. This means that our allowance methodology cannot be reasonably compared with Current Expected Credit Losses adopters. Our net interest margin compressed by 7 basis points for the quarter ended December 31, 2021 compared to the September 2021 sequential quarter as a result of an 8 basis point decrease in the average yield on total interest-bearing assets and no change in the cost of total interest-bearing liabilities. The change in net interest margin was primarily the result of remixing of the balance sheet stemming from the slight increase in average loans receivable, the decrease in average investment securities, the increase in low yield on interest earning deposits, the increase in average deposits, and the decrease in average borrowings. Notably, our average cost of deposits decreased by 1 basis point to 12 basis points for the quarter ended December 31, 2021 compared to the prior sequential quarter. Additionally, our borrowing costs reduced by approximately 22 basis points in the December 2021 quarter compared to the September 2020 quarter primarily due to a $39,000 prepayment fee in December that was not incurred in the September 2021 quarter. The 2.64% net interest margin this quarter was positively impacted by approximately 3 basis points, as a result of the $90,000 recovery of loan interest income on a partially charged-off loan that paid in full in the December 2021 quarter and negatively impacted by approximately 1 basis point as a result of the $39,000 prepayment fee incurred on the prepayment of Federal Home Loan Bank advance described earlier. Net deferred loan costs associated with the loan payoffs in the December 2021 quarter in comparison to the average net deferred loan cost amortization of the previous five quarters did not have an impact as the current net deferred loan costs were very similar to the average of the look-back period. We continue to look for operating efficiencies throughout the company to lower operating expenses. Our full-time equivalent count on December 31, 2021 increased to 170 compared to 166 full-time equivalents on the same date last year, a very small increase. You will note that normalized levels because the employee retention tax credit that was recorded in the September and June 2021 quarters expired after September 30, 2021 consistent with the passage of the Infrastructure Investment and Jobs Act signed by the President on November 15. Our short-term strategy for balance sheet management is unchanged from last quarter. We believe that leveraging the balance sheet with prudent loan portfolio growth is the best course of action, but executing on that strategy in the current environment has proven difficult. In the interim, we are redeploying excess liquidity and government-sponsored mortgage-backed securities with an estimated average life of approximately four years. We exceed well-capitalized ratios by a significant margin allowing us to execute on our business plan and capital management goals without complications. We believe that maintaining our cash dividend is very important; doing so takes priority over stock buyback activity. However, we also recognize that prudent capital return to shareholders through stock buyback programs is a valid capital management tool and we repurchased approximately 103,000 shares of common stock in the December 2021 quarter under the April 2020 stock repurchase program. We encourage everyone to review our December 31st Investor Presentation posted on our website. You will find that we've included slides regarding financial metrics, asset quality, and capital management which we believe will give you additional insight on our solid financial foundation supporting the future growth for the company. We will now entertain any questions you may have regarding our financial results. Thank you.

Operator, Operator

Our first question will come from the line of Tim Coffey with Janney. Please go ahead.

Tim Coffey, Analyst

Hey. Thanks. Good morning, gentlemen.

Craig Blunden, Chairman and CEO

Good morning.

Donavon Ternes, President, Chief Operating and Chief Financial Officer

Good morning.

Tim Coffey, Analyst

Hey, Donovan. The payoffs that you experienced in the quarter, was that in any relation do you think to people trying to get in front of rate hikes?

Donavon Ternes, President, Chief Operating and Chief Financial Officer

I think it's difficult to say. Certainly, there has been much written about possible rate hikes, and some of that written was in that December quarter time period. We did see kind of a shift in what we were experiencing in payoffs. We had more multifamily payoffs in the December quarter than we did single-family payoffs. And in recent prior quarters, the reverse was true where there were more single-family payoffs than multifamily payoffs. So the mix is changing a bit with respect to what those payoffs look like.

Tim Coffey, Analyst

Okay. And then returning your underwriting standards to pre-pandemic levels. Has that been going on for a couple of quarters now?

Donavon Ternes, President, Chief Operating and Chief Financial Officer

Yes. We've slowly improved or loosened our underwriting standards, really beginning about a year ago, maybe even a little bit longer than that, but really probably about a year ago and each quarter we've gotten closer and closer to pre-pandemic standards. Right now, we're just a little bit more cautious on commercial real estate, primarily in the retail and office sectors.

Tim Coffey, Analyst

Okay. And can you kind of describe what you're seeing in the market for loans right now relative to say the prior quarter?

Donavon Ternes, President, Chief Operating and Chief Financial Officer

So the pipelines look pretty good and I've been reading many conference call texts regarding or near texts regarding what others are seeing. And it seems like activity has picked up, particularly in the multifamily commercial real estate sector, maybe a little bit less so in single-family. It seems like the refinance market is going to slow down a bit. And as a result of that, it's very competitive and it's been competitive for a while as everybody has been scrambling for assets. We have seen a little bit more activity with respect to purchased loans. We did not execute any purchases in the December quarter. So the origination volume you saw in the December quarter was our originations. But we've seen more activity recently, and we bid on a couple of packages recently as well. So that seems to be picking up a bit. So from our perspective, loan growth right around the quarter had a couple of quarters where there were net loan growth and then December should pick up a little bit, but we think with better loan growth, if we can get prepayments to fall and it seems to be rising in mortgage rates would set us up well for prepayments to fall.

Tim Coffey, Analyst

All right. Okay. And then just wanted to follow on from me on expenses. To the extent that you are experiencing wage pressures, what is kind of going to be your approach this next calendar year, just on that?

Donavon Ternes, President, Chief Operating and Chief Financial Officer

Tim, when we think about wage pressure, we've been increasing wages all along for the last couple of years it seems. And we do market surveys with respect to where we think wages should be, and we implement on occasion wage increases across categories. We think there is wage pressure out there. We've read much about it as well. We can see that it seems to be more difficult to bring in new applications for potential employment, so it's out there. Our response is going to be, what to do. We obviously have to staff ourselves and we've been able to do so, although there is some pressure out there.

Tim Coffey, Analyst

All right. Okay. Great. Those are my questions. Thank you very much.

Operator, Operator

Thank you. Our next question comes from the line of Nick Cucharale with Piper Sandler. Please go ahead.

Nick Cucharale, Analyst

Good day, everyone. How are you?

Craig Blunden, Chairman and CEO

Hi, Nick.

Donavon Ternes, President, Chief Operating and Chief Financial Officer

Good. Thanks.

Nick Cucharale, Analyst

Good. Just following up on the deployment of cash into securities. What was the amount of purchases you've made so far in the March quarter?

Donavon Ternes, President, Chief Operating and Chief Financial Officer

Well, in the December quarter, we did $15 million of purchases and essentially that kept our cash balances about flat from where they were when we started that December quarter. We have run off, if you will or prepayment cash flows coming off at about $5 million a month or about $15 million a quarter. We would prefer to use that cash flow in populating into our loan portfolio to the extent we can grow it. Secondarily, we would prefer to use that cash to repay or prepay advances as they mature. And then lastly, we're interested in making certain our cash doesn’t get up above kind of where it currently is. We would then go out and look at investment security purchases. One interesting note, if we think about what the Federal Open Market Committee said yesterday with respect to where they're leaning, it appears that March would be lift-off with respect to an increase in interest rates. I think we're already seeing it on the short end of the curve, but what that would also mean is that federal reserve balances, which are currently earning 15 basis points, would probably move up to earning 40 basis points or so, if it's a 25 basis point increase. So with higher cash balances on the balance sheet, we will get some lift with respect to the net interest margins and net interest income once the Fed begins to raise, irrespective of how they redeploy the cash or the cash flows coming in on their balance sheet.

Nick Cucharale, Analyst

That's helpful. And then just following up on the loan side. I appreciate the prepared remarks, but can you provide some commentary on the multifamily side? It sounds like activity is picking up but originations and purchases in this segment were down a bit relative to the previous quarter, some thoughts there would be helpful?

Donavon Ternes, President, Chief Operating and Chief Financial Officer

Yes. We see our pipelines are very close to where they were in the end of the September quarter and the end of the June quarter and in fact you can kind of see that in our origination volumes. It's really competitive with respect to multifamily production. In fact, I mentioned earlier that we had been looking at a couple of packages of multifamily loans. In fact, we see some of those packages. Yesterday, we were alerted that we missed out on a particular bid we had on a package and we were a little bit light with respect to our premium. Nonetheless, that's better activity than we've seen particularly in the December quarter there. So I think origination volume, to the extent that we can land some purchase packages will probably go up. And I think that's potentially in the multifamily sector as well as the single-family sector. Nonetheless, it is highly competitive out there. Yields are going up a bit with respect to multifamily and commercial kind of responding to market conditions, but not as much as you would think given the nature of the competitive landscape.

Nick Cucharale, Analyst

Okay. And then lastly just with respect to credit costs. You posted another negative provision this quarter, asset quality is pristine and certainly future provisioning depends on growth in the overall environment, but do you think there is still room to drive coverage ratio lower, is that starting to bottom?

Donavon Ternes, President, Chief Operating and Chief Financial Officer

Well, one of the things that we look at is where we were pre-pandemic, and really that was the December 31, 2019 quarter. I think we ended the 2019 quarter with about $6.9 million of allowance, and that was about 73 basis points on the loan portfolio. December 31st of 2021, we ended with 77 basis points of allowance on our portfolio. And in fact, we still have a slight factor or slight adjustment in our modeling with respect to pandemic. Meaning that we had some allowance allocated toward the pandemic environment which should move off as we kind of get through 2022 and as we see the economic environment improve and maybe some of the issues that we're seeing with pandemic go away. So I think there is room there with respect to moving down just from the standpoint that we kind of have a pandemic component built into our current allowance that we didn't have two years ago. But secondarily and maybe more important, if you look at our credit quality today in comparison to where we were two years ago it's better. Non-performing assets are lower than they were two years ago and classified assets are lower today and better than they were two years ago. So if we think about moving through this pandemic cycle, we still have a little bit of reserve qualitative component built in with respect to the pandemic and we actually had better characteristics with respect to credit quality from the standpoint of non-performing and classified. So I think there is some room; I don't know that it moves as dramatically as it did in the December quarter.

Nick Cucharale, Analyst

Thank you for taking my questions.

Operator, Operator

Thank you. And there are no remaining questions in the queue, please continue.

Craig Blunden, Chairman and CEO

All right. Well, if there's no other questions, I want to thank everyone for joining us on our conference call and look forward to speaking with all of you again next quarter.

Operator, Operator

Ladies and gentlemen, this conference will be available for replay after 11:00 AM Pacific today through February 3. You may access the AT&T replay system at any time by dialing 1-866-207-1041 and entering the access code 9244107. International participants may dial 402-970-0847. Those numbers again are 1-866-207-1041 and 402-970-0847 with access code 9244107. That does conclude our conference for today. And thank you for your participation and for using AT&T conferencing service. You may now disconnect.