Earnings Call Transcript - PROV Q3 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Third Quarter Earnings Call. At this time, all lines are in a listen-only mode. Later we'll conduct a question-and-answer session and instructions will be given at that time. And as a reminder, we are recording today. I would now like to turn the conference over to 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, 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 Q&A 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 statements 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-K Qs and other SEC filings that are filed subsequent to the Form 10-K. Forward-looking statements are effective only on 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 third quarter results. In the most recent quarter we originated and purchased $94 million of loans held for investment, an increase from the $65.3 million in the prior sequential quarter. During the most recent quarter, we also experienced $53.6 million of loan principal payments and payoffs, which is down from $72.5 million in the December 2021 quarter and at the lower end of the quarterly range. 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 CRE, which remain a bit tighter. Additionally, our single-family and multi-family pipelines are similar in size to last quarter, suggesting our originations and purchases in the June 2022 quarter will fall in the range of recent prior quarters between $60 and $94 million. For the three months ended March 31, 2022, loans held for investment increased by approximately 5% compared to December 31, 2021, with increases in the single-family, multi-family, commercial real estate, and construction loan categories. Current credit quality is holding up very well and you will note that there are just $2,000 of early-stage delinquency balances at March 31, 2022. Additionally, non-performing assets decreased to just $2 million, which is down from $2.8 million on December 31, 2021. Please note that the decline in non-performing assets is primarily the result of forbearance loans previously downgraded to TDR, non-accrual status that were subsequently upgraded to performing status given their satisfactory payment performance in compliance with the terms of their forbearance. As of March 31, 2022, 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 are now primarily classified as performing loans with a few remaining in TDR non-performing status. We recorded a $645,000 negative provision for loan losses in the March 2022 quarter. The allowance for loan losses to gross loans held for investment decreased to 66 basis points at March 31 from 77 basis points on December 31. You will note that we remain on the incurred loss model and have not adopted CECL. This means that our allowance methodology cannot be reasonably compared to CECL adopters. Our net interest margin compressed by three basis points for the quarter ended March 31, 2022, compared to the December 2021 sequential quarter. As a result of a seven basis points decrease in the average yield on total interest-bearing assets, partly offset by a four basis points decrease in the cost of total interest-bearing liabilities. Notably, our average cost of deposits was unchanged at 12 basis points for the quarter ended March 31, 2022, compared to the prior sequential quarter. Additionally, our borrowing costs decreased by approximately 17 basis points in the March 2022 quarter compared to the December 2021 quarter, primarily due to a $39,000 prepayment fee in the December quarter that was not replicated in the March 2022 quarter. The 2.61% net interest margin this quarter was positively impacted by approximately four basis points as a result of lower net deferred loan costs associated with fewer loan payoffs in the March 2022 quarter compared to the average net deferred loan cost amortization of the previous five quarters. We expect that near-term future quarters will also benefit from fewer loan payoffs as a result of higher mortgage interest rates. In addition, new loan production is being originated at higher mortgage interest rates than recent prior quarters and adjusted rate loans in our portfolio are now adjusting to higher interest rates in comparison to their existing interest rates. Also, for multi-family and commercial real estate loans, we're beginning to see some cases where the loans are adjusting above their existing floor rate. These factors suggest that our net interest margin is poised for near-term expansion. We continue to look for operating efficiencies throughout the company to lower operating expenses. Our FTE count on March 31, 2022, increased to 163 compared to 162 FTE on the same date last year, a very small increase. You will note that operating expenses have been very stable at approximately $6.9 million per quarter. After adjusting for the employee retention tax credit that was recognized in the September and June 2021 quarters, we do not expect a meaningful change to the stable run rate. 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. We were very successful in execution this quarter with loan origination and purchase volumes at a higher end of the quarterly range, and loan payoffs at the lower end of the quarterly range. The total interest-earning assets composition improved during the quarter with an increase in the average balance of loans receivable and decreases in the average balance of investment securities and interest-earning deposits. The total interest-bearing liabilities composition also improved with an increase in the average balance of deposits and a decrease in the average balance of borrowings. We exceed well-capitalized capital ratios by a significant margin allowing us to execute our business plan and capital management goals without complications. We believe that maintaining our cash dividend is very important and 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 69,000 shares of common stock in the March 2022 quarter under the April 2020 stock repurchase program. We encourage everyone to review our March 31 Investor Presentation posted on our website. You will find we included slides regarding financial metrics, asset quality, and capital management, which we believe will give you additional insight into our solid financial foundation supporting the future growth of the company. We will now entertain any questions you may have regarding our financial results. Thank you.

Operator, Operator

Ladies and gentlemen, we have Nick Cucharale with Piper Sandler. One moment.

Nick Cucharale, Analyst

How are you?

Craig Blunden, Chairman and CEO

Good morning.

Nick Cucharale, Analyst

Can you share with us loan pricing on new originations in the single-family and multi-family books relative to the portfolio rate?

Craig Blunden, Chairman and CEO

Yes. So new originations in single-family are in the low to mid-fours. Newer originations in multi-family are in the mid-fours. And new originations in CRE are in the high-fours to low-fives.

Nick Cucharale, Analyst

Okay, and then with respect to operating expenses, I heard the commentary that you aren't expecting a meaningful change to the quarterly run rate. Are you seeing the effects of wage inflation? And if so, could you quantify the impact on the expense base?

Craig Blunden, Chairman and CEO

We're not really seeing at this time wage inflation per se. We are seeing that we have more openings than what has historically occurred as staff are entertaining positions with other companies. But to the extent that we are looking at current salaries and employee benefits expense, it's relatively stable at this point. Although I suppose if we were to experience more turnover, we would see a larger impact with respect to wage inflation. But currently, we're not seeing a significant component in operating expenses.

Nick Cucharale, Analyst

Thank you for taking my questions.

Operator, Operator

And then we have the line of Tim Coffey, you're open.

Tim Coffey, Analyst

Thanks, morning, gentlemen. And thanks for taking my questions. Can you kind of describe the market dynamics that you're seeing right now that gives you confidence that the pace of net loan growth we saw this quarter can continue?

Donavon Ternes, President, COO, and CFO

Sure, Tim. I think the first thing I would describe is that our loan pipelines, particularly in single-family and multi-family, are very strong from a historical perspective. In fact, they look very similar to where we began the March quarter at the end of December and beginning of January. And frankly, it picked up steam as we went through the quarter and ended the quarter on March 31st. In fact, with respect to our origination volume, as we think about the March quarter, approximately $51 million was originated in March of the total $94 million that we did in the quarter. Of that $94 million, we had about $6.4 million that we purchased. So purchases were not a significant part of that volume. So from our perspective, when we think about what our origination volume may look like in the June quarter, I think Craig's comments suggested a range of $60 million to $94 million. That's what we've been able to do over the last four quarters. Our pipelines look strong enough to support a volume in that range. But maybe more importantly, due to the rise in mortgage interest rates, we're seeing a significant decline in payoffs volume. In the March quarter, it came down to $53 million, which is at the lower end of the range that we've been experiencing over the last four or five quarters or so. And we would expect that volume to come down again in the June quarter. And to the extent that we're able to originate and purchase that recent range of $60 to $94 million and pay off volume comes down, it once again suggests a positive dynamic with respect to growth of the loan portfolio in the June quarter. The second part of the consideration with respect to lower loan payoffs is that our net deferred loan cost amortization will decline as well because net deferred loan costs get accelerated when the loan pays off. So to the extent payoffs come down, the component in net interest income and net deferred loan cost amortization will also decline. The meaningful impact of that is that net interest margin will improve as a result of that.

Tim Coffey, Analyst

Right. Yeah, exactly. And then can you quantify the impact of net interest income on just the higher rates, not necessarily deferred amortization?

Donavon Ternes, President, COO, and CFO

Well, we normally don't describe or quantify or provide guidance on that basis. What I would suggest as we think about the June quarter, there are a number of positive factors that will positively impact net interest income and net interest margin. One of the things is the loans in our portfolio that are subject to re-pricing. In the June quarter, we have approximately $67 million of loans that we'll re-price upward from their current interest rate. Additionally, in the September 2022 quarter, there are approximately $107 million of loans that are subject to re-pricing. They will also re-price upward based upon current interest rates and where the indices are supporting those loans. On top of that, with respect to positive factors, we have interest-earning deposits that are going to be yielding higher interest rates. They're currently yielding higher rates than where they were in most of the March quarter. As a result of the Fed's increase in the March meeting, I expect that we will have Fed actions in the main meeting and in the June meetings as well, which suggest that what we're earning on interest-earning deposits will increase. We also have the cash flows coming in from investment securities; to the extent that we see those cash flows come in, we're not redeploying currently in investment securities. We are redeploying in loans, and those loan yields are far higher than where those investment security yields currently are. So those cash flows provide an impact with respect to a positive margin. I've already discussed lower net deferred loan costs. You can do the math on that. I think we had $496,000 of net deferred loan costs in the March quarter. If that number comes down, which I expect will occur in the June quarter because payoffs are going to come down, you can estimate what that will do with respect to margin, but it's meaningful. And to the extent we have new loan production coming in and are growing the loan portfolio, as I've already described, the yields in those loans are in the 4% buckets, call them mid-fours across all product lines. And that's a meaningful increase to where loans were coming in during the March and prior quarters.

Tim Coffey, Analyst

Okay. That's great detail, Donovan. I appreciate that. If you dig into the interest-earning deposits, do you have any sense of what the total deposit beta might look like through this cycle?

Donavon Ternes, President, COO, and CFO

Well, for us, I think if we think about our retail deposit franchise, we historically have had the lower end of the range with respect to deposit beta on our retail deposits. We would expect that to continue. I'm not going to forecast what percentage of that might look like as it relates to the Fed funds rate. But we would expect, as well, that we would be at the lower end of the range with respect to retail deposit beta. Where we might see some pressure with respect to our deposits is to the extent that we're growing total assets such that our retail deposit growth is not keeping up with that. We would be accessing the wholesale markets, either brokered CDs, federal home loan bank advances, perhaps to the extent we're interested in tamping down our interest rate risk sensitivity in a rising rate market. And at-the-margin, then any growth with respect to any loan growth that is funded with respect to wholesale funding, such as brokerage deposits in Federal Home Loan Bank advances, would work to increase our overall cost of liabilities. But we don't think that is going to be as meaningful as the increase we're going to see in our interest-bearing assets.

Tim Coffey, Analyst

Okay, that's helpful. What does this mean for the tax rate?

Donavon Ternes, President, COO, and CFO

We guide our effective tax rate is 29.56%. And then there are every year some items that come in that work to lower the effective rate or increase the effective rate a bit. But again, our combined effective tax rate is 29.56%.

Tim Coffey, Analyst

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

Operator, Operator

Any speakers at this point? No one else has queued up. Please go ahead with any closing remarks.

Craig Blunden, Chairman and CEO

All right. Well, I appreciate everyone joining us on our quarterly call and we look forward to talking to all of you again next quarter. Thanks for your participation.

Operator, Operator

And ladies and gentlemen, that does conclude your call for today. Thank you for your participation and thank you for using AT&T event teleconference. You may now disconnect. One moment, speakers.