Earnings Call Transcript - PROV Q4 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Provident Financial Holdings Fourth Quarter Earnings Conference Call. I would now like to turn the conference over to our host, Chairman and CEO, Mr. Craig Blunden. Please go ahead, sir.

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 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, 2019, 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 that they are made; 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 and fiscal year results. In the most recent quarter, we originated and purchased $44.2 million of loans held for investment, an increase from the $28.8 million in the prior sequential quarter. During the quarter, we also experienced $56.5 million of loan principal payments and payoffs, which is up slightly from the $55.7 million in the March 2020 quarter and still tempering the growth rate of loans held for investment. In the June 2020 quarter, we found it a bit easier to originate purchase loans as the quarter progressed as mortgage markets normalized to some degree. However, we're still cautious regarding single-family loan purchase packages, particularly seasoned production because it is difficult to complete due diligence on individual loans consistent with our underwriting requirements. For the three months ended June 30, 2020, loans held for investment decreased by approximately 1% in comparison to the March 31, 2020, with declines in single-family and commercial real estate categories, partly offset by growth in the multifamily, construction, and other loan categories. New loan production seems to improve from California lenders from the March quarter because many of the pandemic operating constraints have been resolved. Current credit quality is holding up well, and you will note that early-stage delinquency balances were just $219,000 at June 30, 2020. In addition, nonperforming assets remain at very low levels, and we're just $4.9 million, which is down from the $6.2 million at June 30, 2019, a 21% decline during the course of the year. However, the situation regarding the pandemic is fluid and may have negative implications for future credit quality, although it's far from certain what those implications will be. We continue to work with our borrowers to provide payment forbearance of up to 6 months. The forbearance amount will be due and payable in full as a balloon payment at the end of the loan term or sooner if the loan becomes due and payable in full at an earlier date. We believe our forbearance plan will meet the broad criteria promulgated by the CARES Act, the interagency regulatory guidance and clarifying statements from the Financial Accounting Standards Board and the Securities and Exchange Commission. As a result, we believe that we qualify for the favorable provision cited in the guidance on the vast majority of forbearance loans. As of June 30, 2020, there were 48 single-family loans in forbearance with outstanding balances of approximately $19.9 million or 2.2% of gross loans held for investment and 5 multifamily and commercial real estate loans in forbearance with outstanding balances of approximately $2.7 million or 0.29% of gross loans held for investment. Monthly payments on the majority of loans in forbearance will not be required to resume until October or November of 2020. Additionally, new requests for forbearance have significantly declined from levels experienced in March, April, and May. We recorded a $448,000 provision for loan losses in the June 2020 quarter, primarily due to an increase in the qualitative components in our allowance for loan losses methodology in response to the pandemic, which has negatively impacted the current economic environment. 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. I also wish to refer you to Slide 13 of our investor presentation, specifically Footnote 5 of the commercial and real estate table. The footnote describes the composition of our commercial real estate secured loan portfolio and the balances that may be considered high risk in the current environment. Additionally, we populated a new table on Slide 13 describing certain characteristics of loans in forbearance. Our net interest margin compressed by 35 basis points for the quarter ended June 30, 2020, compared to the March 31 sequential quarter as a result of a 41 basis point decrease in the average yield on total interest-bearing assets, partly offset by a 7 basis point decrease in the cost of total interest-bearing liabilities. The decline in the average yield on total interest-bearing assets was primarily a result of a sharp rise in liquidity, stemming from the significant increase in total deposits invested at nominal yields. Our average cost of deposits decreased by 6 basis points to 30 basis points for the quarter ended June 30, 2020, compared to the March 31 sequential quarter. And we believe further declines are likely given the current interest rate environment. The 2.9% net interest margin this quarter was also negatively impacted by approximately 7 basis points as a result of the increase in the amortization of the net deferred loan costs associated with the loan payoffs in the June quarter in comparison to the average net deferred loan cost amortization of the 5 previous quarters. We continue to look for operating efficiencies throughout the company to lower operating expenses. Notably, our FTE count on June 30, 2020 was 178 compared to 187 FTE on the same date last year, a 5% decline. As a result of fewer employees and other cost savings, operating expenses declined to approximately $6.6 million in the current quarter compared to approximately $9.7 million in the same quarter last year. Please note, though, that the June 2020 quarter benefited from a $575,000 reversal of incentive compensation accruals previously expensed in the first 3 quarters of fiscal 2020. Likewise, it should be noted that we incurred approximately $1.2 million of one-time costs in the June 2019 quarter last year associated with scaling back the origination of salable single-family mortgage loans. Additionally, on a sequential quarter basis, operating expenses declined by approximately 4% primarily as a result of declines in salaries and employee benefits, equipment and other expenses, partially offset by increases in sales and marketing expenses and deposit insurance premiums. Our short-term strategy for balance sheet management is unchanged from last quarter. We believe that leveraging the balance sheet with prudent loan growth is the best course of action that executing on that strategy in the current environment may prove very difficult. 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 to shareholders and doing so takes priority over stock buyback activity. As a result, we did not repurchase any shares of common stock in the June 2020 quarter and wish to emphasize that safeguarding capital is becoming increasingly important in the current environment. And it's the wisest course of action until we get better clarity on the current economic landscape. We encourage everyone to review our June 30 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 strong 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

We do have a question from the line of Matthew Clark.

Matthew Clark, Analyst

Maybe we can start with the margin. The accelerated amortization sounds like it negatively impacted your loan yields there a little bit and the excess liquidity is significant. Can you just kind of talk through the puts and takes of the margin as it relates to the excess liquidity, new loan pricing? The funding is a little easier to kind of see. But just on the asset side, what the outlook is there?

Donavon Ternes, President, COO, CFO

Sure. I'll grab this. It's Donavon, Matthew. The largest impact in the June quarter was, as you described, the interest-earning deposits or the significant increase in liquid assets. For example, the March quarter, we had approximately $61.9 million of interest-earning deposits or overnight deposits, if you will, as investments. And that was earning 120 basis points for the quarter. And then we move into the June quarter, and we see the large rise in deposits that came in during the June quarter, which were essentially invested in large part in overnight advances, and that was $135.1 million, but the yield dropped to 11 basis points. So through the June quarter, we were essentially repositioning that liquidity out of overnight advances into investment securities and obviously to the extent that there was loan growth -- in the loan growth, although that actually shrunk up a bit. So as we think about the remainder of this calendar year and the beginning of our fiscal year, we're really going to need to redeploy those excess or that excess liquidity primarily into loans as the preference, but then secondarily into investment securities, such that the yields we are earning on those investments are significantly larger than what we did in the June quarter. So that's the first thing. And then secondarily, as we think about where loan yields are coming onto the balance sheet, single-family loans are coming onto the balance sheet in the low 3% range; multifamily and commercial real estate are in the mid to high 3% range. So we are investing in the low 3s to the high 3s with respect to new single-family, multifamily, and commercial real estate production. And obviously, to the extent that that growth takes some of that excess liquidity off the books, there will be a nice bounce with respect to the margin as we think about going forward. And then secondarily, the liability side, as it relates to our cost of liabilities, will also get some helpful go-forward bounce, if you will. First of all, we have about $90.5 million of CDs that are maturing over the next year. Right now, those CDs are probably in the very high 90 to 110 basis point category, and those are being reinvested at maturity in the low 20 basis point category. So we'll get some bounce to margin as we go down the timeline there. And then secondarily, we have FHLB advances that are maturing through the course of the year. There's about $30 million of FHLB advances. And those advances and their cost are in, call it, $257 million range. They will either be paid off with excess liquidity or in the event we need the funding, we will replace those advances with significantly lower-cost funds. So if I think about our net interest margin, we were hit pretty significantly in the June quarter, primarily because of excess liquidity and our job during fiscal '21 is essentially to redeploy that excess liquidity into much higher-yielding assets. And as a result of that, I think our net interest margin is probably closer to the bottom of our range than the top of our range on a current basis or at the June quarter, if you will.

Matthew Clark, Analyst

And on the security side, I guess, what are you buying with that excess liquidity to the extent you're redeploying it?

Donavon Ternes, President, COO, CFO

Yes. It's primarily in the mortgage-backed securities, GSE types. And it can range from adjustable rate all the way to a fixed rate product, but we're keeping the average life relatively short. But ultimately, we want cash flow products such that we're getting cash flows back to either redeploy into loans or also potentially redeploy in this excess liquidity. One thing to think about as it relates to the excess liquidity, much of that excess liquidity was the result of the significant increase in deposits. The significant increase in deposits in the June quarter was largely the result of the stimulus programs that were putting money in depositors' pockets, and they were then placing them into bank accounts, including PPP funds. Although we didn't make the loans, we were the recipient and beneficiary of some of the funding that some of our customers received in the form of deposits. One would expect that as we go down the timeline, that funding will be used by the various businesses and individuals and will then be depleting some of the excess deposits on our balance sheet as well. So we may wish to carry higher liquidity balances than we normally carry, at least over the next quarter or so until we really understand where this excess liquidity from these deposits may land or whether or not they're short-term or longer-term in nature.

Matthew Clark, Analyst

Understood. Okay. And then on the single-family residential loan portfolio and just loan growth overall, yes, the balances in terms of the rate of decline slowed, at least, on a sequential basis. I guess what are your thoughts about being able to maintain loan balances? Or should we continue to expect a little bit of shrinkage?

Donavon Ternes, President, COO, CFO

Well, I think on a fiscal year basis, we ginned up about 3% annual growth in our loans receivable or loans held for investment. I would expect that we would also be in the low to mid-single digits with respect to growth over the course of the fiscal year, but much of that is going to depend upon what the real estate markets look like. Right now, the single-family market is primarily driven by refinance activity into 30-year fixed-rate products. Historically, we've not placed that on the balance sheet, although we may adjust our position with respect to that as we go through fiscal '21 because that's primarily where the market is. And then secondarily, as we think about multifamily and commercial real estate, there may also be an impact with respect to volume or market capacity because it's going to depend upon what the actual economics of the individual collateral or property looks like, whether or not they're impacted by COVID-19 with respect to their rents and the like. So it is conceivable or possible that the opportunity in multifamily and commercial real estate goes down as a result of borrowers essentially not being able to refinance or being uncomfortable with purchase activity in the current environment. So our expectation is that we would probably be low to mid-single digits with respect to annualized growth in the loan portfolio. But I think we're going to be impacted as well with prepayment activity, again, in the single-family portfolio more so than in multi and commercial real estate as a result of current interest rates.

Matthew Clark, Analyst

Okay. Great. And then on the deferral activity, very, very low. It sounds like the requests have slowed significantly as well. I guess how are you thinking about the unemployment benefits and stimulus that the government's providing? And should that get cut? Is that of a growing concern? Or -- I know you have low loan-to-values and all that, but just what are your thoughts about the potential for deferrals to pick up again?

Donavon Ternes, President, COO, CFO

Well, so far, I mean, we're not experiencing significant inquiries with respect to deferrals. We've essentially modified in forbearance those that were coming in from April, May, and June. The total numbers are very low with respect to the percentage of our overall portfolio. There is, of course, always a possibility that requests start increasing again depending upon what occurs with respect to any additional government stimulus programs, but it's very hard to forecast that. All I would suggest is given what occurred in our balance sheet and what we actually did in forbearance in the June quarter being significantly lower than what we've seen across the industry, we would have that same expectation that in the event we do see a rise in requests, our portfolio would probably fare better than many in the industry, particularly if we gauge it against what we saw in the June quarter and March quarters in comparison to others in the industry.

Operator, Operator

Our next question comes from the line of Tim Coffey.

Timothy Coffey, Analyst

Given the commentary that you just provided on kind of your loan growth outlook for the next fiscal year, if the lower levels of originations, is that going to have -- is that kind of limited impact on the growth in your noninterest expenses?

Donavon Ternes, President, COO, CFO

Well, I don't know if it will have a limiting impact. We've seen noninterest expenses or operating expenses decline significantly. And then even over the course of this fiscal year, we saw our FTE count decline by approximately 5%. And we're still looking for opportunities with respect to FTE count as well as other operating expenses. So I think the first 3 quarters, we were coming in at about $7.5 million per quarter this fiscal year. And then if I look at the June quarter and I adjust for the $575,000 or so, call it, $600,000 of reversal of incentive compensation that benefited the June quarter, that puts us on a run rate of $7.2 million, $7.3 million a quarter in operating expenses, which is lower than the $7.5 million run rate that we had in the first 3 quarters. So our expectation is we're going to be in the low $7 million number for operating expenses over the course of fiscal '21. And it's not specifically related to loan origination volume per se and incentive compensation tied to loan origination volume per se. Obviously, if volume goes down, incentive comp will go down, but I don't know how meaningfully it will go down in comparison to total operating expenses.

Timothy Coffey, Analyst

Okay. That's helpful. And then switching gears over to your noninterest income. Obviously, consumer activity has been well relative to historical periods and your fees reflect that. Do you have any visibility on when you might see client depositor activity start to pick up again?

Donavon Ternes, President, COO, CFO

I think that's pretty difficult to forecast. We're seeing less activity. And additionally, while we didn't quantify it, we were completing some fee waivers in the June quarter as well. So there was kind of a twofold impact in the June quarter with respect to noninterest income, both from the standpoint of reduced consumer activity. But secondarily, there were some fee waivers as well. We would expect the fee waivers component to go away. But when consumers begin their activity, I think, is highly dependent upon when economies open and when consumers are actually out and about and shopping and going to restaurants and movies and the like. So I think that's highly dependent upon the circumstances around the pandemic.

Timothy Coffey, Analyst

Okay. All right. I understand. And then in terms of the buyback, and Craig, I heard the commentary you made on, you may want to maintain capital. But there are banks in the west that are starting to approach the regulators about the opportunities to buy back stock. If the regulators were to start expressing an ability or willingness for the banks to start buying back stock, would that change your view on reinstituting the buyback at all?

Craig Blunden, Chairman and CEO

I'll take that one, Tim. Certainly, that would be an indicator that would mean we'd certainly look more favorably at that. But at this point in time, the regulators are certainly not looking favorably at buybacks. So I'd love to be interested in hearing if there's other institutions that have received permission to go ahead and do some limited buybacks; certainly, at these price levels, it's really attractive, again, where is this economy headed next quarter or two with the effects of the pandemic on it.

Operator, Operator

There are no questions in the queue. Please continue.

Craig Blunden, Chairman and CEO

Well, if there are no further questions, I want to thank everyone for participating in our call today. And we look forward to talking to you next quarter. Thank you.

Operator, Operator

Thank you. Ladies and gentlemen, this conference will be available for replay after 11:00 a.m. Pacific today through August 5, midnight. You may access the AT&T replay system at any time by dialing 1-866-207-1041, and entering access code 2795378. That does conclude our conference for today. We thank you for your participation and for using AT&T event conferencing service. You may now disconnect.