Provident Financial plc

Ladies and gentlemen, thank you for standing by. Welcome to the second quarter earnings call. At this time, all participant lines are in a listen-only mode. Later, there will be an opportunity for your questions, and instructions will be given at that time. Should you require assistance, please press star, then zero, and we will assist you offline. As a reminder, today's conference call is being recorded. I will now turn the conference over to Craig Blunden. Please go ahead.

Good morning, everyone. This is Craig Blunden, Chairman and CEO of Provident Financial Holdings. And on the call with me is Donovan Turnis, 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, 2020, 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 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 $29.6 million of loans held for investments. a decrease from the $48 million loans in the prior sequential quarter. During the quarter, we also experienced $59.6 million of loan principal payments and payoffs, which is down from the $66.3 million in the September 2020 quarter, but still tempering the growth rate of loans held for investments. In the December 2020 quarter, competition remains elevated for lower credit risk loan products, and it seems that many multifamily and commercial real estate borrowers have been on the sidelines waiting for better general economic conditions. Additionally, we are still cautious regarding single-family loan purchase packages, particularly season production, because it's difficult to complete due diligence on individual loans consistent with our underwriting requirements. For the three months ended December 31, 2020, loans held for investment decreased by approximately 3% compared to September 30, 2020, with declines in the single-family, commercial real estate, and construction categories, partly offset by growth in the multifamily loan category. Current credit quality is holding up well, and you will note that early-stage delinquency balances were just $350,000 at December 31, 2020. However, non-performing assets increased to $10.3 million, which is up from the $4.9 million at June 30, 2020. The increase in non-performing assets was a result of forbearance loans downgraded to TDR non-accrual status as a result of not being able to resume their monthly payments at the expiration of their initial forbearance. We extended the forbearance period for another three months, triggering the downgrade in non-performing status. Additionally, the non-performing downgrades resulted in a reversal of accrued interest receivable of approximately $126,000 during the December 2020 quarter. We continue to work with our borrowers to provide payment forbearance for up to six months, but note that new requests for forbearance has significantly declined from levels experienced in March, April, May, and June 2020. In the event forbearance is granted, 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. Our forbearance plan criteria were promulgated pursuant to 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 favorable provisions cited in the guidance on the vast majority of our forbearance loans. As of December 31, 2020, there were six single-family loans in forbearance under outstanding balances of approximately $1.8 million or 0.21% of gross loans held for investment and two multifamily loans in forbearance with outstanding balances of approximately $763,000 or 0.09% of gross loans held for investment. You will note that the significant decline in number of balance of loans in forbearance on December 31 in comparison to September 30, 2020 balances as a result of these loans that resumed routine monthly payments were migrated to TBR after receiving a forbearance extension. Additionally, as of December 31st, just 17 loans scheduled to resume their monthly payments subsequent to their initial forbearance with a combined principal balance of approximately $6.3 million were granted an additional three months of forbearance relief. Sixteen of the 17 loans, or approximately $5.8 million, were classified as restructured loans and downgraded to non-performing status during the quarter. One of the 17 loans has previously downgraded and classified. We required a $39,000 provision for loan losses in the December 2020 quarter. The allowance for loan losses to gross loans held for investment increased to 99 basis points on December 31st from 95 basis points on September 30th. 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 18 basis points for the quarter ended December 31, 2020 compared to the September 30th sequential quarter as a result of a 21 basis point decrease in the average yield on total interest earning assets, partly offset by a three basis point decrease in the cost of interest bearing liabilities. The decline in average yield on total interest bearing assets was primarily the result of the sharp rise in liquidity stemming from the significant increase in total deposits and loan prepayments and reinvested at lower yields. Our average cost of deposits decreased by three basis points to 21 basis points for the quarter ended December 31, 2020, compared to the September 30th sequential quarter. And we believe that further declines are likely given the current interest rate environment. I would also like to point out that we paid off $20 million of federal home loan bank advances late in December quarter, reducing our borrowing costs by approximately 27 basis points as we begin the March 2021 quarter. The 2.6% net interest margin this quarter was also negatively impacted by approximately five basis points. As a result of the increase in amortization of the net deferred loan costs associated with the loan payoffs in the December quarter, in comparison to the average net deferred loan cost amortization of the five previous quarters and by approximately four basis points stemming from the previously described reversal of accrued interest receivable on the newly classified nonperforming loans. We continue to look for operating efficiencies throughout the company to lower operating expenses. Notably, our FTE count on December 31, 2020 decreased to 166 compared to 184 FTE on the same date last year, a 10% decline. As a result of fewer employees and other cost savings, operating expenses declined to approximately $6.9 million in the current quarter compared to approximately $7.6 million in the same quarter last year, a decline of approximately 9%. Additionally, on a sequential quarter, operating expenses declined by approximately 1%. 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 may prove difficult. In the interim, we're redeploying excess liquidity and government-sponsored mortgage-backed securities with estimated average lives of approximately four years. We exceed well-capitalized capital 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, and doing so takes priority over stock buyback activity. As a result, we did not repurchase any shares of common stock in the December 2020 quarter and wish to emphasize that safeguarding capital has become increasingly important in the current environment. However, we also recognize that prudent capital return to shareholders through stock buyback programs is a valid capital management tool, and we will be reviewing our current position on buybacks in the March 2021 quarter. We encourage everyone to review our December 31st investor presentation posted on our website. You'll find that we 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. In particular, slide 13 contains the forbearance table as of December 31, 2020, and footnote 5 of the commercial real estate table describing the composition of our commercial real estate secured loan portfolio and the balances that may be considered higher risk in the current environment. We will now entertain any questions you may have regarding our financial results. Thank you. Leah?

Ladies and gentlemen, if you would like to ask a question, please press 1 then 0 on your telephone keypad. You will hear acknowledgement that your line has been placed in queue. Once again, if you have a question, please press 1-0 at this time. One moment, please, for the first question. And one moment, please. And we have a question from Tim Coffey. One moment, please. And go ahead, sir.

Thank you. Morning, gentlemen. Good morning. Craig, can we just real quick just go over the non-recurring or the extraordinary items that flow through the interest income this quarter?

Yeah, I'll take that, Tim. So, first of all, we had about a five basis point net interest in net interest margin impact as a result of the accelerated deferred, net deferred loan costs coming from the particular loans that prepaid during the quarter. And then secondarily, we had approximately a four basis point negative impact to net interest margin as a result of downgrading the forbearance loans that we extended, migrating them out of the forbearance category, which is acceptable to accrue interest, into the non-performing status, where we had to reverse the accrued interest receivable on those. That was about $126,000 for the quarter, and the impact was about four basis points higher. compression to our net interest margin.

And the five basis points, how much is that in dollars?

In dollars, I don't have that readily handable or handy.

I can work my way into it.

Yeah, actually, you know what? I just grabbed it. It's about $132,000 for the quarter. So on an annualized basis, it's about five basis points on the net interest margin.

Okay, that's helpful. Is that just a function of the way the rates move during the quarter? Obviously not the four basis points one, right? That's totally different, but the five basis points. Is that just a function of the way the interest rates move during the quarter?

No, it's specifically tied to the prepayment of loans during the quarter. The specific loans either have net deferred loan fees or net deferred loan costs attached to them. that are either accreted over the life of the loan or amortized over the life of the loan. When the loan paid off, the net deferred costs or net deferred fees, which in total was net deferred costs, had to be accelerated in the quarter of payoff. And that occurred in the December quarter. And that can deviate from one quarter to the next Number one, depending upon the absolute dollar amount of payoffs, as payoffs accelerate, there's more opportunity for net deferred costs to be accelerated. But secondarily, net deferred fees or net deferred costs are attached to individual loans, and depending upon which loans pay off will determine what occurs with respect to net deferred loan costs or net deferred loan fees that come in through the income statement.

It's certainly not a new phenomenon. I think we've seen this before in previous down rate cycles. Also not a new phenomenon is kind of the pace of payoffs. Is it your kind of, you know, where you sit right now, reasonable to expect that there's going to be headwinds to net loan growth because of the payoffs and, you know, to a certain extent the challenges of finding new loans?

Yeah, I think that's fair, but I kind of want to put it in context. If we think about the payoffs that have been occurring and you look at the starting and ending balances by loan category, you will see in the December quarter single-family payoffs accelerated to such a degree that single-family loan portfolio came down. The multifamily loan portfolio actually increased during the quarter, and the commercial real estate and construction loan portfolios came down just a bit during the quarter. So the phenomenon with respect to payoffs in the December quarter was primarily in the single-family area. And because we are in the fixed-rate market we are with respect to where rates are with single-family, I would expect those payoffs to remain elevated. We did not see the same elevation in multifamily and commercial real estate during the December quarter, although that could occur as well. And then secondarily, with respect to debt, generating or originating loans in any given quarter. That's a function obviously of competition as well as what we're looking to do as it relates to our underwriting. And the key component there is to think about COVID-19 and how we responded with our underwriting criteria through COVID-19 In fact, we tightened underwriting standards in March of last year. We loosened them a bit in May of last year. We loosened them a bit more in November of last year, but still a bit tighter than where we were pre-COVID. And we are looking to perhaps loosen them again in the March quarter to probably get back to pre-COVID type underwriting as the impact of COVID becomes more transparent, if you will. And frankly, our portfolio has held up pretty well, except for that single family category where we downgraded 16 or 17 loans. Okay.

Yeah. Is it kind of your expectation that, again, where you sit right now, that if you look at kind of provision expenses, it could be much closer going forward to calendar second half of 2020 relative to the first half of calendar 2020? Yes.

I think that as we look at our loan portfolio, the increase in non-performing loans came directly from the forbearance loans where we extended the forbearance beyond six months. But we're starting the March quarter with just eight loans in that grouping, six single family and two multifamily. So the source of those non-performing loans are far smaller than they were in the September quarter. And then additionally, if you look at how our allowance actually grew during the period, calendar 2020, as you suggest, March was the largest provision. June was the second largest provision. And then the September and December quarters declined in provision, even though the allowance had gone up. And lo and behold, we obviously saw then the deterioration in non-performing with respect to those forbearance loans following what we had actually done in the provision. So if I think about the future provision, it again would be determinant or dependent upon what we see in non-performing loans as we go forward. and based upon what we see at the current portfolio level at December 31st, it does not appear as if we would see a significant rise in non-performing, given the position of the portfolio at December 31st, and frankly, somewhat improving general economic conditions.

Okay. All right, I'll stop there. Thank you very much, Alvin.

And our next question is from Bob Schoen. Please go ahead.

Hey, good morning. It's Bob Schoen. I'm from Matthew Clark. Maybe if we could just start with the downgrades and restructuring classified. Can you maybe give some color around what went into those restructuring of those loans? maybe kind of weighted average LTVs and debt service coverage ratios, just trying to get a better understanding of those 16 loans. Thanks.

Sure. So with respect to the restructuring terms, none of the terms were changed as it relates to the notes other than extending payment forbearance for another three months and then the three months were tacked onto the back end with respect to repayment in a balloon. I don't have the specifics with respect to the weighted average LTVs of that portfolio. You can get a sense of where they were by looking at the September 30 investor presentation on slide 13. You'll see the weighted average LTVs of the SFR loans at that time, and a portion of that were the 16 or 17 that were extended. Overall, we don't believe there is significant loss content in ultimately associated with those loans because you will see their lower LTV or well protected by the LTVs and then secondarily the California real estate markets are very very strong such that if those loans further deteriorated where we took them down the foreclosure path because the borrowers were unable to begin making monthly payments again We just don't see the loss content of any significance, if you will. With respect to the specific provisions associated with that, while I don't know that we have it in our earnings release, you'll see it in the Form 10-Q. I believe the individually evaluated allowances associated with those loans were $570,000. And I think that 570 moved up from around $50,000 previously. So about $520,000 was specifically earmarked in the form of allowance against those loans.

Awesome. That's great, Collar. And then maybe if I can just sneak one more in. Regarding share purchases, I know in your prepared remarks you talked about that it's something that's going to be re-evaluated. Maybe can you just talk about... any change in willingness to start those repurchases. I know that the full authorization is still available, and we've got kind of a run-up in the price towards tangible book value, so maybe any color around that would be great. Thank you.

Sure. So We obviously understand where our capital positions are, where our opportunity lies. We've been a little bit constrained with respect to growth in the fact that origination volume has not exceeded payoff volume. And so capital returns in the form of repurchases, from our perspective, is something we should be thinking about now. And secondarily, because we've, you know, we're not through the COVID economy, if you will, or economic situation, but because the vaccine has been rolled out and people are getting inoculated, you know, it does appear to be something that should improve as we go through calendar 21. So it is back on the table for our consideration. That consideration obviously involves discussions with our regulators. Those discussions are ongoing. And, you know, I guess that's the color I could provide at this time. The price to tangible book being near zero 100% or right around the same level or maybe a little bit above tangible book is not a hindrance per se because we think franchise value is obviously greater than that. Although, yeah, it sure would have been nice to repurchase six months ago, I suppose. Thank you for that. I'll step back.

And we have no other questions at this time. You may continue.

Well, if there are no other questions, I want to thank everyone for attending our quarterly conference call and look forward to speaking with all of you again next quarter. Thank you.

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