Provident Financial plc

Ladies and gentlemen, thank you for standing by. Welcome to the first quarter earnings call. At this time, all participants are in listen-only mode. Later, we will have a question-and-answer session. Instructions for queuing up will be given at that time. Should you require operator assistance, press star zero on your phone's keypad. As a reminder, today's conference is being recorded for replay, and that replay will be available starting today at 11 a.m. Pacific, and through November 3rd at midnight. To access that replay, dial 866-207-1041. Enter access code 3655739. International participants can dial 402-978-0847. Again, the phone numbers for domestic are 866-207-1041. 1-0-4-9, International, 4-0-2-9-7-8-0-8-4-7. Access code for that replay is 3-6-5-5-7-3-9. Again, replay from today, 11 a.m. Pacific through November 3rd. At this time, I would now like to turn this conference over to your host, Chairman and CEO, Craig Blunden. Please go ahead, sir. Thank you, John. 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 statements is available from the earnings release that was distributed yesterday, from the Annual Report 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 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. In the most recent quarter, we originated and purchased $60.9 million of loans held for an investment, a decrease from the $93.3 million in the prior sequential quarter. During the most recent quarter, we also experienced $53.9 million of loan principal payments and payoffs, which is down from the $79.9 million in the June 2021 quarter and still tempering the growth of loans held for investment. In the September 2021 quarter, competition remains elevated for lower risk loan products, but it seems that many mobile family 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 multifamily pipelines are similar in size to last quarter, suggesting our originations and purchases in the December 2021 quarter will be similar to the volume we experienced this quarter. With the three months ended September 30, 2021, loans held for investment increased by approximately 1% compared to the June 30, 2021, with increases in the single-family and multifamily loan categories, partly offset by declines in the commercial real estate and construction loan categories. Current credit quality is holding up well, and you will note that there are just $20,000 of early-stage delinquency balances at September 30th, 2021. Additionally, non-performing assets decreased to $6.6 million which is down from $8.6 million on June 30th, 2021. Please note that the non-performing assets are largely comprised 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. At the time, we extend the forbearance period Beyond six months, we downgrade the loans to non-performing status. As of September 30, 2021, there was one single-family loan in forbearance with an outstanding balance of approximately $308,000, or 0.04% of gross loans held for investment. On March 31, 2021, we ended new requests pursuant to our forbearance program. Existing forbearance loans will run their course as provided in their individual forbearance agreements and may be eligible for an extension. We recorded a $339,000 negative provision for loan losses in the September 2021 quarter. The allowance for loan losses to gross loans held for investment decreased to 86 basis points on September 30th from 88 basis points on June 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 expanded by 17 basis points for the quarter ended September 30, 2021 compared to the June 2021 sequential quarter as a result of a 14 basis point increase in the average yield on total interest earning assets and a five-basis point decrease in the cost of total and sparing liabilities. The increase in the net interest margin was primarily resolved with the remixing of the balance sheet stemming from the increase in average loans receivable, the decrease in average investment securities, the increase in average deposits, and the decrease in average borrowings. Notably, our average cost of deposits decreased by two basis points to 13 basis points for the quarter ended September 30th, 2021, compared to the prior sequential quarter. Additionally, our borrowing costs decreased by approximately three basis points in the September 2021 quarter, compared to the June 2021 quarter, primarily due to a $21,000 prepayment fee in June that was not replicated in the September 2021 quarter, in addition to the scheduled maturities in the September quarter of higher cost borrowings. The 2.71% net interest margin this quarter was also positively impacted by approximately five basis points as a result of decrease in amortization, the net deferred loan costs associated with the loan payoff in the September quarter in comparison to the average net deferred loan cost amortization of the previous five quarters. Also, the net interest margin improved as a result of the $139,000 recovery of loan interest income on two partially charged-off loans that paid in full in the September 2021 quarter, impacting the net interest margin by approximately five basis points. We continue to look for operating efficiencies throughout the company to lower operating expenses. Notably, our FTE count on September 30, 2021, increased to 164 compared to 163 FTE on the same date last year, a very small increase. You will note that we recorded a $1.2 million credit for the employee retention tax credit in the September 2021 quarter, consistent with the Consolidated Appropriations Act of 2021 and the American Rescue Plan Act of 2021, where eligible employers can claim a maximum credit equal to 70% of $10,000 of qualified wages paid to an employee per calendar quarter. The general requirements to be eligible to claim the credit is a 20% or more decline in gross receipts in the calendar 2021 quarter compared to the same quarter in calendar year 2019 and 500 or fewer full-time employees based on the average of the 2019 calendar year. Additionally, we received a $125,000 litigation settlement in the September 2021 quarter, which was reported as a credit to other non-interest expense, which we consider a one-time item. Our short-term strategy for balance sheet management some change 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 lives of approximately four years. We exceed well 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. Doing so takes priority over stock buyback activity. However, we also recognize that prudent capital returns to shareholders through stock buyback programs is a valid capital management tool, and we repurchase approximately 50,000 shares of common stock in the September 2021 quarter under the April 2020 stock repurchase program. We encourage everyone to review our September 30th investor presentation posted on our website. You will find that we 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 of the company. We will now entertain any questions you may have regarding our financial results. Thank you. John? Ladies and gentlemen, if you would like to ask a question, please press zone zero on your phone's keypad. You will hear an acknowledgment that you've been placed in queue, and you can remove yourself from queue at any time by repeating the 1-0 command. Once again, for questions, press 1-0 at this time. And our first question comes from Nick Churcherail with Piper Sandler. Go ahead, please. Your line is open. Good day, Craig and Donovan.

How are you?

I'm well. Thank you. Thank you.

Good. Thank you. So first I wanted to start with loan production. I appreciate the commentary and the prepared remarks, but can you provide some color on the environment you're seeing and how that may unfold? You know, do you see production accelerating as we head into calendar 22?

Yeah, I think what we, uh, see is, uh, a very, uh, a highly competitive market. So, uh, a few things with respect to multifamily and commercial real estate. Uh, it seems like, uh, activity is improving and, uh, borrowers are returning to the market. Purchasers, uh, are completing transactions. Um, and so there's more confidence out there. And additionally, uh, there are many borrowers that may have the ability to lower their interest rate if they were to refinance. So we think that that activity is improving, and that's a good thing for the market. However, there's a great deal of competition with respect to that product, and so we do see competitive pressure as it relates to funding volume there. But generally speaking, our outlook is much improved with respect to funding volume there than certainly it was a year ago or even perhaps nine months, six months ago. It's better today. With respect to single family, a couple of things have occurred. Mortgage rates have begun to climb with respect to 30-year fixed. That may slow some production with respect to refinance activity, although the purchase money market is still very strong. But if we think about where interest rates are today and we take out the refinance market, that could ultimately be net negative, if you will, with respect to the opportunity of future funding volumes. but that's largely dependent upon where mortgage interest rates are going. I think the Freddie Mac survey came out this morning, and the average 30-year fixed has gone up over the course of the last month or so. And that certainly is an impact with respect to refinance activity. But that also may mean that our... payoff volume may also begin to decline such that we're still able to gin up loan production growth even in a more competitive environment and even in perhaps a higher interest rate environment for single family loans.

That's very helpful commentary. Just given the excess liquidity position, is there opportunity to restructure some borrowings and further drive down funding costs?

There are opportunities with respect to that. We consider that on an ongoing basis. We look at what the earn-back period might look like with respect to the prepayment penalty incurred in the event we were to prepay the advance. And in some cases, it doesn't necessarily make sense. And just to kind of... elaborate a bit, I guess, on the prepayment penalty. It's obviously set with respect to where current interest rates are in comparison with the borrowing rate with respect to the target advance we're looking to prepay. And the lower the current interest rate, the larger the prepayment penalty to the extent interest rates back up a bit or rise a bit the prepayment penalty also goes down a bit. So it's not a clear-cut decision because if rates were to rise, you could have ended up paying back in advance a month or two early relative to where those current interest rates are and relative to what that then prepayment penalty would look like a month or two later. So it's not an easy decision either. and there's a bit of forecasting involved with respect to that prepayment. But there is opportunity, and we've done so in the past, and we could potentially do so in the future. Although the other alternative with respect to that liquidity is to go out and put on relatively short-term mortgage-backed securities or the like, and then we're flipping from a 15 basis point yield call it to 100 basis point yield. And that would also show improvement with respect to the use of liquidity as it relates to our net interest margin.

Okay. And then lastly, on the tax rate, this quarter's level is still below where you've historically run, which you pointed out was in part at least due to the employee retention tax credit. What's your expectation for the go-forward tax rate?

So our statutory tax rate on a consolidated basis is 29.56% without any permanent or temporary adjustments. As you point out, the employee retention tax credit is non-taxable at the state level. So to the extent it is recorded, which it was in June and September of the combined tax rate is something less than the 29.56%. So we always describe 29.56% as our statutory tax rate, but in any given quarter there can be implications on that tax rate with respect to temporary or permanent differences between book and tax.

Thank you for taking my questions.

Our next question is coming from Ben Gerlinger with the HubD Group. Go ahead, please.

Hey, good morning, guys. Good morning. I was wondering just to quickly follow up on the retention cash credit. I know having conversations with Donovan that it was a potential to see the continuation. I was curious if you had any more clarity on that. I know from my past conversation, I believe it would have been one more additional quarter. Does that just be my first question?

Yeah, so a little bit of color on that. In the current administration's proposal for their Build Back Better plan, the employee retention tax credit would end at September 30 rather than its currently scheduled and at December 31st. They are doing so to help pay for the plan. So that's a complication. We don't necessarily understand where that will go. So there's a risk there with respect to December being in play. And then secondarily, As it relates to the general criteria that we mentioned earlier or that Craig mentioned in his prepared remarks, the 20% decline in revenue is the general test from the current quarter to the base year quarter. But there's also a provision that describes if you have qualified in the previous quarter you automatically qualify in the subsequent quarter as it relates to that 20% revenue test. In our case, we qualified on that test in June, so we automatically qualified in September irrespective of what the revenue test looked like in September of 21 versus the base year of September 29th. If we do that test, we did not qualify in September on that test, so we qualified on the basis of having qualified in the prior sequential quarter. As a result, December will have to stand on its own with respect to the 20% revenue test, and we cannot qualify based upon the sequential quarter because we didn't qualify in September. and therefore it is, I wouldn't say unlikely, but it is quite possible that we will not qualify in the December quarter, and that would then suggest that we are through. So there's a couple of reasons we may not qualify in December, and the September quarter will be the end of the credits that we recorded.

Gotcha. Okay. That's a helpful color. And then my follow-up kind of had to dovetail off of Nick's previous question about the long-growth mix and how it relates potentially to the margins. Are you seeing sustainability within the mix itself? I know that the current margin was a little elevated due to some kind of non-core events that were more so kind of truing up So when you think about the margin for the next couple of quarters, do you think we'll have some perversion a little bit lower? Or do you think they're kind of sustainable in this 270 area given the momentum in the shift?

So if I think about the 271 margin for the September quarter, we've described about 10 basis points out of two particular components. number one component was the decline in the net deferred loan costs in September quarter from the June quarter. That is purely a function of which loans pay off and how much volume pays off. And the fact that we declined to about $53 million or $54 million, I forget the exact number, of loan payoffs in the September quarter, that's the lowest payoff number that we've had in many. And in fact, that's the first quarter in many quarters where this decline in net deferred loan cost amortization actually was a positive contributor to our margin. So depending upon where payoffs go and which specific loans pay off, that five basis points could be around the five basis points plus again, or it could flip to a slight negative. So that would then potentially put pressure on that 271. The second component was with respect to two specific charge-off loans that paid in full during the September quarter period. there was approximately, in addition to the charge-off that we recovered, which was including those two loans, about $165,000 for the quarter, there's about $139,000 of recovered loan interest that we recorded in the September quarter related to those two loans that paid in full. So it is possible that we have Other charge-off loans pay us in full in the December quarter, but that event is less frequent, if you will, on an ongoing basis. So there's about five basis points as well that could potentially be meaningful with respect to a negative implication in the December quarter relative to the 271 margin. So there's 10 basis points on that 271 that is potentially at risk with respect to the December quarter. So it wouldn't surprise me if we dropped a bit in the margin in the December quarter, depending upon the outcome of those two areas. But I do think it's quite possible that we should be above our net interest margin relative to the low point that we hit in the June quarter, which was 254. So, you know, that's the color I have. I guess if you can forecast payoffs and what that means to net deferred loan costs and which of our charged off loans pay us back in full, it becomes more meaningful on your forecast with the margin.

Right. Yeah, no, I get that there's a lot of moving parts and a lot of unknowns. But that color and commentary is really helpful. I think that's all I have. I appreciate the time, guys. I'll be back.

Thank you.

Once again, ladies and gentlemen, for questions, press 1-0. At this time, we will go to Tim Coffey with Jannie. Your line is open. Go ahead, please.

Thank you. Morning, gentlemen.

Morning, Tim. Morning, Tim.

Donovan, if we can stick with the question on the margin. Looking at your period and balances of cash and equivalents, they were greater than the average balances during the quarter. What is the appetite for you to start really kind of allocating that in this next quarter or two? Because it seems like that would have a big impact on your margin, too, if that were to sit there or grow.

Yes, your observation is correct in that balance. We don't like to see our cash and cash equivalents probably above the $70 million level or so, and our ending balance is larger than that. So we can redeploy that either preferably into loans and new loan origination and purchase production or secondarily into investment securities. So we get more bang for the buck if it's loan production, obviously, and we have net loan growth that absorbs that cash versus investment securities. But even in investment securities, we pick up 85 basis points or so, and that's meaningful. So we look at that all the time, and to the extent that it gets elevated – we put it to work in one place or the other. The default position is investment securities.

Okay. The payoffs in the quarter, we're starting to see businesses become more active and we're starting to see payoffs across the industry right now. The level that you saw this quarter, was that greater than your expectations?

Well, no. I mean, the Payoffs we saw this quarter were down substantially from where they were in the June quarter and the March quarter. In fact, I think it's the lowest level that we've seen in some time. I haven't gone back and looked at each quarter, but the $53.9 million is a lower number just generally speaking. To the extent we continue to see that number fall, I would expect that we would see better loan growth. Right now, for the last two quarters, we're on essentially a 4% annualized loan growth rate, and that's hampered to some degree by payoffs. But if we think about payoffs, I think single-family payoffs might decline as a result of refinance activity declining and interest rates going up. but it's quite possible that we see an increase in multifamily and commercial real estate payoffs because we see more activity in that sector because I think everybody has gained a bit more confidence with respect to the economic environment. So the two may be offsetting. I guess the way I would describe it, if you look at the $53.9 million this quarter in comparison to the $79.9 million in the June quarter, that's probably our range of payoffs in the December quarter.

Okay. All right. That's helpful. Thank you. And then, Craig, just looking at the cash dividend, you haven't increased it since 2017. Your capital levels are about the same, if not a little bit higher. You seem to be on a good trajectory right now with earnings. Is there any thought towards increasing it this year?

You know, Tim, that's a question that hadn't come up, to be honest. We haven't discussed that at this time. Certainly, it's always a possibility. But, yeah, I think we're at a pretty good level where we are. And, again, we would, of course, like to continue the stock buybacks. I would argue the same point that Craig is making. I think the cash dividend yield is over 3%. Right now, that's a pretty decent yield with respect to the cash dividend. To the extent that you point out, there's other capital available. I think given our stock price and given our thoughts with respect to stock purchases, that's probably the way to redeploy that excess capital. And we continue to do both.

All right. Great. Thanks. Those are my questions.

Once again, for additional questions, please press 10. We're going now to Rob Cook with PRV. Go ahead, Lex.

Hi there. I was just wondering, do you have any kind of internal ROE, ROA targets that you set forth or that the board sets forth for this institution?

Well, we obviously develop a business plan each year, and contained in that business plan are various targets, including net income, ROA, ROE, efficiency ratio, and the like. So the answer is yes, but that's internal. We don't publicize or describe those numbers publicly.

It just seems to me we are – underperforming quite a bit is all. That's just, I guess, a little bit of the frustration probably from shareholders that have been involved in this story. It's just, you know, it's one thing when the market doesn't value your company, your deposits, but there's a compounding ROE effect. You can sit there, you can be patient, and you can wait. But it just gets very frustrating when we don't have any compounding are we to the story. So just thought I'd share that because I know analysts sometimes don't necessarily want to dictate that part of the story. So thank you for your time.

I appreciate it. Yeah, go ahead. Rob, I appreciate your frustration. And I have to agree with you some. And, you know, as far as The value of deposits today, you know, that's always been what we thought over time was our franchise value in an area that has lost most of the institutions like us. However, today, the institutions I talk to are all awash in cash. And the future value is there, but the current value, I don't think – is that strong today, unfortunately. And I think people understand that.

Sure, and it takes two to make a market. That's just where I differ a little bit because I do think there are some forward-thinking bankers in the state of California and other states that happen to have growth engines to them. And I'm not suggesting we should start taking on an asset class that we don't know anything about. That would be the last thing I would suggest. But there's still an appreciation for deposits out there. There still are good bankers. There still are people that believe that rates will go higher at some point. So I guess I do view that there are people out there that would value these deposits. Just the current market. And again, I think that's just because of our underperforming lack of compounding, are we?

Could be. And I'm sure there probably are. To be honest, I haven't heard from them.

Okay.

Thanks, guys. Thank you. And once again, for additional questions, please press 1-0. And after that prompt, we have no additional questions in queue. All right. If there's no further questions, I'd like to thank everybody for participating in our quarterly conference call. I look forward to speaking with all of you next quarter. Thank you. Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. And for using AT&T Event Conferencing, you may now disconnect.