PROV - NASDAQ

Ladies and gentlemen, thank you for standing by, and welcome to the First Quarter Earnings Call. At this time, all participants are in a listen-only mode. And later we will conduct a question-and-answer session. Instructions will be given at that time. [Operator Instructions]. As a reminder, today's conference is being recorded. I'd now like to turn the conference over to our host, Mr. Craig Blunden. Please go ahead, sir.

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, 2022, and from the Form 10-Qs and other SEC filings that were 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 first quarter results. In the most recent quarter, we originated $84.6 million of loans held for investment, a small decline from the $85.9 million in the prior sequential quarter. During the most recent quarter, we also experienced $31.7 million of loan principal payments and pay-offs which is down from $41.3 million in the June 2022 quarter and at the lower end of the quarterly range. Currently, competition remains elevated for loan originations, and it seems that many borrowers have reduced their new activity as a result of rising mortgage interest rates. Additionally, we're seeing more demand for single-family adjustable-rate mortgage products as a result of higher fixed straight mortgage interest rates. For the most part, our underwriting requirements have not changed, but certain loan products, such as retail and office CRE remained somewhat tighter than other CRE products. Additionally, our single-family and multi-family pipelines are modestly smaller in comparison to last quarter suggesting our originations in the December 2022 quarter will decline from this quarter, but still remain within the range of recent prior quarters, which has been between $60 million and $95 million. For the three months ended September 30, 2022, loans held for investment increased by approximately 6% as compared to June 30, 2022, ending balances with increases in single-family and multi-family loans more than offsetting small declines in the commercial real estate and construction loan categories. Current credit quality is holding up very well, and you will note that there are just $1,000 worth of early stage one balances as of September 30, 2022. Additionally, non-performing assets decreased to just $964,000, which is down from $1.4 million on June 30, 2022. We recorded a $70,000 provision for loan losses in the September 2022 quarter. The allowance for loan losses to gross loans held for investment decreased to 57 basis points on September 30, 2022, from 59 basis points on June 30. You'll note that we remain on the incurred loss model and have not adopted CECL, means that our allowance methodology cannot be reasonably compared to CECL adopters. Our net interest margin expanded by 12 basis points for the quarter ended September 30, 2022, compared to the June 2022 sequential quarter as the net result of an 18 basis point increase in the average yield on total interest earning assets and an 8 basis point increase in the cost of total interest bearing liabilities. Notably, our average cost of deposits increased by just 2 basis points to 13 basis points for the quarter ended September 30, 2022, compared to 11 basis points in the prior sequential quarter. Additionally, our borrowing costs increased 13 basis points in the September 2022 quarter compared to the June 2022 quarter. 3.05% net interest margin this quarter was positively impacted by approximately 4 basis points as a result of lowered net deferred loan costs associated with fewer loan payoffs in the September 2022 quarter, in comparison 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 prior recent quarters and adjustable 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, loans are adjusting above their existing floor rates. These factors suggest that our net interest margin will continue its near-term expansion. We continue to look for operating efficiencies throughout the company to lower operating expenses. Our FTE count on September 30, 2022, decreased to 160 compared to 164 FTE on the same date last year. You will note that operating expenses increased to $6.9 million in the September 2022 quarter consistent with a stable run rate of approximately $6.9 million per quarter. We expect a similar run rate for the remainder of fiscal 2023, but also anticipate some pressure on operating expenses as a result of increased wages and inflationary pressure on other operating expenses. 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 volumes at the higher end of the quarterly range and loan payoffs at the lower end of the quarterly range. Total interest earning assets composition improved during the quarter with an increase in the average balance of loans receivable and decreases in the lower-yielding average balances of investment securities and interest-earning deposits. However, the total interest-bearing liabilities composition deteriorated a bit. It's a small decline in the average balance of deposits and an increase in the average balance of borrowings. 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. We also recognize that prudent capital returns to shareholders through stock buyback program is a valid capital management tool, and we repurchased approximately 50,000 shares of common stock in the September 2022 quarter. For the fiscal year-to-date, we distributed approximately $1 million of cash dividends to shareholders and repurchased shares of common stock cost of approximately $723,000. As a result, our capital management activities resulted in an 83% distribution of year-to-date fiscal 2023 net income. We encourage everyone to review our September 30 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.

Thank you. [Operator Instructions]. Our first question will come from the line of Nick Cucharale of Piper Sandler. Please go ahead.

Good day, Craig and Donavon, and how are you?

Great. Good morning.

I wanted to start with loan pricing. What are you putting single-family and multi-family production on the book set?

So right now, Nick, new originations remember there's pipelines involved and they could be coming in at lower rates than I'm going to describe now. But new applications, new loan originations are coming in, in the high fives to the low sixes across all of our products.

Okay. The commercial real estate portfolio has been relatively consistent over the past several quarters. You mentioned the tighter retail and office markets. Can you provide some additional color on your appetite for adding CRE credits? Is it your expectation that the current trend continues in future periods or does it inflect when we see a pickup in activity?

The CRE is kind of interesting for us in that what we're doing in that category is essentially augmenting our main business lines of single-family and multi-family. And so we're not looking to grow that category significantly above where it is. We'd like to see some growth there. But overall, when we think about CRE, we're particularly with respect to retail anchored by big box, for instance or office, the big box or online capabilities of purchasing products these days suggests that we need to be cautious in that type of retail and office is the remote work situation. There are some data out there suggesting that far fewer workers are back in office space and there's difficulty bringing them back into office space. So we're cautious there as well. So overall, we're interested in commercial real estate, but probably staying away from those categories. We described in one of our slides in our Investor Presentation, the type of office -- or CRE that we have in portfolio, the highest category happens to be office. There's also some mixed use in that space. There's some retail. There's warehouse. There's mobile home parks, medical and dental office, very little in the way of restaurant or fast food or non-gasoline. So it's an area of interest for us, but it's not the main driver of our loan portfolios.

Okay. Very helpful. And then lastly, is it your expectation that you adopt CECL in September 2023 quarter?

No. Our CECL adoption will be July 1 of 2023, and you will see it for the first time in the September 2023 quarter. But essentially, we're in the process now of putting all of the legwork in to getting us to the point of being able to adopt CECL on July 1.

Right. Thanks for the clarification. Thank you for taking my questions. I appreciate the color.

Thank you. And our next question comes from the line of Tim Coffey of Janney. Please go ahead.

Right. So yes, I have questions about kind of how you're managing deposit costs going forward. Obviously competition is starting to increase on rates. Competitors are moving their rates up, especially kind of in your markets. What are your plans to kind of control deposit costs near-term?

So, Tim, you point out heightened competition and that in fact is the case. We're beginning to see that. When we think about our deposit costs, we entered this cycle with none in the way of wholesale deposits. So our thinking is, and the way that we're managing that is our retail deposit base is relatively stable over various interest rate cycles. And we don't have to compete aggressively on our transaction accounts to keep that base in place. The one area of retail where we do have to respond to the market is the CDs or certificates of deposit. And right now, we are responding by having our rack rates higher than what they were. But additionally, we're responding on a case-by-case basis with customers who have maturing deposits that are looking for a higher rate and can demonstrate that there are competitors out there willing to give them that higher rate. We will generally match that rate to keep that relationship in place. As a result of that, our deposit costs because our base deposits are relatively stable, will be well controlled, although they will be increasing. Where we will see more increase in our deposit costs is with respect to wholesale funding. So for the first time in quite a few years, we put on $30 million of brokered CDs toward the end of August this quarter. And to the extent that our growth rate with respect to the loan portfolio increases to such an extent that our deposits -- core deposits are not keeping up, we will be funding ourselves more wholesale and that will bring deposit costs up as well to the extent that brokered CDs are coming in, but that's only at the margin because again the base is stable, call it $950 million of a stable base, which will rise very slowly in cost in comparison to growth of the balance sheet, which will be funded at the margin with respect to wholesale deposits, federal home loan bank advances or other types of funding. So you can see that further quarter, I think our deposit costs went up by 2 basis points in comparison to the June quarter that was driven by the $30 million of brokered CDs. Our other costs or our base costs stayed relatively the same in comparison to last quarter.

Okay. Great. That's great color, Donavon, thank you. And then just kind of if we could talk about the secondary market for mortgage loans if you had to sell a loan out of the portfolio for whatever reason, is there a active secondary market for it? If so, and if there is, what do you -- how do you see that market evolving over the next couple of quarters?

Well, it's interesting. There is an active secondary market and in fact, we've been in that market off and on purchasing loan packages by others that were originated by others. We still see those packages, but the rise in interest rates places those packages at a discount if one were to purchase them. And so there is some price discovery going on with respect to what a seller may be interested in selling that package at in contrast to what we would be willing to pay. So there's a widened gap in that price discovery in comparison to what it was and that's a function of rising interest rates. So the market is active. We're still seeing it. Freddie and Fannie are still in the market with respect to a single-family production. So it's there, it's just different in that loan package originated two months ago is selling at a discount today. And oftentimes, the seller is unwilling to accept the discount that we might be willing to pay.

Okay. And as interest rates decline in calendar 2023 based on forward yield curve, would you expect that market to cure itself or could you see some dislocation a little bit longer?

Well, it's all dependent upon how quickly the Fed is moving or how quickly the Fed tops out with respect to what they're doing with the targeted Fed funds rate. I expect that even after the Fed starts or stops raising interest rates at some point in the future, there will be a little bit of lag with respect to more liquidity coming into that market because again those loans are being originated probably at something less or two months or three months prior to that last stop in rising interest rates.

Okay. And then my last question was on the non-interest expense growth. I think Craig mentioned -- I think Craig mentioned that was going to come with kind of an inflation growth rate attached to it. Is that in the mid-single-digits or do you think you could be higher than that?

Well, I think it's -- I think we described a stable run rate of about $6.9 million. And I think if you look back quarter-over-quarter, year-over-year, you're going to see that it's about $6.9 million with some adjustments for items kind of coming in. Last quarter, I think we were at $6.4 million. But that's because we had some recoveries on some things that came in as a credit to expense and it lowered our operating expenses by about $500,000 from the $6.9 million run rate. So we think $6.9 million is a stable run rate, but there is some pressure out there with respect to wages, with respect to the inflation on other products and services that we use. So there could be a bit of pressure, but I would keep that probably in the low-single-digits based upon what we're seeing currently.

Okay. Great. That's great color. Those are my questions. Thank you very much for the time.

Thanks.

Thank you. [Operator Instructions]. And speakers, there are no further questions in queue from the phones at this time.

All right. Thank you. I want to thank everyone for joining us and we look forward to speaking with you next quarter.

Thank you.