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Edited Transcript of PROV earnings conference call or presentation 29-Jan-19 5:00pm GMT

Q2 2019 Provident Financial Holdings Inc Earnings Call

Riverside Feb 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Provident Financial Holdings Inc earnings conference call or presentation Tuesday, January 29, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Craig G. Blunden

Provident Financial Holdings, Inc. - Chairman & CEO

* Donavon P. Ternes

Provident Financial Holdings, Inc. - President, COO, CFO & Corporate Secretary

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Conference Call Participants

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* Kevin William Swanson

Hovde Group, LLC, Research Division - Director & VP

* Timothy O'Brien

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the second quarter earnings call. (Operator Instructions) As a reminder, today's call is being recorded.

I would now like to turn the call over to your host, Craig Blunden. Please go ahead, sir.

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Craig G. Blunden, Provident Financial Holdings, Inc. - Chairman & CEO [2]

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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 measure 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, 2018, and from the Form 10-Qs that were filed subsequent to the Form 10-K. Forward-looking statements are effective only as of the date they're made, and the company assumes no obligation to update this information.

To begin, I want to 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.

I would like to begin this morning by highlighting the results in our community banking business. Over the course of the last year, our net interest margin has expanded. Core deposits have been stable, credit quality remained strong, but our loan growth has been below our expectations, a result of significant prepayments and disciplined underwriting standards reducing loan origination volume.

In the most recent quarter, the community banking staff originated and purchased $15 million of loans held for investment, a decrease from $21 million in the prior sequential quarter. And single-family loans originated -- portfolio from the mortgage banking division increased to $24 million in the December 2018 quarter from $16 million in the prior sequential quarter.

During the quarter, we also experienced $41.2 million of loan principal payments and pay-offs, which is down from the $62.9 million in the September 2018 quarter, but still tempering the growth of rate of loans held for investment.

Additionally, we estimate that the decrease in acceleration of amortization of net preferred loan costs associated with the lower loan pay-offs in the December quarter in comparison to the average of previous 5 quarters improved our net interest margin by approximately 1 basis point this quarter. For the 12 months ended December 31, 2018, loans held for investment declined by approximately 1% with the largest declines in multi-family and construction, partially offset by growth in commercial real estate loans.

Competition for new loan production is intense, but we will not chase loan production volume if we must loosen our underwriting standards to do so. Clearly, some lenders have done so, given the overly competitive environment. We're very pleased with credit quality. You will note that early-stage delinquency balances were negligible at December 31, 2018, for the second consecutive quarter.

In addition, nonperforming assets remain at very low levels, are now just $6.1 million, which is down from $8.6 million at December 31, 2017, a 30% decline during the course of the year.

We experienced a net recovery of $123,000 during the quarter ended December 31, 2018, compared to a modest net recovery of $7,000 for the September 2018 quarter and a net recovery of $43,000 during the June 2018 quarter.

As a result of the low levels of nonperforming and classified assets and the net recovery for the fiscal year-to-date, we recorded a $217,000 negative provision in December 2018 quarter. We're very pleased with these credit quality results.

Our net interest margin expanded by 46 basis points for the quarter ended December 31, 2018, compared to the same quarter last year as a result of the 48 basis point increase in the average yield on total interest-earning assets, partially offset by a 2 basis point increase in the cost of interest-bearing liabilities. It should be noted that our average cost of deposits increased by just 2 basis points for the quarter ended December 31, 2018, compared to the same quarter last year.

The net interest margin was augmented by approximately 10 basis points this quarter with the recognition of interest income from 2 nonperforming loans that were paid in full and the special cash dividend received on the Federal Home Loan Bank San Francisco stock.

Over the course of the past 12 months, we have been able to hold the line on the cost of core deposits, while maintaining the balance of core deposits and decreasing the balance of time deposits. It's also noteworthy that our net interest margin expanded to 3.54% for the December 2018 quarter, the highest level in many years.

We're still adjusting our mortgage banking business model to respond to a generally more challenging mortgage banking environment. We currently employ 148 FTE in mortgage banking, down from 169 FTE employed on September 30, 2018.

During the quarter, we reduced our origination staff by 4 professionals, while our fulfillment staff declined by 17 professionals. The adjustments are more pronounced from December 31, 2016, when we first started reducing our origination capacity commensurate with changes in market opportunities. Since then, our origination staff has declined by 40%, our fulfillment staff has declined by 58% for a total staff reduction of 52% in the mortgage banking division. Similar to the actions of our competitors, we're responding to the less favorable environment by taking capacity out of our platform.

New mortgage loan applications decreased in the December 2018 quarter from the prior sequential quarter, and based on current information, we would expect volumes in the March 2019 quarter to be lower than the December 2018 quarter and significantly lower than the March 2018 quarter.

The loan sale margin for the quarter ended December 31, 2018, was similar to the prior sequential quarter remaining at the high end of the range. We resisted the competitive pricing pressure recognizing that lower loan sale margins will not necessarily successfully offset the higher loan origination volumes. We will continue to adjust our mortgage -- our business model and FTE count as we've done in the past, commensurate with changes in market opportunities and the mortgage banking operating environment.

During the most recent quarter, we have reduced mortgage banking operating expenses by approximately 24% in comparison to the same quarter last year, a combination of fixed cost and variable cost savings after adjusting for the litigation settlement expense recorded in last year's quarter.

Our short-term strategy for balance sheet management is unchanged from last quarter. We believe that releveraging the balance sheet with prudent loan portfolio growth is the best course of action. For the foreseeable future, we believe that maintaining a significant cushion above the regulatory cap ratios of 8% for Tier 1 leverage and 13% total risk base is wise and are confident we'll be able to do so. We currently exceed each of these ratios by a significant margin, demonstrating we have the capital to execute on our business plan and capital management goals.

Additionally, in the December 2018 quarter, we further delayed our stock repurchase activity, believing we will have better opportunities to execute on repurchases in future quarters. Nonetheless, over the course of the year, we have executed substantial returns of capital to shareholders in the form of cash dividends and stock repurchases.

We encourage everyone to review our December 31 investor presentation posted on our website. You'll find that we've included slides regarding financial metrics, community banking, mortgage banking, asset quality and capital management, which we believe will give the 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. Kevin?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we do have a question from the line of Tom O'Brien, Sandler O'Neill.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [2]

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So you talk about releveraging the balance sheet as a -- did you say short-term or long-term strategy, Craig? I didn't catch that or...

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Craig G. Blunden, Provident Financial Holdings, Inc. - Chairman & CEO [3]

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Well, it's -- it would be nice if it was short term, but it's looking like long term at the moment.

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Donavon P. Ternes, Provident Financial Holdings, Inc. - President, COO, CFO & Corporate Secretary [4]

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In the current environment, with respect to what we would argue are more conservative underwriting standards than many competitors. And as a result of that, we are finding that competitive pressures are lower than our loan origination volume.

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Craig G. Blunden, Provident Financial Holdings, Inc. - Chairman & CEO [5]

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And we know that from the loans that have gone elsewhere during the application process.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [6]

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I mean, your underwriting requirements have been consistent and that's been a consistent headwind, I guess, for you guys for as far back as I can remember. So maybe it's a little more acute now with -- in the marketplace given similar remarks made by other bankers that I've talked to. But is it -- looking out into the calendar year, do you anticipate being able to make some headwind in growing your balance sheet, growing loans? And will that help you to continue to engage in the mortgage banking business, do you think?

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Donavon P. Ternes, Provident Financial Holdings, Inc. - President, COO, CFO & Corporate Secretary [7]

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Well, I think you're talking about 2 separate items. If we're thinking about balance sheet growth, we're really thinking about the community banking business. Part of which is single-family loan origination volume, which is primarily adjustable rate which many applicants are not interested in. Although as interest rates have risen, there's been more interest by applicants for adjustable rate loans. And you'll see that our single-family production volume has gone up a bit as a result of that.

But if you're looking or speaking to the community bank as it relates to the competitive pressure on origination volume, I think we are seeing some lenders who have actually backed off a bit with respect to being so competitive, primarily on underwriting terms. As a result of the concern with respect to whether or not we're long in the tooth of the economy and the like and whether real estate values can really continue going up in the multi-family and commercial real estate sector. So I think that will help some.

And then, another consideration is with respect to prepayments. So to the extent that interest rates have risen, which they have, and new loans are being originated at a higher interest rate than what may be in the balance of portfolios across the universe of banks, there conceptually will be fewer loan pay-offs that are occurring with respect to that loan -- with respect to those loan portfolios.

Now we did see a decline in pay-offs in the December quarter from the September quarter and the June quarter of '18, which September and June were very high numbers, and that then did help us with respect to maintaining our balance in the portfolio.

So it will continue to be a headwind, I think, but I think that pressure might be alleviated to some degree with respect to the lenders backing off a little bit on their aggressiveness in multi-family and commercial, and with respect to loan pay-offs declining as a result of the rising interest rates.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [8]

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So talking about the mortgage banking business and looking at the slide deck in your locked pipeline. The locked numbers that you had at year-end, are those some of the lowest you recall seeing in your business?

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Donavon P. Ternes, Provident Financial Holdings, Inc. - President, COO, CFO & Corporate Secretary [9]

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Yes. They're certainly the lowest with respect to this cycle. And remember that the mortgage business is somewhat cyclical as well, the December quarter can still be a relatively decent quarter with respect to volumes. But as you work your way through the December quarter, you're essentially funding out of your pipeline because the pipeline doesn't grow during the holidays.

And then, as people come back in January, that pipeline begins to build once again, but not sufficient to offset the decline from the prior quarter. So the March quarter can actually be a lower production volume quarter in the entire year. So we would expect weaker volumes in the March quarter than what we saw in the December quarter.

And we've noted that whenever we described ourselves in a current quarter, what we would expect, we would point everybody back to the locked pipeline that we disclosed and to the lock -- to the extent the locked pipeline is low or starting at a very low number, we would expect that that volume then doesn't get funded as much through the quarter.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [10]

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It seems like it's about 60% of last year's number. And, obviously, historically, that March production and March business has been historically seasonally low and -- but this just seems more acute than typical.

I guess looking beyond that at the business, are there any signs, anything in the marketplace that looks promising in -- from the standpoint of your mortgage banking business here looking beyond the March quarter out into the spring quarter and then into the summertime? Anything in Southern California in the housing market that you find could help shore up the business and...

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Craig G. Blunden, Provident Financial Holdings, Inc. - Chairman & CEO [11]

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Well, it's hard to say. If you think back a year ago to what we were talking about, we were looking forward to spring and summer buying seasons, except they didn't happen. They were very quiet compared to prior years.

At this point, the market still seems slow. There's a lot more properties listed for sale, but they don't seem to be moving. Now whether that's because of the time of the year right now, can't say, but we're not hearing or seeing a lot of activity from our real estate business with realtors. And so I hesitate to guess that we're going to have that strong spring buying season because at this point I just can't see it.

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Donavon P. Ternes, Provident Financial Holdings, Inc. - President, COO, CFO & Corporate Secretary [12]

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Yes. And the other thing to think about, at least in California which is where we conduct our business, so as interest rates have gone up, obviously, the refinance volume has declined considerably. And even with rates having come down a bit from kind of their December quarter highs if you will, they're only off by about 40 basis points or so, if you will, on a 30-year fixed conforming. That doesn't necessarily entice an existing borrower to go out and refinance their product.

But coupled with that is the fact that loan sales activity in California has come down to very low numbers. And if you read any data in California, really across the entire state, home sales themselves are down as much as 20% on a year-over-year basis and maybe a little more in other pockets, a little less in other pockets.

But that's kind of new in this part of the cycle in that not only is refinance volume down, but also home sales are down even though inventory is up. And so that doesn't necessarily suggest that the headwinds are going away anytime soon.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [13]

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So with that, can you talk a little bit about your commitment to that line of business strategically at this juncture, given kind of how poor the outlook is here at this point and how weak volumes have been from a cyclical standpoint? And also kind of looking at your quarterly loss levels in that unit, where does your commitment stand relative to where it's been historically?

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Craig G. Blunden, Provident Financial Holdings, Inc. - Chairman & CEO [14]

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Well, it's -- we just haven't seen a cycle like this last this long, Tim, the downward cycle. And it's just been really surprising and difficult for us to plan what we're doing. We've continued, as you've noted, that we've tried to right size this thing, but just seems like every quarter we're still a little behind on where the volumes are going. And it's -- we would have never expected looking at past cycles that we would have been in this position today. So...

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [15]

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Are you at a point where you can continue to make incremental adjustments to the business to, I guess, just try to minimize losses in a low production environment?

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Craig G. Blunden, Provident Financial Holdings, Inc. - Chairman & CEO [16]

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In the past, we've done some reductions. And then, 60 days later, had to hire the people back. So unfortunately, but -- so that's why I think there's always a slight lag there, but yes, we can still make incremental reductions to a point.

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Donavon P. Ternes, Provident Financial Holdings, Inc. - President, COO, CFO & Corporate Secretary [17]

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And additionally what you've seen, if you look at those quarters -- quarterly losses, essentially the changes that we have been making to reduce capacity and operating expenses have essentially stabilized the losses. So the losses aren't getting any more, but they're also not being reduced, that's because the origination volume is going away as quick -- or a bit quicker than the changes that we can make. So the operating losses are stabilized, that's not comforting per se, but that's what has occurred during the cycle.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [18]

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I notice that on the operating loss front that there has been some stability there. And obviously, the profitability of the community bank has offset and you guys have generally stayed profitable, and that's a credit to you given kind of the situation in mortgage banking.

One last question. As far as loan sale margins are concerned, can you give any color? I mean, obviously, there was some stability, that was a minor positive point of note for the quarter. Can you share any thoughts looking out about the landscape there? Is it heading in a direction you don't like as well kind of given what's going on in the March quarter? Or do you feel like that number is okay, and that's where the market is kind of settled out at this juncture?

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Donavon P. Ternes, Provident Financial Holdings, Inc. - President, COO, CFO & Corporate Secretary [19]

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Well, I think we're pretty disciplined with respect to our loan sale margin. We analyze that daily, if you will, and we change our pricing daily with respect to what the environment looks like. But I think the takeaway with respect to where we're at today in our margin, in comparison to the range that we describe in our investor deck, we're at the high end of the -- of our loan sale margin.

I think we'll remain disciplined and possibly stay up at that higher end of the range because what we find is we can't generate enough volume by lowering that loan sale margin to offset the lower margin. So it's a balancing act between volume and margin.

We've landed at the high end of the range right now, but that doesn't mean that we wouldn't chase some additional volume if we saw that it was really there and could get paid for that additional volume by lowering our margin. So it's settled where it is right now. We're going to be in that range, I would expect, and maybe at the top end of that range.

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Operator [20]

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Our next question is from the line of Kevin Swanson, Hovde Group.

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Kevin William Swanson, Hovde Group, LLC, Research Division - Director & VP [21]

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Just one question, kind of follow-up. Have you guys just seen any change in the overall level of nonbank competitors, I think maybe some commentary out of a few have seen some consolidation. Just curious what you're seeing on that front?

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Craig G. Blunden, Provident Financial Holdings, Inc. - Chairman & CEO [22]

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With respect to mortgage banking competitors?

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Kevin William Swanson, Hovde Group, LLC, Research Division - Director & VP [23]

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Yes.

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Craig G. Blunden, Provident Financial Holdings, Inc. - Chairman & CEO [24]

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Yes. I mean, there are competitors that are -- nonbank competitors that maybe don't have the staying power that a bank -- a mortgage banker or a true bank -- community bank has. And so yes, we've also seen some of those pressures. Kind of another thing we've seen this quarter is from a few, those that are holding a servicing portfolio, they've not necessarily been able to markup that servicing portfolio to offset the origination losses.

And in fact, because interest rates have come down, prepayment speeds in their models have probably gone up a bit and they've actually had to mark those servicing portfolios down in some cases from the higher end of the servicing portfolio range. So that would also add pressure with respect to profitability for some of these nonbank competitors that hold a tremendous amount of servicing.

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Kevin William Swanson, Hovde Group, LLC, Research Division - Director & VP [25]

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Okay. And just curious on kind of the business you guys do in the mortgage banking. How -- is there a percentage on competition with these nonbanks, like, do you -- each loan, is it a couple of them? Is it maybe one? Maybe once in a while? Just kind of curious.

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Craig G. Blunden, Provident Financial Holdings, Inc. - Chairman & CEO [26]

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It's increasing. That'd be the best way to put it, especially by the direct lenders, nonbank direct lenders.

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Donavon P. Ternes, Provident Financial Holdings, Inc. - President, COO, CFO & Corporate Secretary [27]

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And the other thing that we're seeing, we're a QM lender. We are seeing many other nonbank lenders who have gone down the path of looser underwriting and credit standards, getting into non-QM product. That has increased some, but there's a lot of talk around that right now.

So I think we are going to see some of that occur. As pressure or headwinds persist, you'll see some lenders slip down the credit curve and accept looser underwriting standards in order to keep their volumes, that's not something we're interested in at this stage.

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Craig G. Blunden, Provident Financial Holdings, Inc. - Chairman & CEO [28]

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And by the way, we've seen that from bank competitors as well, just not nonbank.

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Kevin William Swanson, Hovde Group, LLC, Research Division - Director & VP [29]

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Okay. Yes, I guess that kind of leads me to my -- maybe my final question is, obviously, credit for you guys continues to steadily improve. Are you guys seeing anything to suggest the cycle may turn? I know you mentioned that it seems like maybe houses are staying on the market for a little bit longer. I'm just curious what you're seeing on that end.

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Craig G. Blunden, Provident Financial Holdings, Inc. - Chairman & CEO [30]

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Well, I don't -- no, I don't think so, not at this point. I think it's -- part of it is not interest rate support, it's price. And prices are up significantly in most areas above even the peaks of 2007.

So until people adjust their prices a little more reasonably, I think there's a lot of people sitting on the sideline saying, I don't want to pay the top of the market and then see values go down after I buy. So they're just not entering, and that's what I'm hearing from a number of realtors that we do business with.

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Donavon P. Ternes, Provident Financial Holdings, Inc. - President, COO, CFO & Corporate Secretary [31]

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Yes. And so -- yes, there could be some -- well in fact, we're seeing from the data, the rate of increase with -- or price appreciation has gone down. It's still up year-over-year, but it's up much less so than it was a year ago and a year prior to that. So price appreciation has certainly come in with respect to the single-family space.

With respect to multi-family and commercial, we're not seeing anything in particular in traditional lending, if you will. There might be some things in shared national credits or leveraged lending that certainly if you read some of the OCC data or regulatory data, there's some weakness or some softness there.

But in the fundamental or bread-and-butter multi-family lending or commercial real estate lending, we're not really seeing anything that would suggest we're at the top of a market that's going to soon come in from where it currently is.

Again, I think we would probably argue the same point that the price appreciation in those markets will slow, but at the end of the day, debt covers are still there, interest rates are still relatively low by historical standards and there just doesn't seem to be a lot of pressure, if you will, on poor credits in those markets.

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Operator [32]

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(Operator Instructions) Okay, now at this time, we have no further questions in queue.

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Craig G. Blunden, Provident Financial Holdings, Inc. - Chairman & CEO [33]

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Well, if there are no further questions, I appreciate everyone's participation in our call and I look forward to speaking with all of you again next quarter. Thank you.

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Operator [34]

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Thank you. Ladies and gentlemen, that does conclude your conference. We do thank you for joining. You may now disconnect. Have a good day.