Provident Financial Services, Inc. (PFS) Q4 2011 Earnings Report, Transcript and Summary

Good morning, and welcome to the Provident Financial Services Incorporated Fourth Quarter 2011 Earnings Release and Conference Call and Webcast. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Leonard Gleason, Investor Relations. Please go ahead.

Thank you, Andrew, and good morning, everyone. Thank you for joining us this morning. The presenters for our fourth quarter earnings call are Chris Martin, Chairman, President and CEO; and Tom Lyons, our Executive Vice President and CFO. Before turning the program over to them to discuss our financial results, I would ask that you please take note of our standard caution as to any forward-looking statements that may be made during the course of today's review of our financial performance. Our full disclosure and disclaimer can be found in the text of today’s earnings release. A copy of that notice and all of our SEC filings may be obtained by accessing the Investor Relations page on our website, www.providentnj.com, or by calling Investor Relations at (732) 590-9300. With that, I'm pleased to introduce our Chief Executive Officer, Chris Martin, who will offer an overview of our fourth quarter financial results. Chris?

Thanks, Len, and good morning, everybody. Provident Financial Services achieved record net income and earnings per share for 2011 of $57.3 million and $1.01, respectively, driven primarily by improved net interest income. On a quarterly basis, the company reported earnings of $0.26 a share compared to $0.21 for the fourth quarter of 2010, which represents an increase of 23.8%. This was accomplished in a very difficult economic and unsettled regulatory environment. And while we are proud of our results, we remain focused on assisting our customers who have been affected by the deep recession as we attempt to help them resolve their financial challenges. Our return on average assets improved to 83 basis points for 2011 versus 73 basis points for 2010. Return on tangible equity for 2011 was 9.8%. Earnings for the quarter reflected market compression that was slightly more than anticipated, as investment yields declined due to prepayments of mortgage-backed securities and related accelerated premium amortization. In addition, many loan customers sought lower rates as their loans came up for renewal or sought accommodations in the form of rate reductions as the yield curve flattened and rates hit historic lows. With rates on deposits approaching their floors, we will attempt to increase our lending volumes to mitigate these reductions. Our total organic loan growth of 5.5% for the year was attained by increased loan originations of $1.5 billion, coupled with residential loan purchases of $79 million, with multi-family lending representing the bulk of our loan portfolio growth. Prepayments and refinances have slowed as of late, yet our pipelines have remained consistent as large bank competitors have been distracted by regulatory and political challenges, along with risk analyses of their capital levels, and have not been providing customers with a true high-pitch [ph] banking relationship. Total average loans and deposits grew year-over-year in linked-quarter. Core deposit growth increased during 2011, up 11.9%, while total deposits were up 5.7% net as we continued to allow the run-off of CDs. Core now represents 78.1% of total deposits, and our borrowings were down as this funding was replaced with less costly core deposits. Our capital levels continue to be strong and remain well in excess of regulatory requirements, as earnings growth has enabled us to build capital while still providing a solid cash dividend to our stockholders, one which has never decreased since going public in 2003. And we also purchased 348,000 shares during 2011, as we continue to view our stock was a solid investment. Credit quality remains a challenge, made even more tenuous by the delay in the New Jersey foreclosure process, which is now averaging over 2.5 years for many delinquent residential loans. Credit trends continue to show improvement with net charge-offs and early-stage delinquencies down from 2010. Tom will discuss our margin efficiency ratio in further detail. But we look forward to additional expense reductions with the disposition of our 2 former operating facilities in the fourth quarter and the accompanying improvement in the collaboration that comes from our management staff being in one location. We will, however, continue to invest in people as we seek to add to our relationship teams in commercial lending and wealth divisions. With that, Tom?

Thank you, Chris, and good morning, everyone. Our net income for the fourth quarter was $14.9 million or $0.26 per share compared to $15.6 million or $0.27 per share for the third quarter of 2011. Net interest income after the provision for loan losses increased $955,000 compared with the trailing quarter to $47.9 million. Improvements in credit quality and the related reduction in provision for loan losses combined with loan growth and the deployment of excess liquidity to offset the impact of the reduction in the net interest margin. The net interest margin decreased 11 basis points compared with the trailing quarter, to 3.39%, driven by a 45 basis point reduction in the yield on AFS securities and a 16 basis point reduction in yield on loans. Yields on mortgage-backed securities fell during the quarter as prepayments resulted in accelerated premium amortization and cash flows were reinvested at lower market rates. Loan yields also remained under pressure as 10-year treasury rates dipped below 2% and pricing competition for the best quality credits intensified in the face of needed economic growth. Partially offsetting the impact of reduced asset yields on net interest income, our average net loans outstanding increased by $114 million or an annualized 10% compared with the trailing quarter. As of year end, total loans increased $85 million versus the trailing quarter to $4.7 billion, with net growth in multi-family mortgages of $67 million, C&I loans of $35 million, and CRE loans of $17 million partially offset by a decrease in residential mortgage loans of $39 million. Total commercial loans, consisting of commercial real estate, construction and C&I loans, increased to 60% of total loans at December 31. During the quarter, our funding continued to shift to lower costing core deposits with core accounts excluding all-time deposits representing 78% of total deposits or 57% of assets at December 31. Average non-interest-bearing deposits increased $74 million or 49% annualized to $680 million for the quarter ended December 31. As a result, the average rate paid on all deposit funding decreased 8 basis points to 63 basis points for the fourth quarter. The company provided $6 million for loan losses, exceeding our net charge-offs of $5.3 million or 46 basis points of average loans. This compared with the provision of $7.5 million in the trailing quarter. Nonperforming loans decreased $3 million to $123 million or 2.63% of total loans at December 31 from $125 million at September 30. Total delinquencies decreased $9 million compared with the trailing quarter to $113 million or 2.44% of the portfolio at December 31, while 30- to 89-day delinquencies decreased $1 million to $36 million with 0.78% of total loans at December 31. The allowance for loan losses to total loans was 1.6% at December 31, down slightly from 1.61% at September 30, while the allowance to non-performing loans was 60.7% at the end of the year compared with 58.8% at September 30. Total non-performing assets consisting of nonperforming loans and foreclosed assets totaled $135 million or 1.91% of total assets at December 31 compared to $132 million at September 30. Foreclosed assets increased $9.9 million to $12.8 million as the company completed the foreclosure of an approved and improved land parcel zoned for residential development that is valued at $5.5 million. Noninterest income was unchanged at $8.7 million compared to the trailing quarter, as the $700,000 increase in fee income primarily attributable to the August 11 Beacon acquisition and commercial loan prepayment fees was largely offset by a $600,000 reduction in securities gains. Within the other noninterest income category, the company absorbed $319,000 in losses associated with the November sale of 2 former administrative facilities. Noninterest expense increased $1.3 million versus the trailing quarter to $36 million, primarily as the result of increases in advertising, consulting and nonperforming asset related costs. Annualized noninterest expense to average assets were 2.04% and the efficiency ratio was 57.85% for the quarter ended December 31. The company reported income tax expense of $5.5 million for the fourth quarter compared with $5.1 million for the trailing quarter, and our effective tax rate increased to 27% from 24.6% for the third quarter of 2011. The company realized a reduction in valuation allowances against subsidiary company New Jersey net operating losses in the trailing quarter. The company currently projects an effective tax rate of approximately 27% in future periods. And with that, we'd be happy to take your questions.

[Operator Instructions] First question comes from Jason O’Donnell of Boenning and Scattergood. Jason O’Donnell: Tom, can you just break out what the OREO expense was this quarter? I apologize if I missed it.

Sure. For $1.1 million -- $1.0 million. It was $781,000 in the trailing quarter. Jason O’Donnell: Okay. Great. And then can you just -- do you happen to know what the impact was of the, if you could isolate it, the accelerated premium amortization was on M&M [ph] trend this quarter?

It was about 7 basis points on the margin. Jason O’Donnell: Great. And then, it looks like operating expenses came in a little higher than I was projecting. Were there any onetime items in your expenses this quarter that I should be aware of? M&A expense or anything else?

There was some additional cost around the closing of the Beacon acquisition, that was a couple hundred thousand dollars. We did have some additional costs around the remediation from hurricane Irene, actually. We had some damage in our Denver office that was repaired and some remediation has been filed. That probably was about $220,000. In addition, it would be dispositioned at the -- or actually, that's in the other income section. I think we talked about that. We did realize a further final loss on the sale of those 2 administrative facilities of about $319,000. Jason O’Donnell: The final loss is how much, I'm sorry?

$319.000.

The next question comes from Julienne Cassarino of Prospector Partners.

What were the TDRs or renegotiated loan balance at the end of the quarter?

Total TDRs were $63.1 million during the period.

And then what was it last quarter? Was it $60 million? What was it last quarter?

Sorry, Julienne, I don't have the last quarter number in front of me. I think it was pretty close, I think it was in the high 50s.

Okay, okay, great. And just to -- you were discussing about offsetting margin compression with loan growth in 2012. And I was just wondering, big picture, what kind of loan growth do you need to offset margin compression from the current interest rate environment, roughly?

We think the compression was helped by -- the premium amortization was a little bit more dramatic. We see that slowing up. And we're looking at the portfolio to make sure that with the HARP program, with the HARP 2 and other things going on. We have to watch what's going on in Washington to see if they're going to have more plans to accelerate prepayments. We have to watch that very closely. We still have a little bit of recent availability on the deposits to go down a little more. So we see, again loan growth -- we're not pushing our credit hat, by any stretch, but we're actually getting a lot more looks and opportunity than we had in the past, and the climate and the conversations are a little bit more positive with the economy. So an exact number, I don't have that handy at this point. I know that there was better, but we don't have that number.

Right, but you see loan growth from here picking up pace, generally.

Yes.

Okay, okay. The big banks they are -- you're getting multi-family business from them. Or where is the multi-family growth coming from?

Just truly relationships that we've had in the past. It's mostly in New Jersey and Eastern Pennsylvania, most of our clients that have gone out to Eastern PA, that's where there's been some growth. We don't traffic in the New York area for the most part. And I think it's just the ease, the relationship, the fact that they can get somebody on the phone quickly to give them a quick decision and we're able to do that without having go through an office in San Francisco or in Charlotte, North Carolina.

So these are not the brokered multi-family loans.

We do not do brokered multi-family loans at this stage. We do not, it's all organic.

The next question comes from Matthew Vergossen [ph] of Sandler O'Neill and Partners.

You mentioned that early-stage delinquencies in the quarter were down. I'm just wondering if you could put some numbers around that for this quarter and also for last quarter, if you would.

Sure, Matt [ph]. It's 0.78% for 30- to 89-days for the current quarter, down from 0.81% of loans back in September, 0.85% in June, 1.36% in March. So we're showing a nice continuing trend of improvement there. I guess, the other thing to take some comfort is, is the weighted average risk rating portfolio has improved. Non-performing asset formations declined for 3 consecutive quarters as well, on a net basis.

We don't call it a trend yet. It's just positive.

Okay. And then just specifically with regards to how you guys are thinking about your reserve going forward. This is the first quarter we've seen of nonperforming loan improvement in the last few quarters. Just wondering if you're continuing to build the reserve or if you're targeting, in particular, a specific reserve coverage ratio.

There's quite a detailed analysis that lies behind it, but it generally results in a coverage ratio result of around 155 to 160, based on current risk ratings. So as you see economic improvement, of course, that coverage ratio could come down, but that's the current thinking.

Okay. And then just finally with regards to your multi-family lending. It's currently, I believe, 12% of gross loans or so. Are you managing that towards a specific target?

Like anything that we look at, we look at all asset classes and say, "Where is the bucket? How much will we grow?" We think it's still very stable. These are well-heeled owners of properties and acquirers of properties. So they're very deep balance sheets with solid guarantors, solid background. So we don't see anything dramatic, though we always watch to make sure our exposure does not get overloaded in any one bucket or sector.

Okay. And what's the pricing on those, generally speaking?

Well, it depends on who's behind it, but it's pretty thin. I think, we look at it usually about 240 over on an average. We may have some that are 230 over and we may have some that are 250. And we try to get them to be a 10-year with a 5-year renew date or reprice date. So it will be 5 years and then 250, 240 over the next 5-year adjustment.

The next question comes from Damon DelMonte of KBW.

I guess, first question is probably for Tom here. I just wanted to confirm, so there was like 3 items in the non-interest expense category that we could exclude. That would be OREO, workout costs and then the 200,000 and 220,000. So would a good run rate kind of going forward be somewhere in the, call it 35-ish or so range?

That about what I'm looking for, yes.

Okay, great. Then I guess my other question is, Chris, could you provide us with an update on your thought on M&A? Obviously you did the Beacon transaction last year. But I think the general market will start to see consolidation happen in the back half of 2012. We're seeing from a lot of banks just pressures on margins and challenges to maintain decent earnings. Kind of what your thoughts are and what you're seeing in your region.

Well, we all would have thought it [ph] would have started to happen, also because of the regulatory cycle and changeover from OTS to the OTC. Regulators are coming down hard on all banks, which you'd should expect. So I think that'll start to wear on small firms; also on us, but not to the point that we're looking to exit, but we certainly think there'll be opportunities -- I think the buyer, seller is still not in the same thought process and so that'll take a little while to settle. But as earnings flatten out and margins flatten, we think that it will pick up. Especially with the Fed decision that we're going to be in a hold pattern. So at least 2014, maybe 2015. That's not going to make anybody's margin get any better and certainly would add to the risk if they put on a lot of loans in this environment. So yes, we would agree that the conversations are getting a little more forward but nothing imminent.

Okay. And what's a typical size bank you'd look at? Do you have a range in how big or how small you'd go?

No. We just look at any deal and say, "What is it going to add to the combined entity?" What kind of people you're getting from the organization, because we want to make sure there might be some revenue attached, it's not just an expense consolidation play. And the markets that it's in, are they relevant to us and it going to add value? So no, we do not shut anything down because of size.

The next question comes from Collyn Gilbert of Stifel, Nicolaus.

Chris, just trying to reconcile your comments on loan growth picking up, but yet it looked as if the unfunded commitments fell quarter-to-quarter. Is that a timing issue? Or if you could just sort of clarify that point.

Well, I think you get that towards year end. We kind of forced the -- tried to get some things closed in the year. We have a lot of the home equity deals. We just opened up a product that was no-fees and very low-level loan-to-values and only 40% usage on home equity. So we're getting a lot more opportunity through this product. I think we had over 100 million applications come in. And that was in a timeframe in the December where you usually don’t get any volume. So we're still seeing flow on that area. We're also seeing a little bit of purchase mortgage money as opposed to just refinance. So certain markets are doing better, such as Hoboken and Jersey City where people who had been renting some of their units and now trying to sell them. There's an active market starting up. So that could bode well in the future. So I think we just -- it's one of those things when you get towards the end of the year, people hunker down and then they'll come back in, maybe in the first part of the -- the end of the first quarter.

Okay, that's helpful. And then just thinking about the repricing opportunities on the CD side. So I think it was like 1.46% was your blended CD rate this quarter. Still seems pretty high and certainly relative to what your -- the advertising on the Web. How much further do you think you can go in lowering those rates?

Collyn, there's about $530 million that'll replace the first 6 months of 2012, about 40 basis point pickup on the reprice.

Okay, just 40 basis points. Okay. is that the biggest tranche that you have for the year?

Yes, it tails off a bit from there.

The next question comes from Matthew Kelley of Stern Agee.

Getting back to your multi-family product there. Just to clarify, the index that's priced off. Is that a 5-year CMT kind of index, treasury index?

Yes. For the most part, yes. We're not seeing much in the way of anybody -- because everybody loves to do live bill [ph], but we're using the treasury.

So kind of low 3s then, on coupons.

Mid-3 to 3.75. I don't think that we have anything in the mid-3s really. Might be one small deal, but the rest have been in the high 3s and we've tried to get to the low 4s with floors.

Okay. And how is pricing on more conventional commercial real estate office, retail, industrial, those products? What's the pipeline yield on those things?

The pipeline yield on the what? The commercial?

Yes, on the commercial real estate backed by office retail, industrial, non-multi-family.

Well, the average rate through 2011 was about a 4.7 on commercial mortgages.

But on deals you're looking at now, what are you seeing?

We're still seeing around those numbers. Maybe a little bit -- depending on the size and the scope, might be a little lower. But still in the mid to high 4s, about 300 over the curve can go for 3.25.

Okay. And just in your own internal planning, with the Fed telling us they're hold the next couple of years, a lot of liquidity in the system, a chase-free yield, where do think those yields go when we're talking this time next year?

Well, how much lower can the 5-year go ,I guess is the concern, and even/or the 10-year. Because of what'll happen, everybody is going to stress themselves out and so all markets will probably lead out to the 10-year. I don't know if they can go much lower because we're kind of at a point where we're saying we can put on things at 3 that are commercial properties. So we sort of have a base and when people realize -- we talk to our customers. It's a relation-building practice, to say we're not going to go ahead at that rate, but we're going to do a good job here and maybe we can do something at the reset to make it instead of being 300 over, maybe it would be 275. I think what's going to happen in the market will be that people are going to start putting cash on things so they can get volume in here and yet the borrower will know he has something else to lock in something in the future.

Got you. And then just to be clear on the expense guidance there. The $35 million kind of core run rate this quarter, annualized to $140 million. What about the cost saves on consolidating your buildings in going to one headquarters. Is that kind of included in that number? Or is that going to be a savings beyond that?

I think, that's built in there, Matt. That does about $90,000 a month that we are, as Chris indicated, continuing to invest in the business as well. And that includes the Beacon expenses also. So that was an add-on that we didn't have in the past.

And so off of that $140 million annualized base, what type of growth do think you think we're looking at for the full year?

I'm sorry, Matthew, I didn't understand that. Growth in what?

I mean, will there be growth in that current annualized rate of $140 million? Or are you going to keep it flat around that level?

I think that's the full year. I speculated...

This concludes our question-and-answer session. I would like to turn the conference back over to Christopher Martin, Chairman, President and CEO, for any closing remarks.

Well, again, looking at the broader economic horizon, we're seeing slow improvement in recent trends and many of our commercial customers and clients have shown slightly improved financial results, albeit not great, but better. Unemployment and underemployment in our market have remained stubbornly high and consumers similarly cautious. With the major election in 2012, we anticipate a year of indecision and lack of confidence, accompanied by still evolving regulatory challenges as thoughts, rules and regulations are promulgated and likely make the economic and banking interesting in 2012. Nonetheless, we see this environment as an opportunity to expand our commitment to our clients, customers and stockholders, and we thank you for your time. Have a great afternoon and go Giants. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.