Provident Financial Services, Inc. (PFS) Q1 2012 Earnings Report, Transcript and Summary

Good morning and welcome to the Provident Financial Services Incorporated First Quarter 2012 Earnings Conference Call. [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, sir.

Thank you, Laura. Good morning, everyone. Thank you for joining us today. The presenters for our first quarter earnings call are Chris Martin, our Chairman, President and CEO; and Tom Lyons, our Executive Vice President and Chief Financial Officer. Before turning the program over to them to review 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 earnings call. Our full disclosure and disclaimer can be found in the text of this morning’s earnings release. A copy of that notice and all of our SEC filings may be obtained by accessing 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 first quarter results. Chris?

Thanks, Len. Good morning, everybody, and thank you for dialing in to hear more about our record earnings for the quarter. PFSs results for the quarter reflect our commitment to running our banking in a conservative and consistent manner. This plus our collaborative efforts of our sales and lending team have produced a 39% increase in earnings per share over the same period in 2011 to $0.32. Our return on average assets close to 1% mark to a 1.04% and our return on average equity increased to 7.71%, whereas return on tangible equity was 12.34%. And earnings for the quarter were positively impacted by an increase in average interest earning assets, combined with growth of core deposits, while the margin improved from the trailing quarter by 3 basis points. Our core deposits grew by $77.2 million, as time deposits strategically price downward. Net loan growth was modest in the first quarter, despite organic originations of $347 million. While the pipeline has remained pretty consistent, we are experiencing increased competition from regional and Money Center Banks that has become very aggressive in terms of structure, collateral valuation and grade. Our volumes could've been increased, but this would require change in our risk parameters, which has served us well through the great recession. Overall, the economic data is mixed as of late and the Fed is signaling no changes through at least 2014. We will not compromise our underwriting or credit standard and structure to achieve loan growth and we’ll continue to manage the level of interest rate risk and asset duration. And we selectively match upon larger multifamily loan originations with Federal home loan bank loans to lock in a spread of match duration, which mitigates any material interest rate risk for a portion of our originations. Asset quality has improved, but the New Jersey foreclosure process is hampering, any reasonable expedient resolution to residential delinquency levels. We are seeing some better financial results from our commercial clients, as 2011 was better than 2010 for most. While our OREO has increased, this represents progress as assets are finally moving through the system towards final disposition. Our loan content remained low at an annualized 46 basis points of average loans and this kind of reflects our prudent underwriting standards and the relative stability of our markets. The capital levels remained strong, the increase in our cash dividend by 8.9% announced yesterday represents an approximate payout ratio of 47% based on 12-month trailing earnings. And we repurchased 140,000 shares during the quarter and continued to view our stock as a good investment. Finally, I would be remiss if I did not mention that our efficiency ratio improved to 54.5% from 58.3% for Q1 2011. And we continue to view expense management as essential to improved earnings, while rates stay at or near the zero levels. With those real quick comments, Tom is going to provide further information on our first quarter results.

Thank you, Chris, and good morning, everyone. Our net income for the first quarter was $18.4 million, or $0.32 per share, compared to $14.9 million, or $0.26 per share for the fourth quarter of 2011. Net interest income increased $926,000 compared with the trialing quarter, to a record $54.8 million. The net interest margin increased 3 basis points compared with the trailing quarter to 3.42%, driven by 9 basis point reduction in the cost of interest bearing liabilities. In addition, increases in average earning assets, deployment of excess liquidity and an increase in securities yields combined to overcome pressure on loan yields. Average net loans outstanding increased by $56 million, or an annualized 5% compared with the trailing quarter. As of quarter end, our total loans increased $5 million versus the trailing quarter, to $4.7 billion, with net growth in consumer loans, commercial real estate loans, multifamily mortgages and construction loans partially offset by decreases in C&I loans and residential mortgage loans. Consumer loan growth consisted primarily of first lien home equity loans. Period-ending CRE and commercial loans were impacted by several large prepayments that generated fees of $1.4 million during the quarter. As a point of clarification relative to some peers, the company records loan prepayment fees as fee income and not as a component of interest income. During the quarter, our funding continued to shift to low across in core deposits, the core counts excluding all time deposits, representing 79% of total deposits or 58% of assets at March 31. As a result, the average rate paid on all deposit funding, including non-interest bearing deposits, decreased 9 basis points to 54 basis points for the first quarter. The company provided $5 million for loan losses while net charge-offs were $5.4 million. This is compared with the provision of $6 million in trailing quarter. Non-performing loans decreased $2 million from December 31 to $120 million, or 2.58% of total loans at March 31. Our credit metrics improved again during the quarter, with total delinquencies, early-stage delinquencies, weighted-average risk ratings and classified loan levels also having continued improvement. The allowance for loan losses to total loans was 1.59% at March 31, compared to 1.6% at December 31, while the allowance to non-performing loans was 61.5% at March 31, compared with 60.7% at December 31. Total non-performing assets consisting of non-performing loans and foreclosed assets totaled $135 million, or 1.89% of total assets at March 31, a slight improvement from year end. Foreclosed assets increased $1.6 million to $14.4 million, as a result of the successful completion of a number of residential mortgage foreclosures. At present, $3.1 million of residential OREO properties are under contract for sale. And the company we’re also completed the sale of $1.4 million commercial non-performing loans subsequent to quarter end. Non-interest income increased $4.1 million compared to the trailing quarter to $12.7 million. The company recorded gains of $2.2 million on the sale of $45 million of mortgage-backed securities subject to accelerated prepayment risk under HARP 2.0. Our fee income increased $709,000 compared to the trailing quarter as the previously discussed loan prepayment fees and increased wealth management fees more than offset the reductions in deposit fees. In addition, the company realized other income of $568,000 in connection with the termination of its debit cards rewards program and a $290,000 increase in gains on most sales compared with the trailing quarter. Non-interest expense increased $582,000 versus the trialing quarter to $37 million. As a result of increases in competition and benefits expense, partially offset by reductions in advertising, occupancy, and consulting costs. The company recorded income tax expense of $7.3 million for the first quarter, compared with $5.5 million for the trailing quarter, and our effective tax rate increased to 28.5% from 27% for the fourth quarter of 2011. With that we would be happy to take your questions.

[Operator Instructions] And our first question is from Mark Fitzgibbon of Sandler O’Neill & Partners.

Couple questions for you. First all the synergies from the Beacon Trust deal now in the numbers?

Mark, there's about, we estimate about $250,000 with additional charges that are probably recognized in the second quarter, including the integration of the systems. Other than that the costs have been recognized and we’re starting to -- essentially, yes.

Okay. And then also do you have any idea, what the average rate on the loans and pipeline is? I know you have a bunch of different categories on loans there, but do you have a rough guesstimate of the average rate on those?

Originations for the first quarter have an overall average of about $436. That’s probably indicative of the pipeline rate.

Pretty much and, Mark, you got the gamut of where you are putting multi-family on. It could be $5 million to $10 million even higher, but then you have, but certainly the C&I credits that we do in our business banking unit and our medical lending practice that’s gone through that area also, but -- so they'll be smaller in size.

Okay, and then in the other income bucket, it was about $1.01. Is there any non-recurring items in that line this quarter?

Yeah, $568,000 in connection with the termination of the debit cards rewards program.

Okay, and then last, Tom, maybe could you share with us your thoughts on the margin looking ahead? Should we anticipate some modest additional compression from here?

I think so, Mark. As we just discussed, as the pipeline yields to current loan, ARM rates are lower than the portfolio rates. So we’re going to continue to see some pressure on loan yields. Securities yields have stabilized somewhat. As you saw, they actually improved quarter-over-quarter as prepayments slowed. We did sell that $45 million worth of mortgage-backed and we reinvested some of those funds back in securities at lower current yields, but with more stable prepayment projections. That said, we continue to have re-pricing opportunities. There is about $784 million worth of borrowings and CDs that mature over the next year. We see good growth in core deposits. In particular, smart checking products, which also had a low cost of funds. So I think we will be able to maintain probably maybe 5 basis points of compression in the near term.

And the next question is from Rick Weiss of Janney.

It doesn’t look like there is much mortgage-backing income, so I wonder if you can talk a little bit about your philosophy, how you feel that line of business, is it something that maybe you would like to go into or reasons you should stay away from it?

We would probably say what we are doing, we have an appetite for some of the loans, Rick, but we do look at every bid of interested with that could come from that. We continue to sell the longer 30-year and 30-year by weekly loans. Just to keep that in mind, we don’t want to be stuck in a -- if they do go up in a couple of years, whenever they do, it will be pretty quickly, and we don’t want to have those on our books. We just haven’t seen the need to go out and change our business line of how we get -- we accept what we get, we use a correspondence channel in a very small fashion and we do the underwriting ourselves, besides them doing it. I think our appetite has definitely been more towards the commercial end of the business, and we just sell to keep our risk at a certain level.

And when you do sell, do you sell with release in servicing?

No, we keep the servicing.

Okay. And also in terms of going through provisioning charge-offs, what do you think, for modeling purposes, would you generally keep them around the same level? Is that a good way of looking at it?

No, I think the recovery seem to be gradual. We continue to improvement. We seen the trend over 4 quarters of improvements in early stage delinquencies, weighted average risk ratings, all the items I mentioned in the prepared comments. So I suspected that the reserve will come down at a fairly slow pace as well.

Right, and then, okay, so as you do that, so it’s more or less matching then, I guess, at this point in the recovery?

Yes, I think we’ve come down for example 1 basis point per quarter for the last 4 quarters as -- in terms of coverage of allowance to total loans.

Right, so that accounts for a low growth, is what you’re saying?

Correct, yes.

Okay, got it.

The next question is from Damon DelMonte of KBW.

So Chris, really strong loan originations this quarter. Unfortunately, the net impact was just as a modest increase to loans outstanding. Could you talk a little bit about what was driving kind of the reduction from your current portfolio? Were they more maturities or payoffs or what was the dynamic there?

Well, definitely, we are getting payoffs that’s happening and that certainly is a problem that we have to deal with every day. It’s not a question of just trying to get new originations. Every one of the followers that we have are usually of decent credit that can go and are getting hit by 4, 5 competitors with a lot more aggressive rate and/or structure. So it takes a little bit of time and effort. And if prepayment penalties have burned off over that period of time, it’s kind of tough to keep them. So we’re having to reprice those in between where competition is and where we would like to be and we have a little bit of a leverage there because they are with us already. They wouldn’t incur any dramatic costs as opposed to going outside when they have to do appraisals, phase 1's in the way of environmental and other expenses. So that’s worked out and certainly we’re having to be competitive on every front to keep our business around, much less get new.

Fluctuations in the line of credit usage plays a role in that balance outstanding as well in...

Where does - where do balances stand right now?

In terms of what?

What kinds of balances are you looking at, Damon?

Like for your lines of credit, what are utilization rates right now that you are seeing?

Well, when we are talking about residential firsts, we are only getting about 43% usage on that in the way of the home equity side of the business.

Okay, how about on the commercial side?

I am kind of guessing, but I would think about 40% to may be 45%.

Okay. Okay, that’s helpful. And then I guess Tom, with regards to expenses, I may have missed it in your prepared comments, are there any onetime items in the expenses that we would need to back out from our modeling purposes?

Nothing large. It was about $60,000 related to Beacon integration cost in the first quarter.

Okay, all right. That was immaterial. I guess and then lastly with regards to the outstanding non-performing loans, what are couple of the top credits there and where do you stand in the resolution process of those?

A number of the large credits -- it’s interesting, it tough to move that number because about $39 million worth of it is residential mortgages that are in some stage of foreclosure and it’s a very slow process, as you. In addition, I think the top-end non-performings, probably 5 or 6 of them are current. There is vacancy issues and we prudently move those to non-performing status, recognizing the payments as principal reductions, but they are performing. They are current credits.

Okay.

I think the only thing we can do is just try to keep working with our clients as opposed to trying to take a property and they are still engaged. So we just keep going forward with that, try to work with them. Hopefully, an improving economy will help them get some of their vacancy challenges out of the way and we can go back to a performing status, but we move there very quickly because we don’t want to hide from the fact that it is having a little bit of a trouble.

Let me give you a number on there, Damon, nonaccrual loans include $41 million that are less than 90 days and about $35 million which are current.

Okay, that’s helpful.

And next we have question from Collyn Gilbert of Stifel Nicolaus.

Tom, first at the follow-up on the expense question that Damon just asked. So the $20.5 million that we saw in comp expense this quarter, that’s a good run rate going forward?

There will be some reduction as there is every year as payroll taxes reduced to seasonal limits.

Okay, so there was some seasonality or related to those items in there?

Correct.

Do you know roughly how much?

I want to say about $300,000, maybe.

Okay, okay. And then just another detail question, so you guys generated $1.4 million you said in prepay income this quarter. Do you know what that was in the fourth quarter?

I do. Only $19,000, I’m sorry $660,000 for the full year, last year, $19,000 in Q1 of ‘11. I don’t have the break out, I’m sorry, for the trailing quarter.

Okay.

About $700,000.

$700,000 for the trailing?

Yeah Q4 was about $700,000 versus the $1.4 million in Q1, as well.

Okay. And then the...

[indiscernible]

Go ahead.

I’m sorry. I just wanted to comment on the prepayment penalties. We had one large prepayment penalty on a loan which we actually maintained the balance on. It was sale of a property and we financed the new borrower. So we've maintained the floating but we recognized a significant prepayment penalty on that, about $800,000. That was the reason for the large fluctuation.

Okay. When was that loan originated? I mean, the initial origination on that loan that generated that $1.4 million in pre-pay.

That was about 2.5 to 3 years ago.

Okay. Okay and then just few other minor question before getting to some of the bigger-picture stuff. So the $784 million that you guys are seeing and sort of the borrowings and CDs that are returned over the next year, do you have a weighted average cost or a rough cost on that?

The favorable re-price is about 45 to 50 basis points, I'd say.

Savings?

Correct.

Okay. And then just a final question. So, Chris, you talked about competition increasing in the market area, then how do you guys position yourself with that? I mean, is it the type of thing where you kind of -- you observe market activity for a quarter or 2 and then get back in? Or sort of how do you -- how are you kind of thinking about this environment a little bit longer term and how you are going to position the balance sheet in just your overall business?

We’ve had a lot of conversations on that. We don’t exit markets and make any calls where, I would say, we were not that brilliant. We really look at the market in saying we take what it gives us. So we’re out there and we’re trying to generate business. We look at return on equity model for any loan of substance and make sure that even the smaller loans, because of the absolute level were raked on, we get floors on a lot of our C&I credits . We do not just go to the spread over the curve. We have been able to keep a lot of ours because of the relationships that are tight to our clients and the fact that they are finding is to be very ready to handle anything they want and get them quick answers. The competition has really been picking up from the large money center banks, who, I guess, refocused, they've gone through their stress tests and now they’re reconnecting with their clients. So on seating the incumbent has been a challenge. We had been winning those over time because nobody was calling them back. It’s a little more difficult now because somebody is and we get -- of every deal that we put out there and in the term sheet, we probably have at least 3 or 4 that are coming right behind it. So I guess having the loyalty is going to be a little bit tougher to deal going forward, but we were continuing to pound at it. We’re not making any calls. We are being prudent when we do structured deals, where we’re seeing large C&I credits getting done at 15-year fixed terms from larger banks. I’m not going to say who they are. That’s something that we would not do and we will have to let that credit go away and we are trying to, instead of doing 10-year on some multifamily deals, we’re forcing those issues to be 5 and 5, even though the customer wants certainly something else but we’re trying to coax them into that kind of operation and the opportunity, so....

Okay, so given those trends, would you anticipate kind of the loan growth to fall a little bit shorter than where you put up -- what you put up last year?

Not too much shorter. I think the volume will -- we’ll make the volume target, I think it's just a question of keeping the portfolio. That's the other side of this. It's we don’t want to just go after and acquire and forget the ones that are on our books right now, because we worked hard to get those. So I think it is the combination of making sure you're managing the relationships and yet gathering more from your centers of influence. So I would think we are still going to be, we have to be, in that certain level.

Okay, okay. And then just finally on the M&A front, anything changed there? Do you – is that an avenue that you guys see better opportunity to pursue in the future, or how are you thinking about that?

Well, we try not to comment on M&A. There's certainly chatter. There's conversations out there. I think a lot of it is investor-banking driven. Until we can get a lot more regulations coming through from Dodd-Frank and/or other opinions, we really are saying it is -- we are out there, we look, we model but nothing has come to fruition at this point. We certainly have enough -- we feel very strong, very good about our capital levels, which gives us flexibility. Something we’ve always looked at it is we invest in ourselves or we invest in others. We still want to make sure that that decision is best for shareholders.

Okay that’s helpful that’s all I had.

And our next question is from Matthew Kelley of Sterne Agee.

I was wondering just on your appraisal process for classified and criticized, particularly, collateral dependent types of assets. During the first quarter, what type of reduction did you see in values as a result of re-appraisals for stuff that you have been lugging along for a while?

Matt, we reappraise annually on the classified assets and then collateral valuations are pretty much stabilized over the last year.

Okay, good. And then just on reserve coverage, where do you see that kind of stabilizing? Around the 150, 160 level on total loans? Is that still a level you are comfortable with?

Of course, it is a guess, but I would think around 150 might be where we get to ultimately when things get to a more normalize environment.

Okay. Got it. And what kind of tax rate going forward?

28.5% is what we are projecting based on our current view of taxable income for the year.

All right. Got it. And so as balance sheet growth is more modest, I mean, could we see an uptick in share repurchase activity as the capital continues to build?

If the balance, Matt, as we look at everything that we have, if we have opportunities to lend it out at good levels, we will continue to do that. But we evaluate the buyback consistently and that's something we always look at. And I don’t think we want to say anything. We have a lot of opportunities, yet if that’s the best one for us to get capital back to shareholders that’s the way we are going to do it.

Okay. And then that termination of the 568,000, what is that? And talk about just what you are seeing on deposit service fees and maybe just comment for a second on how you process transactions -- high to low, low to high -- and your view on that issue?

Sure. The termination fee's around the debit cards award program that’s been discontinued. We had accrued liability in connection with assumptions around people redeeming points. When we terminated the plan, the unused points we were able to recapture and record the income on that recapture. I am sorry, what is the second part of the question?

How do you process transaction fees? High to low, or low to high, sequential? I mean, is that something the CFTD's [ph] been taking a look at.

It’s sequential, Matt.

Okay. I got it. All right.

And this concludes our question-and-answer session. I would like to turn the conference back over to Christopher Martin for any closing remarks.

Okay and we appreciate everybody on the call. But as we look ahead to the balance of 2012 there appear to be many challenges that have a substantial impact on our economy, including the problems in Europe, unrest in the Middle East, record deficits in the U.S. accompanied by a dysfunctional Congress and high unemployment levels, which threatened to derail an already modest recovery. But it remains little bit clear they’re actually nominating from Washington then we’ll have to navigate all of the anticipated regulatory changes with limited expectations of relief. The company, however, is excited about the challenges in meeting our competition head-on and we will continue to build profitable, mutually rewarding relationships with our customers, ultimately belong from benefit of our stock orders. We appreciate your attention and have a great day.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.