Provident Financial Services, Inc. (PFS) Q3 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the Provident Financial Services Third 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 Officer. Please go ahead.

Thank you, Megan. Good morning, everyone, and thank you for joining us today. The presenters for our third quarter earnings call are Chris Martin, Chairman, President and CEO; and Tom Lyons, Executive Vice President and CFO. Before beginning the review of 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 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 the Investor Relations page on our website, www.providentnj.com, or by calling Investor Relations at (732) 590-9300. With that, allow me to introduce our Chief Executive Officer, Chris Martin, who will offer an overview of our third quarter financial results. Chris?

Thank you, Len, and good morning, everybody. Our most recent quarter was again marked by steady financial performance in the face of a challenging economic environment. We continue to see substantial growth in our loan portfolio and core deposit levels, as well as further improvement in the asset quality. As a result, despite the Fed's continued accommodative policies, which are aimed at keeping interest rates low and the yield curve relatively flat for the foreseeable future, we have enabled to improve our quarterly earnings per share to $0.28. Our return on average assets for the 9 months ended September 30 was 95 basis points, while the efficiency ratio stood at 57.15%. While business and consumer sentiment has shown some signs of improvement, skepticism regarding the prospects for future earnings growth has left borrowers reluctant to expand their operations. With the political and fiscal policy uncertainties surrounding the upcoming presidential election and the unknown impact of health care legislation, there remains a lack of confidence on the part of businesses and consumers alike to invest or spend. This has suppressed economic growth while the announcement of another round of incident asset purchases by the Federal Reserve has served to maintain interest rates at historically low levels. The prolonged low interest rate environment and the low absolute level of returns on reinvested cash flows will continue to impact our net interest margin. In spite of negligible economic growth, we have demonstrated an ability to win loan market share, with loans growing at a 7% annualized pace for the last 2 quarters. And as we strive to increase the net interest income, continue to grow earning assets while reducing nonperformers should help us to mitigate margin compression. Prepayments in our mortgage-backed securities portfolio had the greatest adverse impact on our margin in the third quarter, which is why we will continue to monitor and when appropriate, sell those securities that are at a greater risk of accelerated prepayment. Overall, our growth in the loan portfolio was strong for the quarter, where our commercial real estate lending, primarily in the multifamily space, has been consistent, accompanied by expansion of relationships in the C&I area. The steady pace of loan originations requires us to balance prudent asset liability management, with the desire for expanding net interest income, even with high quality relationships. And competitive pressures on pricing and credit structures remain intense, but our loan pipelines are sound. And if history is any indication, the fourth quarter is usually our strongest in terms of loan bookings. Our private banking initiative is just getting off the ground via Beacon Trust, our wealth subsidiary, which will provide a market rate of return and further solidify relationships with our wealth clients. And a continued reduction of 8% in problem credits occurred in the quarter. Credit risk ratings improved to their best levels in 2 years, and we have also experienced several significant recoveries. Our lost content has remained controlled at 47 basis points, and we hope to resolve several sizable credits in the fourth quarter. Importantly, there is pending legislation in New Jersey to accelerate the foreclosure process for abandoned properties, which would be beneficial to both Provident and the communities where these properties are located by reducing blight and market devaluation. So how do we continue to grow earnings in this historically low interest rate environment that has an extended horizon and against the backdrop of increased regulations? Improving our efficiencies in expense control is in our DNA, and we are undertaking another series of reviews of our operations in light of this economic malaise lasting much longer than originally anticipated. We are diligently reviewing ways to improve productivity and processes to ensure that we have the best people and practices for the return to a normal economy. Operating expenses were down 2.4% for the current quarter versus the trailing quarter, as operating efficiencies continue to emanate from the recent grants, consolidations and the last year's combination of our administrative offices into one site. In the branch consolidation area, they have resulted in the retention of over 97% of affected deposits. Our efficiency ratio has improved quarter-over-quarter, and we still outperform many of our peers. We continue to invest in our future with people and technology. We have hired our complement of lenders in the health care area. We've added a new head of middle-market lending and augmented our business, banking and commercial real estate areas, with additional relationship managers. We have also opened a loan production office in Bergen County. And finally, we are testing our mobile banking technology for implementation in Q2 2013. On the regulatory front, the proposed Basel III rules do not appear to adversely impact us initially, as we currently exceed the proposed level of capital required. However, we support as do many other community banks, efforts by regulators and members of the legislation to demonstrate that the risk measurement criteria and the cost of complying with the proposal intricacies are overly burdensome, with a backward-looking concentration on real estate issues that are now in the past. We foresee Basel III as having more of an impact on loan pricing than on the level of capital, which could further place a strain on the lackluster recovery currently underway. We continue to build capital through earnings, with our dividend payout ratio currently at 46%. Further issues that we are focused on include the extension of the tag program that is scheduled to expire at year-end, which provides unlimited insurance on certain deposits, but which must be extended by an act of Congress, which is not an easy feat these days. Overall, the outlook for the New Jersey economy is slowing, and the unemployment rate has risen over the last 5 months. So it's only natural that the marketplace is hesitant to expand. This uncertainty is affecting confidence. But we believe with our brand and our commitment to customers and clients, we are winning more than our share of the business available. With those comments, I would like to -- I'll let Tom to go through the financial details. Tom?

Thank you, Chris, and good morning, everyone. Our net income for the third quarter was $16.2 million or $0.28 per share, consistent with the $16 million or $0.28 per share for the second quarter of 2012. Net interest income decreased $863,000 compared with the trailing quarter to $53.7 million, as the net interest margin contracted 8 basis points for 3.31%. Please note that this is the core margin. We record loan prepayment fees and noninterest income and do not consider them in the margin calculation. Pressure on earning asset yields was mitigated by reductions in funding costs and growth in loans and noninterest-bearing deposits. As of quarter-end, our total loans increased $84 million or an annualized rate of 7% versus the trailing quarter to $4.8 billion, with the overall loan yields for the quarter declining 8 basis points compared with the trailing quarter to 4.68%. During the quarter, our funding continued to shift to lower cost and core deposits, with core accounts excluding all time deposits increasing to 81% of total deposits at September 30. Within core deposits, average noninterest-bearing deposits increased by $82 million or 12% unannualized to $771 million. As a result, the average rate paid on all deposit funding decreased 4 basis points to 46 basis points for the third quarter. The company provided $3.5 million for loan losses, while net charge-offs were $5.6 million. This is consistent with the provision of $3.5 million in the trailing quarter. Nonperforming loans decreased $10 million from June 30 to $106 million or 2.19% of total loans at September 30. Our credit metrics improved again during the quarter with total delinquencies, weighted average risk ratings and classified loan levels all showing continued improvement. The allowance for loan losses to total loans was 1.46% at September 30, compared to 1.53% at June 30, while the allowance coverage of nonperforming loans increased to 66.5% at September 30 compared with 62.8% at June 30. Total nonperforming assets, consisting of nonperforming loans and foreclosed assets, decreased $10 million versus the trailing quarter to $120 million or 1.65% of total assets at September 30. We experienced net nonperforming asset outflows of $2.4 million, the first quarterly net outflows since the start of the Great Recession, with recoveries of previously charged-off amounts totaling $1.6 million. Foreclosed assets remained at $13.9 million at September 30, as REO resolutions were largely matched by new inflows Subsequent to quarter-end, however, the company received repayments on an additional $1.9 million of nonperforming commercial loans. And furthermore, a $5.5 million commercial REO property is under contract for sale with an expected fourth quarter closing. Also, at present, $2.6 million of residential mortgage -- residential REO properties are under contract for sale scheduled to close by December 31. Noninterest income increased $447,000 compared to the trailing quarter, primarily due to increases in loan prepayment fees and gains on securities sales. Managed expense decreased $860,000 versus the trailing quarter to $37 million as a result of decreases in compensation and intangibles amortization and nonrecurring expenses incurred in the trailing quarter related to a contract termination in connection with Beacon Trust's systems integration and to branch consolidations completed in the second quarter. The company recorded an income tax expense of $7 million for the third quarter compared with $6.7 million for the trailing quarter. And our effective tax rate climbed to 30.1% from 29.4% for the trailing quarter as a result of increased projections of income from taxable sources. With that, we'd be happy to take your questions.

[Operator Instructions] Our first question comes from Matthew Forgotson with Sandler O'Neill.

Just want to talk quickly about operating expenses. In light of the initiative you mentioned, what's a good run rate to use in the out quarter, and then how are you thinking about it across 2013?

Yes, as Chris indicated, we are currently evaluating those initiatives and it's a little bit difficult to project the impact of some of those at this point. We're still kind of early on in our budget process, so I would expect that we would be able to maintain expenses at least consistent with the current period around the $37 million to $37.5 million on average, I would say, for next year.

Okay. And then just in terms of can you remind us what the 30 to 89-day delinquency was in the quarter?

Yes, total delinquencies were $18.9 million. That's a 30 to 59, and $11.1 million in the 60 to 89 category for a total of 62 basis points.

Got it, okay. So -- and then just finally, just on funding cost, can you talk to us about what kind of leverage you have there to pull at this point in the cycle?

Sure. Over the next year, total funding that's maturing or repricing is about $716 million, currently at a rate of about 1.06 if we were to roll that to current rate it would come down to about 41 basis points. It's in that -- on a quarterly basis, you have borrowings coming up about $29 million in Q4 and then about $25 million a quarter for each of the next 2 quarters after that. The rest of it's CD repricing for the most part.

Our next question comes from Collyn Gilbert with Stifel, Nicolaus.

The growth that you saw this quarter in multifamily, was there anything in particular that was going on there? Was it timing? And then maybe just kind of talk about the growth that you expect from here. I know momentum has been building in the pipeline, and how you think you can grow the portfolio from here?

I think nothing really an aberration by any stretch. We see some refis and some other projects coming in, some other things are maturing, are coming up for renewal and we're getting options there. It's just inconsistent. People see our processes, one that's very straightforward, making decisions quickly. Certainly, it's price-competitive. That's getting tighter and tighter as we go along. And we've been able to follow our clients that have gone out into maybe Pennsylvania with some projects. And have done very well out that way. So we're following our clients. Pricing is very tight. Structure is also important because I know they were out there, some people are doing 15-year fixed. We're not going that route. And -- but it has been mostly New Jersey and Pennsylvania with our clients. We're not in the New York market per se.

Okay. So you are trying to keep it, what is it, predominately a 7-year paper or...

Predominantly 7, 3, and in that first set. So the 7-year would be fixed, and then 3-year and then we'll adjust again.

Okay. And what rates are you seeing on some of the new originations that are coming in?

There are about 3.75 to 3.875, some 4s. But that's about the market. We haven't gone below that at this point, unless it's adjustable -- adjusting the LIBOR.

Okay. And you may have said this in your initial comments, and I apologize if I missed it, but your -- kind of your outlook for the NIM, what are you thinking from here?

I think it's likely we'll see some continued pressure, probably mid-single-digits.

Okay. So better than what you saw in this quarter just because of...

It's pretty tough to project. We caught the most out on the mortgage-backed securities repayments. Cue [ph] infinity [ph] definitely played a role on that, driving down the longer end. It's a little bit tough to predict when that burns out a little bit and we see some stabilization. As we mentioned in the comments, we continually review the portfolio and try to make intelligent sales when we're not comfortable with the risk of accelerated repayment.

But we have an adjusting rate. We have a smart checking product that we were adjusting that rate down effective November 1. And that's approximately $400 million in deposits. Tom, is that the number?

Yes, a little bit more than that.

A little bit more than that. So that will be reset down. So I think it's going to be timing. And obviously, the prepayment's coming in very heavy on the mortgage-backed securities portfolio. We've mitigated some of that, but that continue. We think that would slow down.

Our next question comes from Matthew Kelley with Sterne Agee.

I was curious to get your thoughts on the mortgage banking business. A lot of your competitors have really ramped up this line of business to offset spread pressures, and want to know if you had any thoughts of consideration of building out an effort in that area?

Well, Matt, we've seen that. We did not have that as a business line. We usually just look at anything we can originate, that we just look at asset liability and say we are still continuing to sell 20 and 30-year paper, as we've always done, unless there was a really compelling need to put some on a portfolio, which is a decision that we would look at from an [indiscernible] perspective. We did not think of adding a lot of people or a structure related to that. Not that any of it we don't find fault in that. We'll look at ways of maybe continuing. We're selling things or gains also that maybe we can beef that up through some marketing approach and be able to handle that internally without putting on a whole series or a group of people to generate that volume so that we can handle it internally. And that business is just something we watch very carefully.

Okay, got you. What about maybe just handicap the M&A market this quarter versus the last time you spoke in July. How would you assess the number of conversations out there or your likelihood to transact over the next year?

Well, obviously, we don't comment on anything that's pending or anything of that nature, but there's more and more -- the optics are saying that it's going to get tougher. And if we're seeing it's getting tougher with regulatory challenges and cost and margin compression, I can imagine how bad it would be for somebody who's a bit smaller. So it's phone conversations and/or just passing comments are a little bit better. There's still a difference in deals and devaluations, but certainly the deal up in New York, where it was a 2x book is something that was -- took everybody, I think, by surprise. But there are certain levels that we think might make some sense, and there are certain levels that we wouldn't.

Okay, got you. Then last question, what should we be using for a tax rate going forward?

Matt, I think we're going to be around 30%. As I mentioned earlier, we're still in the budget developing process so I can give you a little more color later. But right now, that would be my best guess.

Our next question comes from Jason O'Donnell with Merion Research. Jason O’Donnell: Just given the well-publicized weakness in the New Jersey economy, how are you thinking about the loan loss reserve at this point and sort of the pace of reserve releases or at least the decline in the reserves to loans ratio here going forward? Any color you can give around kind of where you see that settling out would be appreciated.

We've seen continued improvement in asset quality. And as I mentioned in the prepared remarks, we had some good traction it looks like going into Q4 in terms of resolutions, kind of a thumbnail analysis. It sounds to me that we could probably get down to a 130 level over time if the asset quality continues to improve. And that's something I'd anticipate in the next quarter. But theoretically, we could release reserves down to approximately that level. So it's really going to be a function of how we continue, the improvement goes, whether it continues to sustain.

On the other, this is Chris, the other side of that would be in New Jersey. In the past, we saw that if unemployment continued to tweak up within about 8 months, it sometimes shows through in the residential area. So we're watching that, and I know that we're evaluating it, especially with budget for conversations of where does our GVA percentage fall out. And I think the next couple of months will give us the gauge of where that will flow. Obviously, do we have to increase them? What kind of -- hopefully that the foreclosure process is getting a little bit more efficient. Things are coming through the pipeline, and we're still trying to lobby in New Jersey to make sure that looking at this holding are state-backed, not really helping by keeping a portfolio process so elongated. Jason O’Donnell: Okay, that's helpful. And then in terms of just a housekeeping on any nonrecurring items we should be paying attention to other than the securities gains or a couple of the other obvious things that were highlighted here?

No a quiet quarter this time, really nothing unusual.

And we have a follow-up question from Matthew Kelley.

Yes, in your opening remarks and comments that you've mentioned watching the tag insurance program, how would that impact you? And what's your view on that issue?

Well, obviously, a lot of people put money in because they're not unlimited insurance, noninterest-bearing deposits. And as that safety factor gets pulled away, I think there will be a lot of people, businesses and/or individual clients that are saying I have to be careful but because we're at risk, but every bank, how much money do you leave there if they pull away that insurance. So there would be a lot of deposits in December running all over the place trying to find a home. And that will be an interesting phenomena, where I know that they're doing a lot of lobbying and talking to people in Washington to make sure this gets along with some budget process. But right now, it expires on December 31. Do I think it's going to be running, people running for the doors? No, I think it's just going to be a lot more conversations and a little bit concern just because of the exposure limits.

Got you. And what's your total commercial deposits that could be affected by that? Or would they have to make a decision on what they wanted to do with their funds?

No, we're done with the analysis, Matt. We've run asset liability and liquidity models on, but unfortunately, I don't have it with me. I could not tell you the dollar amount there that's in excess of 250.

Jason, sorry, we'll get back to you.

We'll get back to you on that.

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

Thank you for your time and interest. And hopefully, the next time we communicate, we'll have more certainty on the direction of our economy and our country. And obviously, there's a weather pattern coming up towards the New York, New Jersey area. Hopefully, we'll get through that with not anything like from Hurricane Irene. We hope you have a wonderful day, and thank you for your time.

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