Provident Financial Services, Inc. (PFS) Q1 2016 Earnings Report, Transcript and Summary

Good day, and welcome to the Provident Financial Services Incorporated First Quarter 2016 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mr. Leonard Gleason, Senior Vice President, Investor Relations Officer. Please go ahead.

Thank you, Andrew. Good morning, ladies and gentlemen, and thank you for joining us on this fifth Friday in April. The presenters for our first quarter earnings call are Chris Martin, Chairman, President and CEO; and Tom Lyons, our Executive Vice President and Chief Financial Officer. Before beginning their review of our financial results, we 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 disclaimer can be found in the text of this morning's earnings release which has been posted to the Investor Relations page on our website, provident.bank. Now I am pleased to introduce Chris Martin who will offer his perspective on our first quarter results. Chris?

Thank you, Len, and good morning, everyone. Provident delivered strong operating results with net income of $21 million or $0.33 per share in Q1. Our core net interest margin was stable at 3.11%, and although revenue was down versus the trailing quarter, the majority of the shortfall was in less predictable non-interest income items such as swap income, prepayment fees and gains on sale. Tom will provide more details on these items later in his comments. Our return on average assets was 94 basis points and return on average tangible equity was 10.76%. Annualized non-interest expense to average assets came in at 2.01%, all strong numbers versus our peers. Loan growth was robust as organic originations totaled $647 million during the quarter and the pipeline is at a record high for Provident at $1.5 billion. Growth of the loan portfolio in the next two quarters should be comparable to Q1, subject to the level of loan prepayments. Our consumer lending business is lagging expectations but residential mortgage volume is beginning to show improving trends, in spite of some aggressively price competition that we can't really make head or tails out of. To further our lending efforts in Pennsylvania, we are opening a loan production office in Montgomery County in Q2 and have two relationship managers already in place. We have not made changes to our loan underwriting standards to boost volumes. We have seen deterioration in credit structures offered by some of our competitors who are extending fixed rate terms out to 15 years on C&I loans with no personal guarantees and covenant light or no covenant whatsoever. Prices extremely aggressive but we are maintaining our return of equity thresholds. Credit issues seen benign, with no real trend or pattern in asset quality deterioration, we have not experienced any systemic credit pressure on our C&I or CRE portfolios to-date. Our cautious economic outlook has not changed. However at this time we do not anticipate any material changes in asset quality. Deposits increased nicely during the quarter. We’ve employed a more defensive posture relative to our maturing CDs. Our cost of deposits appears to have bottomed out, yet we do not anticipate any rapid upward trend in rates as the industry copes with maintaining margins. We have expanded our outreach to our commercial real estate and middle market clients to incrementally increase their deposits at Provident. And subsequent to quarter end, we were successful in winning multiple bids for municipal deposits at competitive yet attractive rates. NIM compression will continue, albeit, at a manageable level, as asset low yields remain under pressure. Our ALCO modeling suggests two additional rate increases for 2016 and we have not been this close to a neutral position from an interest risk perspective in the history of us as a public company. We see our local markets improving at a measured pace, while the national and global economic issues that drive interest rates remain volatile. We continue invest in our business with systems and people, as we adopt more tools to enhance our digital mobile technology offerings for customers in a safe and secure manner. Approximately 15% of our customers are using our mobile channels and we see this number increasing daily. We launched People Pay and mobile banking for business during the quarter and we are also offering a mobile solution that offers touch ID authentication for customers with smartphones. Many other initiatives are being vetted to accommodate the self-service clients and to further engage in customer outreach via social media. We consistently pursue efficiencies and improvements to our operations. We sold branch deposits at an underperforming location during the quarter and saved on staffing and lease costs relating to that office going forward. Our branch rationalization continually evaluates our breakeven levels in light of reduced traffic throughout our branch network. We are also streamlining and changing our process fees in the back-office to meet the needs of customers, while adapting to changing regulations and technology. On the regulatory front, we continue to join our industry trade groups to lobby for changes in Dodd-Frank regarding the $10 billion hurdle, but there appears to be little hope to change the rules during the presidential election cycle and we plan to spend approximately $250,000 this year to continue our preparation for going over the $10 billion plateau. On the M&A front, in the near-term, we plan to take advantage of the customer dislocation and disruption bought about by acquisition driven business integration within our markets. Discipline in earnings accretion with an eye towards $10 billion remain the watchwords in our pursuit of acquisitions whether a whole bank or a wealth management firm. Conversations are increasing in number and depth but many diverse issues emanate from those discussions. And we continue to be focused on the drivers of long-term value improving expanding relationships and providing stockholders with positive returns as evidenced by a 5.9% increase in our cash dividends this quarter. With that, Tom will take you into some more details.

Thank you, Chris, and good morning, everyone. Our net income for the first quarter was $21 million, a 2.5% decrease from $21.5 million for the trailing quarter, but a 5.9% increase from $19.8 million for the same period last year. Note that the first quarter of each year is impacted by seasonal expense items such as higher payroll taxes, utilities and snow removal costs. Earnings per share were $0.33 for the first quarter compared with $0.34 for the trailing quarter, and $0.32 for the same period last year. Revenue declined $3.5 million versus the trailing quarter with net interest income decreasing $700,000 despite $105 million increase in average earning assets, which was funded by growth in average deposits as the net interest margin declined 6 basis points to 3.11%. Recall that last quarter included the accelerated recognition of $1 million in deferred income on a prepaid CRE loan which contributed 5 basis points to the margin. 7% annualized average loan growth for the first quarter of 2016 was driven by multifamily and commercial lending. Non-interest income was $2.8 million less than in the trailing quarter, $2.7 million of which was due to lower volatile swap income, loan prepayment fees and gains on the sale of OREO. We provided $1.5 million for loan losses this quarter compared with $1.3 million in the prior quarter. Net charge-offs was $700,000 or an annualized 4 basis points of average loans. Non-performing loans increased $6.1 million from the trailing quarter to $50.6 million or 0.76% of total loans concentrated in $2 million of residential mortgage loans and a $4 million commercial relationship secured by business assets. This slight deterioration appears to be specific to the individual borrowers involved and not indicative of any broader adverse trend. In fact, overall portfolio asset qualities improved with the weighted average risk rating and early stage delinquencies declining and the criticized and classified loan percentage falling to a multiyear low. The allowance for loan losses to total loans was unchanged from December 31 to 0.94%. Excluding acquired loans recorded at fair value, the allowance was 1% of loans. Non-interest expense decreased in the trailing quarter to $44.9 million, helped by lower than expected occupancy costs attributable to the relatively mild winter and lower other expenses. Income tax expense was reduced from the trailing quarter at $8.7 million as our effective tax rate decreased to 29.4% from 30.4%. We currently project an effective tax rate of approximately 29.5% for 2016. That concludes our prepared remarks. We’d be happy to respond to questions.

We will now begin the question-and-answer session. [Operator Instructions] At this time, we will pause momentarily to assemble our roster. The first question comes from Mark Fitzgibbon of Sandler O'Neill. Please go ahead.

Hey guys. Good morning.

Good morning.

Chris, you pointed out something that we’ve heard from a lot of other banks which is that there are some banks in the marketplace that are doing long duration, sort of very aggressively priced credits out there, and we’ve heard from a number of institutions - and I guess, the question I would pose to you is - and I’m sure you don’t want to single anybody out. But are those competitors big banks or mid-sized banks or smaller banks, would you say that are doing these crazy loans?

I would say mostly obviously we compete with be the small to mid-size. I think the larger institutions that have been in this business a lot longer have a little more discipline. Obviously I know that some of our competitors have a lot of capital put to work and also that we’re not trafficking in the boroughs of Manhattan, Brooklyn, Queens and the likes. So we’re not really competing with them directly in that space, but certainly in our markets in New Jersey and Eastern Pennsylvania, we do see other competitors of the smaller being a little more aggressive.

Okay. Secondly, I just wondered if you could share with us what sort of rates you’re seeing on those municipal deposit relationships that you mentioned you just brought in at the end of the quarter?

Portfolio rate goes as low as about 25 basis points, Mark, but new additions would be generally in the 40 to 65 basis point range.

Okay. And then, Tom, I wondered if you could share with us your outlook for the margin given the flatter yield curve, or should we expect some modest NIM compression in coming quarters?

I would expect some more modest compression. It’s come in a little bit since the last time we spoke. I think I was looking for stabilization around 3.10%. It feels more like around 3.06% kind of range now. The margin for the last month of the quarter was 3.08% if that’s an indicator. Pipeline rates are around 3.70%, little bit under 3.70%. Lot of that’s variable product, so we can try and preserve margins through funding it short as well.

Okay. And then the last question I had is in the other income line. It looked like it was a little soft, and I was curious, is that a function of the rate impact from swaps or something else?

To a large extent, yes, it’s really the volatile items, the swaps being the largest one. We had profit on swaps including the CVA adjustment of $1.6 million last year. This quarter was actually a negative $3.16 million. We had a $147,000 of income on swaps, but then we had a negative adjustment because of the decline in rates to the fair value of the swaps. So, I guess, 10-year came down 53 basis points and that’s what drove it. No deterioration in borrower credit spreads.

And I know you don’t know what - where rates are going to be exactly, but it strikes me that this quarter was probably a bit low for that line item?

I think so. Again these are things that are very difficult. We have virtually no control over. We can prospect in the right areas, but it’s really borrower appetite and where the rate movements are at any given time.

Well, obviously the 10-year moving up a little bit more will obviously make the adjustment a little bit better going forward.

Yes.

I’m sorry, one last question. Could you share with us what assets under management were in your trust wealth management business at quarter-end?

$2.2 billion under management and $2.6 billion if we include the ETF indices we manage for total AUA.

Great. Thank you.

Thank you.

The next question comes from Matthew Kelley of Piper Jaffray. Please go ahead.

Yes, hi guys.

Hey Matt.

Maybe just following up on that question about the asset management business. How are you feeling about the margins in that business over time, stable, higher? Where do you see the margins there?

We actually ticked up a little bit this quarter up to 79 basis points on a trailing 12 months return. So I think we’re pretty stable with that level.

We’re pretty stable at that level. I think you want to keep the clients. It’s the competition in that space also. We don’t really look for custody business much in that space, but if our client wants to do that, we could work on it. It’s been pretty stable along. Obviously markets move and that will affect the revenue on the go forward basis. If we have a stable market, I think it’s going to hold surf [ph].

Okay. And then just turning to the conversation about commercial real estate concentrations and pretty big divergence between what’s happening to the OCC regulated banks versus the FDIC state-chartered institutions. And I kind of look you guys above the 300% limit following to that FDIC state camp. And what is your view about how the regulators are going to treat this issue over the long-term? Do you think there would be any conversations of some of these regulatory guidelines in the way the banks are treated between these two regulatory agencies, State versus Federal? Does that change over time at all in your view or they stay the same?

Well, kind of why you support, if you like, the dual system of banking in charters. You keep supporting it. I would think that from our standpoint I would be concerned about everybody being in the same and the regulators making, okay, you can only have X amount of this, X amount of that, and then we’ll all have the same balance sheet. So I think that we haven't had an issue. We’ve been doing this business for a long time and the regulators look at our risk characteristics, our measurement and our quality and we have third-parties validate what we do. So we’re really pretty comfortable with it, though I would agree that the regulators have a different viewpoint on it. The biggest concern I would have if we force everybody out of the commercial real estate space and make them go into C&I and they have no expertise in that, are we just pushing a problem to a different sector. So it’s a challenge.

Sure. Got it. Okay, and then just turning to your tax rate guidance. What’s changing in terms of the balance sheet composition or securities portfolio composition to kind of allow you to take a little bit of leg down the outlook for the tax rate? What kind of planning strategies are in place there?

The REIT also in addition to the balance of tax exempt issue, so we had a little bit of benefit on the state tax side which helped us.

Okay. Got it. And then last question just a modeling issue. What was the accretive yield income, purchase accounting accretion recognized during the quarter?

Mark, I’m sorry. It stopped - I said Mark, I meant Matt. It’s become negligible. I kind of stopped tracking at this point.

Okay. Got it. Thanks a lot.

Thank you.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Christopher Martin - and I do see that another question has just come in. And that is question from Collyn Gilbert of KBW. Please go ahead.

Thanks. Good morning, guys.

Good morning.

So just wanted to follow-up on some of the discussion about CRE concentrations outlook, competitive environment. How are you guys just thinking about loan growth opportunities? I know multifamily was a big growth engine this quarter. Just if you could kind of breakdown how you’re sort of thinking about future growth composition?

Well, I think, Collyn, we’re not really - we always look at what is the best risk adjusted return and making sure you have the right group behind it to support any kind of exposures or outside the parameters that we have established. Of that the pipeline we have about $1.5 billion, we’ll get about a 50% pull-through rate, and in there about - of that - so let's say $760 million, you have approximately $200 million that would be in the CRE space, approximately $190 million in middle-market and $176 million in business banking. So it’s pretty well diversified all the way through including some asset base lending. And I think we look at all of these criteria. One thing I can say that we have done is we’ve gone back and look and keep our thresholds and our return on equity model, so any multifamily, any CRE, any C&I meet those hurdles going forward. And I know that in the commercial real estate space, it’s not just multifamily, we’re seeing a bit of industrial production coming in also.

Okay. That’s helpful. And do you think there is sufficient enough growth for you guys to stay in like 6% to 7% annual loan growth rate?

Yes, that’s what we’re targeting [ph].

Yes, absolutely.

Okay. That’s helpful. And then we could probably sort of decide for this from your NIM comment, Tom. But just loan yields, where are - that pipeline that you talk about, Chris, what’s kind of the average yield on that and then how that just compares to the portfolio yield? I presume when you talk about NIM compression, it’s still coming on the lending side more than deposit or funding pricing pressure?

That’s correct. The pipeline yield is about 3.67% versus I think it was at 3.97% portfolio yield.

Okay.

So it’s coming on the asset side and that’s kind of the challenge is to stay competitive yet not give it all away. And it’s very aggressive and you want to win the good deals but the other ones we would let pass.

Okay, makes sense. And then, Tom, just - go ahead.

I’m sorry, just even though the rates low relative to the pipeline, we do have opportunities on the funding side to match with variable rate funding to still preserve some yields. So you have about 48% of that pipeline is floating rate or variable rate product.

That was going to be my next question, because did you put on some borrowing this quarter that I guess we just kind of think - or would like to hear how you’re thinking about the overall funding strategy matching some of the short stuff I presume with shorter term borrowings. Does that…

Yes, that’s the intention. I mean, you saw a bit of pick-up in brokerage CDs this - on quarter two. Again just a more attractive funding, so it’s not a material piece of the pie but recognizing the short-term nature of some of the assets we’ve put on we were funding it shorter to match.

Okay. And then just one - or actually two - sorry, two more questions. One quick housekeeping item. So you said swap piece were, what did you say 1.47, Tom, for the quarter?

Yes. So on a gross basis that was the income, but the net inclusive of the mark-to-market adjustment, the CVA adjustment, was a minus 3.16%.

Okay. And then - okay, sorry. And then the prepay income this quarter was what?

Prepayments were $747,000 versus $1.1 million last year. We have $483,000 so far in April, if that’s helpful.

Okay. That’s great. Thank you. Okay. And then final question, just the LPO in Montgomery County. Can you talk a little bit about what sort of is driving that and then maybe how you see that market evolving for your future?

Sure. We obviously had a lending group for the Team acquisition and they were in Bucks County and we’ve - the Team has been somewhat replaced by a bit larger background lenders such as people from TD, PNC. And so with that group, they were able to deliver on larger credits and they do kind of go toward and into the Philadelphia market and submarket. So being there and we see that is a pretty fertile area. We thought to put an LPO in that spot, get our name out there. We don’t see ourselves going into center city Philadelphia but some of the people that live and/or work in that space do travel around that area. So we thought that it would be the right idea and expanding the market a little bit.

Okay. Do you have any sort of portfolio targets for that area, Chris?

Well, not that they are already in our Bucks County and Pennsylvania lending pipelines, but that is just - it’s just opening up. So the estimates might be coming to PA for the person then we’ll set the parameters once they get into the lease and get established and have another credit person on staff also.

Okay. That’s great. I’ll leave it there. Thanks guys.

Thank you.

And we have a follow-up from Matthew Kelley of Piper Jaffray. Please go ahead.

Yes, just a quick one on expenses. You do come under your guidance that you gave in January, and when we talk back then you said full-year expenses of roughly $183 million to $184 million. Is that still a good range for the year, or are you tracking a little bit lower?

I think that’s still a good range, Matt, but probably we’ll come in, I would guess, towards the low end of that range. I’m looking for about $45 million to $45.5 million for next quarter.

Okay. Great. Thank you.

Thank you.

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

Well, thank you for your attendance today on the call. As I referenced in our release, we are named by Forbes as one of the Best Bank’s in the United States and we’re very proud of that from our officers and our employees and our board. And we look forward to seeing you and talking to you on our next call. Thank you very much. Have a great day.

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