Provident Financial Services, Inc. (PFS) Q4 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the Provident Financial Services Fourth Quarter 2016 Earnings Conference Call. [Operator Instructions] Please also note that this event is being recorded. I would now like to turn the conference over to Mr. Len Gleason, Investor Relations Officer. Please go ahead.

Thank you, Andrea. Good morning ladies and gentlemen, thank you for joining us on this last Friday in January. The presenters for this quarter earnings call are Chris Martin, President, Chairman and CEO; and Tom Lyons, our Executive Vice President and Chief Financial Officer. Before beginning a 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 it's my pleasure to introduce Chris Martin who will offer his perspective on our fourth quarter financial results. Chris?

Thank you, Len and good morning everyone. Provident again had strong earnings for the quarter of $22.6 million or $0.35 per diluted share exceeding our results from the same period in 2015. Total revenue and net interest income both achieved record levels and balance sheet growth continued as our total asset reached $9.5 billion. Our loan portfolio grew by an annualized 7% during the quarter, CRE loans grew at 13% annualized pace with originations concentrated in retail at 43%, multi-family at 21%, office at 18%, and industrial at 7%. C&I volumes grew by an annualized 20% with originations primarily in the construction industry, hospitality, wholesale trade and rental real estate categories. And on the CRE front, we remain comfortable with our levels versus the regulatory guidelines and pricing has improved as competitors have chosen to slow CRE growth and have adjusted their aggressive pricing and credit terms accordingly. For 2017, we expect more of the same growth in lending, mid-single digits with a 50-50 blend of fixed and variable interest rates. And with interest rate expected to rise, we anticipate the level of prepayments will decline and refinancing should slow. Our deposit growth of 10.6% for the year provided the funding for a long growth and the resultant reduction in our wholesale borrowing. Core deposits represented 90% of total deposits and our loan-to-deposit ratio was 106.9% at December 31, 2016. The composition of deposits was approximately 26% commercial, 59% consumer, and 15% admissible deposit as December 31, 2016. Non-interest bearing deposits grew nicely again in the fourth quarter, totaling 21% of total deposits at year-end. And while we model deposit behaviors conservatively in estimating interest rate risk, we believe we have a high quality deposit base which should prove less interest rate sensitive than many of our peers in a rising rate environment. With expectations for steeper yield curve, we expect the NIM to expand modestly in 2017, as the short duration of our investment portfolio should continue to provide reinvestment opportunities, at improve returns. Credit quality further improved in 2016, our charge-offs were negligible in the quarter and credit metrics remain stable. Loan loss provisions during the quarter were primarily due to loan growth and the process to validate our allowances is thorough and extensive. And we continue to manage our business to generate positive operating leverage that produces a return on tangible common equity of 10% to 12% and a return on average assets of 90 to 100 basis points. As we withstand the increased costs, including regulatory compliance and additional expenses related to preparing for $10 billion in assets, we remain vigilant about expense management and leave no process or efficiency initiatives on the table. With compensation employee benefit costs representing 58% of our operating expenses, we are ever mindful of right-sizing our FTE levels without sacrificing customer relations in compliance, and reducing non-revenue producing personnel with technologies where appropriate, while providing incentives that support our paper performance culture. With the increased acceptance and use of our multiple digital channels, we continue to see efficiencies from our customers who prefer to self-serve. Our technology spending incudes more mobile applications, people pay, apple pay and U-Shield, where the customer can customize their debit card security parameter. And while we continue to broaden our digital delivery channels, we are consolidating two branch locations in the first quarter of 2017 as part of our ongoing branch rationalization. And we've upgraded our asset liability model to prepare for de-fast [ph] and further strengthening our forecasting capability. Our capital levels are strong and the excess capital affords us the flexibility to grow our core business and return capital to our stockholders in the form of cash dividends. On that, score our Board of Directors declared an increase in the quarterly cash dividend to $0.19 per share for $0.18 which represents an increase of 5.6% and approximate yield of 2.7%. And our dividend payout ratio remains around 50%. On the outlook after the surprising results for the election in November, there appears to be a very optimistic tone to the market, and in our conversations with clients. Yet one must be mindful that at least 50% of the country is not pleased. Knowledge of that will likely temper any rapid change in regulations or reforms of Dodd-Frank and with tax policy repeal the Affordable Care Act and infrastructure spending legislation on the agenda. We think that regulatory reform will take a backseat until the second half of 2017 at the earliest. As we do not see Provident problem going over $10 billion in asset until mid-2018 we will continue to pursue changes in Washington to roll back as much as Dodd-Frank as possible. But the tender of the business community has vastly improved, the employment picture has brightened, and collectively these considerations should result in increased economic growth and opportunities for the future. Finally, my comment on M&A; the world is moving quickly and the value branches in combination with digital technology needs to be evaluated differently than in the past. Seller expectations have increased as financial stocks have rallied an average of over 25% since the election, making deals less appealing and accretive. We see opportunities that are more actionable in the wealth management space, and as there are no new banks being formed and the barriers to entry remains to severe, consolidation should continue in the industry. With that Tom, will go over some of the details. Tom?

Thank you, Chris and good morning everyone. As Chris noted our net income for the fourth quarter was $22.6 million compared with $22.9 million for the trailing quarter. Earnings per share were $0.35 compared with $0.36 for the trailing quarter. Revenues increased $2.1 million with net interest income increasing $1.6 million as average earning assets increased by $129 million and the net interest margin expanded 2 basis points to 3.07%. The margin benefitted from favorable reprising of variable rate assets and the deployment of excess liquidity held during the trailing quarter. Average loans grew to 7.25% annualized pace, with 6.6% annualized growth on the spot basis. Loan growth was driven by CRE and C&I lending. This growth was funded by a $193 million or 13% annualized increase in average core deposits. Average interest bearing demand, non-interest bearing and savings deposits all increased during the quarter. Non-interest income was quarter to $419,000, greater than the trailing quarter, as a favorable CVA adjustment related to swap loans resulting from rising interest rates. And increased owned fees in wealth management income more than offset reductions in sales of loans scenario [ph]. We provided $1.2 million for loan losses this quarter, an increase from $1 million in the prior quarter as a result of growth in the loan portfolio. Asset quality metrics was stable versus the trailing quarter with non-performing assets to total assets, non-performing assets to loans REO [ph], 30 to 89 day delinquencies to loans, total delinquency to loans, annualized net charge-offs for the quarter as a percentage of average loans and the weighted average risk rating the portfolio, all equal to or better than similar metrics September 30, 2016. Partially offsetting these positive factors, non-performing loans increased $2.4 million to 0.61% of loans, up from 0.58% last quarter, and criticizing classified loans increased $12 million to 1.99% of loans from 1.85% last quarter. The allowance for loan losses to total loans declined slightly to 88 basis points at December 31 from 89 basis points at September 30. Excluding acquired loans recorded a fair value of the allowance was 0.93% of loans. Non-interest expense increased by $1.3 million in the trailing quarter to $47.2 million, primarily due to increased incentive accruals and stock-based compensation expense resulting from an increase in our stock price. Income tax expense increased from the trailing quarter to $10.2 million and our effective tax rate increase to 31.1% from 28.8%. We early adopted ASU 2016-09 in the trailing quarter reducing third quarter tax expense by recognizing benefits related to stock-based compensation of $158,000. We currently project an effective tax rate of approximately 29.75% for 2017. That concludes our prepared remarks would be happy to respond to question.

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Mark Fitzgibbon from Sandler O'Neill, please go ahead.

Hi guys, good morning. Tom, I wonder how much did the acceleration of the purchase credit impaired loans impact margin this quarter.

Two basis points this quarter Mark, and one basis point in the trailing quarter.

Okay. And then secondly on -- it look like in the average balance sheet the average yield on consumer loans went down a lot like 22 basis points from the third quarter, I'm just curious why was that.

I think that PCI credit was mostly in that category.

It was, okay. In and then how are you thinking about the trajectory the margin, I know you said you expected for the year to be up modestly. And what you're assuming in that -- one rate hike, two rate hikes, what -- what assumptions do you have?

We have three rate hikes projected over the year; June, September and in December of next year. So I guess really only towards two one of them on effective basis. We've seen modest improvement -- as Chris noted, pretty much stable -- on stable basis throughout if we're looking at 308 to 309 for first quarter. It's about 32% of our loans are floating rate at this point, and a little over 60% of variable rate so we have some nice new pricing here.

Okay, great. And in the pipeline it look like was up a lot about almost up by third, what what's driving that is there anything unique, you guys being more proactive or our competitors pulling back in the marketplace or something else.?

I think we got our team in place, we're seeing a little bit of growth in our of Pennsylvania throughout between capital initiatives without really hitting its stride when we opened up that LPO in Wayne, Pennsylvania; we've seen some nice that gains in that space. But I think it's all at all categories are up maybe it's just for me the market were only not giving it away and are we're trying to hold to our target.

The other encouraging thing on the pipeline Mark is the rate is up a 38 basis points versus the pipeline the end of September, so we've got a 392 pipeline currently.

Okay. And then lastly, it looks like your commercial real estate risk-based capital ratio is little bit 400% where you comfortable taking that up to.

We're expecting around 450 and at the end of the year I'd still be comfortable up in the in the 480 kind arrange. We talk to the regulators, we are very good commercial real estate lender, we have appropriate controls in place and we've been able to make them comfortable with our position.

Thank you.

Our next question comes from Collin Gilbert of KBW please go ahead.

Thank you guys. Just around those that the topic of the $10 billion mark and Chris you indicated that you intend to have in the middle of 2018 was that just your profit organically and absorb the cost is necessary or how do we sort of seeing that unfold? And then tying to that too, just want to try get an understanding of that bid -- sorry, necessary expenses, I think you guys have said that maybe an incremental of OpEx to prepare for that, wondering how much of that is in that run rate and how you see that turning as well.

I'll let Tom speak to some of the numbers Collin, but I think we look it probably it right into the first quarter that we would probably go through that, which would mean we probably would be at April 1 for all the reasons that the quarter organ, everything that kicks in when it's effective. I think we're just going to be more prudent our growth target of that will always use, and our credit discipline kind of make the balance sheet get those numbers up by that time frame. I don't think that we're going to be -- if we go to organically it is what it is, we can't really change what's going on I've obviously our conversations in Washington there's certainly not removing bright line test of 10 billion in the 50 billion being moved out which would be helpful. So always be some kind of cost that we probably would not be able to avoid such as the Durbin amendment [ph] there's a lot of change in Washington on that, and Tom go to those numbers. I think which is the cost of doing business if we hadn't acquisition that was accretive and made sense to our organization and shareholders on the go for basis, we would do that anyway. So I don't think that really changes our philosophy to the great, Tom maybe go through some of the numbers.

On the expense copper that the current year we have hard plus about $115,000 in 2016 as well a lot of a lot of soft less in terms of time spend in evaluating preparing, card cost for 2017 objective about 1.6 million. Modeling. Management Risk Management and salary labor costs.

Okay, okay; and is that holding into and if you cover this Tom in your inter -- I apologize, but the CapEx that came in a little bit higher than perhaps what you guys were guiding at the end of 3Q? Was that -- whether are unusual items in there, or that just part of the embedded costs that you need to prepare for this.

Mostly the Q4 2016 expense was really stock-based compensation one up close to the increase of our stock. and little boost in greater than we'd anticipated when we closed Q3 because of performance.

Do you have specific numbers on -- component of that?

One of the change was $566,000 increased quarter-to-quarter related to stock base.

Okay, that's helpful. And then in terms of the -- on the -- side again I apologize if it has been said, what was the breakdown throughout the prepayment income in the quarter [ph].

Sure prepayment income was $344,000 greater than the trailing quarter, where it was 789 versus 445. Net swap profit was $1.6 million compared with 544 so increase. And the bulk of that was in the CPA adjustment which was about $1.4 million positive.

Okay, that is helpful. And then just I know purchases become less of the of the loan growth trajectory here at any update on how your seeing loan purchases your appetite for those of you guys looking forward.

Sorry Chris to step in, we have pretty limited appetite because we've been able to grow up with organic originations at a pace that we're comfortable with I think.

Yes, we're up -- we're not doing it that's certainly went in the past we did a lot more of loan for family purchase loans type of thing, syndicated credit would not doing much of those unless they are relationship driven. So I think that's kind of where we are.

Okay, and then just final question on the [indiscernible] Tom, did I hear you correctly in saying that part of your NIM pick up is going to come just from better investment yields on the security side.

That's true, this quarter if you saw the increase in in the security field and we think we're going to see slow prepayment if we carry rise to so premium memorization come down, and then of course if we do again get rate rises and we have seen some the reinvestment rates are better too. On the potential to shift the funds more long growth that of investments as well. You know we talk about loan deposit ratio and I know that would go up if you do that that shift in mixed. But on average because we're down to about 104% you know and I like to look at the averages as well to spot in the in the coverage of loans to deposits in core deposit 916%. So.

Okay. Should we not expect no additional leverage we have seen at securities portfolio increase. Given where capital position is, I see that you've got the flexibility there but when you have about strategically.

In proximity the 10 billion limit our willingness to put on leverage well unless we get is a significant speaking of the curve that makes it so attractive.

Okay. That's great, thank you.

Our next question from Matthew Breese of Piper Jaffray, please go ahead.

Good morning everybody. Just on the margin really quick point of clarification. Does that -- the market -- is slightly higher, does that include lower prepayment penalty income or is that separate.

We report prepayment income in the non-interest income section and we will always consider to be income.

Got it, okay. And then Chris you mentioned that realistic competition is pull back and the pricing is improved. Could you give me just a little bit more color around that and to what extent pricing has improved what do you see?

Sure. I think which certainly cap rates we're hearing some pretty low level still we saw some that they've improved slightly for a quality product you go from a low 4% to maybe a 5%. And then the older stuff maybe up towards 7% were and there was a lot of growth in the multi-family space in our market. By our competitors some of them they have a lot of it capital put to work. Now that their loan deposit ratios dropped to 115 or 120 I think it would be the guidelines from the regulators kind of making that under pressure, I think they've all moved into a different category, so they're going towards C&A, for the most part those levels have improved because there's less people, on the other hand there's still rates up 25 basis points we kind of mirror that with what's gone on a going forward. So the markets moved it. I think there's still a lot of competition for every good product and good client, so you have to guard the gate to make sure that we are being incumbent and we don't lose that relationship. And I think the market has gotten better also on the other hand refinances will and or loans being sold and moved on the low rates here are going away slightly, so we still think they were in a good position.

I think about 25 basis points to price improvement related to the reduced competition on some of the CRU anytime.

Got it. And it would CapEx incrementally moving higher. Does that mean that the ratio of the valuations have changed and have you seen the price degradation.

Not really, I think praise levels are still okay, I think every just looking at a cycle and looking at the volumes in making sure that you're getting compensated for that, though I think we look at historically where they were at the bad times the market the high of cap rates were in the mid eights I think, so there is a lot of capacity and a lot fear factor that kind of too much higher of then where it had been when the market was having its problems. So for the most part I think everyone taken this under advisement, certainly there's aggressive levels out there, we are sticking to our return on equity goals and our credit discipline, any deal it doesn't need up to our policy goes through a very large debating between our credit group and our originations group and our risk group.

That's all I had. Thank you very much.

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

Well, we thank you for your attention, we look forward to an exciting 2017 and we hope that with Washington addressing some of the regulatory issues that will have some good news maybe in the first quarter, so we'll speak with you in the spring, thank you very much for your time.

The conference has now concluded, thank you for attending the presentation, and you may now disconnect the line.