Provident Financial Services, Inc. (PFS) Q4 2018 Earnings Report, Transcript and Summary

Good morning everyone, and welcome to the Provident Financial Services, Incorporated Fourth Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note today’s event is being recorded. At this time, I would like to turn the conference call over to Mr. Leonard Gleason, Investor Relations Officer. Mr. Gleason, please go ahead.

Thank you, Jamie. Good morning, ladies and gentlemen. Thank you for joining us today. The presenters for our fourth quarter earnings call are Chris Martin, Chairman, President and CEO; and Tom Lyons, 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 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 the fourth quarter. Chris?

Thanks, Len, and good morning, everyone. Provident’s record quarterly and annual results continue to reflect the successful implementation of our strategic objectives. Earnings for the quarter were $35.8 million or $0.55 per share versus a $0.30 per share for the quarter ended December 31, 2017. Full year-over-year earnings increased by more than 26% and we have continued to benefit from our well positioned balance sheet, our deposit and loan pricing discipline and our selective restraint when competing with banks, life insurance companies and other financial intermediaries. Our annualized return on average asset and average tangible equity for the quarter were 1.46% and 15.27% up from 80 basis points and 8.69% for the same period in 2017. Our total assets remain below the $10 billion threshold for enhanced regulatory oversight and Durbin limits on debit card fee income at $9.7 billion at year-end 2018, as our loan levels remain static. Loan pay-offs muted strong loan originations in line of credit advances of $3.16 billion for the year. And we are well positioned for net loan growth in 2019, albeit at low to mid-single digit levels as we anticipate additional pay-offs. The pipeline remains robust and consistent, and we continue to steer away from riskier lending, focusing on portfolio optimization that meets our risk adjusted returns and does not adversely impact the quality of our loan portfolio. Asset quality continued to improve with total non-performers representing 0.35% of total loans at 12/31/18. Foreclosed assets were only 1.6 million at yearend versus 6.9 million at the same period last year. Net charge-offs for the quarter were just one basis point. And we are not seeing any adverse trends that would portend significant deterioration in asset quality as the economy appears somewhat stable. And we remain optimistic, but cautious. Total deposits increased during 2018 by $116 million with CDs making up the bulk of it, as they represented a cheaper source of funding than borrowing. And we really haven’t increased our core deposit pricing on traditional bank accounts appreciably while many of our liability sensitive competitors and those with outsized growth targets struggled to fund their operations. And we continue to forecast that once the Fed stops increasing rates, we should see stabilization in deposit betas. As mentioned in this morning’s release, our board approved a 9.5% increase in our regular cash dividend and also declared a special cash dividend of $0.20 per share. These actions reflect our board’s confidence in our ability to generate strong earnings and to continue to enhance shareholder value. And there was some activity in stock buybacks during the fourth quarter when the market came under pressure. We still have over 2.5 million shares remaining in our current buyback approval. And we also announced our agreement to acquire a successful and seasoned registered investment advisor in Manhattan with approximately 750 million in assets under management, which will elevate our Beacon Trust business to over $3 billion in total AUM upon closing. And we anticipate, we will close this transaction early in the second quarter of the year. Net interest income was again a record for PFS this quarter. The margin performed well increased in six basis points from the trailing quarter to 3.44 % and I note that there are no pre-payment fees included to skew the results. We anticipate continued modest growth in our NIM for 2019. Non-interest income increased $2.3 million for the quarter, and Tom will provide more details. The quarter including some additional expenditure for technology and investments in improving the customer experience. We are enhancing the use of analytics in terms of really understanding our competitors and more importantly, our customers banking needs and expectations. The digital platform is key to competing effectively in the future, so our investments in this channel must deliver a more personalized relationship with our customers.. While we continue to expand resources on technology, we also are focused on improving our operational efficiencies, reviewing workflows, evaluating our staffing models and deploying robotic, process automation where applicable. As for M&A you’ve heard it from us many times. We continue to seek out acquisitions that will enhance net interest income, fee income and our management team. It always comes down to the best opportunity, the right fit and earnings accretion with a reasonable tangible book earn back period. We believe the outlook for growth in the U.S. economy is fundamentally strong, but volatility will continue as geopolitical anxiety adding to the challenge. GDP continues to be strong, unemployment the lowest in almost a generation and at least until the government shutdown improving consumer confidence. Businesses appear to be healthy and their balance sheet and cash flows are the strongest they have been in years. And while New Jersey and Eastern Pennsylvania have their own challenges, we believe they represent some of the best markets in the country and provide ample opportunity for continued growth. At this time, I would like to ask Tom to provide you with more details on the quarter. Tom?

Thank you Chris and good morning everyone. As Chris noted, net income was a record $35.8 million for the fourth quarter of 2018, or $0.55 per diluted share compared with $35.5 million or $0.54 per share for the trailing quarter, and $19.5 million or $0.30 per share for the fourth quarter of 2017. Current quarter earnings were driven by record revenue of $93 million as interest income and net interest income both achieved record levels. Our net interest margin expanded six basis points versus the trailing quarter, as our earning asset yield increased 12 basis points, while the cost of interest bearing liabilities increased 7 basis points. Further helping the margin, average stock holders’ equity increased $19 million for the quarter. Note that our reported margin this quarter with loan prepayment fees excluded and reported as non-interest income. Pre-tax, pre-provision earnings were $44 million, an increase of approximately 17% when compared with the fourth quarter of 2017. Current quarter results included a $2.2 million pre-tax gain on the sale of Visa Class B shares and a $1.9 million tax benefit from a cross segregation study on certain capital improvements. Year-end loan totals increased $22 million from September 30th, as loan originations were 21% percent better than the trailing quarter, but growth was again constrained by a high rate of pay-offs and maintenance of our credit and pricing discipline. The pipeline remains strong at $972 million and while the pipeline rate has decreased 1 basis points since last quarter to 4.94% it still exceeds the loan portfolio rate of 4.49%. Based on our strong loan pipeline, 89% core and non-interest bearing deposit funding and the variable rate nature of many of our assets, we anticipate further modest expansion of our net interest margin in the near term. Credit metrics on the loan portfolio with strong and non-performing assets on net resolutions of $7.3 million during the quarter, declining to 28 basis points of total assets at quarter end. Provision for loan losses was $1.8 million for the quarter, while annualized net charge-offs were just one basis point of average loans. As a result, the allowance for loan losses to total loans increased to 77 basis points from 75 basis points at September 30th. While the allowances as percentages of non-accrual loans increased to 216% from 185% at September 30th. Non-interest income declined by 300,000 versus the trailing quarter to $15.6 million as decreases in bank-owned life insurance income, loan level swap income, gains on loan sales and wealth management income were largely offset by a $2.2 million gain on the sale of Visa Class B shares. Non-interest expenses were an annualized 2.01% of average assets for the quarter. Expenses increased by $2.7 million to $49.4 million versus the trailing quarter, primarily as a result of increased consulting costs related to process and improvement initiatives, data processing, risk management, regulatory and tax compliance as well as compensation and benefits, legal and other expenses. Our effective tax rate fell to 14.3% for the quarter, largely as a result of a $1.9 million benefit recorded from a recently concluded cost segregation study on certain capital improvements. We are currently projecting an effective tax rate of approximately 20% for 2019. That concludes our prepared remarks. We’d be happy to respond to questions.

Ladies and gentlemen, we’ll now begin the question-and-answer session. [Operator Instructions] Our first question today comes from Mark Fitzgibbon from Sandler O'Neill and Partners. Please go ahead with your question.

Hey guys, happy Friday. First question, Tom I apologize if I missed this, but did you give any comments on the outlook for expenses?

I didn’t go outlook, no Mark. I think it’s going to remain about this level in the first quarter. While some of the expenses we incurred in the fourth quarter are not expected to recur, they’re going to be largely offset by the typical first quarter pick up in payroll taxes. Occupancy expenses around utilities and snow removal, and again some continued expenses around growth initiatives.

So I’m a little bit, about – I’m sorry.

I’m looking for about $50 million for the quarter about 204 for the year, assuming the wealth deal closes.

Okay. Great. It looks like this quarter and other expenses they were up quite a bit. Was there anything unusual in there, or is that some of the building costs and such?

Yes, there is a lot of little things and other. I guess, the biggest mover that I could identify would be on the consulting side of things. You know those expenses related to the cost segregation study which obviously provided a nice benefit. There were some regulatory enhancements that we made as well as seasonal work that was being done on. We had a payroll implementation, kind of scattering of things that some of which we had some discretion over the timing over, and we chose to accelerate some of those investments to correspond with the gain that we took on the sale of the Class B Visa shares.

Okay. And then could you update us on where you are in terms of preparation for crossing 10 billion?

Well, this is Chris. We’ve been spending money with consultants with again looking at every little thing that can happen. Right now, we’re with payoffs. We’re going to a different direction. It’s not that we don’t want to go through. We’re preparing. We are we’re also having regulators here on a regular basis, so we’re being treated as if we’re 10 billion and we’re working with them to make sure that we’re able to show the progression. We have definitely spent money on the risk calibrations and more on policy documentation as we go forward. Other than that Durbin is what it is and same with the big bank FDIC insurance. Those will be incurred when and if we cross.

So would you wait until a deal presents itself, or would eventually you make a decision to cross without an acquisition?

The answer would be yes. Not being smug, but it would be either or we are not saying we wouldn’t do a deal to go over 10 billion, that’s not the case at all. If we have to go organically, because nothing hits the hurdles that we’d expect in an M&A deal, we will just go through it. Obviously, getting some scale to offset those expenses would be a preferable way to go through. But, if it happens organically, we will.

Okay, but borrowing that, you probably hold the balance sheet below $10 billion for at least a couple of quarters and until the opportunity presents itself?

Mark, I think as we approach the end of the year, if we’re not going to be at about $10.2 billion, we would probably try to hold back and remain under just to save the extra year on Durbin.

Okay, great. Thank you.

Thank you.

Our next question comes from Collyn Gilbert from KBW. Please go ahead with your question.

Thanks. Good morning, gentlemen.

Good morning.

If we can just go back to the expense discussion for a minute, obviously you guys came in higher than what you all had originally projected for the quarter. And I know you had indicated you accelerated some of those expenses because of a Visa gain. But overall, it looks like expenses are settling out higher in 2019 than perhaps what you would have anticipated. Number one, is that correct? And then number two, if so, is that -- do we attribute this ramp-up really to prepping for $10 billion or are there other things going on? I don’t -- I guess I'm just curious was there a strategic change or something that occurred that’s now causing expenses to run higher than where you would have anticipated in the third quarter?

Yes. I don't think it's a change, Collyn, but it is both. I guess, we’ve been calling them growth initiatives. It’s $10 billion, but it's not strictly compliance. There’s investments being made in data analytics, workflow evaluation, things to try and enhance capacity that will give us a return going forward, but they require some upfront investment, mobile and online banking enhancements and as well as making sure compliance keeps pace with our growth, and then CECL in addition. So all of those things, I think, have been expected all along. Again, some of it got pulled forward a little bit because we had that gain available to us, but I don’t think we're materially different than what our expectations were strategic plan wise.

Okay. That’s helpful. And then in terms of – you’d indicated that $204 million with Tirschwell included in that number. Can you just give us a sense of what fees -- what you're kind of expecting on the fees side then with Tirschwell coming into the fold?

Yes. 3.4 is expenses. I think the fees are about 4 and change, let’s see if I could find here, 4.8.

Okay. That’s helpful. And then just back to the NIM, if you could offer what your -- kind of what your outlook is there, I mean, it’s continued to do -- hold in very well. I know, Chris, you had indicated you’re holding the line on the pricing for your core deposits, but just sort of your outlook there, maybe Tom for the NIM?

Sure. And just to clarify on the wealth acquisition, that’s -- 2019, that's not a full-year annualized. So that’s about three quarters of a year at 4.8, assuming we close the second quarter.

Okay. That's helpful. Thanks.

As far as NIM goes, I think we're looking for one to two basis points a quarter. Obviously the sensitivity to that assessment is what happens on the funding side of things, a lot of which is driven by the Fed and competitors, but assuming that we're right in our projections, looks like one to twp basis points a quarter.

Of expansion?

Yes.

Continue expansion, okay. Okay. That's helpful. Okay. And then, just finally on the tax rate. So that's a huge delta, 20% from 27%. Can you just talk about what’s going into your assumptions there to be able to lower that?

Sure. 27% was always the max based on changes in the state rate, particularly around treatment of real estate investment trust. The state has issued another tariff, what do they call it, state taxable number [Indiscernible] 86 on January 3rd. They still haven't concluded definitively whether the REITs will be part of the combined group. The way the law is currently written, we believe the REIT still benefits from the structure and therefore the tax rate stays about the same at 20% effective.

Okay, perfect. All right. I will leave it there. Thanks, guys.

Thank you.

Thank you.

Our next question comes from Russell Gunther from D.A. Davidson. Please go ahead with your question.

Hey, good morning, guys.

Good morning, Russ.

I just want to follow up on the loan growth conversation. you got comments around low to mid single-digits pipelines a little bit lower coming in to 1Q 2019. So could you share with us sort of what the delta would be for your ability to hit the high end of that guide?

Well, this is Chris. The biggest challenge has been the payoffs. It’s not for getting a decent flow of good loans. The problem is that payoffs keep coming in, which shows through quality of the portfolio that they're very refiable [ph] by other institutions. We are seeing more in the bank space of late taking us out and I think some of those structures and/or pricing is fairly aggressive. So that is the backdrop of as much work as we can do, it takes a couple of loans that go away. We’ve seen them in the first month of the year coming in a little bit higher than anticipated. So it just starts you off a little behind as we go in. So I don't know that we’re – we’d love to say we're going to get to the high end of that, but we’re going to definitely try. We can slow down some of the payoffs, so.

Got you. Okay. No, I appreciate your thoughts there. And then on the RIA acquisition that's scheduled to close, it looks like some decent earnings accretion there. Kind of what's the opportunity set to do more of those going forward?

Well, we – it’s not we’re not trying, there's certainly opportunities. They have to kind of fit the metric and fit the mold, so to speak. We have a very good platform with Beacon. We continue to look at contiguous and there are -- we think there'll be more coming in that space. You just have to match up to what we’re trying to accomplish and mirror what they are trying to accomplish at the same time. We are not just a cash-out. We want to get people that want to stay and involved and help transition the customers over. So we have the capacity to do more, but we always like to get everything under the tent, but we’ll continue to look at that space absent any bank M&A that might show up.

Yes. I think we would like to continue to diversify that revenue stream. I think there’s been something being looked at pretty much continuously for the last several years. We certainly have the capital flexibility to do more of that and the desire to do that.

Got it. Okay, great. And then just -- thanks, guys -- to round out that capital deployment conversation, Chris, I heard you loud and clear you’d continue to look at depository deals. Maybe just a reminder for us in terms of what an ideal target there would look like for you?

Well, I think certainly somebody that’s in market or contiguous. It can be smaller, doesn’t have to be in substance and size. I think when we look at Pennsylvania we’d love to get another -- a little more space in there. We do cover New Jersey fairly well. And I think we just want to make sure that the organization has really good management and solid fundamentals and we can build on that. So I think that anything in the area we don't seem to think about. We’re leapfrogging to other markets that are completely out of our sphere.

Okay, great. Well, that's it from me. Thanks, guys.

Thank you.

Our next question comes from Matthew Breese from Piper Jaffray. Please go ahead with your question.

Good morning.

Good morning.

Good morning.

On the tax rate, you said there was another [Indiscernible] in January and it was unclear if -- or not definitive if the REIT was still protected. So just curious, is your read that, politically speaking, that the tax rate stuff is done at this point and it’s -- the interpretation is that you’re protected or could they come back to this and swing the pendulum back against you?

We are in compliance with current law and the law could change, I guess, at any time as always, but right now the position is that the REIT benefits still endure.

Got it. Okay. And then going back to the expense commentary, thinking about the other expense line, I know there’s some investments, legal consulting in there. How long do you expect that to last? Is that more of a catch-up through 2019 or should we just think about that expense line remaining elevated through 2020 as well?

I think legal will probably come down as we see less in the way of asset recovery expenses. Those were a little bit elevated in Q4. The other investments, regulatory compliance almost never goes down, trying to think what else is in here. The process improvement initiatives that we’re going through, that will have an end to it over the course of this year and offsetting that, we should see revenue benefits accrued during the course of the year as well. Technology, data analytics, I think that’s just you have to establish what percentage of your revenues you want to devote to continue to work on the customer experience and what the market demands.

Right. And could you give us some examples of the areas that needed investments and what the revenue on the other side would -- what that benefit would be?

On the process improvement side of things, I think most of the revenue comes from freeing up excess capacity and some cost saves in terms of personnel through attrition over time, new staffing model being evaluated for the branches, physical location evaluation something we always do. So those are places where you pick up capacity. On the data analytics side, better information should give you better decision making, which should drive greater revenue growth, and we're spending some money there.

Okay.

Yes, Matt, this is Chris. At the end of the day, when you -- you know, Provident, if we're spending money, we’re going to try to figure out a way to save money on the backside of that because that’s kind of how we've always run the business.

Understood, understood. Okay. I think -- and Chris, in your opening comments, you noted that with the Fed pausing, you would expect deposit betas to stall a little bit. Is there any indication with the latest message that competition has started to ease at all?

Little early, though in reviewing other people’s comments, I think everybody is kind of hoping it slows down. New Jersey though, there are still a lot of people trying to fund their pipelines and their loan growth and the only place they can get it is normally through some higher rates whether it be on their core accounts or on the CD levels. It’s tough to generate non-interest-bearing deposits unless you’re generating a lot of C&I and/or commercial relationships. So I think it will continue albeit at a slower pace.

Understood. Okay. That's all I had. Thanks for taking my questions.

Thank you.

Thank you.

Our next question comes from Erik Zwick from Boenning & Scattergood. Please go ahead with your question.

Good morning, guys.

Good morning.

First maybe just on loan growth and I appreciate the comments you made previously, especially with the -- in regards to paydowns. But as I’m thinking about origination volumes, just looking at what’s in the press release, they were down year-over-year about 15%. So kind of, one, curious if that was a reflection of market demand or maybe competitors offering deals at pricing and structure that you were comfortable with. And then I guess, what is your expectation for origination volume in 2019 versus 2018?

Yes. I’ll let Chris jump in on the competitive environment and the forward-look, but I do want to point out the fourth quarter of last year was extraordinary. If you’re looking year-over-year Q4, that was the highest level of originations, I think, I can recall ever seeing here. So we are down about 11% versus Q4 2017, but up 21% versus Q3 of 2018 in terms of origination activity exclusive of line of credit advances, so true originations, meaning including renewals and new money on modifications.

Yes, I think -- this is Chris. From the standpoint of structure, we see a lot of things going on that we would probably not do. We see our 20-year swaps with a four-year interest-only. We’ve seen a lot of no-guarantees on loans that should have partial guarantees. So we are kind of holding back and not allowing the structure unless it really is compelling and the people that we know are -- have very good reputations with us and others, that we are going to stick to where we are in that regard. The only place we could probably play would be in pricing, and even then, we are seeing some deals that we would quote at LIBOR plus 200 and they're being done at LIBOR plus 120. So the people -- the incumbent is very defensive on keeping their book of business, so they are very aggressive, and I think you lead with your chin sometimes on those and we think that some of them aren't really worth the risk. Not that we are saying that everything is perfect in the portfolio, but we think that we are very discerning in how we look at credit and how we see the returns from an equity return basis for our stockholders.

That’s helpful. Thank you. And then on the buyback, you mentioned 2.5 million shares remaining in the current authorization. And I think it’s about $13 million repurchased in 4Q. Just curious about your appetite and potentially price sensitivity for additional buyback going forward. Would we need to see a pullback like we did in the fourth quarter or would you potentially look to be involved without a significant sell-off like that?

No, I think pricing plays a role in that. We're looking for a reasonable earn-back on a risk-free basis, so obviously longer than you would on an -- in an external deal, but we look at value creation relative to multiples of tangible book and earnings, and what the forward earnings accretion brings.

Got it. Thanks for taking my questions.

Thank you.

And ladies and gentlemen, at this time, I am showing no additional questions. We’ll end today’s question-and-answer session. I’d like to turn the floor back over to Chris Martin for any closing remarks.

Well, we thank you for joining us on our call today and we look forward to a very positive 2019 and to warmer temperatures. Certainly have a good day. Thank you.

Ladies and gentlemen, that does conclude today’s conference call. We do thank you for attending. You may now disconnect your lines.