Provident Financial Services, Inc. (PFS) Q2 2019 Earnings Report, Transcript and Summary

Good morning and welcome to the Provident Financial Services, Inc. Second Quarter 2019 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please note today's event is being recorded. I'd now like to turn the conference over to John Kuntz, Corporate Secretary. Sir, please go ahead.

Thank you, Andrew. Good morning, everyone and thank you for joining us today. The presenters for our second quarter earnings call are Chris Martin, Chairman, President and CEO; and Tom Lyons, Senior Executive Vice President and Chief Financial Officer. Before beginning the review of our financial results, we ask that you please take note of our standard caution as to any forward-looking statements 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.com Now I'm pleased to introduce Chris Martin, who'll offer his part on our quarter. Chris?

Thanks, John, and good morning everyone. Provident's operating results were positive despite deterioration to C&I credits which resulted in elevated credit costs for the quarter. Revenue in all categories exceeded the trailing quarter, and operating costs were well contained. And for the first half of the year, our annualized return on average assets was 1.14%. And our return on average tangible equity was 11.67%. Our margin expanded during the quarter to 3.42%. But as Tom will detail later, this was due to the acceleration of accretion of interest income on a loan that paid off during the quarter. Without that noise, the margin would have contracted by 8 basis points. As the prospect for rate cut by the Fed is fairly certain, we will experience some pressure on our margin and as floating and variable rate asset yields compress. We expect this to be partially offset by relief and exceptions deposit pricing and overnight borrowing costs. Market pressure on increasing deposit rates has begun to subside as many of our competitors are experiencing margin compression and contraction at a much greater pace than profit. Money market rates should begin to decrease if the Fed reduces rates. And we will reprice down quickly wherever we can, as exception and relationship pricing concessions are taken off the table. Our deposit mix still remains at over 88% core. As for loan growth, we have strong prepayment activity which contains during Q2 making portfolio growth difficult. We continue to see competition structuring on underwriting, credit structure and pricing, especially in the middle market space. Our lending teams utilized our loan pricing model to ensure an adequate risk adjusted return. And we are seeing our share of lending opportunities in our markets and are approaching them with a disciplined approach to structure in returns. Noninterest income improved during the quarter as a result of increased wealth management income from the Tirschwell & Loewy acquisition accompanied by loan prepayment fees and loan level swap fees. Noninterest expense increased for the quarter to $49.7 million with the additional compensation costs and memorization of intangibles from the T&L acquisition and increases in technology and data processing expenses. Our efficiency ratio and analyze noninterest expense as a percentage of all of the assets remain stable at 53.79% and 2.03% respectively. We continue to invest in technology improvements to build enhance capabilities to meet the ever-growing customer demand to self-serve and deliver the same type of experience whether it be in person or mobile. The small business lending portal has gained traction as we offer our customers and prospects a solution to provide them with working capital to build upon. And we continue to invest in AI and the use of robotics to achieve greater operational efficiencies throughout our organization. Types of credit, we continue to be cautiously optimistic about overall credit quality despite the higher level of provisioning a second quarter related to two C&I credits. We did not see any adverse trends in any particular industry or geographies that cause us to have a negative outlook near-term. We continue to focus on organic growth but have been actively engaged on the M&A front. While the opportunities have increased so has pricing and deal metrics. Any deal we would be involved in must be accretive both financially and strategically. All this must be against the backdrop of improving EPS and shareholder value. We continue to draw ever closer to the magic number of 10 million in assets and all that entails. Provident has invested in enterprise risk, compliance and information security personnel to meet the requirements of our regulators. As the U.S. economy remains healthy, unemployment at a 50-year low and business and consumer competence at its best in the over decade, we do now anticipate any negative economic news on the horizon. Geopolitical and trade concerns aside, that will impact future growth and strength. We continue to meet with our clients and their tone remains positive and constructive. With that, Tom will go over more details on the quarter, Tom.

Thank you, Chris, and good morning, everyone. Net income for the quarter was $24.4 million or $0.38 per diluted share, compared with 19.2 million or $0.30 per share for the second quarter 2018 and 30.9 million or $0.48 per share in the trailing quarter. Third [ph] quarter revenue was $92 million as interest income, net interest income and noninterest income all exceeded trailing quarter and prior year second quarter levels. Our net interest margin expanded two basis points versus the trailing quarter and nine basis points versus the same period last year. The current quarter's margin was aided by the recognition of $2.2 million in interest income upon the prepayment of loans, which had been not accruing prior to being restructured in 2017. While those loans were not accruing, payments reflect to principal when they return to accruing status, these amounts commence to create an interest income over the remaining life of the loans. This secretion then was accelerated upon the prepayment of the loans adding 10 basis points to our quarterly net interest margin. Compared with the first quarter of 2019, our earning asset yields increased 8 basis points, while the cost of interest-bearing liabilities also increased 8 basis points. While we did see some relief in the rate of increase in deposit costs as the quarter progressed. The increase in funding cost for the quarter reflected the lagging effect of the Fed's rate hikes and competitive pressures. Quarter end loan total increased $70 million from March 31st, driven by growth in commercial mortgages, commercial and construction loans. Loan originations were particularly strong under the 113 million betters than just second quarter 2018 and 116 million better than the trailing quarter. Payoffs remain elevated however, with 55 million more paying off in the current quarter than last year and 15 million more in payoffs than in the trailing quarter. The pipeline at June 30th decreased to 979 million from 1.2 billion in trailing quarter, reflecting strong origination activity. Pipeline rate has decreased 23 basis points since last quarter to 4.56%. The slower pipeline rate reflects current market conditions, a decline in treasury rates and a shift in pipeline mix. However, it continues to exceed the loan portfolio rate of 4.51%, adjusted to exclude the recognition of previously nonaccrual interest this quarter. Our provision for loan losses was elevated in $9.5 million this quarter, largely driven by two C&I credits, a $5.7 million relationship with the commercial contractor has been fully reserved pending additional investigation to determine the extent of our loss. The deterioration in this credit appears to be a result of the bar taking on larger projects, slow payments from customers and a parent employee debarkation. 3.3 million was also provided with 1.3 million charged off in connection with our $14.1 million interest in share national credit to a franchise restaurant owner operator that has experienced declining revenues in profits in certain of these properties. This relationship is current as the payments but has moved to nonaccrual based on the bars expressed intent to exit the business. As a result of these two impaired lending relationships, our credit metrics evidenced modest deterioration with nonperforming assets increasing to 40 basis points of total assets at quarter end. Annualized net charge-off to 11 basis points of average loans and the allowance for loan losses to total loans increased to 86 basis points from 77 basis points in the trailing quarter. Noninterest income increased by $3.6 million versus the trailing quarter to $15.8 million. Wealth management income increased 2.2 million, largely due to the completion of the Tirschwell & Loewy acquisition on April 1st. In addition, loan prepayment fees, income for mutual fund, annuity sales and the positive ATM and debt car fees all increased. Loan level swap income also increased 1.4 million versus the trailing quarter more than offsetting a decrease in benefit claims on bank owned life insurance. Noninterest expenses were an annualized 2.03% of average assets for the quarter. Expenses increased by 1.3 million to 49.7 million versus the trailing quarter, primarily as a result of increased compensation and benefits, amortization of intangibles, established to the Tirschwell & Loewy acquisition, data processing and other expenses. Our effective tax rate increased to 26% from 19.9% for the trailing quarter. The increase is attributable to publication of a technical bill that specifies the treatment of real estate investment trust in connection with combined reporting from New Jersey Corporate business tax purposes. As a result, an increase in the tax provision for the first six months of 2019 is required and we’re projecting an effective tax rate of approximately 24% for the remainder of 2019. That concludes our prepared remarks. We’ll be happy to response questions.

We will now begin the question and answer session. [Operator Instructions] The first question comes from Mark Fitzgibbon of Sandler O’Neill. Please go ahead

Hey guys, good morning. I wondered if you can give us any more color on those two credits sort of whether there’s any potential additional loss on that syndicated credit and also give us a sense for how much in total syndicated credits you have in the portfolio today and maybe what the split is between sort of club deals into mix?

Sure, I’ll take the first, total outstanding about $169 million against the $303 million exposure, so it's about $134 million in unused commitments there.

Mark on the loans that are going with the -- fully reserve the amount which we would always try to attack these early. We had a loan that has been doing fairly well back from 2012, his business grew the he couldn’t support it, then he went to other places to get cash and then we’ve had a challenge getting information at this point we really don’t know where he stands and so it’s going into the process of finding out the information that can lead us to either taking the write-off, charge-off completely or at least knowing where we stand on that credit.

Okay. And then Tom I apologize if I missed this, did you give sort of your outlook for the margins for the back half of the year?

Yeah, I didn’t Mark but I think we're probably looking at compression of say 2 to 4 basis points over the second half. Pretty stable from where we are now.

2 to 4 basis points?

Yeah, we've modeled just one great cut at July 31st and we’re taking 2 to 4 over the course for the balance of the year.

Okay. And I guess I'm curious given your comments on M&A Chris, so the bank deals what sort of the top and bottom end of the size range that you contemplate?

I think anything $0.5 billion on up would be now again it depends on its market and obviously we go with the normal metrics and math brings a culture and management team with it at point. But anything under $0.5 billion probably would not be worth, not because their batches wouldn't be worth the impact to the financials and or our company.

In the top end?

I guess to the top end would be MOE type of situation, so that's not to say that we wouldn't ...

Thank you.

The next question comes from Russell Gunther of D.A. Davidson. Please go ahead.

Hey good morning guys. Appreciated your comments on loan growth and where the pipeline fits. I just wanted to see if you could say what's your loan growth expectations are for the back half of this year and kind of what the mix in geographic drivers might be for you guys New Jersey versus Pennsylvania?

This is Chris; the pipeline is still pretty solid. I think that we are doing well in the commercial real estate space. And certainly C&I on a little bit lower level a little less pull through being there is a lot of aggressive things going on in the market. It would be still continuing to be in both Eastern PA and certainly in New Jersey and I think that we are still talking about low single-digits it being that the growth is tempered by prepayments that we still see coming down the pipe.

Okay. That’s helpful. And then I guess the last one would be your expense outlook for the back half of the year it was a bit of a better result than I was looking for, it remains pretty well controlled. You also mentioned the 10 billion marketing prepared remarks. So, just want to get a sense of where you'd expect expenses to trend from here. And anything related to 10 billion preparation that would be incremental spend? Thank you.

I think we're looking at about $49 million a quarter for the back half of the year. That's inclusive of any additional growth initiative costs, around the $10 billion crossing.

Thanks, Tom. Thanks, guys.

The next question comes from Collyn Gilbert of KBW. Please go ahead.

Thanks, morning, guys.

Good morning.

Maybe Tom, just first question on deposit. Can you just talk a little bit about some of the trends that you saw quarter in the deposit outflows and sort of what you're thinking to overall deposit growth going forward?

Sure. Growth is good. We saw nice growth in the noninterest bearing side of things. So, the expectations are going to continue to be able to move that forward. As far as pricing goes, we actually saw some relief when I look at the margin on a month-to-month basis, and the cost of interest-bearing deposit seems to have plateaued. And we have some opportunities to manage some of those exceptional pricing, which will be effective on August 1st. And we'll continue to look at that through the back half of the year as we try to manage our margin. So, feel pretty good about that.

Collyn, this is Chris. And certainly, some of the exception pricing that was done in the past. Certainly, when it runs up, everybody's clamoring for more analysis. Other than that, we see ratings coming down. You're not going to hear the phone ringing as much. On the back half of that we're going to be looking at and being aggressive on the way of repricing downward. And from a cost perspective there, you could borrow much longer with better structure than offering out these higher rates for some of these accounts. So, it does become a funding decision more so than just the relationship.

Okay. Okay, that's helpful. And then Tom, do you going to have maybe a percentage or dollar amount of the deposits, I guess looking primarily at money markets that are, like specifically indexed to rate that we can assume would automatically drop when the Fed cuts?

I don't think we have very much if anything that's index rate.

Yeah, we have not much at all index rate. So, I don't think we have any. So.

Okay. Okay. And then just on the margin, Tom, so you'd indicated 2 to 4 basis points of compression in the back half of this year. Just going to confirm is that also the reported margin this quarter or we -- should we be backing out at 10 basis points to starting at like a 332 level?

That's correct. You need to back out that nonrecurring pick up and income. So, starting off to 32, yes.

Okay, okay. And then I just want to confirm, you guys in terms of the exposure to New York City rent regulated multifamily. Do you have much at all there?

Very, very little, I can think of maybe one, and it's not a big one. And so no, we do not really traffic in that space at all. So, any of the rest control things and things of that nature, we do not really operate in the borough's or in Manhattan.

Okay. Just wanted to check. And then finally, Chris, interesting in your opening comments, just about M&A, and the fact that prices have gone up, which I guess I'm surprised to hear you say that just given the fact that we've had, a couple of deals go off in this market at no premium, last low premium deals? And I guess in my head, I'm kind of just kind of thinking that would be the trend going forward. Can you just sort of give a little bit more color as to where it is that you're seeing pricing increases? Or sort of what's driving that comment?

Sure. I know that the fact is, when we are involved, we get the phone call that we're come in, third or fourth and when we look at the levels that we see as being pretty aggressive. We think that there's a challenge in some of the measurements and some of the assumptions that people are putting in a way, of course, it's pretty -- being pretty aggressive. And we can't make it work. So, it's just telling us that, -- again, these are smaller deals. So, we're missing -- but that's okay, we're trying to stay disciplined. I know that some of the other deals that were at zero premium were certainly other bigger deals. And if you're referring to and or tiny type of situation, there probably is reasons why it was a zero-premium deal.

Okay, that's helpful. And then just one final question, Tom, you only give us good guidance on this in terms of tax change, it's our understanding, I guess, in terms of the status that you if you understanding it, right, but the qualification for the tax benefit could occur if you move the holding company charter to New Jersey. And is that right or can you just talk about some of the dynamics will typically within that you tax guidance?

There's two ways to approach tax planning strategies on that. You can have New Jersey investment companies, it's the parent which are understanding from discussions with the division, not directly with you are professionals. Or it that we continue to receive the preferred treatment of New Jersey investment company. Or as in our case, if you have a Delaware investment company is subject to an apportionment with those gross receipts from the dividend that's distributed to the parent company being part of the denominator in the apportionment calculation. So, whatever works best for an entity is what we would get.

Okay, okay. So no, I mean, obviously, with your guidance of 27%, that indicating that there's no, intended change to offset that. That's kind of where you're going to stand.

So, guidance going forward is 24%.

Right, sorry. Yeah, got it. Okay. Thanks that's all I ahead.

The next question comes from Matthew Breese of Piper Jeffrey. Please go ahead.

Good morning. Just one clarification on the taxes, I know you had said the 24% stood for the rest of the year. Does that hold for 2020 as well?

It does.

Okay. And then just going back to your loan growth commentary? Do you anticipate crossing $10 billion by the end of the year? And if so, could you just remind us of what the Durban exposure is?

Well, first, at this stage, and what we've run our models I would say we probably would not cross through the end of the year. And if we're close in the fourth quarter, we would do something to not go over for that Durban impact, which is approximately $2.8 million and $2.9 million.

Okay, might we see you just sell off some securities to keep balance the total assets below 10. That the tenant strategy?

That's right, Matt.

Okay. Okay, and then just diving into the restaurant portfolio? It sounds like there were some moving pieces there. Just kind of curious, was the operator taking perhaps utilizing some poor financing strategies? Or was there just a change in the business and revenues that lead to deterioration? Just kind of a better characterization of what happened behind the scenes. It was an industry issue or an operator issue?

I think it's more than the second in terms of the operator, operates multiple franchises, one of which is less than favorite, this point, also experienced a little bit of adverse impact from the increasing minimum wages in New York.

Okay, and what type of institution? You don't have to give a specific name, but was it more pure fast food or, or kind of casual dining?

Some of all over multiple of our three different lines.

Okay. And then just looking at fee income. This quarter elevated driven by the wealth management acquisition, but also swap and prepayment fees. If you had to give us some guidance on what portions of that look sustainable in the near term? What were those? And where do you think the income could shake out for the last two quarters of the year?

Yeah, so prepayment fees weren't huge. So, I mean it's very likely, we could see that. Again, as Chris indicated, based on some of the projected payoffs that we're looking at in the back half of the year, wealth management, I expect to remain stable at higher levels net of the T&L acquisition is completed. So, it's really the swap piece that's got some volatility to it. That was $896,000 for the second quarter compared with a negative 460 in the first quarter. Again, some of that's been the mark to market with rates coming down. So, if I look just at the volume piece, we made like $2.3 million, compared to the $218,000 in the first quarter absent the CDA adjustment. So that's, that's the risk, I guess that 2.3 could drop to something less.

Okay. Understood. And then Chris, you'd mentioned in your opening remarks, just a competition continues to stretch on terms and credit. Just curious, where or what sort of competition is being the most aggressive? Are they the banks are the non-banks? And as you consider, where your borrowers are being taken out in terms of lending sheets. Do you see competitors at this point, taking on simply just less profitability extending too much, and now at this point, taking on legitimate credit risk?

Well, certainly, it's all the above, certainly the private equity, the insurance companies are still being pretty aggressive on firms that we wouldn't do. The other side is the covenants that and they're basically we put out a term sheet and then somebody would come back and say, well, we don't need any covenants at all. So, it doesn't kind of end up when you see that in print, it gives you a pause. I mean, I'm not saying they're doing anything bad. It's just they're taking undue risk. And certainly, on pricing is especially in the middle market space. When you try to put together a good offer or good business model plan for them and the incumbent comes back into something at 130 over LIBOR, you really can't do anything about that which is they are protecting their turf, their portfolio. So, we always look and see our culture used to be a lot stronger than it was it used to be 70% to 80% on C&I credits that we wanted. Right now we're down to 40 and we're getting a lot of looks but the fact is we just think some of the structures that people are putting on do give us some pause, so we just say you know what when the deals that we really want but we will not play in the way of taking on credit issues that we think will come back to be a problem.

Okay, just one more. My last one. If we are to see the balance sheet kind of governed under 10 billion. I would anticipate capital continues to build, could you just give us a sense for your appetite in regard to share repurchases.

As we disclosed, we have the authorization and we have the willingness to do that at the right price points. So, the capital options.

Okay that’s all I had. Thanks for taking my questions.

Thank you.

This concludes both the question-and-answer session. And the conference call for Provident Financial Services, Inc. Thank you for attending today's presentation. You may now disconnect.