Provident Financial Services, Inc. (PFS) Q4 2019 Earnings Report, Transcript and Summary

Good day. And welcome to Provident Financial Services Incorporated Fourth Quarter Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please note the event is being recorded.I’d now like to turn the conference over to Mr. Len Gleason, Investor Relations Officer. Please go ahead.

Thank you, Nick. Good morning, ladies and gentlemen. And thank you for joining us for our Fourth Quarter Earnings Call. Today’s presenters are Chris Martin, Chairman, President and CEO; and Tom Lyons, Senior 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 is contained in this morning’s earnings release, which has been posted to the Investor Relations page on our website, provident.bank.Now, I am pleased introduce Chris Martin, who will offer his perspective on the fourth quarter. Chris?

Thank you, Len, and good morning, everybody. Provident’s core earnings of $0.43 per share were impacted by continued margin compression albeit slight and interest increased expenses primarily from consulting fees related to CECL modeling and implementation. Our core return on average assets is 1.13% and core return on average tangible equity was 11.36% for the quarter.We experienced only 2 basis points of margin compression in Q4 and forecast had being relatively neutral in 2020. The re-pricing of deposit relationships that had discretionary rates positively impacted overall deposit flows.Competitive deposit pricing has become more rational in our markets, which is a welcome investment for our funding costs. This affords us an opportunity to reduce the rates on our CD book, although not a large portion of our overall deposits.Key to our success will be our ability to continue to grow our non-interest bearing in core deposits. We believe we have reached an inflection point in loan pricing and predict lower single-digit growth in the loan portfolio, which continues to be bombarded by payoffs and refinances away from us. Our loan portfolio is skewed to variable rate products and we continue to swap out longer term fixed rate loans.C&I lending has become more competitively, but we are winning our share of quality loans and relationships. The middle market space has faced headwinds relating to the origination of loans at levels that meet our ROE hurdles.We take all commercial lending expectations to the level of GDP growth, so low single-digit growth is what we expect to see in 2020. Our residential lending has picked up of late and we continue to be selective in our credit decisioning and lead the aggressive lending to competition that even have outside growth targets to bolster their margins. Further we are seeing more and more interest only periods extended and longer fixed rate terms than we have in a long while emanating from the agencies and companies.On the matter of CECL implementation, we expect incremental volatility since reserve levels will be very dependent on the macroeconomic forecasting. This could affect loan pricing in the future also.Our credit costs were elevated this quarter versus the same quarter last year as we continue to conservatively evaluate our classified credits. We have deemphasized our exposure and concentration in certain industries, while also staying away from leveraged lending.We believe the current economic backdrop supports a relatively stable credit outlook and our net charge offs for the year were slightly higher but still in line with peers. Speculation about a potential recession has been on our and other bankers minds over the last couple of years, but it is not over yet and we try to spot the potholes beforehand.Fee income continued its improving trend with wealth management leading the way along with loan level swap income and loan prepayment fees. The additional valuation adjustment to the T&L transaction is proof positive that this acquisition is exceeding our initial estimates.Expenses were higher in the quarter with the majority being in compensation and the non-cash contingent liability for the T&L acquisition. Consultant and technology expenses continue to increase as we prepared for CECL, regulatory costs for being $10 billion and technology investments to remain relevant in the new digital banking paradigm.We continue to balance expenses with investments in the customer platform and product sets. Our tech spend is embodied in more consumer-centric, efficient and agile decision for our clients to enhance their relationship with us.Information compiled in our data warehouse and our use of data analytics will be key to understanding our clients’ needs. Reliant on AI will likely expand in the years ahead especially in the payment channels. We are also investing in the universal banker model, better recruiting processes and onboarding orientation, and constantly evaluating our branch network.As for M&A, we expended a fair amount of time and energy in 2019 assessing potential acquisitions and continue to have more than enough capital to achieve better returns for our stockholders through whole bank transactions and RIA purchases.We can fund our organic growth and support a solid and consistently above average cash dividend with a -- with only a 54% payout ratio in support of buybacks, when they meet our total return criteria.The consumer segment appeared to be in good shape from both the credit and spending perspective, and the labor market may be the best that we have seen in a generation. That interest rate policy is expected to be in a hold for a while, with geopolitical issues, pandemic risk and the presidential election grabbing the headlines, we believe the economy will continue to grow in spite of these distractions.With that, I will turn it over to Tom for his comments. Tom?

Thank you, Chris, and good morning, everyone. Our net income was $26 million or $0.40 per diluted share, compared with $35.8 million or $0.55 per diluted share for the fourth quarter of 2018 and $31.4 million or $0.49 per diluted share in the trailing quarter.Current quarter earnings were adversely impacted by a $2 million or $0.03 per basic and diluted share net of tax expense, increase in the estimated fair value of the contingent consideration liability related to the April 1, 2019 acquisition of New York City based IRIA, Tirschwell & Loewy.As previously disclosed, the earn out of the contingent consideration is based upon T&L achieving certain revenue growth and retention targets over a three-year period from the date of acquisition.Based upon T&L’s recent positive operating performance and improved projections for the remaining measurement period, an increase to the estimated fair value of contingent consideration was warranted.At December 31, 2019, the contingent liability was $9.4 million, with maximum potential future payments totaling $11 million. Excluding this charge, the company would have reported net income of $27.9 million or $0.43 per basic and diluted share and net income of $114.6 million or $1.77 per basic and diluted share for the quarter and year ended December 31, 2019, respectively.Our net interest margin contracted 2 basis points versus the trailing quarter and 23 basis points versus the same period last year. To combat margin compression we continue to reprice downward deposit accounts with negotiated exception rates. This deposit rate management coupled with an $80 million or 21% annualized increase in average non-interest bearing deposits resulted in a 3-basis-point decrease in the total cost of deposits this quarter to 65 basis points.Non-interest-bearing deposit averaged $1.6 billion or 23% of average total deposits for the quarter. We will continue to thoughtfully manage liability costs as the rate environment evolves.Quarter end loan totals increased $66 million or 3.6% annualized from September 30th as growth in CRE, construction and residential mortgage loans was partially offset by net reductions in C&I, multi-family and consumer loans.Loans originations excluding line of credit advances reached their best levels of the year up $106 million or 30% versus the trailing quarter to $461 million. But sales remained elevated up $46 million or 18% versus the trailing quarter with $298 million.The pipeline at December 31st decreased to $905 million from $1.1 billion at the trailing quarter end, reflecting strong year end closing activity. The pipeline rate has decreased 14 basis points since last quarter to 3.97% at December 31st. The lower pipeline rate reflects current market conditions and a decline in interest rates.Our provision for loan losses was $2.9 million for the current quarter, compared with $0.5 million in the trailing quarter. Our annualized net charge offs as a percentage of average loans were 26 basis points for the quarter and 18 basis points for the full year.Overall, credit metrics remained stable this quarter with non-performing assets totaling 55 basis points of total assets at quarter end. The allowance for loan losses to total loans decreased to 76 basis points from 79 basis points in the trailing quarter, largely as a result of improvements in qualitative allowance factors.Non-interest income decreased slightly versus the trailing quarter to $17.7 million, as lower swap fee income offset, increased bank loan life insurance benefits and loan prepayment fees.Excluding the increase in the fair value of the contingent consideration liability related to the P&L acquisition, non-interest expenses were an annualized 2.05% of average assets for the quarter.Core expenses increased $1.2 million versus the trailing quarter with consultancy and audit costs related to see CECL implementation, additional examination and consultant fees have totaled of $1.4 million driving the increase.We did once again benefit this quarter from an FDIC insurance small bank assessment credit of $758,000 and our total remaining FDIC credit potentially realizable in future quarters is $1 million.Our effective tax rate decreased to 23.6% from 24% for the trailing quarter and we are currently projecting an effective tax rate of approximately 24% for 2020.That concludes our prepared remarks. We would be happy to respond to questions.

[Operator Instructions] First question comes from Mark Fitzgibbons, Piper Sandler. Please go ahead.

Hey guys. Good morning.

Good morning.

Good morning.

Just curious, you guys have been holding the balance sheet under $10 billion for a while here. Should we assume that absent any acquisitions you will grow through that $10 billion organically sometime within the next couple of quarters?

Yes. This is Chris. Absolutely, Mark. It was just the last quarter. There is no real reason an initiative for us to go through accident acquisition. So we anticipate probably again subject to payoffs and other things that may happen that it would be happening in the middle of the year.

Okay. And then, I wondered if you could share with us what total assets under management are today and specifically at Tirschwell & Loewy?

Total assets under management are $3.4 billion, T&L is about $922 million.

Okay. And then I am curious of the $4.7 million in net charge-offs that you had this quarter, where did those come from, what was kind of the breakdown?

Primarily the C&I category, it’s about four borrowers that make up the bulk of that diverse industries, no pattern to it, really nothing notable in terms of an indicator or any future deterioration.

Okay. And then, Tom, I wondered, if you could just share with us any guidance on the margin and expenses for 2020?

Sure. The margin looks pretty stable for us. Give us a plus or minus 2 basis points, I’d say. But we expect to hold around these levels. We continue to see a downward pressure on the asset yield side of things but we think we are able to manage the liability cost effectively going forward. In terms of expense, probably, in the $51.5 million kind of range a quarter, we got about $207 million roughly for the full year, expected non-interest expenses.

Okay. And then, lastly CECL implications, any updates there?

We are not really providing guidance on the impact of CECL yet. We are on target with our planning -- cross-functional planning, the governance control frameworks in place. We are fine tuning completing validation of the model.So we expect, we will be in position to disclose those results in the 10-K filing. Difficult to project future provisioning now, given the volatility associated with the economic forecast and other model variables, we have more to come.

And just one final question for you Chris, I am curious as to your thoughts on the M&A environment and if there’s a -- if bank deals or a higher priority or asset manager deals or a higher priority for you all?

Well, with our capital levels, we consider those opportunities for us to grow. There are obviously less and less available as the market has been pretty hot in the New Jersey and Pennsylvania. So we continue to see that as an opportunity for us to grow and leverage.So we will continue to do that and we will do it in the same disciplined manner that we do with every investment and utilizing our capital. So, I would say, yes, it’s always been on the forefront. I think it just even more so now as we go through $10 billion.

And which is the priority would you say bank or asset manager deals?

The answer would be, yes, the most accretive definitely. If we can expand our deposit base and opportunity lowering cost I think a whole bank acquisition would be preferable. But in the interim we think that the wealth management space probably going to have a lot more opportunities being just a numbers game.

Thank you.

Thank you. [Technical Difficulty] Hello?

Mr. Wicker, are you there?

Hi. Yes. Good morning. Can you guys hear me?

Yeah. We can hear.

Yeah. We can.

Okay. Great. Thanks. Good morning. I guess, first starting with the loans. You noted the pipeline is down, looks it’s down year-over-year and quarter-over-quarter. I am curious what’s driving that and whether it’s a function of market demand or your appetite for loans given that the interest rate environment or potentially some other factor?

I think the seasonality in terms of the quarter over a trailing quarter was from closing activity period and still pretty stable levels are close to a $1 billion to $906 million, $905 million at the end of the period. I think demand remains pretty consistent. We are not really seeing a big trial up here.

Yeah. I think, [inaudible] -- this is Chris. The first quarter we are seeing definitely some C&I coming in at a decent level of product we would like, I think, the pull-through is only about 55% of deals sheets versus getting to finalized, certainly in the commercial real estate also it’s been pretty healthy. So we are looking forward to the first quarter being a little bit better than last year.

Got it. And then just looking at the balances of multi-family loans they declined throughout the year about $200 million year-over-year. Was that decline conscious on your part, I am wondering if it’s related to the pricing structure you are seeing in the market, concentration perhaps or maybe some other -- something else?

Well, it certainly has been a lot of people taking permanent loans out, the agencies are offering a lot of interest only periods longer than we would ever anticipate for a very stabilized properties. So that has definitely hurt the multi-family space and it’s something -- aggressive lending at some high leverage levels that we just would not do and so when people want to take out proceeds and take it back up to 80%, we don’t think that’s a prudent process for us. So they do move on.

I appreciate the color there and then one last one from me. You bought back stock I think in the first three quarters of the year, it doesn’t look like you bought any in the fourth quarter. I am curious kind of what drove that decision to step back and how are you thinking about the opportunity to repurchase in 2020 versus other uses of capital and I know you kind of talked about M&A already a little bit?

Yeah. Bob, again, as always profitable growth would be number one for us that includes M&A, as well as organic growth. We would like to re-lever the balance sheet and Mark asked earlier about the drop and trying to ensure we stayed below $10 billion, and quickly we think we can get up ahead of that. We see steepness in the curve will put some securities on and lever that portfolio up a little bit and hopefully then we mix it to more profitable loans over time.But after growth and certainly buybacks and dividends, the regular dividend is probably remained fairly consistent, given the outlook -- economic outlook. But we have plenty of capital available to do buybacks, if the pricing in the marketplace makes sense.

Great. Thank you for taking my questions.

Thank you.

Thank you.

Next question comes from Russell Gunther, D.A. Davidson. Please go ahead.

Hey. Good morning, guys.

Good morning, Russell.

Hey. I wanted to follow-up on your comments about the loan growth outlook. Appreciate the low single-digit guide. I am curious for your thoughts on kind of what the loan mixed drivers of that would be? And then, Chris, just any further color you could provide on what you think is driving the increased competition in C&I in particular?

Taking the first one, we see again the commercial real estate having a lot of opportunities, obviously, to get size and scale in our market and contiguous. We definitely are still involved in some of the construction of very well-known principles that we have been dealing with for a lot of years. So there’s opportunities in that space.On the C&I side, I think, there are lot of people are trying to diversify their balance sheet. So the competition is definitely there. And it’s across the industry sectors, we do like to do owner occupied properties for the most part, obviously we like a little bit of collaterals that goes along with the C&I credit and the relationships that come with that.So there’s no real industry code or anything that we look at. I know that we -- in the past year emphasized a couple of industry sectors and we just have to be cognizant of what’s going on in the business market to say what do you think it’s going to be there and that will continue to have real positive growth and good financial results.

Okay. Very good. Thanks. And then last question would be on the expense side of things. Understand the guide around $51.5 million a quarter and what the franchise investment is -- and pressures there. I am just curious if you think there’s an opportunity whether it’s branch rationalization or some other leverage to pull to kind of help mitigate that and maybe that’s not a full year ‘20 impact. But I am just curious as to any offsets to continued franchise investment?

Well, we certainly have always been evaluating the franchise within the sale leaseback of a lot of branches a couple of years ago. We always evaluate the profitability of that network and the cost attached to it. So that’s not something that’s new to us.Obviously operating costs as we have gone over $10 billion have the regulators in here on a full time basis. The risk characteristics of the enhanced regulation have caused us to have to invest a little bit more in that space. Obviously, CECL and all of that with all the consultants to make sure and the documentation that. It just adds to the cost structure.On the other hand we are always looking at nickels and dimes add up to dollars. And so, we are always looking around the edges of how can we be more efficient to use technology and at the end of the day, we should be able to achieve the operating efficiencies through some people counts.So, we are really always trying to do that. I think just in this interim period with all the things going on between regulatory and CECL that just added to the consultant expense that hopefully will go down a little bit over time.

Got it. All right. Understood. Thanks for taking my questions, guys.

Thank you.

Thank you.

Our next question comes from Steve [Technical Difficulty]

Steve, you there? Hello? Hello?

[Operator Instructions] Our next question is from Collyn Gilbert, KBW. Please go ahead.

Wow! Good morning, guys.

Hello, Collyn.

Welcome to cyber space, I guess.

The joy of this technology. Okay. So let me start -- let me -- I think, I don’t even -- the last question was on expenses. But I just want -- I am just curious to dig into that a little bit more. So with the increased costs that you guys have had to carry with CECL and crossing 10. Is the expectation then that those costs will not be able to reverse going forward, that some of these new investments are just going to hold or is the thought that those -- you will reverse some of those but they will be offset by other areas within the business?

Gets more part two, I think, certain things are changing, but then other things are growing as we continue to expand and build infrastructure. So the numbers I kind of threw out, we are about $51.5 million a quarter, about $207 million for the year is what we are expecting for non-interest expense.

Okay. And have you quantified -- I know going into crossing 10, I think, if I recall that your expense outlay seems fairly minimal, I don’t remember the exact number. But have you quantified all-in now what the cost has been for you guys to cross 10 putting Durbin aside, just on the expense side?

We got away from trying to even measure it, because it was less specific to stress testing around Dodd-Frank Act stress testing and rather just increases. So we kind of view this as more as growing capabilities commensurate with the sophistication and size of the organization. So we haven’t really isolated so much anymore.

Okay. Okay. And then, Tom, I just wanted to make sure, did I hear you correctly that the pipeline yield -- did you say 370?

397.

397. Okay. Okay. I mean, that’s still quite a bit lower, I guess, in your portfolio yield. But given the NIM guide, do you still feel comfortable that even with the downward pressure there, you can offset it on the funding side, despite the fact that I feel like your funding costs are so low already?

Yeah. We think there’s still some room. Certainly, when I look at what’s coming off in terms of maturities, both on borrowings and some of the time deposits. There is opportunity there and we still have some exception pricing deposits that we can move down further. So we think we can match it.

Yeah. Collyn, this is Chris. And obviously, we are seeing a bit of fixed rate longer term lending in the C&I space with competition and we tend to not win that business, so we don’t think that that’s the right place to be.So -- and we have, obviously, focused on variable rate. Sometimes in our expense but certainly always being prepared to find a match on an asset liability basis to be pretty much a match funded, not being one way or the other, whether it be liability or asset sensitive.

Okay. That’s helpful. Thanks. And then just on the fee side, just, Tom, can you kind of give your outlook there for fees, obviously, elevated this quarter for prepays swaps, maybe if you could break out what those specific numbers were in the quarter and then just your outlook overall for fees?

Sure. Prepayment income was $1.7 million. That was up from $1.5 million last quarter, the other large valve item of swaps that was $1.5 million versus $2.7 million last quarter. So we did have a reduction there. So I kind of see a range of like 16. I know it’s pretty wide, but 16 to 18, given the volatility in those two categories sort of where we land most quarters.

Okay. And then the -- can you remind us -- there is seasonality, right, in the first quarter on service charges. It’s jumped around a bit, but -- I just want to make sure that we are modeling that correctly.

Yeah. I don’t recall seasonality in service charges on the expense side of things. We always have a little bit of seasonality around payroll taxes and typically utilities and snow removal, that kind of stuff, although, it’s been a pretty mild year so far.

Okay. But nothing on the service charge. Okay. They may have been just some other items. Okay. That was all I had. Thanks, guys.

Thank you.

Thank you.

Oh! Wait. No. I actually did have one more, sorry. Dividend, I know you had indicated kind of you prioritized capital and how you want to spend, which is very clear, just curious about the special dividend?

Yeah. We have done, I think, three or four specials in history. I think maybe three. Certainly, something that would remain under consideration, given the high levels of capital that we hold. And again, as to whether or not we prefer special dividend versus buyback really depends on the pricing if the buyback is available.

Okay. All right. I will leave it with that.

Collyn, this is Chris. Obviously, the term special is what has to be considered at the same time. It was routine that, that would be part of our business model. That’s not necessarily the case.

Got it. Okay. Thank you.

Thank you.

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