Provident Financial Services Inc (PFS) 2004 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2004 Provident Financial Services' earnings conference call. My name is Michelle (ph) and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of the conference. (OPERATOR INSTRUCTIONS). As a reminder this conference is being recorded for replay purposes. I would now like to turn the presentation over to your hosts for today's call, Mr. Paul Pantozzi and Linda Niro. Please proceed sir.

Thank you. Good morning everyone and welcome to our third quarter '04 earnings conference call. I will remind you that our discussion today may contain some forward-looking statements and our disclosure regarding those can be found in our SEC filings, as well as on page 3 of our earnings announcement which was released early this morning. You can also obtain copies of any of these going to our website, ProvidentNJ.com, or by calling our investor relations area at 201-915-5344. Senior Vice President and Chief Financial Officer, Linda Niro, will join me in reviewing our third-quarter results. Also present to address any questions you may have, our Vice Chairman, Kevin Ward, and our President, Chris Martin. This was an extremely busy quarter for us, marked by many accomplishments. I am very pleased to report that our initiatives to integrate the former First Sentinel Bancorp have been proceeding according to plan.

All of our data processing now resides on one system, a process that was completed in early September, Labor Day weekend to be precise. We have aligned our support personnel to create a more efficient franchise, and in particular we have centralized all of our lending functions at the former First Sentinel headquarters at Woodbridge creating a loan center with Provident Bank. This is basically in the heart of our geographic footprint and represents a significant convenience for all of our commercial and retail clients. Meanwhile, we've taken care to avoid the difficult customer disruption and defection that can often result with an acquisition. At quarter's end the combined deposit levels at our 22 newly acquired branches are virtually unchanged from their levels at July 14th when we closed the transaction. We created the combination we designed and we're actively pursuing the next phase of our plan to deepen the value of that combined franchise. Our constant core strategies have maintained and have remained in place, and they are to build our commercial loan and commercial real estate portfolios, to achieve a balance with retail loans, to maximize our proportion of core deposits, and to continually improve our operating efficiency.

In the third quarter, we've maintained our focus on each of these goals. Regarding loan growth, we have continued to build our C&I portfolio adding 8.7 million in new outstandings during the quarter for internal growth of 86.2 million, with 34.4 percent since the beginning of the year, plus 6.3 million from the acquisition. Commercial real estate growth has been a little more difficult to achieve in the current economy, but we have been maintaining our levels. The absorption of First Sentinel's portfolio has moved our loan mix back to a more retail oriented posture; at September 30th, the proportion of 64.4 retail and 35.6 percent commercial. We continue our buildout commercial loan generating capabilities however. Likewise, First Sentinel deposit mix had a higher proportion of time deposits, but the steady progress we have made in generating core relationships has resulted in 9/30/04 core deposit ratio being 65.4 percent, essentially the same level as year end 2003.

Our efficiency ratio for the third quarter '04 was 62.29 percent as compared to 66.58 for the trailing quarter and 68.63 for the third quarter '03. While 62 percent does not, I repeat, does not constitute what we consider an acceptable level of efficiency, it does indicate the progress we have made to date and provides a benchmark for further improvement. It is essentially a new starting point for us. Linda will be reviewing our detailed financial results for the quarter, but I want to emphasize our posture with respect to our highly competitive marketplace. You're all familiar with that. We continue to see new formidable entrants into our competitive space. We are used to that; that's part of our history. We certainly welcome that challenge and we have a straightforward business model that our commercial and retail clients continue to find valuable. We now have a greatly enhanced franchise through which to execute against that model. We all recognize and we have been focusing on execution. We understand that that is the key to our success going forward. At this time, I would like to turn it over to Linda to review the financials with you.

Thank you. Good morning. My comments are going to address changes in net income and the balance sheet compared to the trailing quarter of this year. Net income in the third quarter increased $4.8 million or 46 percent from the trailing quarter and this is primarily due to the impact of the acquisition of First Sentinel and their results of operations effective July 14, 2004. Changes in the balance sheet composition in the third quarter included a reduction in investment securities as a percentage of total assets to 31 percent compared to 36 percent of total assets at June 30th. Total loans increased to 57 percent of total assets at September 30th, compared to 55 percent at the end of the second quarter. Excluding First Sentinel, short-term investments decreased $161.1 million, and securities available-for-sale decreased $285.1 million during the third quarter. This is due to the payment of the cash portion of the merger consideration for First Sentinel and funding loan growth in the quarter, which increased $164.5 million.

The composition of the loan portfolio has shifted more towards retail loans. At September 30th, retail loans accounted for 64.6 percent of the loan portfolio compared to 58.7 at the end of the second quarter, and commercial loans decreased to 35.4 percent of total loans at September 30th compared to 41.3 percent at June 30th. Intangible assets increased to $429.6 million at September 30th compared to 23.6 million at June 30th. Goodwill recorded for the acquisition of First Sentinel was $382.3 million, and a core deposit intangible in the amount of $33 million was recorded on July 14th. Core deposits as a percentage of total deposits were 65.4 percent at September 30th, and that is just slightly down from 66.1 percent at June 30th. Total wholesale borrowings and retail repurchase agreements represented 18.95 percent of total assets, compared to 16.2 percent at June 30th. The net interest margin improved to 3.43 percent during the quarter, increasing 15 basis points from 3.28 percent at June 30th.

Purchase accounting adjustments, primarily related to the fair market value adjustments for the First Sentinel borrowings, have contributed approximately 14 basis points to the margin improvement. Other positive factors during the quarter were an improvement in the yield at 63 basis points, compared to the trailing quarter in the investment portfolio which was related primarily to a reduction of premium amortization expense of 35 percent compared to the prior quarter. The cost of interest-bearing deposits decreased to 1.29 percent in the third quarter, compared to 1.35 percent in the second quarter. Compared to the trailing quarter, noninterest income increased $1.5 million or 19 percent. Fee income on deposit accounts increased 950,000 or 20 percent due primarily to increases in overdraft fees. Gains on securities sales increased 270,000, and income on a bank owned life insurance increased 304,000 or 31 percent, and that is almost exclusively due to the addition of $25 million in bank owned life insurance from First Sentinel. Total noninterest expense increased 8.3 million or 31 percent compared to the trailing quarter. This increase includes 1.3 million in onetime merger related expenses and core deposit intangible amortization expense in the amount of $1.4 million. Compensation and benefit expense increased 3.9 million or 34 percent compared to the linked-quarter, again, primarily due to the addition of some First Sentinel staff and management and that includes all of the management and staff in all 22 branches, as well as the majority of lending officers and related lending staff. Asset quality improved slightly in the third quarter. Total nonperforming loans as a percentage of total loans decreased to 13 basis points at September 30th compared to 17 basis points at June 30th, due in part to the high quality of the First Sentinel loan portfolio.

During the quarter, the provision for loan losses was 1,050,000, and that was unchanged compared to the trailing quarter. Net charge-offs for the third quarter were 1,265,000. For 9 months, the provision for loan losses were 2.7 million compared to net charge-offs for 9 months of 2.6 million. The allowance as a percentage of total loans has increased to 90 basis points at September 30th compared to 88 basis points at June 30th. The allowance as a percentage of nonperforming loans increased to 688 percent at September 30th compared to 525 percent at June 30th. Now I would like to turn the call back over to Mr. Pantozzi.

We are ready for any questions that you may have out there?

(OPERATOR INSTRUCTIONS). Laurie Hunsicker of FBR.

Good morning Paul and Linda. How are you? Actually very good quarter. Just wondered if you could comment on a couple of things that we're looking at here. I guess starting with asset quality since that's where you finished, what is the target for your reserves in terms of a percentage of loans, or how do you look at it?

I'm sorry, Laurie, I didn't hear your entire --.

Your loan loss allowance, as a percentage of loans, currently 90 basis points. What is your target for that?

Laurie, that is going to depend on quickly we remix the portfolio back to more of a commercial orientation. The closer we get to commercial -- if we're getting closer to that 50/50 mix, our target would be 1 percent. So as we begin to shift, you can see that percentage go up.

Okay. I guess in terms of FSLA, are we going to see any more merger charges or are we finished with FS?

We believe we have captured the bulk of the merger-related charges. If there are any out there, they would certainly not be material.

What tax rate should we use? It jumped up to 32 percent this quarter?

Right. It was a little bit high due to some certainly events related to this quarter with respect to the vesting of the stock awards. We are comfortable using a 30 percent effective tax rate.

In terms of your efficiency ratio, and Paul you addressed this, you kind of said the 62 percent provides a benchmark for further improvement, and obviously FSLA was sitting at 40 something. Did you all have any cost-saves that already started this quarter? Or you all had a percentage target of about 20 percent; can you comment on how we are going to see that play out?

Laurie, there were minimal cost-saves recognized in this quarter. This is Kevin Ward speaking, I’m sorry. We have indeed validated the 20 percent that we talked about way back in December of last year when we announced this deal. We have actually validated slightly more than the 20 percent. Rather than go into specific numbers by each category, the most significant component of cost-saves is clearly compensation and benefits. We're looking at that being just north of 50 percent of the cost-saves. The other significant component would be fees and benefits related to the directors' plans and the ESOP of the former First Sentinel. Those accounted for about 30 percent of the cost-saves. So we have indeed validated that we are through the 20 percent target that we talked about. The majority of those cost-saves, we will begin to see them in the fourth quarter but most of them will really begin to impact us in 2005.

Okay, and so if we spread the remainder over 2005 that should get us to a good number?

Yes. If you remember we talked about 25 percent of the cost-saves really being applicable to 2004, so at that 20 percent number we were looking at somewhere around 5 percent cost-saves for this year and 20 -- north of 20 percent for next year. We're still comfortable with those numbers.

Perfect. One last question. You all bought back a lot of stock this quarter which we absolutely love. I calculate that about 1.1 million shares are remaining in your current authorization, is that right?

No, 737,000 shares. I think we talked about that.

Yes, you did. I came up with a different number because you all had announced another reauthorization of 927,000, I guess back in July.

Right.

I was coming off of a different number. Okay. I guess if you could comment just a little bit, Linda, with respect to how quickly we will see that chunk repurchased and then how you all feel about authorizing another, just kind of your stance on share buyback (multiple speakers).

Just based on our experience in the half quarter, we were able to repurchase more shares, get larger blocks than we had anticipated; so that certainly was good. As we approach the end of this program, the board certainly will be discussing an additional repurchase program and it will be up to them to really analyze it and announce it when appropriate.

Okay. When is the next board meeting?

Next week.

Okay, great. Thank you very much.

John Kline of Sandler O'Neill.

Good morning. Just a couple of questions. One, how is your commercial pipeline looking right now?

The commercial pipeline is a little bit slow on the real estate side, commercial real estate, but construction lending and commercial and industrial lending have held up fairly well. So we are just -- whether it is just a slowdown in closings, we haven't been seeing a lot of activity in the CRE side, but C&I and construction remain fairly consistent with prior quarters.

Just a follow-up to that first question, what are you seeing in terms of pricing for your commercial loans? Is it aggressive out there? Are you having to make concessions in terms of the spreads where you are issuing these at?

Actually, John, the pricing has been pretty rational. This is Kevin Ward again. A lot of the pricing pressure of earlier quarters in the year has abated somewhat. We have always been pretty much -- on the commercial real estate side, we have not been a big multi-family player because of the pricing pressures in that arena. So on the office and -- industrial and office building in the strip center, pricing has been reasonably rational.

Good to hear that. Just a second question. In terms of acquisitions possibilities, when would you be ready to pursue another acquisition? Would you be ready to go now? Do you feel comfortable doing that? What are you seeing in terms of potential inventory in the marketplace?

Our priority right now, John, is to make certain that this integration continues without delay, and the second part of that is certainly the retention and expansion of that marketplace. As you can appreciate, it is a very important market to us. It has filled in a very critical area that allowed us to have a very logical footprint in the 10 county market that we serve, but that is our number one priority. We have not engaged in any analysis at this juncture to make a determination as to what might look good to us in the marketplace. That is not on the table as we speak.

Great, thanks.

Rick Weiss of Janney.

Good morning. I'm wondering, I guess this is probably for you Linda, a net interest margin question. What affect is the flattening yield curve having? And also with respect to the purchase accounting adjustments, about how many quarters, is your best estimate, before they go away – the borrowings, I guess run off?

The margin -- we are not feeling any impact of the flattening as of yet because we have not had to increase our core deposit, interest-bearing core deposit rates, such as savings or NOW account rates. But we do expect that that will have some negative impact over the next couple of quarters. We have the benefit because we have had commercial loans reprice upwards as well as, although minor, impact short-term investments.

With regard to the purchase accounting adjustments and predominately related to the borrowing portfolio, since that is really the largest piece, I would expect the benefit of that to perhaps remain in place for the next 4 to 5 quarters, probably 4 though. I don't think I would go out beyond that, because we have actually tied the purchase accounting adjustments to each individual borrowing. So if we did not prepay any and we just left them, the runoff as scheduled, we have a fair amount of borrowings that are going to be coming off in 2005 and the related benefit, of course, will go away when they mature. So once we get past some of the benefits of the fair market value adjustments on the borrowings, all-in it will probably -- there will be a negative, somewhat of a negative or neutral impact on the margin.

With respect to the investment securities, do you see them running down a little bit; use those funds to get the fund loan growth?

Absolutely. That has been our intention. Our investment portfolio for several quarters was much higher than we are used to seeing it, and that is exactly what is going to happen. We're going to see it runoff and we're going to fund loan growth.

I am sorry, what were the net charge-offs in the quarter?

1.265 million.

So about how much came over from First Sentinel then, about -- was it 12 million?

That was -- their allowance was 12 million.

Got it. Thank you.

Jared Shaw of KBW.

Good morning. One question remains. How much do you think you had of expenses related to Sarbanes-Oxley this quarter? And I guess how much do you think it would be through the end of the year as you have -- as all the banks come into compliance with Sarbanes-Oxley?

We are still continuing to get -- that's really such a variable number as we shift the project and we talk about testing and development of the narratives around all of the operations here. I would estimate, in the quarter, it would probably be 200,000 to 300,000 in Sarbanes-related expenses in the fourth quarter.

Nothing in the third quarter?

Very minor. We really have not had any invoices that have come through yet, in the third quarter. They're starting to flow through now.

When is your next scheduled regulatory exam?

Next regulatory -- we're completing the exam now with the state.

Great, thank you.

Matt Kelley with Moors & Cabot.

Just a quick question. Looking at the charge-off rates, to follow-up on Rick's question there, it looks like the annualized number is about 15 basis points. It was 13 in the second quarter -- kind of between 10 and 15. Is that the right level you anticipate going forward?

That is correct; I think that would be a good level for us,

Okay.

Want to get it closer to 10.

Again, to follow-up on I guess Laurie's question from earlier, the longer-term goal is to get this up to 1 percent reserve levels?

Has the portfolio shift been more towards commercial? Yes.

So would the 90 basis points be kind of an inflection point or a low point and build from here then?

I would expect that to be the inflection point.

In your second quarter 10-Q for PFS, just kind of looking at the interest rate sensitivity, should we expect much of a change with all of the purchase spending adjustments baked in for the First Sentinel deal in terms of being liability sensitive still?

We will still be liability sensitive. I would not expect any significant change.

Good quarter, thank you.

(OPERATOR INSTRUCTIONS). Collyn Gilbert of Ryan Beck.

Good morning guys. Just a couple follow-ups to what sort of has already been asked. In terms of -- let me -- just a housekeeping item. The merger charges in the quarter were 1.3 million, you said Linda?

Correct.

Okay, so that is going to be nonrecurring.

Correct.

And then the charge-offs, to kind of go where I thought Rick was going but he didn't, the increase on a linked-quarter basis was due -- how was that split between First Sentinel and PFS?

Predominately PFS. First Sentinel has virtually nothing in the way of charge-offs.

Was there anything in particular that was driving it, any one large credit for the increase this quarter?

We did have a large marine loan that was charged off from 400,000. However we have the boat secured and we are in the process of selling it and we expect, if not a full recovery on that, pretty close to it.

Okay, great. Just trying to gauge here and I know you said that the interest rate sensitivity isn't changing much from where you filed in the second quarter Q, but what is sort of the makeup of your commercial portfolio now as it stands with First Sentinel? Sort of a split between resi and commercial and fixed versus ARMs? What does that portfolio looks like now?

The commercial portfolio?

No, the total mortgage portfolio.

Total mortgage portfolio right now is 51 percent of total loans versus for example, June quarter we are at 44 percent. So much higher in terms of residential loans.

So your mortgage -- the way that you've -- that is all residential mortgage in that line item?

Right.

Is it up mostly all then fixed -- I mean the terms there within that portfolio, all 30 year fixed or do you have some ARMs in there?

No, mostly ARMs.

Great, that was it. Thanks very much.

At this time, you have no further questions.

Well if there are no further questions, I would like to thank everyone for participating in our third quarter call and we look forward to seeing you and talking with you between now and our next quarter, which would be in January. Thank you very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.