Provident Financial Services Inc (PFS) 2004 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the 2004 fourth-quarter Provident Financial Services earnings conference call. My name is Anthony, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. (Operator Instructions).

I would now like to turn the presentation over to your host for today's call, Mr. Paul Pantozzi, Chairman and CEO. Please proceed, sir.

Thank you. Good morning, and welcome to our call. We'd like to get right into the review of our quarterly and annual results. But first, I'd like to provide you with our standard caution relative to any forward-looking statements that might arise. A disclosure regarding those can be found in our SEC filings, as well as on page 3 of our earnings announcement released last evening. You can obtain copies of any of these at our website, ProvidentNJ.com, or by calling our Investor Relations area at 201-915-5344.

For our presentation today I am joined by CFO Linda Niro; Vice-Chairman Kevin Ward; and our President, Christopher Martin -- here to answer any questions you may have.

Our operating results indicate that we have continued to reap the benefits of our First Sentinel acquisition. Diluted earnings per share for the quarter just ended was 24 cents. That's an increase of 60 percent above the matching quarter in 2003, 27 percent above the linked third quarter '04. That brings the annual diluted earnings per share to 80 cents.

Linda will take us through the earning specifics, but I want to highlight a few of the factors contributing to this performance. We're committed to operating an increasingly efficient organization. Fourth quarter '04 represents the fourth consecutive quarter that we have reduced the ratio of operating expenses to average assets. This has been a major factor in reducing the full-year 2004 efficiency ratio of 62.3 percent from 66.9 percent 2003. We will continue to focus on further improvement in this area throughout the coming year.

The other element I want to emphasize is loan growth. Apart from the nearly $1.2 billion that came over from First Sentinel, the bulk of which was residential mortgages, we experienced 12.3 percent of organic growth in our total loan portfolio as of year-end 2004. A third of that came out of our C&I lending efforts. We have achieved this while maintaining our asset quality, as non-performing loans ended the year at 17 basis point of total loan portfolio.

Regarding deposits, we've continued our strategy of optimizing the ratio of core checking and savings deposits. Beyond 859 million brought over from First Sentinel, we are experiencing organic growth of about 2 percent as of year-end. Since we have continued to price time deposits competitively, but not necessarily aggressively, we have experienced some runoff.

All of these factors have kept the core deposit ratio above 65 percent at the end of 2004 as it was at the end of 2003. This has allowed us to control our interest expense more effectively.

Finally, I'm pleased to report 2 developments in our capital management strategy. Yesterday, our Board of Directors approved the 16.7 percent increase in our quarterly cash dividend to 7 cents per common share. We also authorized the Company to commence its second share repurchase program of 5 percent or approximately 3.7 million outstanding shares. Our first repurchase program, which was authorized in January 2004 and then expanded in July after the acquisition, was completed in fourth quarter '04 for a total buyback of just under 4 million shares.

With that, I would like to turn it over to Linda to take us through the financials in greater detail.

Thank you. Good morning. Net income in the fourth quarter increased 3.7 million or 36 percent compared to the trailing quarter, primarily due to a reduction in income tax expense, a 5 percent increase in net interest income and a reduction in compensation and benefit expenses.

Total assets decreased just under 2 percent compared to the trailing quarter. The investment portfolio as a percentage of assets decreased to 30 percent from 31 percent in the prior quarter.

Total loans at year-end represented 58 percent of total assets, compared to 57 percent at the end of the third quarter. Total loans decreased 1 percent compared to the trailing quarter. And for the year, loans, excluding the loans that were acquired from First Sentinel, grew 12.3 percent.

During the quarter, residential mortgages and construction loans decreased $30 million and $43 million, respectively. Residential loan prepayments increased 30 percent during the quarter and direct originations decreased 46 percent.

Commercial real estate loans and C&I loans increased $21 million and $10 million, respectively, compared to the prior quarter. Consumer loans increased $7 million compared to the trailing quarter. Within that increase, indirect auto loans increased 1.3 million to approximately $70 million during the quarter and currently represent 13.5 percent of the consumer portfolio. Average FICO scores for indirect auto are 756 for new autos and 746 for used.

Core deposits decreased 1 percent compared to the trailing quarter. Core deposits as a percentage of total deposits improved to 66 percent from 65 percent at September 30.

Total wholesale borrowings and retail repurchase agreements also decreased during the quarter 73 million or 6 percent. Wholesale borrowings decreased to 18.1 percent of total assets at year end compared to 19 percent at September 30.

Compared to the trailing quarter, the net interest margin decreased 5 basis points to 3.38 percent. During the quarter, premium amortization increased 30 percent. And that contributed 8 basis points to the decline in the yield on the investment portfolio and contributed 2 basis points to the decline in the net interest margin.

Non-interest income decreased 1.6 million compared to the prior quarter, due primarily to a decrease in retail fees of 540,000 and a decrease of 580,000 in gains on security sales. Total non-interest expense decreased 2.1 million or 8 percent compared to the third quarter. Compensation and benefit expense decreased 3 million compared to the linked quarter. Compensation expense decreased during the quarter due to a reduction in executive severance and the capitalization of severance expenses related to the merger.

Benefit expense decreased due to onetime adjustment to pension expense, a reduction in employee insurance expense. And that was offset by increases in stock-based compensation.

Advertising expense compared to the linked quarter decreased 800,000. Other non-interest expense increased 1.5 million during the quarter, due primarily to $500,000 in nonrecurring merger-related expenses and $400,000 in expenses related to the implementation of Sarbanes 404. Year to date, expenses related to Sarbanes 404 implementation were $550,000.

For the fourth quarter, income tax expense was 4.9 million, resulting in an effective tax rate of 22.2 percent. Excluding the tax benefit of $1.8 million, the effective tax rate would have been 30.6 percent. And year to date, our normalized tax rate would be 30.8 percent.

Now, I would like to turn the call back to Mr. Pantozzi.

We would like to open it up for questions at this point.

(Operator Instructions) Jared Shaw, Keefe, Bruyette & Woods.

Linda, actually, could you just go through the year-end balances on the loan portfolio again? I missed some of the numbers that you were reading off there.

Certainly. I read off these changes, so I will give those to you. Residential mortgages and construction loans decreased 30 million and 43 million, respectively. And commercial real estate loans increased 21 million. C&I loans increased 10 million. And consumer loans increased $7 million during the quarter. I can actually give you the balances in the categories, if you would like those.

Just the grosses -- that's fine there. Then in terms of the other expenses you went through -- the merger charge and the Sarbanes-Oxley charge, are the merger charges pretty much done now? Do you expect anything in first quarter?

Yes, we expect that they are done. We're not expecting anything in the first quarter.

Okay, and then with Sarbanes-Oxley 404 costs, is it pretty much done with what we've seen in 2004? Or could there be a little more in '05?

For implementation in '05 -- there will be costs related to Sarbanes testing.

Okay but the majority of the initial run-up has been --

The big piece has been expensed.

Okay. And then on the compensation, you said that you had capitalized some of the charges there. Was that associated with noncompetes and things? Or where did that -- does that show up under goodwill on the balance sheet now?

Yes, that was just severance costs associated with individuals who did not stay on with the Company. And it's now part of goodwill.

And you are amortizing that over -- what, the eight years?

Not goodwill. We only amortize (multiple speakers) core deposit intangibles.

Okay, so you are not amortizing that at all.

No, it's permanent.

Okay. And then the tax rate you said was 30.6, normalized for the quarter. Should we still be using 30 percent for '05, or (multiple speakers) bring it up a little bit?

I would use about 31 percent.

31 percent. And those are most of my questions. Thank you.

John Kline, Sandler O'Neill.

Just with respect to non-interest expense and the compensation line, Linda, you mentioned there was a onetime reduction with respect to the benefits. Could you go over that again?

Yes, we had a onetime adjustment in pension expense. We had expensed too much, and it was part of the year-end reconciliation. So we reversed that, and it was a reduction in pension expense.

How much was that?

Approximately $1.5 million.

And it was offset by an increase in stock-based compensation?

Some of that. That was a small increase -- stock-based compensation.

(multiple speakers) Is that the ESOP plan that you're talking about?

All 3 of them, but the bigger part was the ESOP. We also did have reductions in regular compensation.

Okay. And the reversal of the valuation allowance on the deferred tax asset -- do you expect any more of that going forward?

No. That's a onetime event.

Okay. And did you say that commercial real estate was up? Or was that down for the quarter?

No, commercial real estate was up -- up $21 million.

That was up 21 -- or was that C&I?

C&I was up 10.

Okay -- sorry about that. I know you just mentioned it. I apologize. Was construction down for the quarter?

Yes, it was. Construction was down $43 million.

What was driving that?

We actually had 1 large borrower that paid off right at year-end. I think it was about $38 million that paid off right at the end of the year.

Okay, but the averages look like they were up for the quarter.

That's right.

Okay, okay. 1 last question. How is that loan pipeline looking at this point? And actually, what I'm seeing with a lot of other banks in New Jersey is they are seeing some decreases in some of their lending categories. Is the competition really heating up? And I'm just curious if you could provide a little bit of color on the competitive environment for us.

I can talk to the pipeline. I will let Kevin talk about the competitive environment. The pipeline is down slightly versus the third quarter. But again, that is all in construction. We have a slight increase in CRE and a slight increase in C&I loans. So, the only down piece is construction. And I think Kevin could talk about the competitive environment.

The competitive environment, interestingly enough, is much on the interest rate side rather than on the underwriting side. And we haven't really seen anybody really relaxing their underwriting standards. Pricing to the various yield curves, be it treasury, LIBOR, or Fed funds, has tightened up. There's a little bit of almost irrational pricing going on in the marketplace. But we have been able to stay away from a lot of that while maintaining our pipeline. The commercial real estate pipeline is actually pretty solid at this point. The construction loan pipeline has slowed somewhat.

Are you seeing it from the larger banks?

Yes, we are starting to see it from the larger banks that they are tightening up their pricing. But they are not relaxing their underwriting standards at all. So it may have a little impact on net interest margin. But the good news is nobody is really relaxing their underwriting standards.

Right, but I would think, too, that's in the types of credit -- or the customers that you lend to, hopefully they are not dipping down quite that low.

Actually, I think it's more a case of us having moved up into their marketplace, in some instances. We are doing some larger loans. And we're starting to see the Bank of America, the Wachovias, WaMu in our marketplace. We're competing with them for loans where we have stepped up in size.

Laurie Hunsicker, Friedman, Billings Ramsey.

Just to follow a little bit on John's line of question. In terms (ph) of the projected loan growth that you're looking at -- if we're trying to forecast earning assets going forward, I assume your securities portfolio will pretty much stay flat.

It will probably decline as we fund -- we are expecting loan growth. And that will be funded, in addition to deposits, out of the investment portfolio.

Okay, what's your target asset mix there?

We'd like to drive investments down more towards 25 percent.

Okay. And so in terms of 2005 loan growth as a blend, what are you looking at there?

Low double digits.

Low double digit -- okay. And I just wondered if you could comment a little bit in terms of the margin contraction that we saw and what steps you might be taking to jump it back up a little bit, or what your thought is on the shape of the yield curve?

Well, we see the yield curve continuing to flatten and short-term rates continuing to go up. The fourth-quarter spike-up in premium amortization was a little bit unexpected. Given where rates have been, we expect that amortization to go back down. So that will somewhat help the margins.

And we should start to see assets beginning to reprice up. We're starting to see increases in short-term repricing assets slowly -- nothing really significant. And again, we're just trying to hold the line on funding costs, which -- that's an area that's been heating up in terms of everyone out trying to attract deposits, I guess, ahead of further rate increases. So we're looking for just a little bit more compression.

Okay, and then, Linda, in the noninterest income in the fee line, you mentioned the drop. It was a big drop. Can you talk a little bit about forward direction of fees and what would be a good run rate there -- what you all are expecting?

That was somewhat unusual but until we get a better feel for run rate out of the First Sentinel branches and complete expansion of product line in the Middlesex County area, I think that was an unusual drop. Some of it could be attributable -- just be attributed to people gaining a better understanding, particularly around the overdraft privilege product, and perhaps not being so willing to overdraw their account.

So we're looking just to continue that. I would say a run rate there -- should be more around the $5.5 million a quarter in that product line.

Okay. And then, over to capital management -- glad you increased your dividend. Great job -- saw you announced a buyback. Just wondered if you could give us some guidance with respect to how quickly for modeling purposes we are going to see you actually repurchase those shares. Would we expect to see you complete the 3.7 million in the first half of this year?

It will depend on the price of our stock where it makes sense and the availability.

Okay, but it is safe to assume that you all will continue to be somewhat aggressive?

Again, it will depend on the price and where we are in our tolerance for repurchasing the stock.

Okay. And just 1 general question from you, Paul -- if you could just talk a little bit about your thoughts in terms of what you're seeing in mid-Atlantic M&A and what your status is at the moment?

Our status is focused on our integration as we reported in our last call. And that continues, in addition to some organic growth throughout the system. So our contention right out of the gate was -- retention and expansion of the relationships that we absorbed through First Sentinel. So that continues, and will continue.

We've got a modest de novo schedule going. We're looking at certain sites. But at this point in time, the focus is all internal.

Rick Weiss, Janney Montgomery Scott.

I just wonder if we could talk on the other side of the balance sheet with deposits. How do you see growth coming from there? And what's the pricing like right now?

Pricing is fairly competitive. I think everybody is out there -- in addition to focusing on core deposits, you're also starting to see the markets heat up for time deposits. Our strategy has not changed in terms of we're not going to be a price leader with regard to pricing. However, we'll probably look to do more targeted marketing or market-specific pricing to gain deposit share.

Okay, because it seems like when -- as rates are starting to move up, it's harder and harder to get those core deposits. You are around 65 percent right now, I think. So like in a year or 2 years from now, do you think you would be doing well to keep it at 65, or could that ratio go up a little bit or just kind of what --

It's our targets to improve it. And you're right, it's very difficult in a rising rate environments to keep that ratio higher than 65 percent due to competition, due to people moving funds then out of those core deposit products into higher yielding time (ph).

Actually, Rick, as you heard Paul mention, we feel pretty proud about the fact that we were able to maintain it at the 65, 66 rate as a percentage of total deposits throughout 2004 in what was a much more competitive marketplace. If you watch the advertising that's going on in the newspapers, the shift now has gone away from the free checking advertising and virtually everybody who advertised is advertising an interest-bearing checking account or money market account of some sort.

Yes, it seems like everybody has their work cut out for them. I guess with the North Fork acquisition or -- having the (ph) new players on the deposit side are making it even tougher for you, or is it about the same as it always has been in terms of the competitors in your area?

We really have not felt the presence of North Fork to this point other than on some of the retail deposit area, where they are shifting their business model. We do expect that in the near future as they settle into the marketplace, we will feel their presence more.

Collyn Gilbert, Ryan Beck.

Just a question on credit. I think after last quarter's call, you guys had indicated that your goal for the reserve was to be around 1 percent. Is that still your goal? And if so, what would be the timeframe for that?

The goal of 1 percent would be dependent upon any change in the mix of the loan portfolio. So while we're still heavily retail, we're comfortable in the low 90s.

The other thing that might influence us is greater-than-expected growth in the loan portfolio. So our target is going to be dependent on how much growth we see in the commercial portfolios. If they continue to increase, you'll start to see that allowance as a percentage of loans increase.

Okay. And then just a follow-up in terms of charge-offs and your kind of outlook where that stands. I think, again, last quarter, you said 9 to 10 basis points. Is that still on track for trying to achieve that in '05?

We believe that's still on track.

Okay. And then Linda, just another housekeeping item -- I apologize. When you went through the detailed expenses, sort of the onetime things, what was the dollar amount of the executive severance costs?

Well, the reclass of severance was severance related to First Sentinel. And that was just over $900,000. Now, executive severance, which we had during the course of the year, was $1.8 million. And those expenses ended in August.

Okay. But in the fourth quarter it was just --

There were no executive severance costs in the fourth quarter.

Karen Forbes (ph), Sandler O'Neill Asset Management.

I'm sorry if I missed this, but could you just go over the reason for the sharp decrease in the other fee income?

Yes, primarily due to retail fees dropping 540,000 and the other was a decrease of 580,000 in gains on securities sales. We had gains on the sales in the third quarter. And we did not take any gains in the fourth quarter.

And how much were the gains in the third quarter on the securities sales? They were 580,000 (multiple speakers)

580,000.

Okay, and there were none in the fourth quarter. And just -- can you give us the number for the ESOP and stock option expenses in the fourth quarter and the fourth quarter last year?

I can give you the fourth quarter this year. (multiple speakers) I think I do have them -- hang on a second. Okay, ESOP expense for the fourth quarter this year was 800,000. And it was 600,000 in the quarter last year.

And can you give -- well, I guess, can you give the stock award and stock options expenses, as well, then?

Yes, stock option expense for the fourth quarter of this year was 860,000. Stock award expense was approximately 1.5 million. And last year, stock option expense was 900,000. And the award expense was 1.3 million.

Okay great and just a question on the merger charge. It was 291,000 this quarter for the FSLA merger?

Yes, net of tax.

Can you just give the pretax amount?

Yes, it was close to 500,000 -- just under 500.

500,000 -- okay. And just the loan growth -- I know it's down 1 percent period and linked quarter. And you had mentioned that large payoff towards the end of the quarter. Is that mostly the reason for the decrease?

Yes, it is.

Okay. And you didn't sell any loans then?

No, other than the normal 30-year fixed that we sell at origination.

And do you have the number for the gain on those loans sales?

I do not have that. (multiple speakers) It's not significant, though.

Matthew Kelley, Moors & Cabot.

I just wanted to kind of make sure I'm clear on the starting point for the comp and benefit line as we start to look at the model for the first quarter of '05. Are we supposed to add back that onetime pension expense to the 14.7, and kind of start with a $16 million run rate?

It actually would be a little higher run rate now, because you're going to add the 1.5 million, and you're also going to add the severance expense back. So, it's more like 17.2 or 3.

That's a good starting point?

Yes.

Okay. And I just wanted to -- wonder if you could give us an update on the asset sensitivity? I know that looking at the 10-Q -- up 100 basis points, and I.I. would be down 10.5. Has that changed much at year-end?

Well actually, we've become slightly liability sensitive -- and I say that very slightly. However, I just would remind you that what you see in our filings are interest rates shocks. So it's a complete worst-case scenario. And I would say that we're really not that interest-rate sensitive. You would want to reduce those numbers probably by 50 or 60 percent. And even that would be fairly conservative.

Okay. And I just wanted to confirm the 31 percent tax rate (multiple speakers)

Yes. That would be the normalized tax rate.

And to follow-up on Collyn's question from earlier, the provision or the reserve coverage ratio -- 90 is kind of the baseline you would like to maintain -- 90 bp's?

Yes; we don't want to be below that.

John Kline, Sandler O'Neill.

A quick follow-up. Paul, you talked about improving your efficiencies as you go forward. 2 questions -- 1, what are some of the actions that you're taking to improve that ratio? And do you folks have a target in mind as you move into '05?

Target in terms of --

Where you would like to see the ratio?

Yes, we all along have indicated that we would like to get down to the mid-50s as a next starting point. But each time we improve, obviously, that's our next starting point working our way toward the mid-50s target. In terms of initiatives, we're beginning potentially an organizational assessment by discipline, by area to determine where the early wins can be achieved in terms of efficiencies. We're looking at staffing models. So the organization is basically going through a total assessment over the next several months.

Ross Haberman, Haberman Funds.

Could you discuss the competition locally? I think you said growing the loans and some of the specific categories on the commercial side were fairly tougher this quarter compared to prior. Could you discuss that a little more particularly in light of some of these new conversions which are coming up -- specifically, Kearney; the additional Hudson City, which will be converting in a couple of months -- and what your expectation is in terms of competition when all these banks have all that additional equity that they (ph) have to put to work?

Actually, the business models of both Kearney and Hudson City -- more particularly Hudson City at this point -- is very much 1-to-4 family retail oriented. So their additional capital should be deployed along the same business lines that they are currently in. My understanding is that Kearney Federal in their prospectus talks about doing more commercial real estate and C&I.

But as we have increased our lending levels and have been moving up in the size of the loans that we do, we anticipate we'll see -- and it's not only the converting mutuals that are driving the marketplace out there. There are a number of 250 million to $0.5 billion commercial banks that are at the low end of the marketplace. At the top end of the marketplace, we clearly have all of the major competitors that are national competitors here -- Wachovia, Bank of America, PNC, Washington Mutual, and recently, the advent of North Fork. So, we anticipate the competition will remain robust. But we do believe we'll be able to generate low double-digit numbers as it grows out of our loan portfolio.

Could you address the same question regarding the deposit side?

As I said earlier, on the deposit side, we have really seen -- the heating up of that side of the pricing is pretty much in the short end. We don't really see anybody extending out, trying to attract longer-term deposits. The interest-bearing checking account and interest-bearing money market accounts appear to be where the heat is currently. And everybody has shifted their advertising to those products. Our view is that the deposit rate -- our growth in deposits in the coming period should be in the mid-single-digit range.

Ross, Chris Martin here. The one thing to add on both sides of that in the competition is really the service element that we drive at the same time on both ends of that, which is on the lending front as we achieve and go after the relationship in both sides of it -- so lending and the deposits. And same on the retail front is that -- you know, the people that are in front of these people make it less likely for them to leave before fulfilling that role. So that does play into this very heavily.

No, I was just thinking about the possible prospect of say, Kearney for argument's sake wanting to basically, as you say, get into the commercial business in a bigger way buying -- end up buying business at your expense, as well as everyone else's expense.

(Operator Instructions). Joseph Leonie (ph).

Without having thoroughly studied the numbers yet, it looks like First Sentinel contributed somewhere in the neighborhood of 20 to 30 cents a share on a half-year basis to earnings. Given the cost of that acquisition in terms of the tangible book value of the bank, what are your objectives or expectations for profit contribution, even in a general sense, from First Sentinel going forward?

Actually, when we did the presentation many, many months ago, we talked about an earnback of approximately 4 years in the tangible book value dilution that occurred. Everything that we see tells us that those projections will indeed hold for us.

Gentlemen, you have no further questions. I will turn it back to you for your closing remarks.

Okay, well, we thank you very much for participating in this call. And we certainly look forward to the next quarterly call in April. We thank you very much.

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