Provident Financial Services Inc (PFS) 2005 Q4 法說會逐字稿

Ladies and gentlemen, thank you for your patience. Due to technical difficulties on our end the call was a bit delayed in starting, and I apologize. Welcome to the Provident Financial Services fourth quarter 2005 earnings conference call.

At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference please press star, zero on your telephone keypad. As a reminder, this conference is begin recorded.

It is now my pleasure to introduce your host, Mr. Paul Pantozzi, Chairman and Chief Executive Officer of Provident Financial Services. Thank you. Sir, you may now begin.

Thank you, and good morning, everyone. Welcome to our fourth quarter 2005 earnings call. I’ll start by providing our standard caution as to forward-looking statements that may be made in the course of our discussion this morning. The full disclaimer can be found in our earnings announcement released earlier today, and you can obtain a copy of that as well as our other releases and SEC filings by accessing our web site, providencenj.com or by calling our Investor Relations area at 201-915-5344.

For today’s presentation I am joined by our Chief Financial Officer Linda Niro.

For the fourth quarter we reported earnings of $0.23 per share and for the full year earnings were $0.89 per basic share and $0.88 per diluted share. We believe that these results reflect several decisions we’ve made regarding product pricing, balance sheet repositioning, expense management, and capital management.

Throughout 2005 short-term interest rates continued to rise faster than long-term rates, creating a flat and ultimately an inverted yield curve. This put pressure on net interest margins across the banking industry and we were no exception.

Our margin for the full year 2005 was 334 compared to 340 in 2004. To avoid further compression we resisted aggressively pricing up our interest bearing deposits, and the results were some erosion, particularly in our [forced] savings balances. We continued to monitor this very closely, and we continue with a pricing strategy that works in conjunction with both preserving our margin and market share.

On the asset side, we’ve had reasonable success in our lending initiatives given the fiercely competitive environment that has prevailed throughout our market. Even though we continue to experience accelerated paydowns in almost every loan category we ended the year with a net gain in total loans outstanding, with most of the growth coming from our construction and C&I portfolios. At the same time, we’ve incrementally reduced our securities portfolio as we progressively reduced wholesale borrowings.

As a result, net loans represented 70.5% of our earnings assets at the end of 2005 versus 65.4% in 2004. We hope to build on that ratio but I want to emphasize that we don’t intend to do it by undercutting the competition on rates or by jeopardizing our asset quality by lowering our underwriting standards.

We ended the year with approximately $700 million in our loan pipeline, of which nearly $480 million is in commercial real estate, construction, and C&I commitments. We think this will support our efforts to minimize further margin compression.

We continue to make progress in reducing our operating expense levels. The ratio of noninterest expense to average assets was 2% for the full year 2005, down significantly from 224 in 2004. While the voluntary retirement initiative completed in the second quarter created a onetime pretax expense of 1.4 million it has continued to reduce our ongoing compensation costs.

Also, in the fourth quarter we successfully renegotiated contracts with four of our information technology vendors. While this had a minor impact on expense reduction in 2005 it is expected to result in overall annual cost savings in excess of 1.5 million. We will continue to review our vendor relationships in every discipline throughout the Company with an eye on constantly improving our operating efficiency.

Regarding capital management, we repurchased a total of 5.4 million shares of Company stock in 2005. The pace of our buyback activity slowed in the fourth quarter as we funded loan commitments and deposit outflows. But we continue to view our stock as a good investment. As of 12/31/05 we have approximately 2 million shares left to repurchase under the current authorization.

Finally, in 2005 we reviewed and we continue to review several market expansions and franchise expansion opportunities, while we consistently found that pricing of real estate with denovo branch expansion was inflated and the price of expectations of acquisition candidates were unrealistic. We believe that this disciplined approach was the right one. We’ve now begun to see signs of rational pricing returning to both arenas. And we will continue to seek opportunities to prudently grow our Company.

With that, I’ll turn it over to Linda for the detailed review of our financials.

Thank you, Paul.

Net income for the fourth quarter decreased 1% or about 170,000 to 14.8 million, and basic and diluted EPS of $0.23 were flat compared to the trailing quarter. At yearend total assets were $6.1 billion compared to $6.4 billion at December 31st, 2004, a decrease of 6%. The decrease in total assets was mainly due to a 19% reduction in the investment portfolio, a 17% reduction in borrowings, and a 3% decline in total deposits.

Net loans at yearend were $3.7 billion, an increase of $34 million or 1% compared to the yearend 2004. On a linked quarter basis, total loans increased $59 million or 1.6% with growth of just about $59 million in a construction portfolio and [$16 million] in the commercial portfolio which was partially offset by a $23 million reduction in the residential mortgage portfolio. YTD the construction portfolio increased $100 million or 53%. Commercial loans increased $40 million or 11%. And consumer loans increased $42 million or 8.2%.

Within the consumer portfolio fixed rate home equity loans increased $45 million, home equity line of credit balances decreased $11.3 million, and the indirect auto portfolio increased $1 million to $71 million. For the year residential mortgages decreased $92 million or 5% and commercial real estate and multi-family loans decreased 57 million or 7%.

Asset quality continues to remain good and credit quality trends are stable. Compared to the trailing quarter nonperforming loans decreased 460,000 or 7% to $6 million compared to $6.5 million. Nonperforming loans as a percentage of loans improved 2 basis points to 16 basis points, and the allowance as a percentage of nonperforming loans improved to 533% from 505% during the quarter.

The investment portfolio decreased $358 million or 19% for the year as a percentage of total assets, total investments decreased to 24.7% at yearend compared to 28.8% at yearend 2004.

Total deposits decreased 129 million or 3.2% for the year. Total core deposits decreased 7% during the year but within that category core checking account balances increased $47 million or 5%. Compared to the trailing quarter total deposits decreased $43 million or 1%.

For the year total borrowed funds decreased $196 million or 17%. Borrowed funds as a percentage of total assets decreased to 16% at yearend compared to 18% at yearend 2004.

The net interest margin compressed 4 basis points to 3.27% in the fourth quarter compared to 3.31% for the trailing quarter. For the year the margin decreased 6 basis points to 3.34% compared to 3.40 in 2004.

Noninterest income in the fourth quarter was $7.7 million, a decline of $140,000 or 2% compared to the trailing quarter. Fee income declined $670,000 or 10.6% primarily due to reductions in loan prepayment fees of $600,000. Other noninterest income increased $573,000 in the fourth quarter as a result of gains on loan sales of $79,000 compared to losses on loan sales of $220,000 in the trailing quarter.

Additionally, a gain of the $240,000 was recorded on the call of the Federal Home Loan Bank advance and the accretion of the related purchase accounting adjustment and a gain of $69,000 resulting from the sale of a branch property was also recorded in the fourth quarter.

Total noninterest expense decreased $487,000 or 1.6% during the fourth quarter. Compensation and benefit expense decreased $600,000 or 4% during the quarter. Total stock based compensation was $2.8 million, unchanged from the third quarter. Total stock based compensation for the year was $11.4 million, a decrease of $300,000 or 2.5% compared to $11.7 million in 2004.

Income tax expense in the fourth quarter decreased $790,000 or 10.5% to $6.8 million compared to $7.6 million in the trailing quarter. The effective tax rate in the fourth quarter was 31.4% compared to 33.6% in the third quarter. During the third quarter income tax expense increased due to a reversal of a previously recognized tax benefit related to the vesting of restricted stock awards. For the year the effective tax rate was 31.9% compared to 28.1%. And, again, in the prior year income tax expense was reduced $1.9 million due to the take-down in the valuation allowance against the deferred tax asset that was related to the Provident Bank Foundation.

And, now, we’d like to open up the call to any questions.

[CALLER INSTRUCTIONS.]

Our first question is from Mark Fitzgibbon with Sandler O’Neill Asset Management.

Good morning.

Good morning, Mark.

Good morning.

The first question I have for you, Linda, I am curious what should we be assuming for kind of a normalized tax rate, is 31 and change the right number or is it likely to revert back to sort of 33, 34?

I think 32.25 is probably a good rate to use.

Okay. And let’s just assume for a minute the yield curve holds constant for the remainder of this year. Are we likely to see the margin continue to trickle down a little bit?

We would expect some additional compression, not unlike what we saw this year; certainly in the first half of the year.

Okay. And I’ve heard from some other banks in your market that some of the larger regional banks, like [Bank of America], have gotten very aggressive on deposit pricing. I wonder if you have sort of a general comment on that, whether you’re seeing it or not? And how you’re, you know, competing against that?

There are pockets of competitive pricing with regard primarily to CD promotions or money market type accounts. And we assess the market really on a weekly basis, and we’ll respond depending on our cash flows and funding needs and try and go to the least expensive product that we can. We selectively can see, but our focus, again, remains with core checking products and trying to keep that stable low cost funding base.

Okay. And the last question I have for you, I mean you obviously have lots of excess capital, and you have been buying back your stock pretty aggressively. I guess I’m wondering how you sort of evaluate the buyback today? Is it, you know, with this move, the little bit of a move we’ve had in your stock price is it likely that you’d be as aggressive, less aggressive, or more aggressive?

Well, you know, we evaluate it every time we get ready to go into the market. And as long as we’re still getting our low to mid double-digit internal rate of return based on our price we still feel that we’re a good investment and we’ll, you know, absent any other investments that might appear to be better or unless we see a real surge in loan growth we will be in there buying our stock.

Thank you very much.

Sure.

[CALLER INSTRUCTIONS.]

Our next question is from Laurie Hunsicker with FBR.

Yes, hi, good morning. Linda, just to follow-up on Mark’s question about effective tax rate, that 32.25 that you’re guiding us to, does that include the proposed change to the New Jersey State tax credits regarding [taxed] dividends at the REIT, or are you all not affected by that?

It does include the changes, yes.

It does include the changes, okay. And then, also, just going to his question about buybacks, if we were sort of looking at a model and assuming that you stay at current levels, what could we assume in terms of share repurchases this year? What would be a good…

Again, it’s just going to depend on the volume trading levels, what’s available.

Is there a price level at which you back-off?

Again, it’s based on our internal rate of return. So, we evaluate it every time there’s a move in the price.

Okay. And maybe you could comment, or, Paul, you could comment, in terms of your excess capital it’s been awhile, obviously, since we’ve seen you do an acquisition. If you could just remind us in terms of where you’re looking at ideally for a target M&A? Where would the size constraints be on either side in terms of how small you go, how large you would go? And then when you would potentially consider being on the other side of that?

I think we continue to look in the general market, which is really the State of New Jersey. We’ve indicated that we would like to fill in certain counties that we’re in and maybe create adjacencies. So, size wise, you know, it could be anywhere from 500 million to 1 billion or even larger than that. So, it depends on what’s available and what is in our interest and what makes good sense for us from a pricing standpoint.

Can you remind us where your target markets are?

Well, we’re in 10 counties, north to south, northern part of the State, Bergen County, Morris, and in the southern part of the state, Ocean County. But the central part of the state, as you know, sort of has opportunities, as well, in Middlesex, Somerset, Union, et cetera, going due west towards Pennsylvania. So, there’s quite an expanse of real estate in those areas, in opportunities.

Okay. And then will you just comment in terms of when you would consider being on the other side of the transaction? When you would find a merger partner that you’d say, ‘this would work,’ or if that’s just not the angle that you’re taking at the moment?

We’ve been inquisitive, and I think we’ve indicated that right out of the gate when we did the IPO, that that is our direction, that is our focus, and that’s part of our strategic planning, and so we haven’t given any thought to the other side of that transaction.

Okay, great. Thank you very much.

You’re welcome.

Our next question is from Rick Weiss with Janney Montgomery Scott

Good morning.

Good morning.

Good morning.

I was wondering if you could talk about loan growth? It’s been pretty slow and I’m sure it’s due entirely to the market, but what’s your perception to going into ’06, how that’s going to look?

Well, you know, as we mentioned, we’re not looking to chase any new product into the door by way of compromising pricing or underwriting standards. However, we do feel that there are opportunities out there on the small business side, so that’s going to be one of our areas of attention and focus in the coming months. The commercial real estate side of it represents additional opportunities and, again, our pipeline is pretty strong as we speak.

So, the focus needs to be on the small business side. FDA lending is one initiative that we’re looking at in the next several months, so we feel there would be some opportunities associated with that particular area.

Does it make any sense to purchase mortgage loans in this kind of environment, Paul?

Well, if there’s an opportunity to do so we certainly would consider that as part of our strategy, in addition to the direct origination, yes.

Okay, thank you.

Our next question is from Theodore Kovaleff with Sky Capital.

Yes, so we can have somewhat of a better ability to project earnings, I’m wondering what your expectations are for interest rates for the year? That’s the first part of the question.

Okay.

And the second part?

Well, the second part falls from the first, so.

Okay. Well, we’re looking near term for the Fed to finish their two increases and, hopefully, be done. And we’re looking for a slight steepening of the yield curve. You know, overall, it’s going to look, in our view, pretty much the way it does now; not a whole lot of difference.

Okay, so, in other words, you’re looking for 50 basis points?

Yes.

Okay. And what sort of actions are you taking to take advantage of this climate?

Well, we continue to shorten the investment portfolio to have funds available if we can to reposition. We’re focusing on commercial type loans with floating rates, again, to get more floating rate assets on the books. And, you know, if we’re out in the wholesale market, perhaps pushing the liabilities out a little bit since the curve is so flat.

And how much left do you have of fixed rate in your portfolio?

Fixed rate loans?

Yes.

The portfolio is about 50, 50. 50% floating and 50% fixed.

Okay.

With most of that, you know, just being a mix of different loans.

Okay, thank you.

You’re welcome.

Our next question is from Collyn Gilbert with Ryan Beck

Thanks, good morning, guys.

Good morning.

Good morning.

Just kind of a follow-up to some of the loan questions that have been asked. The growth that you’re seeing is that through taking away market share from competitors, or is it organic, or how are you achieving that kind of loan growth, primarily on the commercial side?

That is a combination of both organic, existing client and new business, as well.

Okay. Is there one sector that’s showing more intense price competition than another, or how is the pricing environment then?

I think we’ll find pricing pressures across all product lines on the commercial side.

Okay. Has that changed at all? Or do you see that intensifying in ’06?

I think it will intensify a bit, yes.

Okay, okay. And then just, Linda, on the reserves front if you could give us a little bit of color as to what you expect credit to look like in ’06 and maybe where you see the reserve going, if we’ll see kind of a continual decline in that ratio?

Well, first of all, with regard to the reserve, we’re probably in terms of the allowance as a percentage of total loans right around the low level that we feel we’re comfortable with. I don’t view it as declining during the year; of course, it will depend on loan growth, the mix in the portfolio; and we do an extensive review each month on credit quality. So, you know, we have seen improving trends or at least stable trends in credit quality, but once we see growth, you know, you could see a change in the provision.

Okay, okay. And then, Paul, were your comments at the beginning, did you talk, when you were talking about the loan growth numbers were you talking, and then, Linda, I think maybe you said some, too – talking – was any of that on the linked quarter basis or was it all YOY?

It was both. It was loan growth was in the fourth quarter, the big piece, and YOY about 1%.

But I mean when you gave the sector breakdown?

Oh, my sector breakdown, that was the quarter, Collyn.

Okay, all right. Thank you.

You’re welcome.

Our next question is from [Jerry Kerney] with Sandler O’Neill Asset Management.

Yes, my questions have all been answered. Thank you.

Okay. Our next question is from Matthew Kelley with Moors & Cabot.

Yes, on the shrinkage of the securities portfolios, down about 19% over the course of the year, now down to about 25% of the total balance sheet. If the yield curve remains flat could we see the same type of reduction over the next 12 months?

It’s very possible.

Okay, so it could get down to around 20, 21% of the total balance sheet?

It’s very possible.

Okay. And then in terms of the expense reduction efforts the operating expenses ex amortization during the quarter has been running about 28 million to 28.5 million. Is that kind of a run rate to put a growth rate on, or is there more expense reduction efforts in the pipeline to bring that down further?

We’re constantly focused on expense reduction on that, but I think probably a good run rate is right around $30 million a quarter.

Okay. And then I know you had mentioned the total noncash comp expense is 2.8 million. I was wondering if you might be able to break it out by options, restricted stock and [EOSOP]?

Sure. I’ll get that number. Do you want – I can give you the quarterly breakdown?

Yes, just for the quarter.

Sure. For the fourth quarter options, 857,000. EOSOP, and I’m actually going to give you both, but EOSOP 678,000 and stock awards 1.2 million for the quarter.

And is remodeling into ’06, is it – what should we be looking for in each of those buckets?

I think those are probably good numbers to run forward.

Okay. That’s it. Thank you.

Our next question is from Jared Shaw with KBW.

Hi, good morning.

Good morning.

Good morning.

Most of mine were answered. Just, Paul, if you could just give a little more detail on when you’re looking acquisition targets not just a geography but is there a certain business mix that you’d be looking for or is it mostly, is your primary measure the geographic expansion, and secondarily to that the business mix?

Well, you know, we’d like to look at the business mix, and as we become more commercial like that would be our preference, but I think the overall analysis bring value to this Company and needs to be accretive right out of the box. And if we realize that we can put our business model on top of whatever that franchise looks like and be successful that would be an opportunity for us.

So, if it’s accretive and in a good market but happens to be heavily thrift like that’s not a reason not to do it in itself?

That’s correct.

Okay, great. Thank you.

[CALLER INSTRUCTIONS.]

Our next question is from [Joseph Leone], a private investor.

Good morning. Paul and Linda, how are you doing today?

Good, how are you?

Good.

Okay. Could you provide some comment on the performance of the First Sentinel acquisition so far relative to some of your more important expectations? And relative to that there was some expectation going in that their cost control systems would be of value to Provident because their efficiency ratio was lower. Has that happened?

I think generally speaking, yes, the expectations that we had out of the gate were exceeded in terms of cost savings. There was better performance in terms of retention than average, and I think on a go-forward basis we’re looking to take more advantage of that particular market. It’s a very strong market for us, so we’re in the process of designing marketing initiatives that will make that happen.

Okay, that’s fine. Thank you.

Our next question is a follow-up from Laurie Hunsicker with FBR.

Yes, thanks. Linda, hi. One more question.

Sure.

Within your other other income was there any nonrecurring?

The only thing, I mean as we see it now that would be nonrecurring was the gains related to the Home Loan Bank advance and related purchase accounting [adjustment].

And how much was that?

$240,000.

$240,000, okay. Great. Thank you.

You’re welcome.

Our next question is from Matthew Kelley with Moors & Cabot.

Yes, I’d like to follow-up on charge-offs. That’s been pretty consistent over the last couple of quarters, running right around 8 to 10 basis points on a quarterly basis. Is that kind of the same level you’re expecting or could we see modest up ticks in that?

We’re expecting it to remain stable. Everything that we see when we go in and review the portfolio doesn’t indicate anything else.

Okay. And then to maintain this level of reserve coverage would require by my estimate close to $1 million, $1.5 million a quarter for each of the quarters in ’06 – is that kind of what we’re looking at here to hold that 80, 85 basis point type of coverage?

It will, again, depend upon loan growth, what that looks like, as well as the composition of that growth, in addition to credit quality, and if there was any changes in the credit quality level.

Okay. And then just a follow-up question on the margin. I know that I believe earlier you had said that you’re anticipating two more moves by the Fed. You know, if you look at a kind of a Blumberg consensus forecast for the shape of the curve, most folks hate to use kind of the consensus but are still looking for a very, very flat curve throughout the course of the year. If that were to kind of play out how much additional margin compression from the 327 could we be looking for?

I’ll tell you, our current estimate is that there would be some compression in the first half of the year between 3 and 6 basis points, and then we look for it to improve later in the year. So, all in for the year we’re looking for the margin to actually remain flat.

Okay. And then the second half of the year, what’s kind of the assumption that’s driving the halt to the sequential compression?

Some additional core account growth as well as floating rate loans, predominantly construction, C&I, those types of products.

Okay. All right, than you.

I’m showing no further questions in queue at this time.

Okay. Thank you very much for attending this session. We look forward talking to you next go-around. Thank you.

This concludes today’s conference. Thank you for your participation. You may disconnect your lines at this time.

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