Provident Financial Services Inc (PFS) 2006 Q3 法說會逐字稿

Greetings ladies and gentlemen. And welcome to the Provident Financial Services, Inc. Third Quarter 2006 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow this formal presentation. [OPERATOR INSTRUCTIONS]

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

Thank you. And good morning, everyone. Welcome to our Third Quarter 2006 Earnings Call. I'll start by providing our standard caution as to any forward-looking statements that may be made in the course of our discussion. A full disclaimer can be found in the text of our earnings release and you can obtain a copy of that, as well as all of our releases and SEC filings by accessing our website, Provident NJ.com, or by calling our investor relations area at 201-915-5344.

For today's presentation, I'm joined by our Chief Financial Officer, Linda Niro.

In the Third Quarter, we continued to meet the challenges imposed by a tough interest rate competitive environment. For several prior quarters, we have been reporting on our efforts to minimize compression of our net interest margin in the face of rising and the continued flat to inverted yield curve.

In response to ever-increasing competition for rate conscious depositors, however, we made a strategic decision to protect our depositor relationships, largely by means of promotional rates on certain products.

The result was that first total deposit balances increased during the third quarter due to growth in the time deposit and change rate savings categories. And secondly, the interest cost of deposits rose 34 basis points to 263, as compared to 229 for the quarter ended June 30, '06. This is the main cause of the 16 basis point compression and our net interest margin compared to the trail of the quarter.

The rest of our near term operating strategies have remained consistent. We continue to reduce our wholesale borrowings and securities assets in order to mitigate long-term interest rate risk. We continue to build a ratio of commercial real estate, construction and P&I loans to total loans for the same reason. These loans represented nearly 40% of our loan portfolio at the quarter's end compared to 39% at the end of the quarter and 37.5% at December 31, '05.

And we have made progress in this regard. We have continued to maintain our high credit underwriting standards and strong assets quality.

Ongoing management of non-interest expense has remained a priority. Despite the increase in total expenses as compared to both the trailing and matched quarters, our operating expenses for the 9-month period shows significant reductions in every major expense category, compared to the same period in 2005.

These efforts are designed to preserve both our franchise and our long-term earnings potential. In keeping with that, I want to mention our pending acquisition of First Morris Bank and Trust. We outlined the specifics of that transaction during a conference call held Monday, October 16th. And that presentation is archived in our investor relations website. Here I just want to emphasize that this opportunity represents a strategic deployment of our capital by acquiring a bank with strong balance sheets and attractive retail locations in a strong and growing market.

Now, I'll turn it over to Linda for a detailed look at our financial results.

Okay. Thank you, Paul. Good morning. Net interest margin compression at 16 basis points during the quarter resulted in a decrease in net interest income of $2.8 million or 6.5% to $39.9 million compared to $42.7 million at June 30.

Interest income on a like quarter basis was flat, while interest expense increased $3 million or 10.5% due primarily to a $3.1 million increase in deposit interest expense.

As a result of the strategic focus to retain existing customer relationships and attract new customers, several promotional campaigns were in effect during the quarter.

Compared to the second quarter, the average yield on interest earnings assets increased 9 basis points to 5.61%, while the average cost of interest bearing liabilities increased 27 basis points to 2.88%.

Average earnings assets as of September 30 declined $96.1 million or 2%, compared to the trailing quarter, primarily due to decreases in average investments of $91.3 million or 6.5%. Lower costing average core deposits decreased 2% on a lead quarter basis, and average borrowed funds decreased 5%.

Net income for the quarter ended September 30 was $13 million, a decrease of $500,000 or 4% compared to net income of $13.5 million for the quarter ended June 30. Basic and diluted earnings per share for both quarters was $0.22.

Total assets at September 30 were $5.8 billion, a decrease of $228.4 million or just under 4% from year-end and a decrease of $36.2 million compared to the second quarter. The reduction in the balance sheet continues to be the results of reductions and investments in borrowings.

Total loans decreased $14.2 million to $3.76 billion from $3.77 billion at June 30. Commercial real estate loans increased just under $32 million or 4.5% and construction loans increased $8.1 million or 3% during the third quarter. This growth was partially offset by a $41.3 million or 2.4% decrease in residential mortgages and an $11.9 million, 3% decrease in commercial loans.

Total unfunded loans pipeline increased to $806 million from $791.3 million at the end of the second quarter. During the quarter, construction unfunded commitments increased $12.1 million, commercial loan commitments increased $5 million and commercial real estate commitments increased just about $4 million.

Total non-performing loans at September 30 were $6.8 million or 18 basis points of total loans compared to $5.7 million or 15 basis points of total loans at June 30. Included in the non-performing loan category are two commercial mortgages -- mortgage loans for $429,000 that were passed maturity by more than 90 days and still accruing interest. Subsequent to the quarter end, one of these loans was paid in full. And we anticipate full collection of the remaining loan.

Total investments decreased $57.2 million or 4.3% to $1.27 billion at September 30, from $1.33 billion. As a percentage of assets investments have decreased to 21.8% from 25.4% at year-end. Total deposits increased just about $14 million in the third quarter. Fund deposit balances increased $37.7 million, savings balances increased $23.4 million and money market balances increased $15 million, offset by decreases in demand deposit and now account balances of $36.9 million and $25.3 million respectively.

Customers continue to shift deposit dollars into high rate CDs and in money market accounts from lower yielding core account products.

Wholesale borrowings have decreased $38.6 million or 4.7% compared to the trailing quarter. And as a percentage of total assets, borrowings have declined to 13.5% from 16% at year-end.

Non-interest income for the current quarter was $8.3 million, an increase of $1.1 million or 14.4% compared to $7.3 million in the trailing quarter. Fee income was flat in both quarters with increases in deposit fees and equity funds. Fee income is offset by a decrease of $149,000 in loan-related fee income.

Gains on security sales were $1.1 million in the third quarter compared to losses on security sales of $1.1 million recorded in the second quarter.

Other income decreased $1.2 million to $225,000 compared to $1.4 million in the trailing quarter primarily due to reduction in gains recognized on the call with home loan bank advances, resulting from the accelerated accretion of related purchase accounting adjustments.

Total non-interest expense was $30.1 million in the third quarter compared to $29.9 million in the trailing quarter. Excluding the one-time executive severance expense recorded in the third quarter, non-interest expense decreased 2.2% on a linked quarter basis.

Including the one-time executive severance, salary and benefit expenses of the current quarter increased $700,000 or 4.3% to $16.8 million compared to $16.1 million in the trailing quarter. Advertising and promotion expense decreased $428,000 or 35% on a linked quarter basis, due primarily to the timing of the marketing initiatives throughout the year.

Income tax expense decreased $871,000 or just under 15% to $5.1 million compared to income tax expense of $5.9 million at the end of June. The effective tax rate decreased to 28.1% in the third quarter compared to 30.6% in the second quarter. And income tax expense was favorably impacted by an increase in managed bond income and bank-owned life insurance appreciation.

And now we'll open it up for questions.

Ladies and gentlemen, at this time, we will be conducting a question and answer session. [OPERATOR INSTRUCTIONS]

Our first question is from Mr. Mark Fitzgibbon with Sandler, O'Neil. Mr. Fitzgibbon, please state your question.

Good morning. First, I wondered if you could share with us where you think the effective tax rate might be looking at the coming quarters? Is it sort of 28%, given some of the changes you've made to the balance sheet?

I think Mark, a better gauge really would be about 30% at this time. It was a little unusual because muni income as a percentage of pretax income made up a significantly greater proportion. We're expecting to see some loan growth. So it may -- it's going to fluctuate a little. I would still on an annualized basis use 30%.

Okay. And then secondly, it looked like from the linked quarter commercial loan yields rose quite a bit, up like 60 basis points. I'm wondering, was there anything unusual in there that drove that number?

There wasn't that I'm aware of -- I mean other than maybe some loans repricing up. A lot of the commercial portfolio was adjustable on maybe an 18-month time to reset or 12 months. So I think just resetting up to current rates.

Okay. And could you share with us what the net interest margin was at the end of the quarter?

At the end of the current quarter?

Yes.

It was -- I don't have that rate off the top of my head. The margin was 317 for September. It was at 333 at June.

Okay. Linda, do you get the sense that the rate of decline in the margin is slowing? So in coming quarters, we would maybe see less compression?

Right now, my best estimate for the current quarter would probably be anywhere between 7 to 10 basis points of compression. And that's assuming our balance sheet looks reasonably the same as it looks now. And the reason for that again, some of the competitive pressures, some of the promotional -- the lag effect of the promotional campaigns, as well as CDs continuing to reprice up. So I think we'll probably see some more compression.

And the last question I had relates to the provision. Should we expect the provision to match charge-offs going forward or not necessarily?

No. Not necessarily. Again, it's based on growth in the portfolio, the shift in the mix. It's the mix of the portfolios increasingly greater -- greater proportion of commercial loans. You're going to see that 86 basis points probably be somewhat of a higher number. Maybe it's 88 or 89. But we don't base our provision on charge-offs or net charge-offs.

Great. Thank you very much.

Sure.

Our next question is from Mr. Theodore Kovaleff of Sky Capital. Mr. Kovaleff, please state your question.

Yes. I'm interested in knowing about your attitude towards future acquisitions. Certainly your recent one was not oversized. And I'm wondering whether or not the -- this recent event leads you to swear off anything else or are you open to additional activity?

At the present time, our focus is on the current acquisition. We're always evaluating other opportunities in the market place, however. But at this moment in time, we want to stay focused on this very important transaction.

Thank you.

Our next question is from Mr. Steve Moss with Janney, Montgomery, Scott. Mr. Moss, please state your question.

Good morning Paul and Linda. I was wondering about the construction loan commitment. That line seemed pretty strong or stable quarter-over-quarter. Are you seeing any softening in that pipeline?

I think on the residential side, we're starting to see a slow down. And I would expect that it will continue to slow down through the end of the year.

Okay. And do you see any softening in commercial real estate prices or do you think things are holding up fairly well in New Jersey?

They seem to be holding up. It's really the residential market. I'm sure as everybody is aware, is we're seeing price declines.

Okay. Thank you.

Our next question is from Mr. Matthew Kelley with Sterne, Agee. Mr. Kelley, please state your question.

Yes, hi. I was wondering if you might be able to give us kind of a big picture overview of what you're seeing in the M&A market right now in New Jersey? Has it picked up beyond the last couple of weeks and months relative to where we were 6 to 12 months ago? Just kind of curious of what you see out there for potential deals and books that come across your desk?

I think that the pace has accelerated somewhat. We've obviously looked at a number of transactions over the last 6 to 7 months. I would expect that it might accelerate in the next several quarters.

Okay. And then just kind of looking at the expense side of the P&L, for instance, how much is kind of left going forward to take out of the institution in terms of will there be any potential branch closures, additional and reduction headcount? What's the next phase of the expense reduction plan?

We're in the midst of evaluating the branch system. And while we don't have any firm decisions made at this point in time, we would expect going into the new year that if there's an opportunity to consolidate or improve current facilities, we would take advantage of that. We're in an assessment stage which is really ongoing of the entire company. So that quarter to quarter, we're looking for opportunities wherever they may reside. So efficiencies across the board, and that will sometimes impact take down as well. So it's an ongoing process. And we expect improvement as we go forward.

Okay. And then just one last question. On the capital front, can you just remind us what your kind of comfort minimum target level is for tangible capital really kind of looking out 12 to 24 months after the First Morris deal is closed, thinking about where that might kind of trough out by choice in terms of a level you'd like to maintain?

7% would be a goal.

Okay. All right. Thanks a lot.

Our next question is from Miss Laurie Hunsicker with FBR. Miss Hunsicker, please state your question.

Yes, thanks. Good morning. Just to follow-up on what Matt was asking about M&A, can you just give us a little bit more color on how the First Morris deal came together? Was there a bidding process? And how that all played out?

We don't comment on the details of how those things come about. But we had a book. We looked at it. And we reacted to it.

Okay. There was a book. Okay. And if you were to kind of quantify, again, just on a more macro level, on how many books are you potentially looking at per quarter?

We haven't tracked it. In the last 6 to 9 months, probably 5 or 6.

5 or 6. Okay. And then to the extent that obviously First Morris is packing cash, can you just remind us when you will likely enter a blackout period in terms of share repurchase?

Well, it would really come once the proxy statements go out. So, I think we're looking at late January, early February.

Okay. Early February. Okay. And then any sort of guidance you can give us for next year in terms of the big macro -- everything? We're seeing margin pressure. Obviously this is a good way to bill your earnings --

Again, we evaluate our buy-backs constantly based on current rate of return, earnings accretion, tangible book value dilution and that will continue to be part of our capital management strategy.

Okay. I guess asked another way, assuming your stock stays roughly at current levels, and assuming the interest rate and assuming you don't do another acquisition, would it be safe to say that you may be will repurchase at a similar rate to what we saw this year?

It's very possible. Again, based on all those metrics that I just described.

All right. Thank you all.

Our next question is from Matthew Kelley with Sterne, Agree. Mr. Kelley, please state your question.

Yes. Just two follow-ups. I was wondering if you could just comment on the core deposit kind of trajectory here. It has been down for 7 quarters in a row now in terms of the sequential levels. And I know there hasn't been much balance sheet growth. But is that a concern, just kind of the piece of run-off of kind of the core deposit franchise or core deposit element of the franchise? And what might be done to kind of put a halt or put an end to that to the best of your ability in terms of product changes?

Well, really it's a result of the rate environment. And it's more of an unfavorable shift certainly as opposed to just straight run-off. Customers who sat in passbook savings earning less than 1% have moved en mass to CDs where you can get 5% or greater. So, our focus continues to be on other types of core account products, money market accounts, interest bearing checking accounts and as well as offering competitively priced CDs. And that's part of our strategic focus again to maintain and build our franchise. Until short term rates start coming down, I don't think you're going to see much of an improvement in core deposits as a percentage of total.

Okay. And then I was wondering if you guys were to give a little bit of commentary just on the condo market right there in Jersey City? Just kind of anecdotally your opinions kind of being right there on what you're seeing in terms of the sell through those properties and your involvement. And whether or not you think that increases or decreases over the next 12 to 18 months? Just your opinion on what you're seeing there.

Yes. We're not involved with any of the real high rise projects that are taking place currently. But in speaking with several developers recently, there seems to be a shift towards the rental market given the pricing of real estate. There were a couple of projects that are coming out of the ground that are condos. But there are a couple that are rentals as well. And that's a significant shift for downtown.

Okay. Thank you.

Our next question is from Mr. Jared Shaw with KBW. Mr. Shaw please state your question.

Hi. Good morning. Just on the -- following up on Matt's deposit question, are you starting to see on the CDs and the time deposits, do you think you've reached your peak on interest rates there, on what you're paying? Are you starting to pull back at all? Or is that still increasing right now?

We think we're probably seeing the peak. Hopefully the senate is done and that would be a good thing. But at least the outlook that they perhaps might be done for maybe the next two meetings seems to have taken pressure I think off the entire market. And hopefully we can get rates down a little bit.

Have you seen a pull back though in the overall market -- I guess in the competitive market?

A little bit. We're starting to see it.

Okay. And then do you have what the margin was for the month of September?

I believe it's 309.

Great. Thank you very much.

You're welcome.

Our next question is from Mr. Steve Moss with Janney, Montgomery, Scott. Mr. Moss, please state your question.

Yes. Actually it's Rick Weiss. I was wondering if I could ask a question about the de novo strategy, if you've changed your thinking given how hard it is to get the core deposits at this time and how it takes a longer time for a new branch to break even. So, do you have a new strategy or are you just going to continue doing a couple a year?

Well, the strategy hasn't changed. We've got a couple that are in the pipeline, which are projected for the last part of '07. And we also recognize the pressures associated with profitability and generating new deposits. So we really haven't changed direction there.

But Paul would they need more fill-in type of areas or would you expand it to new territories like the de novo?

They happen to be fill-in locations.

Okay. Thank you very much.

[OPERATOR INSTRUCTIONS]

Ladies and gentlemen, there are no further questions at this time.

Thank you very much. We look forward to talking to you on our next call. Thank you.

This concludes today's conference. Thank you for your participation.