Provident Financial Services Inc (PFS) 2007 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Provident Financial Services second quarter 2007 earnings conference call. (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. Good morning, everyone. Welcome to our second quarter 2007 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. The full disclaimer can be found in the text of our earnings release and you can obtain a copy of that, as well as our releases and SEC filings, by accessing our website, ProvidentNJ.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; and by Chris Martin, our President and Chief Operating Officer to Provident Bank.

Our second quarter earnings results were $0.22 per basic and diluted share, as compared to $0.22 in the matching quarter of 2006. Earning results for this past quarter were impacted by an insurance claim settlement of a fraud loss that was recognized in 2002. This resulted in a recovery, net of tax, of $3.5 million. Partly offsetting this extraordinary item were the First Morris merger integration charges recognized in the quarter.

Our net interest margin for the second quarter held steady in comparison to the trailing quarter at 3.02%. Our earnings remain primarily dependant on our ability to manage interest rate spread, and for the past several quarters the economic and competitive environment have put pressure on those spreads. In response, we have continued to de-leverage our balance sheet and to emphasis the generation of core deposits and commercial loans to mitigate interest rate risk.

Our integration of the First Morris acquisition has proceeded on schedule and according to plan, highlighted by a successful data systems convergence completed at the end of May. This transaction contributed to growth of 8% in total assets, to $6.15 billion, as compared to prior quarter's end. Among the strategic benefits resulting from this acquisition were increases in the proportion of core deposits, total deposits, and in the proportion of commercial and commercial real estate loans to total loans. So you expect to take advantage of the opportunity that the Morris County market offers.

Merger integration activities were largely responsible for increases in our non-interest expenses during the quarter as we welcomed new staff members, operated new retail locations, and made expenditures on the necessary advertising and supplies. When we announced the First Morris transaction, we projected cost savings of 39% from their pre-existing operating expense structure. We believe that this has been achieved. As I have stated in the past, we will continue to review all of our operating areas, as well as our entire retail franchise, to wring out additional efficiencies.

At this point I think it's important to address where Provident stands with regard to asset quality and credit risk. First, regarding subprime loans and related assets, our securities portfolio contains no CDOs, and the collateralized mortgage obligations that we do hold are uniformly AAA-rated. Our loan portfolio does not contain negative amortization ARMs, or interest-only mortgages, nor have we originated or purchased any of the several loan types that recently received adverse attention from the financial market.

As part of our community reinvestment responsibilities, we have for several years offered loan programs for low-income borrowers, and for borrowers with FICO scores of 620 or below. These loans comprise less than 2% of our loan portfolio, have low LTV ratios, and are with few exceptions performing in accordance with their terms.

Second, regarding our loan delinquency ratios, to date we have not witnessed dramatic change from the relatively low delinquency levels we have traditionally experienced. We continue to believe that our conservative underwriting standards, knowledge of our borrowers, and depth of experience in our marketplace, have helped us remain adept at managing ongoing credit risk. We believe that our asset quality metrics bear this out.

On the capital management front, in the second quarter we repurchased 2.5 million shares of our stock, thereby completing our fifth repurchase program. I'm pleased to report that the Board has authorized our sixth repurchase program for approximately 3.2 million shares. In addition, the Board has declared a 10% increase in our quarterly cash dividend, based on confidence in our ability to generate sustainable core earnings results and in the interest of providing increased value to our stockholders.

With that, I'd like to turn it over to Linda who will take us through the financial results in greater detail.

Thank you, Paul. Net income for the quarter ending June 30 was $13.6 million, an increase of $2.8 million, or 26%; compared to $10.8 million for the quarter ended March 31. Basic and diluted earnings per share were $0.22 at June 30, compared to $0.18 in the trailing quarter. Excluding the one-time gains recorded in connection with the insurance settlement and one-time merger related charges, net income was $10.4 million, or $0.17 a share.

The net interest margin held steady at 3.02% for the quarter. Net interest income increased $2.8 million, or 7.4%, to $40 million in the current quarter, compared to $37.3 million in the trailing quarter.

Interest income increased $6.9 million, or 9.8%, and interest expense increased $4.1 million, or 12.6% on a linked quarter basis. The increase in net interest income was primarily result of loans and deposits of $335.7 million and $509 million, respectively, that were acquired from First Morris.

Interest expense on borrowed funds decreased $1 million, or 11.5%, and average borrowed funds decreased $72.7 million in the second quarter. The average yield on interest-earning assets increased 9 basis points to 5.81% for the three months ended June 30. Average earning assets increased $374.4 million from the trailing quarter, as a result of the First Morris acquisition.

The average cost of interest-bearing liability increased 5 basis points to 3.23%, compared to 3.18% at March 31. The average cost of deposits increased 15 basis points and the average cost of borrowed funds decreased 17 basis points.

Average interest bearing deposits increased $458.5 million, to $3.8 billion at June 30, from $3.4 billion at March 31.

Non-interest income increased $6.5 million to $14.2 million during the second quarter, compared to $7.7 million in the trailing quarter. Fee income increased $1.3 million, or 24.2%, to $6.7 million compared to $5.4 million in the trailing quarter. The increase in fee income is attributable to increases of $365,000 in loan related income, $360,000 in deposit fee income, and $200,000 in trust income related primarily to the increase in customer relationships as a result of the First Morris acquisition.

Other income decreased $743,000 to $225,000 during the second quarter, compared to $1 million in the first quarter. The decrease in other income is attributable to $897,000 in interest earned on federal income tax refunds, taxes refunded in connection with the previous acquisition and that we recorded in the first quarter.

Non-interest expense increased $4.8 million, or 16.4%, to $34.1 million compared to the linked quarter. Compensation and benefits expense increased $1.6 million, or 9.9%, to $17.8 million primarily due to the addition of branch and lending staff from First Morris and the addition of small business and middle market relationship managers to support the company's lending and retail banking initiatives.

Increases of $678,000 in advertising expenses, and increases of $427,000 in occupancy expense, were primarily due to the addition of nine branch offices and related advertising in Morris County related to the acquisition.

Data processing expense increased $556,000 during the second quarter to $2.6 million, from $2.1 million at March 31. The increase in data processing expense is primarily related to one-time expenses of $255,000 related to the merger and integration of First Morris's operation.

Other operating expenses increased $1 million, or 24%, to $5.5 million in the second quarter, primarily due to $161,000 in miscellaneous one-time merger related expenses, and increases in printing and stationery expense and debit card expense resulting from additional customer accounts acquired from First Morris.

At June 30, total loans increased $345.3 million, or 9.2%, compared to March 31. Excluding $335.7 million in loans acquired from First Morris, total loans increased $9.6 million. Within the loan categories, and including loans acquired from First Morris, commercial loans increased $152.3 million, or 32%; residential loans increased $63.7 million, or 4%; consumer loans increased $61.8 million, or 10.5%; commercial mortgage loans increased $60.9 million, or 8.2%; and construction loans increased $6.3 million, or 2.4%.

The unfunded loan pipeline increased to $816.5 million at June 30 from $705.5 million at March 31. Commercial and commercial mortgage unfunded commitments increased $30.1 million and $15.4 million, respectively. Consumer and residential mortgage loans unfunded commitments increased $33.5 million and $21.2 million, respectively.

The provision for loan losses was $1.2 million for the quarter ended June 30, compared to $300,000 for the quarter ended March 31. During the second quarter non-performing loans increased $3.5 million to $11.1 million. Included in the non-performing loan category are $1.5 million in loans that were acquired from First Morris that were determined to be impaired and recorded at fair value on the acquisition date. Non-performing residential loans increased $1.4 million in the second quarter.

Non-performing loans as a percentage of total loans increased to 27 basis points at June 30, from 20 basis points at March 31; and the allowance as a percentage of non-performing loans was 332.4% at June 30, compared to 430.3% at March 31. The allowance as a percentage of total loans increased to 89 basis points at the end of the second quarter, from 87 basis points of the end of the trailing quarter.

Now we'd like to open it up for your questions.

Thank you. Ladies and gentlemen, at this time we will be conducting a question and answer session. (Operator instructions) Our first question comes from Mark Fitzgibbon. Please proceed with your question.

Good morning. First, I had a couple questions related to First Morris. Are we likely to see any additional charges in the third quarter related to the deal?

If there are any expenses, Mark, they would be extremely low, below $100,000. We've pretty much captured all the one-time merger-related expenses.

Okay. And then could you just remind us when you expect to have all the cost saves from the deal extracted from First Morris?

By end of year, certainly.

Okay. And then, Linda, could you just share with us kind of your outlook for the margin? Maybe where it was at the end of the second quarter?

Margin was 302% at the second quarter and we expect it to remain steady, possibly a little bit of compression in the third quarter, possibly 2 to 3 basis points.

Okay. And the effective tax rate was a little bit lower this quarter, 28%, is 30% sort of a good run rate?

29% would be a good run rate for the year.

Okay, great. Thank you very much.

You're welcome.

Our next question comes from Roger [Conlin].

Good morning. Since you went public four years ago, many similar companies have already been acquired and taken over for huge premiums. And here we are this morning, four years later, more than 200 million shares have traded of Provident stock in the open market since that time. And now that just about everybody, especially the institutions that bought Provident stock in these secondary markets, now has a loss on their investment. So I think you'll have to go long and far to find some happy shareholders.

Meanwhile, our book value has been given away to other shareholders. We gave away $400 million of book value to First [Engle] shareholders. We gave away $80 million more to First Morris shareholders. Our book value has evaporated from $14 a share down barely $8 a share, and the last acquisition was still mind-boggling to me, to pay somebody three times book in this environment. Do you really think there's anybody out there that's willing to pay us three times book for our stock right now? I really doubt it.

So I would really just like to say that I recently was a large shareholder in Penn Federal. I know how it feels when a company is taken over. Trust me, it's very euphoric. I would have much rather seen that you had sold the company when you had the opportunity for maximum price; now we're stuck with what we have.

So in closing, I would just advise you to -- we're like a little sandwich shop on the Boardwalk down in Atlantic City. Banking is getting international, national; everybody wants to take our lunch. It's really time to go. So I would really advise you to shine this place up and find a buyer.

Thank you very much.

Our next question comes from Collyn Gilbert. Please proceed with your question.

Well after that, I think I'm going to have an oddball question for you guys.

Just following up actually to Mark's question, in terms of kind of the expense level, Linda, could you give a little bit of color as to kind of what you think a baseline of expense we should be looking at on a quarterly basis?

Yeah, absolutely, Collyn. I would expect -- we reported just over $34 million in this quarter; about $32.5 million would be probably a good run rate going forward, and we don't see the one-time expenses flow through, and we continue to focus in operating efficiency.

Okay. And then, just in terms of the margin, just the compression of 2 to 3 bits, is that primarily from competitive pressures on the funding side? What are some of the dynamics there now with First Morris that's going to be driving the margin?

Yeah, that's what we're looking at. We're looking at short-term deposits that are going to be coming up for repricing, as well as competitive pressure and our desire to maintain our market share, not only in the Morris County area, but for our branch networks.

Okay. And in terms of the share repurchase, with another 3.2 million authorized, I would imagine that you guys are going to be just as aggressive this quarter if not more so than you were in the second quarter?

As the opportunity arises, we planning on proceeding with our share repurchase program.

Okay. And when can you start getting back in? Can you get in on Monday?

I think -- Monday, yes.

Okay. Okay, great. Thanks very much.

Our next question comes from Matt Kelley. Please proceed with your question.

Hi, guys. I was wondering if you could talk just about the provisioning expenses going forward. You had a pretty good jump here to $1.2 million. I know some of that is due to the First Morris, but also just a weakening of the overall portfolio modestly. I was wondering if you could just talk about what you're seeing in each of your markets, areas that maybe you're a little bit more concerned about, where you're pulling back, and also quantify your residential construction loan portfolio in the context of where that provision level could go in the coming quarters.

Well, a couple of things. We are seeing a slowdown in general in residential construction. There are pockets of activity with regard to commercial-type construction, small office buildings, strip centers; and we're seeing some steady activity in the commercial lending arena. With regard to the provisions during this quarter, we do an extensive analysis of the allowance, and that determines what our provisions will be based upon the portfolio. Part of it is we've had a pretty good shift to more commercial loans as a percentage of the portfolio, due in part to the First Morris acquisition. So I think we've talked over time as we see our portfolio shift back to more of a commercial weight, our provision would go up accordingly, based on the additional risk.

And we would continue to do that same analysis during the quarter. We're seeing some slowdown in certain activities, but we are not seeing anything unusual or inconsistent with what's going on in the current marketplace.

So you think the $1 million run rate is something that could be repeated?

Again, I hate to make that prediction because it's based on the losses that are inherent in the portfolio when we do our evaluation, and any shift in the mix, any growth; so it's really going to depend on any changes in credit quality, if they become adverse and we're not expecting that, as well as the growth in the continued shift in the mix.

Okay. Would you comment at all just on your watch list credits, how that's proceeding? I know that the NTAs were up, but what's on kind of the 30-day, 60-day watch list pockets? How are those progressing?

Those, really no changes there. The bulk of that, again, as you would expect, because of the size of the portfolio, is in residential, but it's really nothing unusual. They can change from month to month depending on when payments are received. So we are not seeing anything there at all that would give us concern.

Okay. And what's the size of the total residential construction loan portfolio at period-end?

The total portfolio is I believe just over $220 million, but I don't have an exact number for you, Matt. I can certainly provide you that.

Okay. Would that mean the commercial construction line that you're talking about?

Right. That's all construction. And that is residential construction, big projects.

Okay. And one more time, what was the total dollar amount of loans from First Morris that came over, and deposits?

$335.7 million in loans and $509 million, I believe, in deposits. Yeah, $509 million.

Okay. Thank you.

Our next question comes from Rick Weiss.

Actually, Matt got pretty much everything. Just in terms of the big picture though, looks to me like this quarter is kind of a continuation of a tough macro environment, tough yield curve, except asset quality gotten a little worse. Do you guys see any kind of glimmers of light that -- lying ahead that will lead to higher earnings growth?

Well, we've seen an increase in the pipeline in terms of mortgage lending. Obviously, it's a tough environment to try and grow the balance sheet when you're dealing with a flat yield curve, but we are focusing on our small business and middle market initiatives, which typically provides us with a lower cost source of funds, and we're out there in terms of expanding our presence in not only the Morris County area, but some of the other areas where we have a significant branch presence, Middlesex County, Ocean, Monmouth, of course Hudson, and Essex Counties.

Do we anticipate trying to de novo at this time into those areas, to build a presence?

We have a couple of branches lined up between now and year-end into the first quarter of '08; (inaudible), specifically.

(inaudible) Okay, great. And just one I think I missed. What did you say normalized earnings -- you called it, $10.4 million, was that right?

Yes, $10.4 million.

Okay, great. Okay, thank you.

You're welcome.

Our next question comes from James Abbott.

Hi, good morning. I was wondering if you could give us a sense on the small business and middle market initiatives that you just spoke about as to what sort of the typical loan might be there, any industry that you're targeting, or if it's more broad-based, but the typical revenues. And also what the pricing is on the loan product and is it priced off of prime, or are they more -- just kind of give us some color on that if you could.

We've got the small business and middle market areas structured to go out and generally saturate the markets that we're serving and create a lot more awareness as to our product offerings. The small business lending typically is any loan up to about $1.5 million. The middle market would be any company with revenues of between $7.5 and $50 million. There's a broad base right now, recognizing that it's a very competitive landscape for that type of business, so we're focusing on the obvious players within our markets and trying to be very aggressive in that regard.

Thank you. And the pricing on a typical middle market loan, just so we can get a sense as to -- as the portfolio progresses that direction, how we need to think about the loan yields going forward?

This is Chris Martin. It would certainly depend on the company that we're trying to do business with, but Prime based, and then depending on the risk and/or the EBITDA, and/or the debt service coverage, it could be Prime plus. There hasn't been much LIBOR type of financing going on right now. Some of them might be term and fixed, also, certainly is spread over the 10-year on a good company, could be up to $140 million, $150 million over the 10-year.

Okay. And on the Prime based, Chris, are you seeing much -- there are other companies that are seeing Prime minus 50, Prime minus 75 basis points. Are you able to price above that, or are you also subject to that?

You're certainly going to be subject to the competitive pressures in the market. On the other hand, it would have to really be adjusted for any kind of risk that's in there if we're going to go Prime under. And I'm sure there's others that are doing floors on some of those loans also.

So just to clarify one last thing, as I think about this going forward, you're probably holding a line in terms of Prime right now, and in some cases getting a little over Prime, but that's generally where we should be thinking?

Yes. The other side would be on the deposits, that you do get a decent balance that comes in in a non-interest bearing or low cost of funds, you certainly could go to Prime minus at the same time. So you have to look at the relationship, not just the loan.

Okay. Thank you, I appreciate that. And then, also, if you could give us your -- some statistics on -- updated statistics on loan to values and so forth on the construction portfolio. I'm just kind of interested in getting a sense as to where you are there.

Generally about 75%, 70% to 75% LTV.

Okay. And the typical project size?

It's all over the place, depending on the project. Could be from a couple million to $5 million.

Okay. And then last question, and then I'll move on, is what are some of your largest projects? Can you quantify the upper end of the range for us there?

We have some seasoned ones that have been done in the past in the Jersey City and Hoboken that can range from the $15 million to $20 million. We've had a couple that might have been bigger that we might have participated with other lenders at the same time, project specific. I mean, that's really about the depth that we would go. We haven't done many of those lately, for the obvious reasons.

Okay. And any of your construction projects migrate downward in the watch list as far as gradings go this quarter?

There might have been one, one or two, but nothing significant.

Not extensive.

Not the scale. It might have gone from a 3 to a 4.

Okay. Thanks for the time and the thorough examination; I appreciate your patience there.

Thank you.

Your next question comes from Ellen [Kelly]. Please proceed with your question.

My question is for Mr. Pantozzi. Good morning, sir.

Good morning.

When a bank takes over a bank, rather than tell you how to run the bank -- I don't want to do that, but I do have a question. When a bank takes over other banks, how in depth is the analysis of the financials before you proceed to take it over? Because it seems like some people aren't happy with the acquisitions by Provident. Could you share that with me how in depth do you go on the financials to make sure this is a good acquisition for Provident?

We got at extreme length and into extensive depth in reviewing the financials, and that's been part of our discipline for many years. We recognize that you can't please everybody in the marketplace, but we felt very comfortable with the acquisition that we've made. And of course, we use outside investment bankers consulting with us as well. So this isn't something that we do on the back of a napkin.

We've also turned down a number of transactions over the last couple of years that were not within our particular discipline. And we're very happy with the process that we've got in place because it's worked for us time and time again.

Second question, Mr. Pantozzi, I know you're expanding into other market places, especially in the state of New Jersey, but Provident has an extremely strong presence in Hudson County. Do you feel that Provident is still, on the commercial lending side, particularly on the Gold Coast, which would include Weehawken, Jersey City, and Hoboken that we do have -- continue to have a strong presence in the lending area. And also that we are maintaining, has you have done in the past to my knowledge, a strong conservative look at loans so you don't put the bank in jeopardy. Will we still have a strong presence there?

Absolutely. We've got a great brand and market awareness of our product line, and as we've indicated during this call, our credit quality continues to be one of our strong suits.

Thank you, Mr. Pantozzi.

You're very welcome.

Your next question comes from Matt Kelley. Please proceed with your question.

Thank you. Just to follow up on some of those comments there, I mean, have you been pulling back more recently in those kind of Gold Coast markets? I mean, we go over there and take a look and it's just a ton of activity and does seem like it's a little bit overdone, relative to where we are in the real estate cycle. And maybe if you could just comment on that, it's right in your own backyard, and give us some of your thoughts on what you're seeing over there and where that particular submarket might be.

When you talk about the Gold Coast and that particular region, we're typically not involved with the very large projects associated with that market. We have some smaller ones, and to us the market is still very strong. Some statistics recently indicated that there's strong sales in some of those units that are being built. But again, high rise units are not the kind of product that we go after because those type of deals are just not within our risk profile.

Okay. Thank you.

You're welcome.

There are no further questions in the queue at this time. Mr. Pantozzi, I'll turn the floor back over to you.

Well thank you very much for joining us on this call. We look forward to hearing from you. Thank you.

Ladies and gentlemen, this concludes our teleconference. Thank you for your participation. (Operator instructions)