Provident Financial Services Inc (PFS) 2007 Q4 法說會逐字稿

Welcome to the Provident Financial Services fourth quarter 2007 earnings conference call. (OPERATOR INSTRUCTIONS). Please note this conference is being recorded. Now I would like to turn the conference over to Mr. Paul Pantozzi.

Thank you and good morning, everyone. Welcome to our fourth 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 this morning. The full disclaimer can be found in the text of our earnings release, and you can obtain a copy of that, as well as all our releases and SEC filings, by accessing our Web site, 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.

Diluted earnings per share for fourth quarter 2007 was $0.08 as compared to $0.22 reported in fourth quarter 2006. Like the rest of the banking industry, we have had to contend with the turmoil in the capital and credit markets and the deterioration in the overall economy that characterizes the current environment. While we are far from pleased with our earnings for the past quarter, we believe that we have continued to respond appropriately to those challenges, and that our business fundamentals and our ability to manage credit risk have remained solid. There are several moving parts and unique items within our fourth quarter financial performance. We're going to reverse our usual order and have Linda first take you through the results in detail, and then I will follow with some additional commentary.

Thank you, Paul. I'd like to begin with a discussion of our net interest margin, which decreased 13 basis points to 2.84% during the fourth quarter, as compared to 2.97% during the third quarter of 2007. The decrease in the margin was due primarily to an 11 basis point reduction in the yield on interest-earning assets to 5.76%. The decline on average yields in our loan portfolio is the result of decreases in short-term interest rates and the reversal of interest income on nonaccrual loans, which resulted in a 3 basis point decline.

The average yield on real estate secured loans decreased 19 basis points to 5.81 in the fourth quarter, while the average yield on commercial loans decreased 13 basis points to 7.19. The total cost of deposits decreased 6 basis points sequentially, and the total cost of interest-bearing liabilities decreased 1 basis point. For the year, the net interest margin decreased 27 basis points to 2.96% at December 31, 2007, compared to 3.23% in the prior year.

Average yields on interest-earning assets increased 25 basis points, and the average cost of interest-bearing liabilities increased 53 basis points. The average cost of deposits rose 61 basis points year-over-year, and the cost of borrowed funds increased 35 basis points, a reflection of higher-than-expected deposit rates in the New Jersey market.

Turning to the investment portfolio, total investments increased $21.3 million during the fourth quarter. The portfolio consists primarily of agency mortgage-backed securities, and has a weighted average life of 3.9 years and a duration of 3.3 years. During the fourth quarter, $81.2 million in mortgage-backed securities with an average yield of 4.10 were sold and reinvested in agency and AAA mortgage-backed securities with an average life of 4.7 years and an average yield of 5.26%. We estimate that the loss of $972,000 realized on the sale will be earned back in a little over a year, and we project the transaction will be accretive to 2008 earnings by $0.01 a share.

Additionally, a decision was made to reclassify the loss on one of the common stock holdings in the portfolio as other than temporary, based on the decline in market value. A $1 million impairment charge was recorded to reduce this security to its December 31, 2007 carrying value.

Regarding the loan portfolio, our residential construction lending and credit quality continued to be adversely impacted by the implosion of the sub-prime lending industry and the inability of many potential homebuyers to obtain conventional mortgages.

During the quarter, total loans increased $68 million, or 1.6% sequentially. The largest increase in the portfolio was in commercial loans, which increased $58.3 million, or 8.9%. Commercial loans as a percentage of total loans continues to increase, and represented 45.2% of the portfolio at year-end, compared to 41.3% at December 31, 2006.

The growth in the loan portfolio, particularly in the commercial sector, along with the slowdown in sales of residential construction projects, an increase in nonperforming loans and downgrades in risk ratings in the loan portfolio, has led to an increase in the provision and the allowance for loan losses. Net charge-offs during the fourth quarter were $539,000 compared to net recoveries of 137,000 for the same period in 2006. And for the year, net charge-offs were $1 million, compared to net charge-offs of 866,000 in 2006.

The provision for loan losses was $3.7 million in the fourth quarter, compared to $100,000 in the fourth quarter of 2006 and $1.3 million in the third quarter of 2007. The provision for loan losses for the year was $6.5 million, compared to 1.3 million in 2006.

The increase in the provision in the allowance for loan losses when compared to the same period in 2006 is attributable to a year-over-year increase in nonperforming loans, organic loan growth, and an increase in commercial loans acquired from First Morris in the second quarter of 2007.

Total nonperforming assets, consisting of nonperforming loans and foreclosed assets, totaled $35.7 million, or 0.56% of total assets, compared to 11.6 million, or 19 basis points of total assets at September 30. As of year-end, loans past due 30 days were 1.08% of the total loan portfolio, compared to 69 basis points at the end of the third quarter and 42 basis points at December 31, 2006.

On the deposit front, total deposits decreased $49.5 million, or 1.2%, during the fourth quarter. Increases of $62.7 million in demand deposit balances were more than offset by decreases in savings balances of 67.3 million and time deposit balances of 44.8 million.

Looking at other components of income and expense, non-interest income in the fourth quarter decreased $2.5 million, or 31.4%, to $5.5 million from $8.1 million in the third quarter. Fee income decreased $500,000, primarily due to $530,000 in equity fund losses. Fees on deposit accounts increased 110,000, or 3.2%, in the quarter. Losses on security sales and impairment write-downs were $1.9 million in the fourth quarter, compared to a minor gain in the third quarter.

Noninterest expense decreased $1.9 million, or 5.3%, to $33.8 million during the fourth quarter, compared to $35.7 million in the third quarter of 2007. The decrease in noninterest expense was due to a $3.4 million reduction in salaries and benefit expense, to $17.4 million compared to 20.8 million in the third quarter. The reduction in salary and benefit expense is due to a $2.2 million reduction in compensation expense and a $1.2 million reduction in stock-based compensation expense.

Other operating expenses increased $1.1 million, to 6 million in the fourth quarter compared to 4.9 million in the trailing quarter, due to increases in examination fees, printing and stationery expenses, and consulting expense.

Finally, income tax expense decreased 525,000 to 1.6 million in the fourth quarter, compared to $2.1 million in the trailing quarter. The effective tax rate was 24.9% in the fourth quarter, compared to 20.2% in the third quarter. The decrease in income tax expense was attributable to reduced taxable income. The increase in the effective tax rate on a linked-quarter basis was primarily due to the securities impairment charge, which had no tax benefit as a result of its characterization as a capital loss. The effective tax rate for 2007 was 26.5%, compared to 30.2% for 2006.

With that, I'd like to turn it back over to Paul.

Thank you, Linda. I'd like to add some further context to certain of the details in Linda's review, and to offer some insight as to what we see lying ahead in 2008.

We've consistently stated that our strategy involves moving to more of a commercial bank balance sheet and business model. We think we have made good progress toward that goal, as evidenced by a $208.3 million increase in commercial loans, and a $144.6 million increase in commercial real estate and multi-family loans outstanding at year-end 2007, as compared to year-end 2006. This, as Linda noted, resulted in a ratio of loans to commercial borrowers of 45.2% [of the] total portfolio, up from 41.3% at the end of the prior year.

We intend to remain an active commercial lender in our marketplace. In response to market conditions, we have deemphasized our construction lending and concentrated our efforts on generating middle-market and small-business commercial credits. We have no intention of [lowering] our conservative underwriting standards, and we'll continue to be vigilant in our assessments of credit risk during this unsettled economic environment.

Regarding net interest margin, the Fed rate cuts that occurred prior to year-end impacted loan yields. But because of continued intense competition for deposits in our market, repricing of liabilities has not followed suit. We expect competition for deposits to remain intense. And when we take into account the Fed's most recent rate reductions, we don't anticipate expansion in our net interest margin in the near future.

We have continued to maintain a solid capital position, and this has facilitated our ability to pay cash dividends to our stockholders. As the current environment continues to unfold, we will place the highest priority on capital maintenance as a fundamental safeguard against the potential effects of an unsettled economy. Our future stock buyback activities will be assessed accordingly.

Finally, we will continue to assess opportunities for profitable franchise expansion, but we will remain highly selective. In April we completed our acquisition of First Morris, and our retention of the customer relationships we picked up in that transaction has been good, with 98.3% of deposits acquired on our books at year-end. We also exceeded our expectation for cost saves. We had targeted 39% and achieved 42%.

In the fourth quarter we opened an additional de novo branch in Morris County, which is already off to a strong start. We currently have three additional branch projects in various stages of development throughout our market area.

Regarding possible acquisitions, we will continue to review opportunities that make economic sense. But for the foreseeable future, those are apt to be exceedingly rare. We view dilution to our tangible book value as undesirable, unless there is a clear path to earning it back within a reasonable timeframe.

With that, I'd like to open up the call to questions.

(OPERATOR INSTRUCTIONS). Mark Fitzgibbon, Sandler O'Neill.

Actually, this is Alex Twerdahl from Sandler O'Neill. My first question is, you mentioned the downgrades of risk ratings on certain credits. Aside from the four large problem loans, how many other credits were downgraded, and how much of total loans does that represent?

Alex, there was a fair amount of activity in the quarter, but those were the major ones that were downgraded and that had an impact.

Okay. Thank you. My second question is the effective tax rate has jumped around in recent quarters. Can you give us an idea of what the normalized tax rate should be going forward through 2008?

We estimate that our normalized tax rate will be 27%

Thank you very much. That's all for me.

Ross Haberman, The Haberman Fund.

Did you mention your interest rate sensitivity at year-end? And if we do see another cut or two, how do you see that affecting the margin?

Again, near-term, we expect that it may have no real significant effect. We're starting to see deposit rates, or average cost on deposits, come down very slowly. And that's really tied to the competitive marketplace. Whereas rates on our floating-rate assets are repricing almost immediately with changes in prime rates or LIBOR. So, near-term, until we can start seeing time deposits roll down in rate, and depending on where we can go in our marketplace and how rapidly we can respond, we don't see within the first quarter any significant improvement in the margin.

In terms of your specific markets, can you touch upon what sectors, either by category or geographic -- what's good, what's bad? Clearly, refinancing is going to be good. Is the northern part of the market better than the southern, or could you touch upon that in terms of loans and loan demand?

The market itself where we are located in north and central New Jersey is still doing fairly well. We haven't had many issues regarding that, specific areas. There's nothing really that's grown in the markets we're in. I think there's just a general slowdown in the economy that will probably affect how those come out. But housing has been okay, not running off [great guns]. The urban areas and some of the projects we have have still done fairly well, albeit a little bit slower. But we don't see anything dramatic on the horizon.

One final question, if I may. The sale of [Commerce] -- do you see that better for you on the deposit side? And what are you doing, I guess, to take advantage of it?

I think that represents an opportunity for us. Anytime there's significant change or an acquisition in the market, there's usually opportunities for other institutions that have been well placed and stable within those markets to achieve some benefits. We've accelerated our business development efforts in terms of small-business across our markets. So, we feel there will be some opportunities in the coming months. We're seeing some incremental increase in business as we speak.

Do you think you can pick up personnel, customers, or maybe even branches?

We haven't looked that far, but at this point in time we're concentrating on business development. We have a full complement in terms of personnel, so we're not actively looking for a bunch of people.

Thanks. Best of luck.

Steve Moss, Janney Montgomery Scott.

With regard to the loan loss reserve and net charge-offs, what are your expectations going forward?

We really evaluate the portfolio very carefully every quarter, and we spend a lot of time with the lending folks. Right now, we are not seeing anything significant. But that's right now. We assess it on a quarter-by-quarter basis. Our increase in the provision, as we stated in our press release, is due mainly to growth, growth in the commercial sector, as well as some adverse changes in risk ratings, which lead to an increase in your required reserves.

With regard to share repurchases here, you seem to be indicating more hesitancy. Just (inaudible) work through what you're changing thoughts are here, since you still are well capitalized.

Again, we evaluate stock repurchases constantly. They're subject to our internal review, subject to where we think we can get a rate of return where our best use of capital is. However, we are really committed to using our capital to support organic loan growth. That's our business model. We're committed to that. And again, we evaluate it on a monthly, weekly basis.

One last thing. With regard to -- I might have missed this. How much were the equity fund losses during the quarter?

The equity fund losses were 539,000.

Thank you.

Damon DelMonte, KBW.

Linda, with regard to the marketing expense this quarter, do you guys have some sort of initiative going on that would cause it to spike up to 1.6 million?

We have several initiatives related to small-business, as well as our platinum product. And also, fourth quarter is typically a quarter where you see increase in accruals. But we also have an escrow account campaign going on as well.

So we wouldn't expect this level of expenses going forward in that category? Is that correct?

That's correct.

With regard to the $0.01 worth of expenses for the executive separation program, is that broken out anywhere in the release?

Yes it is. It's broken out right in the second paragraph.

I guess better said, is that included right now in the salary and benefit line. So, would you exclude that for (multiple speakers) purposes?

That will not be recurring.

(multiple speakers)

Lastly, with regard to your construction portfolio, can you just give an overview as to kind of how you're seeing the loans performing. Were any of the ones that went [NPA] this quarter related to construction projects?

Yes. There was one. One was related to a construction project; however, that one has a 100% reserve of the estimated loss against it. The bulk of them were in the commercial sector, in commercial mortgage.

And again, with regard to the construction portfolio, how are the projects that the builders are involved in? Have you seen a big slowdown in the builders' ability to turn over the final product, or are you seeing things continue to chug along?

We've seen a slowdown, but sales are continuing. So they're slower than expected, and the projects are taking longer to turn over. And this has been -- we've been seeing this for the past two quarters.

Okay, great.

Some of them might be turning into rental properties as well, as opposed to for sale.

Thank you very much.

(OPERATOR INSTRUCTIONS). It seems we have no further questions.

Thank you very much for your attention and participating in this call. We look forward to next quarter. Thank you.

That does conclude the conference. Thank you for attending. You may now disconnect.