Provident Financial Services Inc (PFS) 2010 Q3 法說會逐字稿

Good morning, and welcome to the Provident Financial Services Third Quarter 2010 Earnings Conference Call. (OPERATOR INSTRUCTIONS) Please note, this event is being recorded. I would now like to turn the conference over to Mr. Leonard Gleason, Investor Relations Officer. Sir, please go ahead.

Thank you, B. J., and good morning, everyone. Welcome to the Provident Financial Services, Inc., Third Quarter Earnings Call. Our presenters this morning are Chris Martin, Chairman, President, and CEO; and Tom Lyons, our Senior Vice President and CFO.

Before turning the program over to them to discuss our third quarter results, I would ask that you please take note of our standard caution as to any to any forward-looking statements that may be made during the course of today's review of our financial performance. Our full disclosure and disclaimer can be found in the text of today's earnings release. A copy of that notice and all of our SEC filings may be obtained by accessing the Investor Relations page on our website, www.ProvidentNJ.com, or by calling our Investor Relations Department at 201-915-5344.

With that, it's my pleasure to introduce our Chief Executive Officer, Chris Martin, who will provide the highlights of our third quarter financial results. Chris?

Thank you, Len. Good morning, everyone. Our third quarter operating results continued a steady trend of improved earnings in a difficult environment against a backdrop of high unemployment and underemployment, increased regulation, and a struggling New Jersey economy.

Our earnings totaled $13.5 million, or $0.24 per share, which represented a 55.2% increase in our quarterly earnings from the same period last year.

Margin expansion increased modestly in the third quarter by 2 basis points to 3.50%, with the main driver being reduced funding costs.

During the quarter, we increased our core deposits as a percent of total deposits to approximately 73%, representing an increase of $183.2 million, or 5.4%, from December 31, 2009.

Time deposits declined by $177.8 million, or 11.8%, from the end of '09. Our efforts to expand relationships with CD customers will continue, but we remain focused on building out our community banking model of increased core funding.

The average cost of deposits for the third quarter declined to 1.05%, from 1.13% for the trailing quarter.

Borrowing decreased $51.7 million, or 5.4%, to $904 million during the quarter as excess liquidity was used to pay down some borrowing. We have during the quarter continued to match-fund large CRE and multi-family loans to lock in the spread, thereby extending duration in borrowings to offset deposits that may be subject to repricing if and when rates rise.

Loans increased $17.5 million during the quarter, but decreased $47.6 year-to-date, or 1.1%, despite in-house organic originations totaling $960 million for the nine months ended September 30, 2010. We do not use brokers to originate loans; we cultivate relationships by using our centers of influence, our advisory council, and our relationship managers to generate leads.

The loan mix continues to trend toward commercial loans, but we will continue to meet the needs of our community in term of retail originations in consumer and mortgage lending.

The Company continues to sell the majority of its 30-year originations to the agencies to minimize interest rate risks. Opportunities, although improving slightly, are challenging in our market due to conditions that disqualify potential borrowers due to cash flow issues, active valuations, and equity shortfalls.

We continue to seek out potential customers that meet prudent credit underwriting standards. As evidence, our pipeline continues to grow and our unfunded commitments total $824 million at September 30.

Asset quality still struggles, with nonperforming loans totaling $103.5 million at September 30, 2010. Residential mortgage delinquencies remain an area of concern, as the New Jersey foreclosure process is one of the most difficult in the country.

Avoiding the foreclosure processing issues reported in the media, we maintain all of our loan files and we directly manage all of our foreclosure work. Whenever possible, we attempt to assist our borrowers to minimize the cost to them as well as to the bank. And until the employment picture and/or the real estate values improve in New Jersey and the surrounding areas, this will be an issue we have to deal with for the foreseeable future.

Our provision of $8.6 million during the quarter was, likewise, reflective of the current economy and the increase in nonperformers. Net charge-offs were $1.3 million in the quarter, and the allowance now stands at 1.58% of total loans.

Our operating expenses decreased $1.9 million, or 5.3%, for the quarter, and our efficiency ratio improved to 56.02% for the three months ended September 30, 2010, from 66.74% for the same period in 2009. We will continue to work at further streamlining our operations by utilizing our new technologies and systems to enhance our automated processes.

Tom Lyons will provide you with some additional details on our financial results. Tom?

Thank you, Chris, and good morning, everyone.

Net income for the third quarter of 2010 was $13.5 million, or $0.24 per share, compared to $12.9 million, or $0.23 per share, for the second quarter of 2010. Compared with the trailing quarter, third quarter results benefited from an $894,000 increase in net interest income, driven by reductions in the cost of funds as we continue to emphasis core deposit generation and favorably reprice interest-bearing liabilities.

At September 30, 2010, the ratio of tangible common equity to tangible assets increased to 8.81%. The Company's regulatory capital ratio strengthened further, and the Company and the Bank continue to be well capitalized under current regulatory guidelines.

During the third quarter, total loans increased by another $17.5 million, as net growth in the commercial lending categories outpaced net reductions in retail loans. Commercial mortgage loans, including multi-family loans, increased $48 million, while construction loans decreased $9 million and commercial loans, consisting of middle market and business banking loans, decreased $5 million.

An $18 million decrease in residential mortgage loans during the quarter was partially offset by a $3 million increase in consumer loans, driven by growth in home equity loans and lines.

Total commercial loans, consisting of commercial real estate, construction, and C&I loans, increased to 54.3% of total loans at September 30, compared to 53.8% at June 30.

Nonperforming loans increased to $103.5 million at September 30, 2010, from $93.2 million at June 30. The increase in nonperforming loans was largely due to a $10.6 million increase in nonperforming commercial loans and a $1.1 million increase in nonperforming consumer loans.

The increase in nonperforming commercial loans was primarily attributable to the addition of a $9.7 million relationship with a manufacturing entity which is secured by real estate and business assets and which is current as to principal and interest as of September 30.

Partially offsetting these increases, nonperforming multi-family loans decreased $1.2 million versus the trailing quarter as a result of foreclosures to $62,000 at September 30. In addition, nonperforming construction loans decreased $427,000 compared to the trailing quarter due to repayments.

Provision for loan losses was $8.6 million for the quarter ended September 30, compared with $9 million for the trailing quarter.

Net charge-offs during the third quarter were $1.3 million, compared with net charge-offs of $6.5 million in the trailing quarter.

The allowance for loan losses increased to 1.58% of total loans at September 30, compared to 1.42% at June 30.

Total nonperforming assets, consisting of nonperforming loans and foreclosed assets, totaled $109.2 million, or 1.61% of total assets, at September 30, compared to $97.9 million, or 1.43% of total assets, at June 30.

Nonperforming loans as a percentage of total loans were 2.38% at September 30, compared to 2.15% at June 30.

Total delinquencies increased to $123 million, or 2.82% of the portfolio, at September 30, compared to $106 million, or 2.45% of the loan portfolio, at June 30.

30- to 89-day delinquencies increased to $41.7 million, or 0.96% of loans, at September 30, up from $33.2 million, or 0.77% of loans, at June 30.

The increase in early-stage delinquencies occurred primarily in 30- to 59-days past due residential mortgage loans, which increased $6.8 million versus the trailing quarter. In addition, 30- to 59-day past due consumer loans increased $1.3 million compared to the trailing quarter.

Our net interest margin increased 2 basis points to 3.5% during the quarter, compared to 3.48% in the trailing quarter. The increase in the margin was due primarily to a decrease of 9 basis points in the average cost of interest-bearing liabilities to 1.42% for the third quarter. The average cost of interest-bearing deposits and borrowings decreased 8 and 12 basis points, respectively, compared with the prior quarter.

Despite pressure on earning asset yields attributable to the sustained low rate environment and flattening of the yield curve, the Company projects some continued net interest margin improvement in the fourth quarter of 2010, principally as a result of continued favorable repricing of interest-bearing liabilities and further deployment of excess liquidity.

Our total deposits decreased $2 million during the third quarter of 2010. Time deposits decreased $47 million, while core deposits, consisting of demand deposit accounts and savings accounts, increased $45 million. The Company remains focused on creating and expanding core deposit relationships while strategically permitting the runoff of certain higher-cost single service time deposits. At quarter end, our core deposits as a percentage of total deposits were 72.9%, compared to 71.9% at June 30.

Noninterest income was stable at approximately $8 million in both the third and second quarters of 2010. The income increased slightly compared with the trailing quarter, and the Company's efforts to opt in frequent users of overdraft protection appear to have been successful, as we experienced no reduction in related income as a result of the enactment of Regulation E.

Noninterest expense also remained stable versus the trailing quarter at $34 million, as increases in compensation and benefits expense were largely offset by reductions in advertising expense and intangibles amortization.

The efficiency ratio improved to 56% for the third quarter of 2010, compared with 56.4% in the trailing quarter, and the ratio of annualized operating expenses to average assets improved to 2% for the third quarter from 2.02% in the previous quarter.

The Company recorded income tax expense of $4.7 million for the third quarter of 2010, compared with $4.2 million in the trailing quarter. The Company's effective tax rate increased to 25.9% for the third quarter, compared to 24.7% in the previous quarter, primarily as a result of the nonrecurring increase in tax-exempt income from the benefit paid on the Bank-owned life insurance policy in the prior quarter.

The Company currently projects an effective tax rate of approximately 25% for the balance of 2010 based on current estimates of 2010 taxable income.

And with that, we'd be happy to take your questions.

Thank you. (OPERATOR INSTRUCTIONS) Rick Weiss, Janney.

Good morning.

Good morning.

I was wondering if you could talk a little bit about loan growth. Chris, when would you expect that to resume?

Well, though we're seeing some tepid signs of a little bit more activity, it's still challenging out there. I think until this economy gets a little bit better footing, it's going to be very slow -- I think until the economy gets a little bit more traction. But we're making every effort to get there; I just don't think we're going to have a heck of a lot of things going on. There's not much demand and there's certainly-- a lot of people are still just trying to figure out where sales are going to come from, or their services are going to be utilized by consumers. So we're just trying to-- we're plugging away as much as we can without dropping our credit hat.

Okay. Are you seeing any loan growth from competitors-- or, how's the competition been?

The competition has picked up a bit. The larger institutions, the big banks, have come back into the market, where they were absent for a few years. Pricing pressures certainly are there from like competitors in the community banking space. But competition's always been there, it's just where do you compete -- whether it be on rate, credit, or value of collateral?

Okay, thanks for taking my question.

Thank you.

Steve Moss, Janney Montgomery Scott.

Good morning, guys. Thanks for taking my call.

Morning, Steve.

Just a couple of things here. First, you guys overprovided by quite a bit this quarter relative to charge-offs. How should we think about things? How about coverage in the future quarters?

I think resolution in nonperforming assets is going to continue to be a focus. There's the potential that we could see some additional charge-offs in the fourth quarter. So the provision relative to the charge-offs -- it's something to consider, but really our provisioning is based on the credit quality of the existing balance sheet. A lot depends on risk-grading deterioration or whether things hold up at this point.

Okay. And then, you guys briefly mentioned about deposit costs here. Is there anything that'll prevent you guys from dropping deposit rates much more?

Well, I think there's still some opportunities -- obviously, some CDs that we're either repricing and they're running off or-- certainly borrowings that are coming due in the next few quarters are dropping a good amount, upwards of 200 basis points for borrowing.

So we're using-- we could also get more aggressive on that front, but as we mentioned in our comments, we want to make sure we're positioning the balance sheet for when and if rates are going to get higher. If we can lock in spread by doing match funding with those borrowings, we will continue to do that. So rather than getting shorter, we're trying to be a little bit more structured in our approach.

But Tom, a little bit on the numbers.

Give you some numbers on maturing funding over the next couple of quarters. We have about $367 million maturing in the fourth quarter. The improvement-- roll-over rates would be about 90 basis points. And about $348 million coming off in the first quarter of '11 with a favorable reprice of about 75 basis points.

Okay. And Chris, from your center of influence, what are your thoughts on M&A? We've seen some activity here in the New York market. Is it likely a (inaudible) in New Jersey some time soon?

I think it still has a little time to go. Everybody's trying to figure out what's going to happen on the regulatory front, and the costs that are related to following up with all the new rules, regs, and compliance issues that may come out of the Dodd-Frank bill. That'll take a little time for people to settle in on from a smaller community bank space.

I think there'll be more conversations. But I think we're always looking at the opportunities; on the other hand, we don't think they're going to open the floodgates like some of our investment banker friends would like it to be.

Okay. And if you guys aren't getting much in terms of loan growth here, what are you guys looking on the investment securities side?

I'm sorry -- what was the question?

If you guys aren't getting much in terms of loan growth, what is your appetite on the investment securities side here?

I think you saw some growth over the quarter; I think we're up about $115 million, if I remember correctly, quarter to quarter, primarily agency mortgage-backed securities, low loan balance, relatively short duration, concern about extension in a rising rate environment. I think we've positioned our portfolio pretty conservatively, but it's better than some of the alternatives. So we look forward to good structure and good cash flows, and we'll continue to do that.

Yes, I think on that side that's why we don't have to be as aggressive in the deposit front. Because in this environment, if we don't have the loan demand we don't want to grow the investment book to be as big as it used to be on the balance sheet.

Great; thank you.

Thank you.

Damon DelMonte, KBW.

Hi, good morning guys, how are you?

Morning.

Tom, I think you mentioned that the performance related to Reg E was very strong this quarter; you didn't have much of a drop-off at all in fee income. Do you think that's sustainable going forward? Do you feel that you've, I guess, locked in, or opted in, everybody you need to?

We're going to continue our efforts to pursue to those that we haven't, but I think, given there's some evidence that we've targeted the right people, that the most frequent users have adopted in. And actually September, I think, was our fourth largest month of income for the year, and October to date looks pretty good, too. So things seem to be holding up well.

Okay, great. And then, I think you had mentioned that you expect a favorable trend for the margin in the coming quarter. Could you tell us what the margin was as of the last quarter of the month?

It was 350.

Sorry, the last month of the quarter, I meant. Okay, 350. That was for the month of September, it was 350?

That's correct.

Okay. That's all I have; thank you.

Thank you.

Matthew Kelley, Sterne Agee & Leach.

Hi, guys. I was wondering if you could talk about just kind of yields on CRE and C&I loans during the quarter -- how that compared to 2Q. And then, what you're seeing real time today. Just how things have trended in terms of spreads over an index or that matched funding spread you referenced.

Well, certainly on the matched funding spread, a couple of the things that we've done -- we've actually gotten to 250 to 300 basis points on a couple of the deals. And that's matching up funding at five or 5.5 years on something that has an average life of about the same, from our standpoint.

In the way of spread, the way of the multi-family, you're talking about 250 basis points over the 10-year. Certainly if you're going to the five-year, it's a little bit thinner, at about 125. And the commercial space, you're talking upwards of 250 basis points over the applicable Treasury and the 10-year, and certainly less as you roll down the curve.

All right. So--

Rates are dropping, and kind of we're watching this very carefully. We're getting to a place where we worry about the absolute rate, even though it's spread to Treasury and all those type of items, and LIBOR. We just don't like the absolute level, though, so we're kind of digging our heels in and keeping our floors in place. Certainly competition is doing a little bit different than we would, but there's a certain minimum that we think is-- to be in that business.

Okay. And what about in the C&I arena? What percentage are you able to get floors on those right out of the box, and where are those?

Loan to values, you're talking about?

No, spreads on C&Is.

I think the spread is 75% of the other.

Okay, got you. What about TDRs during the quarter? What were the TDR accruing restructured loans at the quarter end? It looks like $2.8 million at the end of the second quarter.

Yes, it was $2.8 million at the end of the third. We had one additional come on -- I think it was $600,000 at the end of the second. With a $2.1 million restructuring done during the quarter.

Got it.

The rate actually went up versus the previous rate, but we extended the term. The amortization period changed; that loan has been current throughout but the borrower had some cash flow difficulties and we made the accommodation.

Okay. And there's an exposure draft out there on some changes, potentially, on how banks account for TDRs, how they report them. Any thoughts on that?

It could expand, I guess, the number. I think a lot of people, including us, have taken the position that if there's an immaterial modification in the cash flows, it's not reportable to troubled debt restructuring. So there could be some additional loans disclosed.

Okay, got you. And what about the tax rate for '11?

I think around 25% is still our current estimate. We're in the budget process currently, so I can give you more guidance on that maybe next time out. But the 25% seems to be reasonable for us.

Unless you're telling me, Matt, that you know something we don't of what's going on in Washington. The unexpected.

Yes, what would bump it up potentially is earnings improvement. If we're able to get asset quality improvement and generate more taxable income, you'll see that rate bump up.

Got it. All right; thanks, guys.

Thank you.

Collyn Gilbert, Stifel Nicolaus.

Thanks. Good morning, guys.

Good morning.

Chris, could you just talk a little bit about loan growth?

Or lack of? We have, again-- I guess the last three years or so have been treading water. Not that we haven't originated upwards of almost $1 billion in loans every year, but the cash flows coming off of those, and we had a lot of construction loans that were paying down and not troubled. And we still continue to see that. Our portfolio, when they're good quality, they can also refinance elsewhere. So that also accelerates some of the amortization and the cash flows.

But our pipeline's getting a bit better than it had been in the past. If rates stay this low, people have options, the people who are doing good things, so they can go to competitors and price us one versus the other.

Again, as I mentioned in my comments, we don't go to the broker network and we're trying to do all this organically with our own group as opposed to reaching in and buying paper. We could do that and increase loans, but we don't think that increases core relationships or franchise value. We always review that in our budget and strategic plans, but at this stage, we think our pipeline has actually gotten to a good spot and it's getting a little bit better as we've gotten our message out to the market that we are relevant.

Okay, that's helpful. When you talked about competition, perhaps giving up on pricing, or when you kind of were talking about focusing on rate and maybe competition isn't -- is it some of the smaller banks that are being a little more aggressive on competition, or the bigger banks, or people that are trying to break into a business line that they may not already be in?

It's-- more of the larger banks, I think, are trying to make their inroads. So I think they can lead with that, and they can take it on the chin, as opposed to some of the smaller banks. There will be, I think, the mutuals -- specifically in our market -- that are going to jump into that market because the residential mortgage area is flooded and they're not seeing the volume in that area, either.

And I think with the larger banks, again, they're trying to hold on to their relationships that they've had in the past. And we've been able to win some of the-- even though they're at the incumbent bank, people are frustrated because they don't get any phone calls back and a whole different team is in place. So that's helped us win some business.

Okay, that's really helpful. When you had talked about kind of match-funding some of your larger loans, does that indicate that some of the loans that came in in this quarter were of larger size -- of the $17.5 million that you saw? I was just kind of curious what the average loan size was of that. Or if you're trying to go higher in actual loan commitments.

Again, these are specific, and obviously we wouldn't do match funding on loans that are $1 million or $2 million. It wouldn't be efficient for us. Some of these are multi-family deals that we've been able to match-fund that go into the $10 million to $15 million range with, again, the same credit parameters we've used in the past. And with people that we've done business with before. This isn't just somebody off the street. And we continue to see that as very profitable business, and certainly good for the balance sheet, where we're able to lock and load.

We'd love to see more of that business. But I think when the larger competitors have come back in, they're going to try and draw on that first.

Got you. Okay, that's very helpful; thank you.

Thank you.

Jake Civiello, RBC Capital Markets.

Hi, Jake.

Hi, guys; how are you?

Good.

Good. Can you provide us any commentary about the dividend? Do you have a certain payout ratio you intend to target, or have you given any consideration to potentially increasing the dividend?

Well, the Board certainly reviews the numbers and looks at the market, looks at the payout ratio. And I think back when we did our IPO in 2004, we stated about a 40% payout ratio. And as we've looked at it, we evaluate the capital, we evaluate what's going on in Washington, the Basle III. We're being a little prudent in looking at it and watching it, though it's something we'll consider.

We're also considering what may happen in tax policy because if they change that to be taxed at ordinary income rates, we might have some other values to our shareholders. So we will continue to look at it on a quarterly basis with our Board and evaluate accordingly.

Makes sense. Thank you.

Thank you.

Damon DelMonte, KBW.

Hey guys, just a quick follow-up question. Regarding your consumer portfolio, what are you seeing in the of line usage in home equities? Any pick-up there?

A little bit of pick-up; it's about 42%.

It was 41.

That'd be a little. How about in the way of demand for new home equity loans or lines of credit?

It's picked up a little bit and I think what we're seeing is the loan to values are not astronomically outside of our parameters. I think we're comfortable. And in fact, we go back to your last question -- if it went up from 41 to 55 I might be a little concerned at what might be going on. So we like it when it's a little bit incremental as opposed to all at once.

And we've seen some pick-up during the quarter in the first lien home equity products, good LTB -- 40% and change.

Okay, great. Thank you very much.

Mark Fitzgibbon, Sandler O'Neill.

Thank you for taking my question. Chris, I was wondering -- with it being difficult to grow the balance sheet, why not use some of the excess capital to buy back stock?

Certainly, Mark, that's evaluated all the time, to say where's our best use of capital? And being that we've seen the pipeline get a little bit stronger in here and we've got a little bit more direction on where our capital regulations are going to go in the future, we're able to look at that a little bit more objectively than in the past. I think everybody was a little concerned about what capital levels would have to be in the market at that time. So we continue to look at that opportunity.

On the other hand, we think that we have some growth prospects in here that would probably be a better use of that.

At these levels, do you think the stock is attractive?

I don't make that call, necessarily; I let the shareholders make that call. Does it have an IRR that's better than maybe other opportunities? It's at a trade-off right now.

Okay. And then secondly, I was a little surprised -- you guys seem to have a decent amount of construction loans in your pipeline. Given your concerns about the New Jersey economy, does it make a lot of sense to be booking those kinds of loans right now?

Well, these are not necessarily just New Jersey. They're in Pennsylvania -- neighbors of ours that we've lent there before and they are on multi-family projects, for the most part. And these people have been in this business a long time that we've had -- recurring customers.

I guess apartments are going to be where things are going to go, I think, for the next three to five years, and these have done very well in the near past that we've done with those customers in Pennsylvania and in New Jersey. So it's people we're familiar with that have very good balance sheets and aren't over-levered.

And then lastly, based on what you see with the early-stage delinquencies, do you feel like the provision is likely to hover in that sort of $8.5 million range?

Yes, that seems reasonable, Mark. I'm hopeful that things will improve, but we saw some deterioration in risk ratings during the quarter, saw nonperforming tick up, mostly due to that one large loan. But that does impact our coverage ratios, our allocation of the allowance.

Okay, thank you.

Thank you.

Thank you. This concludes our question-and-answer session. I would like to turn the conference back over to our host for any closing remarks.

We thank you for your questions and appreciate your taking time to listen to the results of PFS. We look forward to speaking with you next quarter. Have a great day.

Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.