Provident Financial Services Inc (PFS) 2014 Q4 法說會逐字稿

Good morning and welcome to the Provident Financial Services Incorporated fourth-quarter 2014 earnings release conference call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the conference over to Leonard Gleason, Investor Relations Officer. Please go ahead.

Thank you Gary. Good morning, ladies and gentlemen. Thank you for joining us on this gray January morning. The presenters for our fourth-quarter earnings call are Chris Martin, Chairman, President and CEO, and Tom Lyons, Executive Vice President and CFO.

Before beginning their review of our financial results, we ask that you please take note of our standard caution as to any forward-looking statements that may be made during the course of today's call. Our full disclaimer can be found in the text of this morning's earnings release which may be obtained by accessing the Investor Relations page on our website, ProvidentNJ.com.

Now I'm pleased introduce Chris Martin, who will offer his perspective on our fourth quarter's financial results. Chris?

Thanks Len. Good morning everyone. We appreciate your participation on this call.

Our fourth-quarter results were strong with record levels of net interest income, net income, earnings per share, and asset size, which stands at $8.5 billion at December 31. We had solid loan growth, increased fee income, and tight expense control in the fourth quarter, and as you may have noted in our earnings release, a 6.7% increase in our cash dividend. We also had record core revenue and earnings for the fourth year in a row, and we achieved a 1% return on average assets during the fourth quarter, which is a significant accomplishment given the current interest rate environment.

It was also a very busy quarter at Beacon Trust with the October closing of a small Wealth Management acquisition in Suffolk County, Long Island with approximately $140 million in assets under management, and our year-end announcement of the proposed acquisition of the MDE Group and Acertus Capital Management, an end-market high-performing wealth asset management company located in Morristown, New Jersey, with approximately $1.5 billion in AUM. Combined, pro forma Beacon Trust footings will total $2.5 billion in AUM and we are currently awaiting regulatory approval and anticipate a second-quarter 2015 closing. Acquisitive growth in Wealth Management is an integral part of our strategy to diversify our revenue stream.

Moving back to our fourth-quarter performance, solid results were produced with controlled loan growth of 8% annualized despite some large payoffs and fierce competition. The growth for the quarter was led by multifamily CRE, residential mortgage, and C&I loans. The environment remains challenging, however, as market rates have compressed and so have some of the credit parameters offered by our competition, along with aggressive terms. But markets are improving and our clients' balance sheets support further growth in the future as our loan pipelines remain stout.

Funding for our loan growth has come from increased non-interest-bearing deposits which grew by $184 million in 2014, accompanied increased borrowings to extend duration and mitigate future interest rate risk. Our core deposits represent 86% of total deposits at December 31, 2014.

The margin held up well during the quarter, but with the current flattening in the yield curve, it is likely to come under pressure as asset on rates are reduced and funding costs are near floor.

Noninterest income improved with additional Wealth Management fees, complemented by deposit fees from the Team Capital acquisition.

With regard to expenses, noninterest expense included the remaining transaction costs from Team Capital, and Tom will discuss those further, but be assured that we are working hard to manage our expenses as we build up our risk and analytics area as we approach $10 billion in total assets.

Our efficiency ratio for the quarter on a core basis was 55.7%, and operating expenses to average assets were 1.96% for the same period. Asset quality continued to improve and net charge-offs for the quarter were 19 basis points of average loans. As the New Jersey and Pennsylvania economies improved slightly, so have delinquencies in loan risk ratings. Provision expense of $1.3 million for the quarter was primarily due to the increased loan volume.

Our capital continues to grow with our leverage ratio at 9.21% at December 31, providing us dry powder for organic growth, acquisitions, stock repurchases, or increased cash dividends as we announced at this morning. But we will, as always, stay focused on accretive opportunities that enhance long-term value.

And before I hand it off to Tom, I would like to recognize our staff and management for their efforts in attaining these record results and the positive work of the Provident Bank Foundation which has impacted communities throughout eastern Pennsylvania and New Jersey with over $19 million donated since its inception.

Tom?

Thank you, Chris, and good morning everyone. Our net income for the fourth quarter was $21.2 million compared with $19 million for the trailing quarter. Earnings per share were $0.34 compared with $0.30 for the trailing quarter. Earnings for the fourth quarter were reduced by $384,000 in final costs related to the Team Capital acquisition. Earnings for the trailing quarter were more significantly impacted by costs related to the acquisition and related systems conversion totaling $2.2 million, or $0.04 per share, net of tax.

Net interest income increased by $349,000 compared with the trailing quarter to $63 million as average net loans outstanding increased by an annualized rate of 5%, or $71 million, more than offsetting a 3 basis point decrease in the average yield on loans to 4.27%. The net interest margin benefited 5 basis points for the quarter as a result of the accretion of purchase accounting adjustments.

Average securities balances decreased by $71 million. However, yields increased by 3 basis points versus the trailing quarter as a result of a decrease in premium amortization on mortgage-backed securities. The cost of interest-bearing liabilities decreased 1 basis point as borrowing and deposit costs declined with the combination of these factors resulting in our net interest margin remaining unchanged versus the trailing quarter at 3.3%.

We provided $1.3 million for loan losses this quarter compared with $1.5 million in the prior quarter as asset quality metrics, including weighted average risk ratings and delinquencies, continue to improve.

Nonperforming loans decreased $10 million from the trailing quarter to $54 million or 0.88% of total loans. Net charge-offs for the quarter increased slightly to $2.8 million, or an annualized 19 basis points of average loans. The allowance for loan losses to total loans decreased to 1.01% from 1.06% at September 30. However, the allowance coverage of nonperforming loans increased to 115%.

Noninterest income increased $107,000 compared to the trailing quarter as a reduction in securities gains was more than offset by an increase in gains on loan sales. Noninterest expense decreased $3.5 million versus the trailing quarter to $42.3 million. Compensation and benefit decreased $2.7 million and included $400,000 in final costs related Team Capital transitional employees compared with $922,000 of transitional severance and compensation expense recognized in the trailing quarter. The current quarter reflects cost saves incrementally realized following the May 30 acquisition and Labor Day weekend systems conversion.

An additional $251,000 in transaction costs were included in other noninterest expense categories this quarter, primarily data processing expense, compared with $2.8 million in the trailing quarter. Excluding these acquisition related items, our efficiency ratio was 55.7% and our annualized operating expenses to average assets were 1.96% for the fourth quarter of 2014.

Income tax expense was $10 million compared with $7.9 million for the trailing quarter and our effective tax rate increased to 32% from 29.4%. The increase was primarily a result of a $639,000 write-down of existing deferred tax assets due to the apportionment of income to Pennsylvania stemming from the Team Capital acquisition. We currently project an effective tax rate of 30.5% for 2015.

That concludes our prepared remarks. We would be happy to respond to questions.

(Operator Instructions). Mark Fitzgibbon, Sandler O'Neill.

Hey guys. Good morning. The first question I had is on expenses. Tom, I wondered if you could share with us sort of what you think run rate expenses will look like in the first quarter. Is something similar to the 4Q number likely?

I think a slight increase, Mark, probably $43 million to $44 million. You have the usual increase in payroll taxes and some compensation increase due to annual merit increases in the first quarter, and as well there's a little bit of year-end adjustments around things like incentive accrual that were favorable in Q4 that will be expected to increase a little bit in Q1 of 2015.

And then starting to come back down again in 2Q from synergies as well as lower payroll tax, etc.?

That's correct.

Okay. Secondly, the net interest margin held up a little bit better than you had predicted last quarter. Obviously, we are in a tough yield curve environment. How are you thinking about the margin going forward, excluding the purchase accounting adjustments which I know you detailed for us last quarter?

The purchase accounting adjustments are going to come in a little bit. I think they're going to come down by about 3 basis points attributable to that next quarter. And the rest of it, I think the outperformance was due to a little bit better than expected performance on the funding side. We were able to reprice some borrowings favorably and we were able to hold the line on some deposit pricing although that's becoming more challenging, as Chris noted in his opening remarks. We're starting to see more competitive pricing on deposit products out there and we're probably going to have to start to do something more to defend our market share there. So those are the challenges.

The on rates for new loans are in 9 to 10 basis points if you look at our pipeline. And the new loan originations in Q4 were down about 9 to 10 basis points versus the trailing quarter. So we are looking at some pressure there.

Okay. And then lastly, Chris, you've been saying for a while that pricing on multifamily credits has gotten crazy. So I guess I was surprised that you guys had such strong growth this quarter in multifamily. Has something changed there?

I think our discipline, certainly from a credit standpoint, has been steadfast. We have shortened up on the terms, so it would be like five or seven. We're not going out in 10 year. And if possible, we would do a swap transaction if we are going to do anything over that term. So I guess the fact is that we are not winning anywhere near what we would like to have bid on because of the pricing. There are some good deals out there. Some of them we're just not going to get to. But I think we kind of think of where the returns are. We're not going out too long in the term, and I think being [150] over the treasury is probably where we're going to be at the base.

Thank you.

David Bishop, Drexel Hamilton.

Good morning gentlemen. I'm just curious in terms of what you're seeing in terms of the pipeline, and maybe just the growth this quarter. I don't know if you can sort of ring fence it around sort of legacy Provident versus what you're seeing emanate out of the legacy Team Capital markets.

Pretty consistent in terms of the mix, David, versus the trailing quarter, both within the Provident portfolio as well as the Team Capital.

Okay. And then in terms of the outlook and use of capital, obviously the increase in dividend, how about just in terms of what you're seeing and thoughts on whole bank M&A? Are you seeing more books out there, the quality of books, and then the potential for -- the size of potential acquisitions you're contemplating?

This is Chris. There's not a lot of proliferation of books. I think the future is going to be more of negotiated kind of transactions, not say that we are in any. We would never comment on that. So I think this is more building relationships and putting one and one together, not just throwing the book out there on an auction basis. I think it's going to be more selective than it was in the past. But I think that's kind of what we are seeing. We are not seeing any whole amount of books coming in and the conversations are still -- everybody's assessing this market, the flat field curve, and what is it going to mean for their future. The same with us.

Got it, great. Thank you.

Rick Weiss, Boenning.

Thank you. Good morning. Can you talk about, with the loan growth, how are you going to be funding the loan growth going forward? If deposit pricing is getting competitive, and say your loans to deposit ratio is starting to creep up a bit. Would you be using cash flow, some securities or more borrowings?

Those are both available to us as well as, as you said, having to be a little more competitive on the deposit pricing side of things. Our all-in cost of deposits was 26 basis points for the quarter. It's been one of our strengths and we think we have been rational in improving our deposit pricing, but you have to do what you have to do sometimes to maintain market share. So that's why I said we're going to face some margin pressures along with everyone else. But we do have borrowing capacity certainly. I think we are about 17% assets, 17%, 18% assets now. And we do have stable cash flow in our securities portfolio that are available to fund loan growth also.

In essence, we could shrink the portfolio of investments if we thought that was the best alternative. Certainly, Home Loan Bank and other borrowings, even though that throws the loan-deposit ratio up slightly higher, I think you have to not be tempted to put out really short duration, high price deposits knowing that you're extending out on the duration side on the loans because -- we are not the only ones that are seeing the flat yield curve. Commercial borrowers and even the residentials are saying hey, there might be an opportunity to refi with the rates absolutely as low as they are going. So those conversations are starting to pick up too. So that automatically says compression.

I think the other area in terms of funding that could potentially help us is what we saw over the last couple of quarters is the transition with Team Capital and some run-off of higher cost funds that should slow. And then beyond that, I think we have opportunity to increase our funding -- or deposit gathering capabilities in those new Team Capital Markets as we establish a greater presence. We've just completed a bunch of sales training with people, get our product set more known and spend a little bit on advertising, and hopefully start to draw some more deposits from those markets.

Okay. And I guess as a follow-up, what is the duration of your securities portfolio?

Just under four years, about 3.8 years.

Okay. And my last question, I guess in terms of the deposits, it looks like it's hard to read with Team Capital, but the deposit fees, it looks like it decreased a little bit one quarter. Is that seasonal or is this a trend that's going on in the industry, do you think?

Probably more industry trend than seasonal, I think.

I think people aren't going to be -- again, they overdraft, everything. In the past, people would let them continue to have overdrafts, and that world has tightened up. We never had a problem with it. Regulations have changed and they are looking at it. So we've run always a very clean program with that, but I think everybody has gotten to s realizing that is very expensive to have to cover an overdraft at $35, so I think everybody is managing their assets and their balance sheets a little bit better.

If I could clarify real quick on the investments, the overall is $3.85 million and the AFS is $3.45 million.

Okay. Got it? Thank you.

Collyn Gilbert, KBW.

Thanks. Good morning guys. So Tom, after holding the reserve levels pretty flat throughout most of 2014, they dropped obviously in the fourth quarter. Just curious kind of what facilitated that and then how you're thinking about the reserve levels going forward.

It was really an improvement in asset quality. I think we covered our new loan production appropriately, but we had those improvements in weighted average risk rating delinquencies, some significant resolutions. I think we are down close to 30% in NPLs over the course of the year. So that was really the driver. It's a balance sheet assessment as to what the appropriate level of allowance is.

Going forward, I guess it could come a little bit lower, probably not that much. I kind of think of if you had no credit deterioration and you were just covering new loan productions, it's probably between 90 and 100 basis points.

Okay. So the drop this quarter was kind of reflective perhaps on what you had seen for the year, kind of rightsizing for where you were as you finished off the year more than anything?

Yes, I think we do that each quarter. I think was the pace of resolution in the current quarter that drove that. I mentioned that charge-offs were up a little bit, but those were all considered and provided for. That was kind of common conclusion on some asset resolutions that drove that.

Okay. That's helpful. And then how are you guys thinking about, obviously bringing on the Wells businesses, kind of the trajectory of fee income growth from here? What are your targets there?

I think we've always said we would like it be up a slope and to the right, but getting that number to be about 20% of our income would be something that would be a great goal for us. But we want to make sure, like any of these things that we do, that we get them all put together, everybody works together, get all the systems in place to achieve the efficiencies, so then the model doesn't get taxed and we are also able to absorb more as we move along. So I think it will be a little bit of that, a little pause here to make sure, one, we get it through the regulatory process, but I think our goal would be to get it to be at 20%.

Do you think, Chris, that's something that can happen like in the next 18 to 24 months, or is this more of an aspirational goal?

I might extend it out a little bit longer than that, but our strategic plan would certainly be within a three-year time frame.

Okay, that's helpful. And then just on -- just thinking about you guys crossing the $10 million asset mark and all the planning that you need to do to go into that, when are you, sort of from a budgetary strategic planning standpoint, when are you thinking you guys would cross that level?

From an organic only perspective, it would still be over three years out only because of all the lending we do. The portfolio churns, cash flows come, things move around a little bit. So I think we have predicted we would be very close at the end of year three. And that's without another acquisition that we don't want to ever say no to, but we certainly are cognizant of the changes that will happen and the costs that it would bring to the Company.

We have spent not much in the way of hard dollars, some software we're putting on to look at some stress -- getting ready for DPAS. We brought on a person, we are probably going to bring on a few more to do more of the risk work, which is probably prudent. It doesn't have an immediate return but it certainly allows you to manage your business a little bit better, but we have been doing it well without them. But I think it will be something that will develop over the next couple of years. We're spending the time and effort. That something that's really -- the cost is really the time.

Okay. That's helpful. And then just one final question. Tom, you mentioned that you were seeing kind of coming into this quarter that the on rates of your loans drop 9 to 10 basis points. Is that -- do you think that's reflective of the drop that we have seen in the 10-year, or is that still like a trailing affect? Just trying to -- because a lot of the banks so far has said -- which is shocking to me -- but they haven't really seen a drop yet in the offering rates. So it's interesting to hear that you guys say that you have, so I'm just trying to gauge the timing of that. Is that because your borrowers are reacting more quickly, or is that still sort of a lag effect perhaps of what the executions were back in, say, November, December when loans were being put on?

I think our borrowers are reacting. We have seen some impact from that as well as, again, just the thinness of pricing in the competitive environment driving spreads down further too.

Okay. That's helpful. Great. That's all I had. Thanks guys.

Matthew Kelley, Sterne Agee.

Hi guys. What was the Wealth Management revenue for the quarter and for the year?

For the quarter, it was $2.4 million, and for the year, $9.4 million.

Okay. Got you. And so if we use $9.4 million on $1.5 billion AUM, it's roughly about a 63 basis points ratio there. How is that going to change with the MDE acquisition? Is that going to stay about the same or higher or lower? I'm trying to understand the profitability of that business compared to what you have in place.

I would say the same to slightly higher.

Okay, got you. And then in terms of modeling the impact on capital, is it fair to look at the price paid for Beacon as a decent proxy for cash and goodwill relative to AUM?

A little bit higher than that.

The company, MDE, well, when we did Beacon, it was losing a lot of money, whereas MDE is a very profitable organization.

Okay. Chris, how do you think about the earn-back? In bank M&A conversations, that's the way we talk about the merits of transactions. Talk about committing capital to this business, which diversifies your revenue, but how do you think about capital dilution versus earnings accretions here? How does it compare in your view and the merits of these types of deals versus depository deals?

I think we are looking at -- it's a longer certainly return than a bank deal. We look at bank deals trying to be -- we thought they were going out there when they were four years, and now we are seeing some at five. These are definitely longer, but the returns are somewhat instantaneous. And we're not worried about cost saves necessarily when we do these transactions.

On the other hand, I don't think we're just going to keep being a transaction machine in this. I think we look at it, how does it fit the organization? Can we get our economies out of it? And how to augment, through our lending discipline, private banking that we provide. I think these are things that work throughout our segments of our business.

Obviously what helps to offset -- or to accept a longer earn-back of the book solution is the fact that there's no ongoing capital hold against it, because there's no assets. The assets are customer assets so you (technical difficulty)

Got you. Then a separate subject on cost of funds and deposits. For banks and competitors in your marketplace that have a more pronounced need to raise deposits, what are you seeing for offerings out there for special deposit rates and promotional type activity throughout the New Jersey marketplace from some of your competitors? And what does it take to really raise money in this market?

This is Chris. We are seeing a lot of 1 and 1.25 on the money market, not just community banks, but certainly the regional players, even bigger ones than just people that are in New Jersey, certainly on the East Coast. There's a lot of people chasing the money.

I think it's always the challenge of managing to one ratio being loan to deposits, something that we -- you can't manage it just to 1, but I'm sure it gets to a point where it's very, very -- getting really high that they would want offset that. And it's really tough to think that money is going to be developing a relationship. So we are trying to hold serve as long as possible. As Tom mentioned before in another question, protecting your markets, but there's got to be something else besides just throwing out a high rate that really is a CD.

Yes, got you.

And if we can fund it through borrowings and extend duration and be much less, I will deal with the ratio being a little bit out of kilter for the good reasons of being better prepared if rates -- when and if rates ever go up.

Yes. And then Tom, just for clarification in the model, what was the dollar amount of accretable yield income in the quarter that we should recognize?

It was a 5 basis point impact on the margin, is that what you said?

That's correct.

Okay, got it.

I think it was 4 and change if I met remember the number correctly.

Great, thank you.

David Bishop, Drexel Hamilton.

Just a couple of follow-up questions. In terms of the low level interest rate swap transaction, the income from that this quarter, to the extent that the pricing environment is getting a little bit more competitive there, is that something that could remain elevated in terms of those types of transactions remaining a little bit more elevated in this pricing environment?

Yes, I think where rates are and where customers are looking, especially some of our customers that are smaller loan balances and, the sophistication of getting into a swap really would not be worth their time and/or energy. But I think it will be a little bit less going forward. And that's kind of what we looked back as doing. I Think our mix has been pretty much 50-50 between fixed rate and variable in production. And sometimes the borrower says I would rather just go variable and don't worry about a swap.

Got it. And maybe just some commentary, I noted, on the pricing side, things are getting very competitive. But in terms of the irrationality, any sort of examples you can give in terms of structure, what you're seeing out there that you're stepping away from maybe on the multifamily commercial real estate? What are you seeing in terms of that competitive environment aside from pricing?

Well, we are certainly seeing in the multifamily space, and, again, ours is organic, we are not using brokers, so my reference is really on the fact that we are in New Jersey, we are not doing projects in the boroughs. But we've seen some very, very tight deals in the way of 10-year fixed and probably only about 140 over the curve. There have been some very aggressive cap rates, and I think that's the concern that we would have.

On the other hand, in the commercial world, we are seeing people do things at 150 over treasury to 160, and these may be one-offs. So we are not saying that that's the market. We've also seen construction lending pick up, and that's been at LIBOR plus a spread of usually about 250 to 300 and we are seeing some people getting into the low, even to 200 over LIBOR.

In the C&I world, I would think we look at a 4% rated credit, which is a good credit for us, 3 3/4%, and then some of them you get maybe prime plus 1/2 half to 3/4. There have been people that are doing things at prime minus, and that's kind of where we take a step back.

Thank you guys.

This concludes our question-and-answer session and the conference call. Thank you for attending today's presentation. You may now disconnect.