Provident Financial Services Inc (PFS) 2015 Q3 法說會逐字稿

Good morning and welcome to the Provident Financial Services third quarter earnings conference call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the * key followed by zero.

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 Mr. Leonard Gleason, Investor Relations Officer. Please go ahead.

Thank you, [Carrie]. Good morning ladies and gentlemen. Thank you for joining us on this (inaudible) morning. The presenters for our third quarter earnings call are Chris Martin, Chairman, President and CEO, and Frank Muzio, our Senior Vice President and Chief Accounting Officer, who is pinch hitting for our CFO Tom Lyons, who is unavailable to join us this morning.

Before beginning a 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 has been posted to the investor relations page on our website, providentnj.com.

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

Thanks, Len. And good morning, everyone. Provident's core results were strong with net income of $20.6 million, or $0.33 per share versus $0.30 for the same period in 2014. The quarterly earnings shortfall from the trailing quarter is entirely due to volatile items such as loan prepayment fees, loan level interest rate swap fees, minimal gains on security sales, and lower gains on loan sales, primarily due to lower volume.

Our return on average assets was 93 basis points for the quarter versus 90 from the prior period last year. And return on average tangible equity was 10.93%.

On a year-to-date basis, net interest income totaled $186.1 million versus $175.6 million for the same period in 2014. Net income totaled $62.2 million versus $52.4 million for the nine months ended September 30th, 2014. Return on average assets was 96 basis points versus 89 basis points for the prior year's first nine months.

Net interest margin pressures continued with an additional decrease of four basis points in the quarter to 3.13% as the Fed continues to maintain a zero interest rate policy. Delay by the Fed in raising rates will likely constrain growth in our net interest income, and our net interest margin will remain under pressure as interest rates continue at historical lows.

During the quarter, loan originations were skewed more towards fixed rates than in previous quarters, with no loan level swaps and 61% adjustable rate credits being put on the books versus 77% last quarter. We continue to seek loan swaps for any deals beyond seven years, but competition is offering longer terms and fixed rates. As a result, the average new loan origination rate increased to 3.75% from 3.17% last quarter.

The weighted average yield on the interest earning assets decreased five basis points, while the decline in the weighted average cost of interest bearing liabilities decreased only two basis points.

Our loan growth numbers are encouraging with 8.5% average annualized growth during the quarter. We continue to experience good volume and success in our C&I and asset based lending areas with the addition of several experienced relationship managers.

Our pipeline increased slightly over the trailing quarter and remains at a record level of $1.2 billion. And we have a full complement of lenders in our Pennsylvania markets and are building upon our brand and outreach.

Our 19% annualized growth in non-interest bearing deposits continue to exceed our expectations. Core deposits now represents 87% of total deposits at September 30th, 2015.

Asset quality and credit metrics improved during the quarter with non-performing loans at less than $40 million, down 14% for the quarter and 26% year-to-date.

While Frank will discuss the reduction in non-interest income from the trailing quarter in more detail, the current quarter totaled $12.1 million, which represents an increase of $801,000, or 7.1% from the same quarter in 2014. For the nine months ended September 30th, 2015, we were up $9.6 million from the same period last year.

Non-interest expenses remain well controlled with a decrease of $2.2 million for the quarter versus trailing. Operating expenses to average assets were 1.97% for the quarter, and the efficiency ratio is 58.4%.

We continue to invest in revenue generating personnel and improvements in the systems to support them, while maintaining our personal relationships and credit discipline. And we are constantly reviewing the efficiency and effectiveness of our delivery channels for both the banking and wealth management divisions. Our branch network assessments are ongoing with the repositioning of two of our branches in Pennsylvania to enhance our visibility, while providing improved customer service currently underway.

We hope to deploy Apple iPay to our customers in the first quarter of 2016 after completing exhaustive testing and risk assessment. Controlling costs will be paramount as we build out our risk modeling area to [prepare] for $10 billion in assets.

As a result of the strength of our loan pipeline, our wealth division revenues, credit quality and expense management, our Board of Directors yesterday approved a $0.01 increase in our regular quarterly cash dividend to $0.17 per share. This action reflects our confidence in our ability to maintain and grow earnings per share, regardless of the challenges presented by the interest rate and regulatory environments.

On the M&A front, the whole bank acquisitions and activity have accelerated in our markets, and we balance our acquisition appetite with the requirements of approaching the $10 billion mark, and a need for accretion and improved revenues. Asset management and wealth acquisition opportunities are preferred as they have better IRRs and limited balance sheet impact, but the same diligence and tangible capital earn back disciplines apply here also. Synergies, efficiencies and enhanced product offerings to existing clients will enable us to build a best in breed regional profile for Beacon Trust.

We're also mindful of the new entrants in our markets, and intend to take advantage of any dislocation of customers as they change their product offerings to conform to their data systems and structure, which could potentially lead to customer dissatisfaction.

With that, Frank will go over the numbers in more detail. Frank?

Thank you, Chris. And good morning, everyone. Our net income for the third quarter was $20.6 million compared to $21.8 million for the trailing quarter. Earnings per share were $0.33 compared with $0.35 in the trailing quarter. As Chris discussed earlier, the decline in net income from the trailing quarter was largely due to a reduction in certain non-interest income items that by their nature are difficult to predict, and heavily influenced by customer behavior, especially fees from our loan level swap program, and prepayment fees on loans.

The fundamental activities of the company continue to perform well. Net interest income increased by $873,000 to $52.5 million as the benefits of an $8.5 million annualized increase in average loans outstanding more than offset the six basis point decline in our average loan yield.

The net interest margin declined four basis points to 3.13% while the average yield on earning assets declined five basis points to 3.66%, and the yield on interest bearing liabilities decreased two basis points to 55 basis points.

The cost of deposits was unchanged for the quarter at 25 basis points, and our non-interest bearing deposits increased 19% annualized. They provided $1.4 million for loan losses this quarter compared with $1.1 million in the trailing quarter as the increased allowance requirements for the quarter were primarily a function of loan growth.

Non-performing loans decreased $6.4 million from the trailing quarter to $36.9 million, or 62 basis points to total loan. Total delinquency sales are 94 basis points of loans and the weighted average risk rating of the portfolio remains stable. And charges for the quarter decreased $560,000, or an annualized 4 basis points of average loans compared to 17 basis points in a prior quarter. The allowance of loan loss to total loans decreased to 94 basis points at September 30th from 95 basis points at June 30th. However, the allowance coverage of non-performing loans increased to 153%. Excluding acquired loans recorded at fair value, the allowance is 1.01% of total loans.

Non-interest income declined $4.8 million versus the trailing quarter to $12.1 million. Swap income declined $2.9 million for the quarter, along with a $700,000 decrease in prepayment fees on commercial loans and a $350,000 decline in wealth management fees, attributable to seasonal tax preparation fees that were recorded in the trailing quarter. Also there was (inaudible) gain from security sales and a decrease in gains from the sale of loans in the current quarter.

Non-interest expense decreased $2.5 million versus the trailing quarter to $43.6 million. The decrease in non-interest expense was primarily due to the stock-based portion of annual directors' fees that were expensed in the trailing quarter, lower advertising expense as the company transitions to a new agency, and non-recurring expenses related to the MDE acquisition incurred in the trailing quarter.

Income tax expense was $9 million compared to $9.6 million for the trailing quarter and our effective tax rate decreased slightly to 30.5% from 30.6%. We currently project an effective tax rate of approximately 30.5% for the remainder of 2015.

That concludes our prepared remarks. We'd be happy to respond to your questions.

We will now begin the question and answer session. (Operator instructions). At this time we will pause momentarily to assemble our roster. Our first question comes from Mark Fitzgibbon of Sandler O'Neill. Please go ahead.

Hey, guys. Good morning.

Good morning.

First question is on that other income line. It was a negative $122,000 this quarter. What caused it to be negative? Could you break the items out in that?

Yeah. Basically, Mark, it was a credit valuation adjustment on the swap portfolio.

Okay. And then secondly, it looked like you guys really squeezed expenses in the third quarter and came in below your $45 million run rate guidance. Is it sustainable operating expenses do you think down close to this level?

Mark, we ran that out and looked at where we're going to be projecting going forward. We are looking at probably about $44.5 million on a go forward basis.

Okay. Great. And then your capital continues to build. You're getting close to sort of 9%. Could you share with us, you know, your target longer term and also, you know, maybe what you might do with some of that excess capital? I assume the dividend increase was part of that.

Certainly the dividend increase was a part of that consideration. Absent though what's going on in Washington, regulatory wise obviously regulators love to see more capital. On the back side, we want to make sure we're utilizing it effectively. So I think we will be looking at opportunities certainly to grow our business, which is what we want to do, so that's a primary use of our capital. Payout ratio is at 51%. We don't see them going too much higher but you never know how we're going to return value to shareholders. 9% is a little high from what I would consider. I think 8% and 8.5% in this environment is probably more applicable. So we'll continue to look at that as opportunities present themselves.

And also, I wonder if you could help us think about the margin for the next quarter or two, what your thinking is.

Well, you know where the rates are and where the curve is or isn't. We would look at probably another couple basis points in the fourth quarter and maybe two more in the first quarter absent any kind of, you know, things going on in the market. But I think we level off at that point.

Okay. And then lastly, we've obviously seen some deals recently in your backyard. What do you think is pushing banks to sell? Do you think regulators are becoming more receptive to deals? And do you think PFS is likely to be a [buyer bank] in the coming quarters?

Well, probably can't do anything on the predictive -- on the last comment there. But we certainly have seen what's going on. I think our regulators open -- well, we'll see. Those are two very large deals that were announced and they seemed to be problematic in the past. So it will be interesting to see the timing of those. I think everybody realizes it's getting harder to make a dollar. The costs keep going up from a regulatory standpoint and making sure that we're returning a really good value to shareholders. So I think that all plays into it, which would mean there has been lot more conversation of late than what there had been maybe two years ago. So I think everybody is looking at their budgets and saying this is not going to get any easier no matter what the Fed does.

Thank you.

Thank you.

Our next question comes from Collyn Gilbert of KBW. Please go ahead.

Thanks. Good morning, guys.

Good morning.

I'm going to just follow up with Mark's first question. So the swap adjustment, what was the dollar amount of that?

I think it's a couple hundred thousand dollars.

Okay. And then also what were the prepays? Can you remind us what the prepays were this quarter and what they were last quarter, prepay income?

Well, I'll go back to I guess September of 2014, $983,000. In September they were, of this quarter, it was $636,000.

Okay.

[Back in] June was $1.3 million. So that's really lost about $600,000, $680,000. And obviously the other side of that, Collyn, is that, well, the portfolio gets to grow and we hold on to loans, which I think is probably more important than just getting a prepayment fee.

All right. And that was going to be my next question, too. So Chris, you gave some outlook on the expense levels going forward. Where do you think, you know, recognizing maybe we don't get some of the swap income back or, I don't know, just how you're thinking about that fee line all in going forward.

Well as you know, it comes in in different areas. I think we're going to see a little bit of prepayments in the fourth quarter, a little bit above where we had seen them in the third. And also swaps, I know we have a couple of deals that should close, which will bring that number back up slightly. We don't predict it. The idea of having the swap makes sense for us from an asset liability standpoint. It gets your fee income, on the other hand, if you sold a volume of fixed rate production we had this quarter, it helped our margin a little bit to be sustained.

So putting on swaps is a very low [rate] environment. They don't provide you with the yield but they certainly will be if rates go up. I think we'll see more in the fourth quarter than we certainly did in the third quarter.

Okay. Okay, that's helpful. And then just on the reserve, can you remind us again of what the total, including the credit marks, what your total reserve is? I guess I would have thought maybe you could have -- you were kind of in a position where you could sort of grow into the reserve versus adding to it. Just maybe talk about kind of those two points.

Well, certainly we look at our stress testing and look at our credit marks conservatively yet following GAAP. We did see just the increase was due purely to volume. And so our methodology does not change at all. It is really related to the volume that's going on. Certainly the asset quality has gotten better, but the metrics that we put on really support where we are and we have the dollars put aside.

Okay. Do you have handy what the total marks are? I mean if you think about the total reserve inclusive of the marks on [team].

I don't have that handy. I can get it to you, Collyn.

Okay. Okay. Thanks. And then just on the deposit side, can you -- how do you think about kind of future deposit costs? Do you think you can kind of hold the line in here, and obviously I guess the balance of that would be, you know, continuing to add more on the non-interest bearing side? Or, you know, how do you see that sort of trajectory moving over the next, you know, few quarters or so?

Well I think (inaudible) you've been following a lot of companies and their earnings announcement. It is -- deposit growth has been a challenge for most of the institutions. If they have grown, it's usually due to the municipal side or a special large surrogates type of accounts. The consumer is not really, you know, running to the bank saying I can't wait to get 10 basis points on my asset -- on my savings account. So I think the consumer is kind of, you know not really going to be involved in this.

So do I think we can hold [serve]? I think, you know, we have to defend our market and the people that are out there with the right levels of rates to be able to offer our customers before they get taken by other companies. Albeit that some of the specials that are out there, I think everybody is wise to that. And going from 1% to 1.3% does not move the needle for a lot of customers. They're not going to go shifting their accounts except for hot money.

So deposit growth, we look at our commercial business and what we get in the way of corporate cash management products and certainly the non-interest bearing is coming from that C&I business and certainly the asset based lending group. So we're going to continue to go that route. I'd love to see deposit flow stronger. We're making some headway out in the Pennsylvania markets, albeit slow. Just holding serve and, you know, maintaining our incumbency status for most of our depositors is what we want to do.

Okay. And just on that point too, Chris, like you mentioned in your opening comments, you know, as new competitors come into the market you'll try to ward them off. Can you -- is there any -- do you have any sort of strategy in place to either, you know, take some of the -- and I'm just going to run with [M&T] -- you know is there opportunities from the disruption with (inaudible)? Like just you know kind of what you guys are doing to really try to target some of that customer fall out.

The answer would be yes on both fronts. You know, we don't wish anybody bad things, but obviously we think that we could be in there and offer products that maybe their customers were used to and that's something that we are prepared to do.

Okay. And then my last question, do you want to comment at all on your thoughts on some of the recent M&A that's gone on in the market?

I don't own either --

Opinions, thoughts.

I [won't hold] judgement at all. I mean I think it's just the companies both had the -- the two large ones have had certain issues that I'm sure they had to look at compared to the market expectations. So we will just -- I think we'll just benefit from some of the dislocation that will happen, albeit that most of them aren't in our market specifically.

Okay. So it doesn't change necessarily the way you're thinking about M&A yourself?

No.

Okay. All right, I'll leave it there. Thanks, guys.

Thank you.

Our next question comes from Matthew Kelley of Piper Jaffray. Please go ahead.

Yeah, good morning.

Good morning.

Just going back -- going back to the credit valuation adjustments on the swaps there, what was that related to specifically in terms of an industry or the type of loan we need to make that adjustment from a credit perspective?

It's really just a function of interest rates, Matt.

Oh, okay. Nothing in terms of -- got it.

Nothing.

(Inaudible).

Yeah, there's nothing related to the problems with swap or counterparty or anything of that nature, it's just the interest rate environment.

Okay. All right. Got it. And then what was the AUM balance at the end of the period?

I'm pretty sure it was about the same where we were. We did not lose many clients in the way of assets under management for whatever ones we get. The only thing you probably had was the mark down and it's about $2.4 billion. Certainly the market got hit so everything moves down accordingly. It has since recovered slightly. So if you look at the way the market went down, you know 4% or 5%, it's recovered probably 3% of that already. So it's still in that area, $2.4 billion.

Okay. Got it. And then, Chris, in your travels and sitting down with your customers and your borrowers, you know how would you rate the financial condition of those customers today versus a year ago? I mean is it still getting better or are they facing headwinds in their own sales? What are you hearing from commentary just from your borrowers on the state of the economy there. Maybe just give us a sense of how things are today versus maybe 6 or 12 months ago.

Well, certainly I think that it's stabilized. Some of them are starting to actually spend the money in the plant and equipment, so the CapEx is coming in, albeit in a slow manner. Industry specific certain ones are doing even better. Certainly industrial space is doing fairly well. A couple business in the pharmaceutical side are doing very well. And yet you have some other that are just, you know, getting through. They'd love it to be better. You know, are there vacancies? Nothing traumatic but certainly you're seeing, you know, a couple of clients here and there, just you know struggling to not necessarily make all their numbers, but to maintain. You know, things are slowing slightly in certain markets.

But for the most part I think they're all -- you know everybody harkens back to the day, you know six years ago or something. And guess what? That world is over. I think they're all learning to do more with less and the luxuries that they had back when in the way of a lot of latitude in their volumes have slowed up a little bit. But I think overall our financial wherewithal of our commercial clients is doing very well.

Okay.

Consumer business is certainly still slow, albeit the residential world is picking up, but it's certainly not on the refi area, it's more of a new home purchase or, you know, resale.

Okay. Got it. And then just two other questions in the model here. What was the pipeline yield. It's a number you've given in the past on conference calls. Your $1.2 billion unfunded commitments, what was the yield on that?

That's about 3.47%, of which the fixed is about just under, probably 40%. The variable's about 60%.

Okay. And then last question, just balance sheet composition, earning asset mix. You know, securities balances have been coming down 1% or 2% a quarter. Is that going to continue at the same type of pace as you shift, you know, cash flows from securities into the loan production?

I would say it's going to kind of stabilize, Matt, because of the [fact that] liquidity and all the things related to that, with the regulations, you have to maintain certain items, so we're probably going to have to keep that portfolio in that area, give or take a percent here and there.

Okay.

But it's certainly not going to be running down to 10% or 9% because of (inaudible) liquidity, things you have to put up there. So we'd certainly rather put it out in loans or better return than a mortgage-backed security or a treasury obligation, but for the most part I think we're in that range we stated. The lowest we'd go is about 15%.

Okay. Fair enough. Thank you.

Thank you.

And next we have a follow up from Mark Fitzgibbon of Sandler O'Neill. Please go ahead.

Hey, guys. Just one follow up. What was the swap fees in the quarter? I think it was $2.1 million in the second quarter.

There were no swap fees in the -- Mark, there were no swap fees in the current quarter.

Zero. Okay, great. Thank you.

Okay.

Our next question is a follow up from Collyn Gilbert of KBW. Please go ahead.

Thanks. Sorry, Chris. Just one more. Can you just update us on your thoughts on the $10 billion and, you know, incremental expenses, what you're putting to work. I know you kind of indicated it earlier in your comments, but just sort of quantify that and remind us of the timing in which you think it would be before you cross it.

I certainly think that we're spending a few bucks, certainly we did with systems to make sure that our stress testing can be utilized certainly through our loan portfolio. That has been done. Right now I think if you look at for 2016, between $250,000 and $300,000 would be the cost that we think of more in the way of preparing for, you know, [defast], making sure we have the right modeling in place. And certainly looking at our policies, because you can't just take what you had. You had to move them up and make the fill gap analysis, so we look at a consultant in that regard.

Absent Washington, which I'll be down there this week coming up to talk about legislation that might be able to move that out. I don't hold my breath, but I certainly hope that there's an opportunity and I think the regulators agree that some of the things that are being put on institutions of our size, and even some that are a little bit bigger, are a little bit over the top. But we want to make sure we at least have the voice to, you know, see if we can get some of the regulations modified.

Okay. And any thought on timing? I mean just continue to think about the organic growth base sustaining at this level and then how are you across there?

That would be -- that would definitely be it. Right now we don't put in there and put a deal in there. But again, if it's the right deal for our shareholders, we would -- and it's priced correctly -- we'll go through that. And everybody kind of knows what's going to happen, but that (inaudible). Organically we would not -- we'd model it out. We would not hit that number so the earliest would be 2017 just because of normal cash flow, run off of pipelines, and the portfolios.

Okay. Okay, that's helpful. Thanks.

Thank you.

This concludes our question and answer session. I would now like to turn the conference back over to Christopher Martin for any closing remarks.

Well, we thank you and we look forward to concluding 2015 on a high note. And we'll speak to you again in January. In the meantime, enjoy what's left of the World Series and thank you again for joining us today.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.