Provident Financial Services Inc (PFS) 2016 Q2 法說會逐字稿

Good morning, welcome to Provident Financial Services second quarter 2016 earnings conference call.

(Operator Instructions)

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, Amy. Good morning, ladies and gentlemen. Thank you for joining us on this fifth Friday in July. The presenters for our second quarter earnings call are Chris Martin, Chairman, President and CEO, and Tom Lyons, Executive Vice President and Chief Financial Officer.

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 has been posted to the Investor Relations page on our website, www.provident.bank.

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

Thank you, Len. Provident produced continued strong operating performance during the quarter with net income of $21.4 million $0.34 per share in the second quarter. Revenues totaled $77.7 million, and our net interest income a record $63.9 million, up $841,000 from the trailing quarter.

Noninterest items contributed to the positive results, and our return on average assets remained at 94 basis points. In addition, I'm pleased to announce that our Board approved a cash dividend of $0.18 per share payable August 31. The net interest margin remained steady at 3.11%, but as with many of our financial institutions in our market, it's getting tougher to maintain the spread amidst the every flattening yield curve and aggressive lending by competitors.

We anticipate that the margin will be down slightly from current levels but likely not more than 3 to 5 basis points over the next two quarters as lower for longer remains in effect. With the 10-year US treasury hovering in the 150s we may see an increase in refinance activity as borrowers seek to lock in longer term fixed rate financing. We will endeavor to swap out the interest rate risk exposure on longer term loans.

While the global markets were in disarray post Brexit, there has been no material impact on our business, and our clients experienced only minimal disruption. New loan production was diversified during the quarter, and the loan pipeline remains strong. We saw strong core deposit growth in the second quarter including non-interest bearing deposit balances.

Average loan growth for the quarter of $85 million was more than fully funded by $231 million of average core deposit growth enhancing our liquidity and helping to preserve our net interest margin. We estimate that loan growth will be in the 4% to 6% range for the balance of 2016, and we just opened a loan production office in King of Prussia, Pennsylvania, and the results are already showing great progress.

Our credit performance continued to strengthen with the provision recorded primarily as a result of loan portfolio growth. With many of our competitors taking on additional credit risk, we remain conservative on the deals we can bank that meet our return thresholds without waiving important covenants or structure.

We are not seeing any new adverse credit trends, just working the remaining problem loans through the laborious foreclosure and collection process. Criticizing classified loans declined $22 million during the quarter, and as a percentage of loans are at pre grade recession levels,

The cost of compliance and regulatory burdens is not ebbing. While our efficiency ratio remained below 60% and better than peers we also view our operating expenses to average assets as a focal measure which is just slightly above 2% for Q2 2016.

With customers using our digital platform more and more we are taking our delivery channels to yet another level to meet the changing desires of commercial and retail customers. As you have come to expect, Provident is constantly reviewing its operations for further cost saves while not cutting corners on compliance or risk assessment.

Our mobile offerings are continuously improving, and acceptance by customers continues to grow. With the $10 billion asset level on the medium term horizon, we have initiated the process of meeting the requirements that threshold entails.

Additional branch consolidations are always under review as leases come due while assuring customer satisfaction remains paramount. We have the capital necessary to support the growth of our balance sheet and our strong cash dividend.

We still have plenty of dry powder with over 3 million shares remaining in the buy back program. Finally, on M&A, while organic is our preferred method for growth, we have a strong capital position to support acquisitions whether it be in bank or wealth management firms.

Our culture and success in fully integrating acquisitions make this a viable and prudent use of capital and is consistent with our ability to leverage our relationship building philosophy with our operating platforms. We always focus on acquisitions that will add markets with strong customer demographics, quality personnel and synergies that come from any combination.

Our expectation is that the challenges of low interest rates in combination with the growing cost of regulatory compliance will make M&A volumes increase throughout our industry in the upcoming 12 to 18 months. With that, Tom will take you into some more details.

Thank you, Chris. Good morning, everyone. As Chris noticed, our net income for the second quarter was $21.4 million, a 1.8% increase from $21million for the trailing quarter. Earnings per share were $0.34 compared with $0.33 for the trailing quarter. Revenues increased $1.7 million with net interest income increasing $841,000 as average earnings assets increased by $142 million and the net interest margin held steady at 3.11%.

Average loans grew at a 5.2% annualized pace with originations accelerating toward the end of quarter resulting in 8.6% annualized loan growth on a spot basis. Loan growth driven by CRE, multifamily and commercial lending. This growth funded by a $231 million or 18% annualized increase in average core deposits. Average interest bearing demands, savings and non-interest bearing deposits all increased during the quarter.

Non-interest income was $806,000 greater than in the trailing quarter as volatile swap income, loan prepayment fees and gains on the sale of REO all improved. We provided $1.7 million for loan losses this quarter, an increase from $1.5 million in the trailing quarter as a result of portfolio growth. Net charge offs were $3 million or annualized 18 basis points of average loans. The net chargeoffs were primarily attributable to one commercial relationship which was largely reserved for in the previous quarter and confirmed as a loss in the current quarter.

Nonperforming loans decreased $7.6 million from the trailing quarter to $43 million or 0.63% of total loans. Criticized and classified loan levels and early stage delinquencies both improved during the quarter, and the portfolio weighted average risk rating remained stable. The allowance for loan losses to total loans declined to 90 basis points at June 30 from 94 basis points at March 31. Excluding acquired loans recorded at fair value, the allowance was 95 basis points of total loans.

Noninterest expense increased by $1 million from the trailing quarter to $45.9 million as improvements in occupancy, compensation and intangibles amortization were more than offset by increased other expenses primarily the stock based portion of annual directors fees and increased nonperforming asset related expenses. Income tax expense increased from the trailing quarter to $8.8 million as a result of growth in pretax income. However, our effective tax rate decreased slightly to 29.1% from 29.4% due to a greater proportion of income being derived from tax exempt sources.

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

The first question is from Mark Fitzgibbon at Sandler O'Neill.

Hey, guys, good morning.

Good morning.

Chris, just to follow-up on one of your comments on M&A, you are, I think, in a pretty good position to be picky because you don't need to do a deal. So, what would you be looking for in a bank acquisition? What would it need to have and what financial metrics would be critically important for you guys to meet and evaluate in a deal?

For the most part, Mark, we would look at end market or contiguous to whether it would be eastern Pennsylvania or north central New Jersey. Besides that we certainly are sensitive to tangible book value dilution earned back. Some of the deals have been a little bit aggressive in that space.

The cost saves would have to be there and certainly the accretiveness necessary that make it worthwhile for us to get involved. I think the other side of that is the cultures and the symmetry of the organizations would really compliment one another. I think that is where we would look at also.

Would it be less than a five-year earn back do you think on tangible book dilution or better than that?

It would have to be at a minimum that or better. We have size constraints obviously. We are at $9.2 billion in assets. So, that -- if we push over the $10 billion by doing a good deal that we think makes sense, it is something we would do.

Size is relative, of course. The small ones take as much time and effort as the larger ones, so I think we look at that space and saying is the balance sheet what we would be looking at? Is it an organic kind of origination of loans, or is it an organization that has good core to deposit growth and opportunities.

Okay. Then changing gears, given the regulatory focus on commercial real estate and the concentration you all have, I'm wondering, is it likely that we will see commercial real estate grow slow in the quarters ahead?

I think we have been at these levels, and it's kind of part of our business that has been there for a long history of Provident. I think we have the risk and the assessment of credits in a manner that the regulators approve and appreciate. The other side of that would be I kind of go where the market goes, and we look at the spreads and returns relative to others.

So, something that we are not going to say we are going to diminish. On the other hand, everybody is taking a step back as the regulators are focusing on that more and more. Tom, do you have any other comments on that?

To further that, obviously our loss history has been pretty exceptional there. So I think we have demonstrated the quality of our internal controls and our underwriting processes. Also, the guidelines that are out there, while we have been over the 300% of total risk based capital for a number of years, our three-year growth rate is below the 50% guideline.

In addition, we don't do any lending in -- really any lending in multifamily space in New York City and the boroughs which is where most of the concerns have been expressed. So, we are comfortable with our growth rate and our capabilities in that area.

I guess just to further the comment that Chris was making about acquisition targets, that is a consideration there as well, concentration is a credit risk in any target that you look at and what their growth rates are, too.

Mark, just finishing up on that, this is Chris, is the idea that we think of commercial real estate as an important part of the balance sheet. On the other hand, we have been in the C&I space for a while. It just doesn't grow as fast as the CRE. We have definitely put an emphasis on that business. We like that business because of its relationship that is really -- helps both sides of the balance sheet.

Furthering that, middle market lending is a very strong pipeline at this point. We have a lot of loans approved pending closing. So we are looking for nice pick up in Q3 on the middle market side of things and C&I lending.

Lastly on expenses, and I apologize if I missed this, but did you give an outlook for expenses in the back half of the year. Are they likely to track pretty close to that $49.9 million you had in Q2.

I think a little lower probably, Mark, in the $45 million to $45.5 million. I am good with about $183 million to $184 million for the full year.

Great, thank you.

Thank you.

The next question is from [Matt Shellsice] with [Benning].

Good morning. Really quickly, looking at your loan to deposit ratio and looking at how you are shifting your funding mix by attracting the right types of deposits, are you comfortable with your loan to deposit ratio where it is? Would you like to get it closer to 100, and what are you doing to attract deposits ex leading with rate?

Certainly, Tom will discuss the loan deposit ratio. We are comfortable where it is. If it's at 1, that is probably the pinnacle of where you want to be. It's always subject to where the market is and where you are making you money.

I would go the other side, which is in the deposit market we have done fairly well with noninterest bearing deposits as Tom alluded to in his comments. We've also been successful in winning some larger municipal deposits, which is a market that we thing we can do well in because it does coincide with a full relationship with the Board of Ed corporate cash management products, services and relationships related to it. So, I think that we can continue to grow that area without being the highest rate payer in the deposit space.

I'm more concerned with preserving margin than any liquidity concerns. I am very comfortable with the loan to deposit ratio. I like our cost of deposits at 27 basis points all in inclusive of the noninterest bearing.

Loans to deposit on an average basis actually came down a little bit this quarter based on that strong growth we saw in the core area. We're about 107% on average, about 122% of core deposits which is another metric that I look at rather than including the time deposit base because I don't really draw much of a distinction between time deposits and wholesale borrowings.

The other thing I'd point out is the capacity we have on the borrowing side, we're only about 17% of assets there. So certainly ample liquidity there, and we have a significant unpledged securities portfolio. There is a lot of sources for us in addition the time deposits to total deposits 88% core. So obviously we could pull in time deposits if we wanted to throw out a rate, but we are trying to manage the margin.

Okay. And then with regard to your LPO in King of Prussia, should we view this as sort of a test run? We could expect to see more of this going forward if this one is successful, or is this probably just a once off and leave it as it is?

Kind of what we look at is trying to meet the market. We've looked at the counties around there and having a few people on the ground was a lot more appropriate than having them work out of a different area. Certainly that helps as we -- we are getting some loan volumes coming in from Philly, the Philly area. We don't think we are going to be running into Philadelphia in the way of putting in branches and the like.

But if customers are there and the ability to meet the needs of the market, we look at the LPO as just an opportunity without opening up large branches. And we will see. Over time, if we see the LPO growing, the commercial business growing in the market, then we might look at augmenting it with a small location at best.

We think it is logical market expansion of the team capital markets that we acquired. We've got it fully staffed at this point. We like the opportunities in the commercial lending side of things down there, too.

Just to note on the team capital loans, we have grown that about 11% since acquisitions last year -- over the last year, the Pennsylvania market loans. We are looking to continue to expand in that area.

Okay. Thank you very much.

Thank you.

The next question is from Collyn Gilbert of KBW.

Thanks, good morning, guys.

Morning.

Just to follow-up on your comments about the King of Prussia LPO, are you guys sort of segregating the Philadelphia market at all in terms of where you want to go or where you see the opportunity? I guess I'm asking for, is there interest or are you seeing business on the other side of the river, on the Jersey side or even southern Jersey. Or are you seeing most of the opportunity and do you anticipate it staying in the Montgomery county, Bucks county region.

I would say it's really more in the Montgomery and that region, not across the river into the Camden, lower area. We don't have anybody there. We don't really see much volume coming from there. Of course if our customers are going down there for some reason, we would follow them. But right now we don't see us going across the river into the markets that are contiguous to Philadelphia.

Chris, tying that in, you indicated that the LPO is kind of a more conservative way before opening branches. What about deals? I know you had said obviously you laid out the criteria for deals. Do you see more deal opportunity in the Philly market than you do up here?

I don't know that we see more. I think in the eastern Pennsylvania area there are a lot of smaller institutions that have little -- have market share in their little -- their demographic. I would think that we are going to look at either -- any of the above, whether it be New Jersey or PA, I don't think that we see anything in the Philadelphia market direct that would be of interest for us. But you never can tell.

Okay. Okay. And then if we could shift to the loan pipeline. Tom you talked a little about this, but the mix, how the mix is shaping up, as we closeout second quarter where the pipeline stands today relative to where it was going into the quarter?

Sure. We are down a bit. I think we are about $1.5 billion at the end of last quarter if I remember correctly, we're down about $1.2 billion. Mix is pretty even between floating and fixed, about 53% floating and 47% fixed rate. Projected close rate would be about a 3.63, so, you can see that margin compression continues to be an issue for us as well as the rest of the industry. New run rates coming in in the high 350s, low 360s.

And then a mix between, say, CRE, multifamily versus C&I.

CRE, I don't have it by percentages, but CRE multifamily 131 -- yes, about $594 million in projected pull through, about $132 million in CRE and [$100] and $300 million in C&I.

That's helpful. Sorry to jump back. To the M&A discussion, obviously as you look through your metric cost saves were something that you mentioned, is there -- what -- I know every bank is going to be different, right, in terms of what the cost saves are you can extract.

Is there a certain percentage that you think you should be able to do almost regardless, just given how you operate your bank and how efficiently you operate your bank relative to the target? Where I am going with this is that some may say normal cost savings 30%. Now in the new era of regulation and such that we could see that bump up to 40% in a traditional sense. Do you guys have a thought on cost saves and deal and if you think you can extract more than the average buyer.

Well, I will -- let's be humble. I think that between 25% and 35% always contingent on the -- where the organization is. If it's in market, there is definitely going to be a little more in the way of cost savings because you will consolidate possibly some branches. If it's outside or a new market you are not going to have that opportunity.

There are some that are putting out these very large cost savings, and God bless them. But I don't know how they will do that, especially with the regulatory environment on branch closures getting a lot more scrutiny also.

So I think we would always look out -- we'd always -- we don't say under promise and over deliver, but I think that we are always able to extract long-term the cost saves. And they come from both sides of an organization, not just the acquisition but it would be a combination in saying what is best to breed and what we can go ahead with going forward.

That's helpful. And then just on the crossing of the $10 billion, so, how are you thinking about that? Maybe if you could -- I think maybe you touched a little bit on this, Tom, in your comments but kind of quantify the expense initiative that you are seeing tied to that this year and then maybe even next year. Then also just remind us, too, what the loss of Durbin will do.

This year is relatively small. We had systems work going in and some hiring that will come later as we progress through the process, but I think it's between $250 million and $350 million budgeted for the full year this year or about $1.25 million quarter for each of the next two years, and once we are fully phased in, and we're estimating if we grow organically that happens in 2020 is the first reporting year. Durbin would be about $3.2 million lost income.

$3.2 million. Tom, internal budgets, you don't have yourselves crossing the $10 billion organically until 2020?

We'll be across in 2018, and the first reporting period is 2020 if I'm thinking (multiple speakers).

Got it. Okay. Okay. I will leave it there. Thanks, guys.

Thank you.

The next question is from Matthew Breeze of Piper Jaffray.

Good morning, guys. Chris, I think you noted -- you were talking about commercial real estate, a lot of your peers are pulling back, and I think that means yourselves. Can you give us some specifics on how you are pulling back, how you are adjusting the dials, some examples of what you have done in the way of tightening the lending standards or stepping away from certain markets, perhaps? Just some more detail there.

Well, I think we look at certainly markets that are -- we are not in the boroughs. When we look at multifamily in the areas across from Manhattan and the like, we are watching how much construction is going on and making sure that the market can absorb some of the multifamily projects. We have also started putting floors on fixed rate deals which we had done a number of years ago and then there was no need.

We are going back to putting floors in place. There is also some very aggressive fixed nonrecourse financing going on in the multifamily and even industrial. So, when you talk about 15 year fixed at 3.90% or 4.25% with non-swapped C&I deals. There's a lot of aggressive lending going on out there, and I'm not saying it is wrong, right or indifferent. It's not something that we feel comfortable with.

I think that we are like normal we have return equity hurdles and we are being more discerning in the deals that we want. And I think that's kind of what we have always done. We are not taking anything off the table necessarily and not stopping CRE growth. It's just a question of making sure it meets the parameters we expect.

Does that also imply that the geographic shift on commercial real estate has gotten from Jersey to Pennsylvania in any way.

There is a little more industrial in both New Jersey and in Pennsylvania, and that seems to be the market that is going pretty well. The office retail market has always been a little slower, and we think it will be there for longer, at least in the office space.

There is still a lot of construction going on in Pennsylvania, and we have followed our customers in the past. But there is a little bit of that in New Jersey, too. I don't think we are looking at one market versus the other being in competition.

Got it. Okay. Going back to M&A, you mentioned both -- you would consider both whole bank and wealth management platforms. As you think about acquisitions of both types, is there any difference in terms of the accretion and dilution math on EPS and book value and then the earn back period, because with a wealth management company you take on goodwill. Is there any difference in the math and metrics that are acceptable.

The earn back is certainly longer on the wealth management acquisitions. Really look more for mid to high teens IRR on those. You get a lower IRR on the bank deals but a shorter earn back. As Chris said earlier, that is less than five years where we would target.

Right. Wealth management is it (multiple speakers) 10 years or 7 years?

It is out there around seven years as Tom alluded to because of the goodwill that's put up. On the other hand, it's a business that we like. It's certainly helps grow earnings and doesn't affect our balance sheet size.

Returns are nice because there is no capital hold against assets.

Got it. How do you feel your opportunities to find one of these platforms?

We think it's getting better. As I mentioned, it's going to continue with the DOL and their new regulations. We think there will be more RIAs available. On the other hand it's a process just like any other. People go in there. There may be shopping. We have to look at it. We have to do some diligence, and then they don't show up, or they don't sell. It's a process that is ongoing. We are always involved, and we are seeing a lot of opportunity. We just haven't found the one that matches up.

That's all I had. I appreciate you taking my questions. Thank you.

Thank you.

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