Provident Financial Services Inc (PFS) 2016 Q3 法說會逐字稿

Good morning and welcome to the Provident Financial Services third-quarter 2016 earnings conference call.

(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, Austin. Good morning, ladies and gentlemen. Thank you for joining us this morning. The presenters are third quarter earnings call are Chris Martin, President, Chairman and CEO, and Tom Lyons, our Executive Vice President and Chief Financial Officer.

Before beginning our 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'm pleased to introduce Chris Martin, who will offer his perspective on our third-quarter financial results. Chris?

Thank you, Len, and good morning to everyone on the call. Provident's record earnings of [$22.9 million], and strong EPS results for the quarter of $0.36 versus $0.33 for the same period in 2015, exemplify our consistent performance in extremely competitive conditions. Net interest income achieved record levels again, and strong, measured growth on both sides of the balance sheet continued.

Our loan portfolio grew by an annualized 6.5% for the quarter, as we continued to experience strong origination volume without sacrificing credit structure, accompanied by lower prepayments. Our loan pipeline is skewed toward commercial loans and lines of credit, while our C&I business is experiencing more competition, as many competitors have pivoted from CRE to C&I. As regulatory scrutiny of CRE exposure has impacted our industry, we have seen CRE pricing and deal structures improve. And as we get closer to $10 billion in assets, we will continue our selective approach to loan growth, and have deemphasized lending that has minimal potential for relationship building.

Our deposit growth of 10.2% for the first nine months has supported our organic asset generation and reduced the need for wholesale borrowings. Core deposits represent nearly 90% of total deposits, and our loan to deposit ratio is now at a very comfortable 105%. Average non-interest bearing deposits were up 7% for the year to date. And we're also educating our commercial clients about the benefits of our corporate cash management tools, which rival the money center banks, and further improve and expand our customer relationships.

And as for the Wells Fargo impact, we can confidently state that our sales and service processes are thoroughly vetted, incentive plans are well-designed, and appropriate controls are in place to ensure that our team operates in a manner consistent with our code of conduct which supports a customer needs-first culture.

Net interest margin compression continued at a level that was magnified by excess liquidity garnered from several new deposit relationships that was not completely deployed until the end of the quarter. This excess liquidity accounted for about 3 basis points of the short-term margin compression.

Many, including us, anticipate a Fed [move] in December of 25 basis points, which will not materially impact the Company. We do not anticipate such an increase will have an immediate impact on deposit costs, but will be mindful of competition who have less elasticity in the deposit funding mix, and need to maintain deposit levels to support their liquidity and loan pipelines. We have been originating commercial loans with adjustable rate features and/or shorter duration, which should mitigate increased funding costs associated with an eventual interest rate rise.

Nonetheless, the prognostications for rates staying lower for longer endure. Net interest income is expected to be up modestly next quarter on continued loan growth and investment of the previously noted excess liquidity.

Credit performance remains strong, and given the underlying quality and mix of our loan portfolio, we expect credit quality to remain stable, with provisioning as needed in conjunction with loan growth. Annualized net charge-offs were just 5 basis points of average loans for the quarter, and we're not experiencing any adverse credit trends. With that said, the credit cycle has been in this improving position for an extended time, and we remain vigilant of any signs of weakness.

Costs, including regulatory, compliance, AML and [audit] processes, continue to increase, including preparation for the $10 billion plateau. While we are keeping a tight lid on operating expenses, we are putting some savings back into our mobile and digital platforms with enhancements to our bill pay and cyber security controls for customers. We're focused on improving the connection to our clients for ease-of-use, yet maintaining security and confidentiality that is not obtrusive. Having our efficiency ratio below 60% is extremely important to us, and as Wealth Management as a percentage of fee income increases, and regulatory costs including those associated with the $10 billion hurdle are anticipated, it does take a lot of effort to stay below 60%. Our return on average tangible equity for the quarter was 11.1%, and we have the capital to lever when and if the opportunity presents itself.

With all the challenges the industry is facing, activity on the M&A front continues, and consolidation in the industry will not stop short term. The Wealth Management space is also under pressure, with new DOL rules and registered investment advisors needed to shift their business line approach, which we believe bodes well for opportunities for expanding Beacon Trust. We evaluate any bank and wealth M&A opportunity with the same discipline: accretion to earnings, limited dilution to book value, reasonable earn back, and the quality, culture and talent of the organization on a combined basis.

On the economic front, the local economy in our markets continues to grow at a measured pace, but clients remain somewhat reticent on near-term business prospects, and are still holding off on significant capital expenditures until certainty about tax policy, healthcare costs, and regulatory over-reach abates, and some level of predictability returns. Once the election is over, Washington can attempt to get back to work on fixing the many challenges the US faces. With that, Tom will go over some more of the details.

Thank you, Chris, and good morning, everyone. As Chris noted, our net income for the third quarter was $22.9 million, a 7.3% increase from $21.4 million for the trailing quarter. Earnings per share was $0.36 compared with $0.34 for the trailing quarter.

Revenues increased $1.3 million, with net interest income increasing $1.1 million, as average earning assets increased by $225 million, more than offsetting compression in the net interest margin to 3.05%. A portion of this margin compression was due to excess liquidity held during the quarter, which has been deployed as of quarter end. We anticipate zero to 3 basis points of further compression in the fourth quarter.

Average loans grew at an 8.5% annualized pace, with 6.5% annualized loan growth on a spot basis. Loan growth was driven by CRE, C&I, and construction lending. This growth was funded by a $285 million or 21% annualized increase in average core deposits. Average interest-bearing demand, savings and noninterest demand deposits, all increased during the quarter. Deposit growth during the quarter reflected funding from several new municipal relationships, as well as new and deepening commercial deposit relationships.

Non-interest income was $242,000 greater than in the trailing quarter, as increases in certain less predictable items such as gains on loan sales, swap income, and REO sales more than offset decreases in loan prepayment fees, lower seasonal tax preparation fees at Beacon Trust, a non-recurring gain on the sale of deposits recorded in the trailing quarter, and lower non-deposit investment product sales income. We provided $1 million for loan losses this quarter, a decrease from $1.7 million in the prior quarter, as the impact of further improvements in asset quality mitigated the provision required for portfolio growth.

Net charge-offs were $845,000, or an annualized 5 basis points of average loans. Non-performing loans decreased $3 million from the trailing quarter to $40 million, or 0.58% of total loans. Criticized and classified balances fell to 1.8% of total loans, and total delinquencies declined to 90 basis points. The allowance for loan losses to total loans declined slightly to 89 basis points at September 30, from 90 basis points at June 30. Excluding acquired loans recorded at fair value, the allowance was 0.94% of loans.

Noninterest expense decreased by $47,000 from the trailing quarter to $45.9 million, as decreased Director stock compensation, intangibles amortization, NPA-related expenses, consultant fees, and advertising costs were largely offset by increased incentive accruals, legal and occupancy costs. Income tax expense increase in the trailing quarter to $9.3 million, a result of growth in pretax income. However, our effective tax rate decreased slightly to 28.8% from 29.1%.

We early adopted ASU 2016-09 in the current quarter, reducing tax expense by recognizing current year-to-date tax benefits related to stock-based compensation of $252,000 in the third quarter. We currently project an effective tax rate of approximately 29.5% for the fourth quarter of 2016.

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

(Operator Instructions)

Mark Fitzgibbon, Sandler O'Neill.

This is Nick filling in for Mark. First, you were able to hold the line on expenses this quarter. How are you thinking about expenses in 4Q and into next year?

I think we'll still be about $45 million next quarter, as well.

Secondly, really nice core deposit growth again this quarter. I was wondering if you could talk about deposit pricing in your markets, and how you're able to consistently make headway here.

Certainly has been a mindset that we're doing less transactional business and more relationship building. Our Loan Group has done a great job of going back to our clients, and been able to gather more of that business. In the past, it was more of just get the loan on the books. Now we go back to the relationship with corporate cash management products, and certainly we can compete with the large money center banks with a more customized approach.

We consider everybody's goals and objectives are really -- is about core deposit growth. Everybody works together; both the Retail Team and our Lending Team work hand-in-hand. So I think it really comes back to building our relationships and doing less transactional business.

From a pricing perspective, we've always not been a large player in the CD market, to -- we have approximately 10% in CDs. We don't think the pricing pressure will abate after rates go up. I'm sure there will be competition starting to do some interesting money-market type of transactions. So for the most part, I think it's just our block-and-tackle approach to working with the customer to find out the best solution which has translated into opportunities that have helped our deposit growth.

Great. And then lastly, Chris, I was hoping you could expand on your opening remarks regarding the competitive environment. You mentioned that deal structures and pricing have improved as a result of the regulatory pressures. Are there specific geographies in your footprint that have seen particular improvement, or is it very broad-based?

I would say it's been broad-based, more New Jersey than maybe Pennsylvania, certainly the competition in our markets here have been because of a lot of over-capitalized, converted, and/or people just trying to put money to work. Everybody was kind of giving up on some credit issues that we didn't. The extension of terms was something that we didn't like to see. We've tried to keep the duration shorter.

I think everybody wants the OCC, and everybody starts talking about CRE, everybody took another look at the risk-adjusted rate of returns on those, and said we should be getting paid a little more, and I think the idea of having a portfolio of CRE over 300% for a long period of time has allowed us to develop a great relationship with our regulators that we know how to review and analyze the risk attached to that.

So I think from a pricing perspective, a long-winded way of saying everybody, when the regulators say, do you have a look, everybody kind of comes in on pricing. Tom, if you have anything else on that front?

No.

(Operator Instructions)

Collyn Gilbert, KBW.

This is Chris O'Connell filling in for Collyn. I was just wondering if you guys could expand a little bit more on some of the seasonal changes in the income, and whether you guys expect the strength to continue at these levels?

We had some pluses and minuses in those less predictable items. Prepayment fees were down for us, which was a good thing in terms of earning asset size. It was $445,000 for the current quarter versus $991,000 in the trailing quarter. We saw a nice pick-up in gains in loan sales, about $1.2 million, $1.3 million, versus $384,000 the in the trailing quarter.

A lot of that was SBA loan sales. That pipeline has diminished. I don't think we're going to see that level of gains in Q4. We have a nice pipeline of loans closing, but we're probably not going to be salable into Q1 of 2017, so I expect to see a little decrease in the gain on sales of loans next quarter.

Swap profit was good, and again we have some pipeline there, so that could hold up pretty well for us. We had $544,000 net profit on swaps this quarter, versus $284,000 in the trailing quarter. The other unusual items are things like gains on sales of [REA] was $419,000 this quarter versus $218,000. So those are a little bit more challenging to predict. We have some sales in the pipeline, but there's a lot of things at work there.

Great. It sounded like you would see a pretty neutral effect, at least immediately, assuming a rate hike in December. Could you talk a little bit maybe what the NIM going in and progressing through 2017 would look like, with or without a rate hike?

Either way, we're fairly neutral. I think a rate hike actually helps us a little bit. I know when you look at our disclosures, we show liability sensitivity. We're pretty conservative, I believe, in our deposit-beta modeling, which is probably the primary driver of that. We use a 58% deposit beta in our modeling, but if you want to go to last year's rate hike, I think the actual beta was probably less than 5 basis points.

I don't see a lot of impact from a short -- small increase, if we get one in December, on funding costs here, either. We got a little bit of pickup from LIBOR over the course of this year, as did other folks. I think about 20% of our CRE portfolio is LIBOR-based. So generally speaking, I think it helps us a little bit.

Great. Finally, just any difference or change in your mentality towards crossing $10 billion in terms of cost-building for next year, timing, and I think you might have mentioned organically 2018 before more M&A opportunities?

I think we still the same, in terms of timing on organic basis. We continue to refine our cost estimates. Those have actually come in a little bit. In terms of this year, I think we were giving a higher number before. It's about $250,000, it looks like, for 2016, and about $2 million -- $250,000 for 2016 and $2 million in 2017 expected, in terms of cost for implementation.

Our thought process certainly would be to have the regulators and the legislation looked at a little bit, and I think it's what a lot of the mid-sized banks are trying to speak in Washington about, including a lot of our regulators have agreed that a threshold of $10 billion is a little bit -- a line in the sand that was made under stressful conditions.

We're hoping that some of the pans out, but in between, we're always conscious of that. We don't really hold back on the reins of growth. We're always being prudent pricing-wise and growth-wise that we would always be, and we would not do a deal just to go over, we would do a deal that make sense for the Company.

Great. Thank you, guys. Appreciate it.

Matthew Breese, Piper Jaffray.

I just wanted to touch on the commercial real estate industry, especially in New York City, where there are folks over the concentration. How has it changed, in terms of rates and terms? I was hoping you could provide some specific examples where things have become a bit more rational?

First and foremost, we don't do a lot in the boroughs at all, and we don't utilize most of the broker business, so that being said, from a pricing standpoint, I would think that over the past -- since this has come up from a regular standpoint, rates are up about 25 basis points overall. I think it's rational pricing, I think the deal structure that we have looked at, it's more the people that have been in this business a long time that we have a relationship with, as opposed to growth out -- of people that we don't bank with on a normal basis.

We've looked at multifamily, and certainly in certain markets that we think are not necessarily overheated, but we have enough exposure and/or we see enough that we say we will pull back a little bit, depending on that market, specifically. We follow our borrowers wherever they plan on going, whether it be something in eastern Pennsylvania or towards the main line in Philadelphia, we have no problem following our clients.

Do you foresee any sort of opportunities on the portfolio side, as folks pull back? Will there be any portfolio sales that you could take a look at? Have you seen anything like that?

I have not seen a portfolio coming out at this point, from a CRE standpoint. We're seeing enough growth from where we stand. I think the industrial markets has picked up a bit. We like that area, and so I think we have enough of our own organic appetite, as opposed to buying portfolios. I would think if we were looking at it that way, we would -- look, why wouldn't they be selling the entire company, as opposed to just the portfolios.

Understood. That's all I had. Thank you very much.

This concludes our question-and-answer session, as well as today's conference. We thank you for attending the presentation, and you may now disconnect.