Provident Financial Services Inc (PFS) 2016 Q4 法說會逐字稿

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

(Operator Instructions)

Please also note that this event is being recorded.

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

Thank you, Andrea. Good morning, ladies and gentlemen. Thank you for joining us on this last Friday in January. The presenters for our fourth quarter's earnings call are Chris Martin, Chairman, President and CEO, and Tom Lyons our 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, it's my pleasure to introduce Chris Martin who will offer his perspective on our fourth-quarter's financial results. Chris?

Thank you, Len, and good morning, everyone. Provident again had strong earnings for the quarter of $22.6 million, or $0.35 per diluted share exceeding our results from the same period in 2015. Total revenue and net interest income both achieved record levels, and balance sheet growth continued as our total assets reached $9.5 billion.

Our loan portfolio grew by an annualized 7% during the quarter, CRE loans grew at 13% annualized pace with originations concentrated in retail at 43%, multi-family at 21%, office at 18%, and industrial at 7%. C&I volumes grew by an annualized 20% with originations primarily in the construction industry, hospitality, wholesale trade, and rental real estate categories.

And on the CRE front we remain comfortable with our levels versus the regulatory guidelines, and pricing has improved as competitors have chosen to slow CRE growth and have adjusted their aggressive pricing and credit terms accordingly. For 2017 we expect more of the same growth in lending, mid-single digits with a 50-50 blend of fixed and variable interest rates. And with interest rates expected to rise we anticipate the level of prepayments will decline and refinancing should slow.

Our deposit growth of 10.6% for the year provided the funding for our loan growth and the result and reduction in our wholesale borrowings. Core deposits represented 90% of total deposits, and our loan to deposit ratio was 106.9% at December 31, 2016. The composition of deposits was approximately 26% commercial, 59% consumer, and 15% municipal bond deposits at December 31, 2016.

Non-interest-bearing deposits grew nicely again in the fourth quarter, totalling 21% of total deposits at year-end. And while we model deposit behaviors conservatively in estimating our interest rate risk, we believe we have high-quality deposit base which should prove less interest-rate sensitive than many of our peers in a rising rate environment. With expectations for a steeper yield curve, we expect the NIM to expend modestly in 2017 as the short duration of our investment portfolio should continue to provide reinvestment opportunities at improved returns.

Credit quality further improved in 2016. Our charge-offs were negligible in the quarter, and credit metrics remain stable. Loan-loss provisions during the quarter were primarily due to loan growth, and the process to validate our allowance is thorough and extensive.

And we continue to manage our business to generate positive operating leverage that produces a return on tangible common equity of 10% to 12% and a return on average assets of 90 to 100 basis points. As we would stand to increase costs including regulatory compliance and additional expenses related to preparing for $10 billion in assets, we remain vigilant about expense management and leave no process or efficiency initiatives on the tables.

With compensation employee benefit costs representing 58% of our operating expenses, we are ever mindful of rightsizing our FTE levels without sacrificing customer relationships and compliance and reducing non-revenue producing personnel with technologies where appropriate while providing incentives that support our pay for performance culture.

With the increased acceptance and use of our multiple digital channels, we continue to see efficiencies from our customers who prefer to self serve. Our technology spend includes more mobile applications, people pay, Apple Pay, and YouShield where the customer can customize their debit card security parameters.

And while we continue to broaden our digital delivery channels, we are consolidating to branch locations in the first quarter of 2017, as part of our ongoing branch rationalization. And we have upgraded our asset liability model to prepare for DFAS and further strengthening our forecasting capabilities.

Our capital levels are strong and the excess capital affords us the flexibility to grow our core business and return capital to our stockholders in the form of cash dividends. On that score, our Board of Directors declared an increase in the quarterly cash dividend to $0.19 per share from $0.18, which represents an increase of 5.6% and an approximate yield of 2.7%. And our dividend payout ratio remains around 50%.

On the outlook after the surprising results of the election in November, there appears to be a very optimistic tone to the market and in our conversations with clients, yet one must be mindful that at least 50% of the country is not pleased. Knowledge of that will likely temper any rapid change in regulations or reforms of Dodd-Frank and with tax policy, repeal of the Affordable Care Act, and infrastructure spending legislation on the agenda, we think that regulatory reform will take a backseat until the second half of 2017 at the earliest.

As we do not see Provident going over $10 billion in assets until mid-2018, we will continue to pursue changes in Washington to roll back as much of Dodd-Frank as possible. But the tenor of the business community has vastly improved, the employment picture has brightened, and collectively these considerations should result in increased economic growth and opportunities for the future.

Finally, in my comments on M&A, the world is moving quickly and the value of branches in combination with digital technologies needs to be evaluated differently than in the past. Seller expectations have increased as financial stocks have rallied an average of over 25% since the election, making deals less appealing and accretive. We see opportunities that are more actionable in the wealth management space.

And as there are no new banks being formed, and the barriers to entry remain severe, consolidation should continue in the industry. With that, Tom will go over some of the details. Tom?

Thank you, Chris, and good morning everyone. As Chris noted our net income for the quarter was $22.6 million, compared with $22.9 million for the trailing quarter. Earnings-per-share were $0.35 compared with $0.36 for the trailing quarter. Revenues increased $2.1 million, with net income increasing $1.6 million as average earning assets increased by $129 million and the net interest margin expanded two basis points to 3.07%.

The margin benefited from favorable repricing of variable-rate assets and the deployment of excess liquidity held during the trailing quarter. Average loans grew to 7.25% annualized pace, with 6.6% annualized growth on a spot basis. Loan growth was driven by CRE and C&I lending. This growth was funded by a $193 million or 13% analyzed increase in average core deposits.

Average interest-bearing demand, non-interest bearing and savings deposits all increased during the quarter. Noninterest income was $419,000 greater than in the trailing quarter, as a favorable CVA adjustment related to swap loads resulting from rising interest rates and increased loan fees and wealth management income more than offset reductions and gains on sales of loans and REO.

We provided $1.2 million for loan losses this quarter, an increase from $1 million in the prior quarter as the result of growth in the loan portfolio. Asset quality metrics were stable versus the trailing quarter, with nonperforming assets to total assets, outperforming assets to loans in REO, 30 to 89 day delinquencies to loans, total delinquency to loans, annualized net charge offs for the quarter as a percentage of average loans, and the weighted average risk rating of the portfolio, all equal to or better than similar metrics at September 30, 2016.

Partially offsetting these positive factors, nonperforming loans increased $2.4 million to 0.61% of loans, up from 0.58% last quarter and criticized and classified loans increased $12 million to 1.99% of loans, from 1.85% last quarter. The allowance for loan losses to total loans declined slightly to 88 basis points at December 31, from 89 at September 30. Excluding acquired loans recorded at fair value, the allowance was 0.93% of loans.

Noninterest expense increased by $1.3 million in the trailing quarter to $47.2 million, primarily due to increased incentive accruals and stock compensation expense resulting from an increase in our stock price. Income tax expense increased from the trailing quarter to $10.2 million and our effective tax rate increased to 31.1% from 28.8%.

We early adopted ASU 2016-09 in the trailing quarter, reducing third-quarter tax expense by recognizing benefits related to stock-based compensation of $158,000. We currently project an effective tax rate of approximately 29.75% for 2017.

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

(Operator Instructions)

Mark Fitzgibbon, Sandler O'Neill.

Hey guys, good morning.

Good morning.

Tom, I wonder how much of the acceleration of the purchase credit impaired loans impact the margin this quarter?

Two basis points this quarter, Mark, and one basis point in the trailing quarter.

Okay. And then secondly, it looked like in the average balance sheet, the average yield on consumer loans went down a lot, like 22 basis points from the third quarter. Just curious why was that?

I think that PCI credit was mostly in that category.

It was, okay. And then how are you thinking about the trajectory of the margin? I know you said you expected for the year to be up modestly, and what are you assuming in that one rate hike, two rate hikes, what assumptions do you use?

We have three rate hikes projected over the year June, September, and December of next year. So I guess really only two on an effective basis. We see modest improvement as Chris noted, pretty much stable -- on a stable basis throughout the year. I think we are looking at 308 to 309 for first quarter.

Okay.

And about 32% of loans are floating rate at this point and a little over 60% are variable rates, so we have some nice repricing characteristics.

Okay, great. And then the pipeline, it looked like was up a lot, almost up by a third. What's driving that? Is there anything unique? Are you guys being more proactive? Or are competitors pulling back in the marketplace? Or something else?

I think we got our team in place, we're seeing a little bit of growth in our Pennsylvania through the team capital initiative really hitting its stride when we opened up that LPO in Wayne, Pennsylvania, we have seen some nice gains in that space. And I think, all categories are up, maybe it's just we're meeting the market, we're certainly not giving away and we're trying to hold to our ROE targets.

And the other encouraging thing on the pipeline, Mark, is the rate is up about 38 basis points versus the pipeline at the end of September, so we've got a 392 pipeline rate recurrently.

Okay, and then lastly, it looks like your commercial real estate to risk-based capital ratio is a little above 400%. Where are you comfortable taking that up to?

We are expecting around 450%, at the end of the year. I would still be comfortable up in the 480% kind of range. We've talked with regulators, we are a very good commercial real estate lender. We have appropriate controls in place, and we have been able to make them comfortable with our position.

Thank you.

Thank you.

Collyn Gilbert, KBW.

Thanks, good morning, guys.

Good morning.

Just around the topic of the $10 billion mark, Chris, I know you had indicated that you intend to perhaps hit it in the middle of 2018. Will that just -- you'll cross it organically and absorb the cost if necessary? Or how are you sort of seeing that unfold?

Then, tying to that too, I just want to get an understanding of the necessary expenses. I think you guys had said that maybe an incremental $200 million of OpEx to prepare for that. Wondering how much of that is in the run rate and how you see that trending as well.

I will let Tom speak to some of the numbers, Collyn. But I think we look at, probably it's right at the end of the first quarter that we would probably go through that. Which would mean we probably wouldn't do it until April 1, for all the reasons that the core report and everything that kicks in when it's effective.

I think we're just going to be, we're prudent. Our growth targets that we'll always use and our credit discipline would make the balance sheet get those numbers by that time frame. I don't think that we're going to be -- if we go through it organically it is what it is, we can't really change what's going on.

Obviously our conversations in Washington, there's certainly removing bright line tests of $10 billion and the $50 billion being moved out, which would be helpful. There will always be some kind of cost that we probably will not be able to avoid, such as the Durbin amendment, unless there's a lot of change in Washington on that, Tom will go through those numbers.

I think it's just the cost of doing business. If we had an acquisition that was accretive and made sense to our organization and shareholders on the go-forward basis we would do that anyway. So I don't think that really changes our philosophy to a agree. Tom, maybe you'd like to go over some of the numbers?

Just on the expense, Collyn, for the current year we had hard costs of about $115,000 in 2016 as well as a lot of soft costs in terms of time spent in evaluating and preparing. Hard costs for 2017 are projected about $1.6 million.

Okay.

So, the modeling, on a model risk management and salary labor costs.

Okay, and that is folding into -- and if you covered this, Tom, in your intro, I apologize -- but the OpEx I think came in a little bit higher than perhaps what you guys were guiding to at the end of Q3, was that -- were there unusual items in there, or was that just part of kind of the embedded costs that you will need to prepare for this?

Mostly the Q4 2016 expense was really stock-based compensation went up because of the increase in the stock. And then the year-end extend accruals a little boost greater than what we anticipated when we closed Q3 because of performance.

Do have specific numbers on the stock-based comp component of that?

Went up to -- the change was $566,000, the increase quarter-over-quarter related to stock-based comp.

Okay, that's helpful. And then in terms of the, on the C-side, and again if you covered this I apologize. What was the breakdown of the swap in prepayment income in the quarter?

Sure, prepayment income was $344,000 greater than the trailing quarter. It was $789,000 versus $445,000. Net swap profit was $1.6 million compared with $544,000 million, so a $1.1 million increase. And the bulk of that was in the CDA adjustment, which was about $1.4 million, positive.

Okay. That's helpful. And then just, I know purchases have become less of the loan growth trajectory here. Any update on how you're seeing loan purchases or appetite for those as you guys go forward?

We had good origination activity. Sorry, Chris, I didn't mean to step on you there. Pretty limited appetite because we've been able to grow with organic originations at a pace that we're comfortable with I think.

Yes, we're not doing it -- certainly in the past we did a lot more one-to-four family purchase loans type of things. Syndicated credits, we're not doing much of those unless they're relationship driven. So I think that's kind of where we are.

Okay. And then just final question on the NIM, Tom, did I hear you correctly in saying that part of the NIM pickup is going to come just from better investment yields on the security side? Is the anticipation?

That was certainly true this quarter, if you saw the increase in the securities yield. We think we're going to see slower prepayments, if we get rate rises some premium amortization will come down, and then of course if we do again get rate rises, and we have seen some, the reinvestment rates are better, too. Is the potential to shift to fund more loan growth out of investments as well.

We've talked about loans and deposit ratio, and I know that would go up if you do that, that shift in mix. But on an average basis we are down to about 104%. I like to look at the average as well as the spot. And the coverage of loans to deposits from core deposits is about 116%.

Okay. So should we not expect additional leverage? Or seeing that securities portfolio increase given where your capital position is? It seems like you've got some flexibility there, but how are you thinking about that strategically?

We think the proximity to $10 billion limit our willingness to put on leverage as well, unless we get a significant steepening of the curve that makes it so attractive.

Okay. Okay, that's great I will leave it there. Thank you.

Thank you.

Matthew Breeze, Piper Jaffray.

Good morning, everybody.

Morning.

Just on the margin outlook really quick, a point of clarification, the margin outlook for slightly higher, does that include lower prepayment penalty income or is that separate?

We report prepayment income in the non-interest income section, Matt, we always consider it fee income.

Got it. Okay. So that's broken out. And then, Chris, you had mentioned that of course realistic competition has pulled back and that pricing has improved.

Could you give us just a little bit more color around that and to what extent pricing has improved? What are you seeing?

Sure, I think we -- certainly cap rates, we're hitting some pretty low levels. We saw some that were at 4% and they have improved slightly. For A-quality product you can go to a low 4.5%, maybe to 5% and then that older stuff may be up towards 7%.

And there was a lot of growth in the multi-family space in our market by our competitors, some of them that had a lot of capital put to work. Now that their loan to deposit ratios are up to 115% or 120%, I think and with the guidelines for the regulators kind of making that under pressure, I think they've all moved into a different category so they are running towards C&I.

For the most part, those levels have improved because there's less people. On the other hand, there still with rates up 25 basis points, we've kind of mirrored that with what's gone on going forward. So the market's moved it. I think there's still a lot of competition for every good product and good client, so you have to guard the gate to make sure we're the incumbent and we don't lose that relationship.

I think the market's just gotten better also. On the other hand, refinances will end, or loans are being -- buildings being sold and moved on, the low rates are going away slightly. So, we still think that we're in a good position.

I think it's bout 25 basis points of price improvement related to the reduced competition on some of the CRE lending.

Got it. Okay. And then with cap rates incrementally moving higher, does that mean the commercial real estate valuations have changed? Have seen any price degradation?

Not really. I think praise levels are still okay. I think everybody is just looking at the cycle and looking at the volumes and making sure that you're getting compensated for that.

Though I think we looked at historically where they were at the bad times of the market, the high of cap rates were in the mid-8%s, so there's a lot of capacity and yet not a fear factor that it's going to go too much higher than where it had been when the market was having its problems.

So for the most part I think everybody's taken this under advisement that certainly there's aggressive levels out there. We're sticking to our return on equity hurdles and our credit discipline, any deal that doesn't meet up to our policy goes through a very large vetting between our credit group and our originations group and our risk group.

Understood. That's all I had, thank you very much.

Thank you.

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

Well we thank you for your attention, we look forward to an exciting 2017. And we hope that with Washington addressing some of the regulatory issues that we will have some good news maybe in the first quarter, so we will speak with you in the Spring. Thank you very much for your time.

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