Provident Financial Services Inc (PFS) 2020 Q4 法說會逐字稿

Good day, and welcome to the Provident Financial Services, Inc. Fourth Quarter Earnings Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mr. Leonard Gleason. Please go ahead, sir.

Thank you, Chuck. Good morning, ladies and gentlemen, and thank you for joining us for our fourth quarter earnings call. Today's presenters are Chris Martin, Chairman and CEO; Tony Labozzetta, President and Chief Operating Officer; and Tom Lyons, Senior 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 is contained in this morning's earnings release, which has been posted to the Investor Relations page on our website, provident.bank.

Now it's my pleasure to introduce Chris Martin, who will offer his perspective on our fourth quarter. Chris?

Thank you, Len, and good morning. Thank you for participating today. We sincerely hope that you and your families are healthy.

Our fourth quarter earnings were strong as we successfully completed our systems integration of SB One and met both our expense savings estimate of over 30% and came in under our projected onetime merger-related charges. I would be extremely remiss if I did not recognize the herculean effort by management and the staffs from both companies as they ably met the challenges presented during the pandemic. And Provident was one of only a few financial institutions that announced and completed the transaction and converted systems during this tumultuous time in our country.

Fourth quarter earnings were strong at $40.6 million or $0.53 per share, including $3.2 million in merger-related charges. Net interest income was up 22% quarter-over-quarter. Total assets at December 31, 2020, stood at $12.9 billion, which resulted in an annualized return on average assets of 1.25% for the quarter and an annualized return on average tangible equity of 14.1%. Included in total assets were $473 million in PPP loans, which will continue to be submitted to the SBA for forgiveness throughout Q2 of this year.

With only nominal GDP growth expected in Q2, we anticipate that loan growth will lag and businesses will rebound in the second half of 2021. Credit line usage is down to 41.6% at December 31, 2020, versus 55.7% in 2019.

Another issue is the deleveraging of consumer balances, which should begin to pick up once the vaccine is more widely distributed and people get back to more normalized behavior. With low interest rates, business clients with strong balance sheets and cash flows are able to refinance and/or pay down their loans. Competition for loan growth remains extreme. And our loan pipeline is $1.2 billion with $295 million approved awaiting closing and a 47% pull-through rate expected on the remainder.

Deposits for the year increased $2.7 billion, including $1.76 billion acquired from SB One. Core deposit growth continued throughout the year and represented 88.9% of total deposits at December 31. Deposit trends remained favorable during the quarter. And growth was robust and broad-based, supported by seasonal inflows and pandemic-related customer behavior. We ended the year with a loan-to-deposit ratio of 99.8%, and we continue to interact with our customers to further solidify deposit relationships. We also anticipate that with additional government stimulus, deposits will increase or at least remain at these elevated levels and then begin to gradually be drawn down during the second half of 2021.

The bank also promotes the products and services available through SB One Insurance, a new fee business line for us, along with wealth management offerings through Beacon Trust to further expand our client relationships.

Despite the challenging interest rate environment, our core margins held up well during the quarter. Noninterest income was up $2.7 million versus the same quarter last year, which was primarily the result of $1.8 million contributed by our new fee revenue source from SB One Insurance, accompanied by an increase in the net gain on sale of residential mortgage loans of $757,000 and wealth management income increasing $561,000. These increases were partially offset by decreases in prepayment fees of $882,000.

Nonoperating expenses increased $4.8 million for the quarter, which included $3.2 million of nonrecurring costs related to the acquisition of SB One. Our operating expenses to average assets was 1.82% for the quarter, and our efficiency ratio was 54.12%. We continue to enhance our digital and online mobile banking platforms as client behavior has demonstrated a clear preference for these channels.

As an example, we have seen an increase in Zelle usage of 945% versus our previous person-to-person platform. We will seek to optimize our expanded business model with the driver being ROI and customer relationship expansion supported by analytics. And we consolidated 3 branch locations during the quarter and have another one planned later this quarter.

Our reserve release this quarter primarily reflects Moody's improving macroeconomic outlook. Although I would note, we did add appropriate qualitative adjustments for economic uncertainty as the pace and shape of the recovery is still evolving. We're beginning to see the expected rise in nonaccrual loans and charge-offs that may already been reserved for under our CECL methodology.

We are working with all of our clients to provide hardship assistance whenever possible and prudent. If the vaccination and herd immunity can take hold, we estimate that it would reduce the loss content within our loan portfolio. And Tom will update the loan payment deferrals in more detail, but we have seen most of our clients come out of deferrals and return to full P&I payments.

Our strong capital levels remain above well capitalized, which continue to support growth, a solid cash dividend and an opportunity for stock repurchases that meet our internal return hurdles. We repurchased 1.3 million shares in 2020 at an average cost of $16.59 per share, which leaves PFS with only 262,000 shares remaining in our existing program. Yesterday, our Board authorized the adoption of a new 5% repurchase program, which will commence upon the completion of the existing one.

On the M&A front, despite the fact we just completed the SB One systems conversion in November, we remain open to those opportunities that expand our market and deliver solid returns to our stockholders. We remain disciplined buyers in terms of the financial profile that fits our strategic objectives and culture, and we will assess fee-based businesses along with whole bank acquisitions.

Though there are improving economic indicators in the fourth quarter, we continue to see an uneven recovery and upticks in COVID cases towards the end of the quarter negatively impacted the road to recovery. Overall, our customers continue to be in a much stronger position than we would have anticipated when this crisis began. However, unemployment levels in the market remain high, inventory levels are lower than they were pre-pandemic and the client confidence to invest in their business appears contingent upon the success of the vaccination distribution and the relaxation of government shutdowns.

Despite all this, we believe there's a great potential for expanding economic activity in the second half of the year, especially if there is significant stimulus package.

I'll let Tom go into further details. Tom?

Thank you, Chris, and good morning, everyone. As Chris noted, our net income was $40.6 million or $0.53 per diluted share compared to $27.1 million or $0.37 per diluted share for the trailing quarter. Earnings for the current quarter included $6.2 million of negative provisions for credit losses on loans and off-balance sheet credit exposures, while the trailing quarter reflected provisions of $5.8 million.

Q4 represents the first full quarter of combined operations following the July 31 acquisition of SB One Bancorp with systems integration now complete and the bulk of expected cost saves now achieved. The remaining nonrecurring merger integration costs of $3.2 million were recorded in the fourth quarter, outperforming our expectations as disclosed at the transaction's inception by about $800,000 and helping tangible book value per share to recover and surpass preacquisition levels.

Core pretax preprovision earnings, excluding provisions for credit losses on loans and commitments to extend credit, merger-related charges and COVID response costs, were $50.1 million for pretax preprovision ROA of 1.54%. This compares favorably with $44.4 million or 1.48% in the trailing quarter.

Our net interest margin expanded 3 basis points versus the trailing quarter as we reduced funding costs and grew noninterest-bearing deposits while earning asset yields held steady. To combat margin compression, we continue to reprice deposit accounts downward and emphasize noninterest-bearing deposit growth. Including noninterest-bearing deposits, our total cost of deposits fell to 31 basis points this quarter from 33 basis points in the trailing quarter. Noninterest-bearing deposits averaged $2.38 billion or 24% of total average deposits for the quarter. This was an increase from $2.21 billion in the trailing quarter, reflecting a full quarter contribution from SB One.

Average borrowing levels decreased $82 million, and the average cost of borrowed funds decreased 3 basis points versus the trailing quarter to 1.16%. Quarter end loan totals increased $66 million versus the trailing quarter or an annualized 2.7%, reflecting growth in C&I, construction and consumer loans, partially offset by net reductions in CRE, multifamily and residential mortgage loans. Loan originations, excluding line of credit advances, totaled $868 million for the quarter.

The pipeline at December 31 decreased $138 million from the trailing quarter to $1.2 billion. However, the pipeline rate increased 2 basis points since last quarter to 3.57% at December 31. Our provision for credit losses on loans was a benefit of $2.3 million for the current quarter compared with an expense of $6.4 million in the trailing quarter. We had annualized net charge-offs as a percentage of average loans of 10 basis points this quarter compared with net recoveries of less than 1 basis point for the trailing quarter.

Nonperforming assets increased to 71 basis points of total assets from 42 basis points at September 30. Excluding PPP loans, the allowance represented 1.09% of loans compared with 1.16% in the trailing quarter. While it may seem counterintuitive to see the allowance coverage of the loan portfolio decline while nonperforming loans increased, this demonstrates our stable expectations of loss content in the loans that have been moved to nonaccrual while life of loan loss expectations for the performing portfolio have improved as a result of advances in the pandemic response and improved economic forecast. The expected migration of certain credits to nonperforming status is reflective of the protracted economic challenges faced by certain borrowers in the suboptimal operating environment constrained by pandemic response restrictions.

Where we could no longer confidently support them, more likely than not, expectation that all contractually due principal and interest payments would be made, we have classified these credits as nonaccrual regardless of whether they are receiving short-term deferrals in accordance with the CARES Act.

Loans that have been or are expected to be granted short-term COVID-19-related payment deferrals declined from their peak of $1.31 billion or 16.8% of loans to $207 million or 2.1% of loans. This compares with $311 million or 3.2% of loans at September 30. This $207 million of loans consists of $9 million that are still in their initial deferral period, $51 million in a second 90-day deferral period, $121 million that required additional deferrals and $26 million that have completed their initial deferral periods but are expected to require ongoing assistance.

Included in this total are $49 million of loans secured by hotels with a pre-COVID weighted average LTV of 43%; $36 million of loans secured by retail properties with a pre-COVID weighted average LTV of 58%; $30 million of loans secured by multifamily properties, including $21 million that are student housing-related with a pre-COVID weighted average LTV of 61%; $5 million of loans secured by restaurants with a pre-COVID weighted average LTV of 50%; and $30 million secured by residential mortgages with the balance comprised of diverse commercial loans.

Noninterest income decreased $268,000 versus the trailing quarter to $20 million as growth in loan and deposit fee income, bank-owned life insurance income and gains on loan sales was more than offset by a decline in net profit on loan level swaps, gains on sale of REO and a small reduction in wealth management income. Excluding provisions for credit losses on commitments to extend credits, merger-related charges and COVID-related costs, noninterest expenses were an annualized 1.82% of average assets for the quarter compared with 1.92% in the trailing quarter as the benefits of greater scale and planned acquisition cost saves were achieved.

Our effective tax rate decreased to 23.3% from 25.5% for the trailing quarter as a result of an increased proportion of income coming from tax-exempt sources in the current quarter. We are currently projecting an effective tax rate of approximately 24% for 2021.

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

(Operator Instructions) And our first question will come from Mark Fitzgibbon with Piper Sandler.

First question I have is on, give us a sense, you've got quite a bit of excess liquidity on the balance sheet. How long does it take for you to deploy that? Will that all kind of go away in 1Q, do you think, or most of it?

We're doing our best, Mark, hopefully through loan growth and find suitable investments. I would estimate our excess liquidity of about $284 million at the end of the year. So it's an ongoing process, but we will continue to try and manage that down.

Yes. I would add to that we expect loan growth to be a little bit quicker than -- or a little bit higher than we've been trailing. So between the combined banks that emerge, we expect to deploy that excess liquidity pretty quick throughout the year.

Okay. And then it looks like you've got about $1.1 billion of somewhat higher cost borrowings. I guess I'm curious what the maturity schedule of those looks like. And is there an opportunity to prepay some of those?

Well, Tom is going to get the numbers. The opportunity to prepay is always there, but it doesn't make sense from an economic perspective most of the time with the penalty. The earnback sometimes extend just as far as the duration of the borrowings. So we look at that as you make some decisions, you match up as much as you can with your operations, especially with the home loan bank dividend, very healthy, it doesn't -- it's one of our better yielding assets. Tom, you have a little bit of...

Yes. I would just agree. I'm not a big fan of prepaying borrowings with full yield maintenance. I think it just takes -- it hits the equity in the current period to enhance earnings going forward, but you wind up in the same place where you've lost income currently -- or equity.

In terms of maturing funding overall, over the next 4 quarters, we have close to $1 billion coming off. A lot of it's in the CD portfolio. Let me get the right number here, yes, $1.088 billion total. And I guess the weighted average rate currently is about 98 basis points. The pickup is as much as -- is about 60 basis points, coming down to like 36 on the reprice.

So each quarter, there's like $364 million in Q1, $231 million in Q2, $143 million in Q3 and $170 million in Q4 of '21 that's maturing time deposits. The borrowings rolling off are considerably less, but the CDs make up the bulk of what's going to reprice.

Okay. And then, Tom, excluding the impact of PPP, how are you thinking about the margin going forward?

A little bit better than last quarter, but not a lot. I think we float down to around the 2.95% range. That's actually inclusive of PPP. There's about $8.7 million in deferred fees, I'm sorry, Mark, about $8.7 million deferred fees remaining on PPP currently.

$8.7 million?

That's correct.

Okay. And then on -- as far as operating expenses go, can you kind of update us with your thinking on expense outlook for, say, 1Q and 2Q as the synergies start to come through from the deal?

Yes. I think for the year, we're still around $240 million. You're going to be a little bit skewed a little bit higher in the first part of the year because of the usual seasonal factors and utilities costs, payroll taxes. So maybe a little bit higher than $60 million in Q1 and then floating down.

Okay. And then lastly, I guess, given your buyback announcement, does the buyback make sense at current price levels? Or is it sort of intended to deal with any downdrafts in the market? Because it looked like this most recent quarter, your average price was a fair bit like 15% lower than where the stock is today.

Yes, I think that's more the case with market opportunistic -- we've kind of tried to hug around the 1.2x tangible book level. That gives us the best return in terms of earnback and often the use of capital versus just trying to lever it up.

Our next question will come from Erik Zwick with Boenning and Scattergood.

Tom, if I could just follow-up on the margin commentary you just gave, quickly. I just want to make sure I've got all the pieces right. I think you mentioned in your prepared remarks that the yields on the pipeline, about 3.75%. And that's pretty close to where the current yield in the book is. So it doesn't seem like there should be too much pressure there.

You gave the outline of the maturing time deposits and those pricing lower. That seems like that should be a benefit. And then also the $8.7 million of deferred PPP fees coming through. So just curious where the pressure is coming from in your outlook from the current fourth quarter level of the margin down to that kind of 2.95% that you mentioned?

The pipeline rate, if I misspoke, it was 3.57%, not 3.75%.

Got you. Okay. That helps square that up. And then looking at the run rate for expenses headed into 2021, if I back out the, I guess, about $3.2 million in merger-related expenses in 4Q, that kind of gets into the mid-50s range or so, which was maybe a little lower than I had been expecting prior. Is that a good run rate heading into '21? Are there other factors and inflationary pressures that might kind of drive that higher? What are your expectations there?

Yes. I think it's more like 60% to 61% in the first part of the year per quarter. The normal increases, the payroll tax stuff that we talked about, but also you had an unusual reversal of the credit provisions on off-balance sheet commitments this quarter. That was $3.9 million favorable. We wouldn't expect to see that recur.

Excellent. That's helpful. And then in terms of the newly authorized round of PPP loans, any expectations for what that might add to the balance sheet here in the first part of the year?

I think we're probably, at this point, based on applications we've received, somewhere in the $175 million to the low $200 million range.

Great. And last one and maybe for Chris or anyone who wants to weigh in. You mentioned in 2021, you'll consider fee-based and whole bank opportunities as they arise and if there's a good fit. Just curious if you could remind us on for your target size and any kind of geographic markets that you would look to expand into if the appropriate opportunity presented itself.

Well, this is Chris. And I think we always look at things that are in or contiguous and if they can expand into really good markets that don't really destroy the franchise value of our company, we will look at them. They have to always meet the hurdles and be part of a culture. Size matters. I mean I don't know that we would do $100 million company not because it's bad, it's just the fact -- the economies of scale aren't there.

But I would say at $0.5 billion, it would be a start point, especially if you're looking out in Pennsylvania that has a bunch of smaller companies that maybe gives us some more scale and opportunity. And I think anything contiguous, which is always above Sussex County up into Rockland, Orange County, Westchester, New York, surrounding maybe. And maybe we have, with SB One, a little bit of exposure in Queens, doing very, very well, but that doesn't mean we're just going to go out on an expedition. We just look at opportunities. And sometimes that could be organic versus buying businesses.

On the wealth side, we can definitely expand that horizon a little bit more. And we also look at where our clients are. So I hate to say that Florida has opportunity because there are people down there, but that's certainly been well vetted by a lot of institutions that are looking at that as an opportunity, and the pricing has gotten a little bit askew.

The next question will come from Steven Duong with RBC Capital Markets.

Just on -- first, just on the loan side, can you just tell us what was going on with the commercial mortgage and the commercial loans, just the sequential changes in those portfolios?

Yes. The sequential change is a little bit distorted from the systems conversion that happened in November. Unfortunately, there was some reclassification entries that took place during the period. So it's a little bit challenging, easier to look at the yields overall.

Got it. Okay. And I guess what are you guys generally expecting for the year? I know you're looking at more back weighted? It's just -- is there a general range that you're thinking about, excluding PPP?

Yes. From -- Steven, just from a growth rate, I think what we're seeing in the pipeline, there's a lot of robust activity. And unless things get a little unusual in terms of hyper competition and pricing and structure, we think we could be between that 4%, 4.5% and 6% as a good target for us. Again, we think we could be on the high end if we don't see competitive pressures getting a little outrageous.

But beyond that, the activity, given the circumstances that we're seeing in the marketplace with COVID, et cetera, is pretty healthy and our people are busy.

Got it. And that would really be geared more towards the second half? Or are you thinking it's kind of even right now given where your pipelines are?

I would venture a strong guess that the second half will be better than the first half, but we're seeing how quickly we can pull those loans through the pipeline.

All right. Got it. And then just one last one from me. Just once we get through this, where do you think your reserves will eventually gravitate towards?

I would guess high 90 to low 1% kind of coverage range when I just think about what's typical charge-off activity on our -- our loan portfolio has about a 4-year weighted average life. So if I'm trying to estimate life of loan losses in my my own simple way, taking the 25 basis points as a guess at normal charge-offs. I think our long-term average over the last 5 years, again very benign credit environment, was about 16 basis points. So that kind of gives you the lower boundary. But I think the industry is more in the 25 to 30 basis point kind of range for banks with our kind of composition.

The next question will come from Russell Gunther with D.A. Davidson.

A quick follow-up on the loan growth commentary. I appreciate the thoughts that you guys shared. Within that target, could you guys talk a bit about the mix that you'd expect to be driving that? And any geographic concentrations or outsized contribution?

Sure. I mean from a geographic concentration, I tend to point to the markets we serve, like our primary markets. In terms of the mix, we're seeing a lot -- from a CRE perspective, it's some multifamily, medical office, small amounts of retail and a lot of owner-occupied activity. And industrial is the space that we're seeing and targeting to land into.

While we don't basically red line any categories, we're very careful in the spaces of office, hospitality. There has to be a real strong enhanced underwriting component to that to attract us to go there.

Still a strong emphasis on C&I as well.

Yes. And we have a very strong emphasis on C&I, owner-occupied as well in the 2021 year.

That's great. I appreciate the additional comments there. And then as you think about your fee businesses into 2021, could you talk about overall revenue projections there and particularly curious on the insurance and wealth front?

You want me to take insurance?

Yes.

Sure. Well, the insurance, we definitely had an increase of 17% in the last year. It's really done well. I'd yield to Tony because he ran the business at SB One so he's a little more familiar than we are at this level. So Tony?

Yes. I mean with the insurance, it's a -- I always use an anecdotal point. You can pretty much just check the box and give them 17% to 20% year-over-year growth. However, this year is going to be positively unusual. What that basically means is now that the insurance company has a much broader base to obviously sell its products and services. So we're seeing a lot of good momentum. And I know George is pretty enthusiastic about the activity as we engage with the rest of the teams. On the Provident side -- and so I think he can grow his business much faster than he has historically. But just for purposes of financial projections, let's just say, 17% to 20% year-over-year, but I think he could do better.

On the wealth side of things, a lot depends on market conditions, obviously, but we did close the year at record levels in AUM up to $3.7 billion. Our typical fee rate or our last 12-month average fee rate is 77 basis points. So we did just under $26 million in revenue for 2020. A lot of the same synergies that we're hoping to achieve with the insurance business are transferable to the wealth business as well as we try to broaden and deepen those relationships so the expectations are pretty positive.

Agreed.

That's great, guys. I appreciate the thoughts there. And then the last one for me is just a follow-up. Tom, you mentioned an expense item that you wouldn't expect to run rate. Could you just clarify what that was? I apologize, I missed it.

Sure. That's the provision for credit losses on off-balance sheet credit exposure, so the commitments to extend credit. Again, with the favorable economic forecast that we saw coming out of Moody's, we had a fairly significant decrease in that. We could see some additional decrease if conditions continue to improve, but I wouldn't expect to see anything of that magnitude.

And the magnitude was 3 point...

3.9 -- yes, $3.9 million. It's broken out on the P&L as a separate line item.

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

Well, as we enter 2021, we are increasingly optimistic about our path to economic recovery as we expect to see the rollout of vaccines accelerate near term, providing benefits in the back half of the year. But we will continue to monitor the landscape carefully. And we are confident that the strength of our franchise and the benefits of our merger with SB One positions us well, and we are excited about the tremendous opportunity when the pandemic-related slowdown subsides.

Thank you for your time today, and please continue to wear a mask.

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