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Executives

Paul Pantozzi - Chairman and Chief Executive Officer

Linda Niro - Executive Vice President and Chief Financial Officer

Chris Martin - President and Chief Operating Officer

Analysts

Mark Fitzgibbon - Sandler O'Neill & Partners LP

Richard Weiss - Janney Montgomery Scott LLC

Jason O'Donnell - Boenning & Scattergood Inc.

Matthew Kelley - Sterne, Agee & Leach

Provident Financial Services, Inc. (PFS) Q1 2009 Earnings Call May 1, 2009 10:00 AM ET

Operator

Good morning and welcome to the Provident Financial Services, Inc. first quarter 2009 conference call. (Operator Instructions)

Now I would like to turn the conference over to Paul Pantozzi.

Mr. Pantozzi?

Paul Pantozzi

Thank you and good morning, everyone.

I'll begin with our standard caution as to any forward-looking statements that may be made in the course of our discussion today. A full disclaimer can be found in the text of our earnings release and you can obtain a copy of that as well as our press releases and other SEC filings by accessing our website, providentnj.com, or by calling our Investor Relations area at 2019155344.

For today's presentation I'm joined by our Chief Financial Officer, Linda Niro, and by Chris Martin, our President and Chief Operating Officer.

Thank you all for being with us this morning. I regret that our first quarter earnings release had to be postponed from its originally scheduled date. The delay was due to the additional time required to calculate and verify the amount of impairment to our goodwill, the recognition of which was triggered by a decline in the market value of our common stock in the first quarter of 2009. The calculation was performed by an independent valuation consultant and the verification was made by our independent registered public accounting firm.

I want to emphasize that this goodwill impairment has no impact on our cash flows, liquidity, tangible capital or regulatory capital ratios, nor does it affect our conduct of normal business operations or our ability to generate earnings going forward.

The amount of this non-cash accounting charge was $152.5 million, which equates to $2.72 per diluted share. This brings our first quarter earnings results reported on a GAAP basis to a loss of $143.6 million or $2.56 per share. On an operating basis, excluding the goodwill impairment charge, our core net income for the first quarter was $8.9 million or $0.16 per diluted share as compared to $0.19 per share reported in the first quarter of 2008 and $0.13 reported in the trailing quarter.

The rest of my introductory remarks will address only our core operating results, but I want to stay focused on the topics of liquidity and capital.

While the prevailing economic climate continued to present several challenges to our financial performance, we saw a number of positive developments in the first quarter. We experienced growth in every major deposit category and total deposits increased 6.9%. We attribute this growth to a variety of factors.

First, we believe that this dislocation and uncertainty in the financial services landscape has caused the migration of funds into community banks such as ours with a long track record of stability and prudent management. We've been around for 170 years.

Second, we believe that our deposit products are both competitively priced and designed with features that consumers, businesses and municipalities find valuable, particularly in difficult economic times.

Finally, the efforts of our well-trained and motivated management and staff in building quality and profitable customer relationships continued to provide us with what we believe to be a meaningful competitive advantage. This deposit influx enhanced our already adequate liquidity.

Also, despite $269 million in loan originations and $13 million in loan purchases during the quarter, we experienced significant paydowns in our loan portfolios. Excluding the $85 million in residential mortgage loans that we securitized for future sale, gross loans outstanding decreased $66 million quarter to quarter.

These two factors placed us in a high liquid position at quarter's end with over $304 million in cash and cash equivalents on our balance sheet, more than four times the level reported at year end 2008.

With interest rates at historic lows, this concentration in cash continues to decrease our net interest margin to 3.10% as compared to 3.20% in the fourth quarter of 2008. However, having ended the quarter with over $430 million in loan commitments to commercial borrowers of all types, we expect to deploy these funds in a manner that both fuels economic activity in our region and also enhances our long-term earnings stream.

Regarding our capital position, I want to emphasize that we are not a TARP participant and that we continue to exceed all regulatory thresholds to be considered well capitalized. At March 31, 2009 the company's Tier 1 leverage ratio was 8.22%, our Tier 1 risk-based ratio was 12.37%, and our total risk-based capital was 13.62%.

In addition, as we announced this morning, we have maintained our quarterly cash dividend payable to stockholders at the same level as previous quarters.

I want to add a word about asset quality. We continue to maintain a credit culture that is conservative in its underwriting standards, risk evaluation and management of nonperforming loans. Although we experienced an increase in nonperforming assets in the past quarter, overall delinquencies leveled off and both our net chargeoffs and our provision for loan losses declined significantly from the levels recognized in the fourth quarter of 2008.

While we believe the general economy will remain under stress for the near future, we also believe that our [inaudible] with the credit quality will remain a source of strength for us throughout this period and beyond.

I will now ask Linda to take us through those metrics in detail as well as the rest of our first quarter operating results.

Linda?

Linda Niro

Thanks, Paul.

Turning first to the loan portfolio, total loans decreased $151.4 million or 3.3% during the quarter. The largest decrease in the portfolio was in residential mortgage loans, which decreased $135 million during the quarter primarily as a result of the $85 million in one-to-four family mortgage loans that were securitized and are currently held in the investment portfolio. Commercial loans as a percentage of total loans were 48.1% at March 31st compared to 46.5% of the portfolio at December 31, 2008.

The ongoing deterioration in the economy, increases in the unemployment rate and declines in real estate values continued to have an adverse impact on asset quality. Despite these adverse trends, credit quality remained fairly stable and nonperforming loans increased $4.7 million to $63.8 million compared to $59.1 million at December 31st. The increase in nonperforming loans during the first quarter was primarily due to an increase of $4.4 million in commercial loans and an increase of $2.8 million in residential mortgage loans offset by a $1.9 million decrease in commercial mortgages and a $1.3 million decrease in construction loans.

The quarterly loan loss provision decreased to $5.8 million for the quarter ended March 31st compared to $8.5 million in the fourth quarter. The provision reflects an increase of $2.3 million in specific reserves for impaired loans and $1 million due to downgrades in risk ratings. The allowance for loan losses increased to 1.2% of total loans at March 31st compared to 1.05% at December 31st.

Net charge-offs during the first quarter were $1.2 million compared to net charge-offs of $4.1 million in the trailing quarter.

Total nonperforming assets, consisting of nonperforming loans and foreclosed assets, totaled $68.5 million or 1.03% of total assets compared to $62.6 million or 95 basis points of total assets at December 31st. Nonperforming loans as a percentage of total loans increased to 1.46% at March 31st compared to 1.31% in the trailing quarter.

Total delinquencies decreased to $85.7 million or 1.96% of the loan portfolio at March 31st from $86.7 million or 1.92% of the portfolio at year end.

The net interest margin decreased 10 basis points to 310 during the first quarter compared to 320 during the fourth quarter of 2008. The decrease in the margin was due primarily to a decrease of 17 basis points in the average yield on interest-earning assets to 5.21% compared to 5.38% in the trailing quarter.

The average yield on the investment portfolio decreased 19 basis points and the average yield on the loan portfolio decreased 15 basis points sequentially.

The cost of deposits decreased 8 basis points and the cost of borrowed funds increased 2 basis points sequentially, resulting in an overall reduction in the cost of interest-bearing liabilities of 8 basis points to 2.39% from 2.47% in the trailing quarter.

Total investments increased $46 million during the first quarter to $1.26 billion and represented 19.3% of total assets at March 31st compared to 18.5% at year end. The investment portfolio consists primarily of agency guaranteed mortgage-backed securities and bank qualified municipal bonds. The portfolio had a weighted average life of 3.17 years and a duration of 2.8 years at March 31st.

Total deposits increased $290.5 million or 6.9% during the first quarter of 2009. Core deposits consisting of demand deposit accounts and savings accounts increased $134.1 million or 5% in the first quarter. Time deposits grew $156.4 million or just over 10% during the first quarter. At the end of the quarter core deposits as a percentage of total deposits were 62.6% compared to 63.7% at year end.

Total borrowed funds decreased $165 million to $1.1 billion at March 31st compared to $1.2 billion at year end. Borrowed funds as a percentage of total assets were 16.6% at the end of the quarter compared to 19.1% at year end.

Non-interest income was $7 million in both the first quarter and the trailing quarter.

Fee income increased $125,000 or 2.4% in the first quarter primarily due to an increase of $848,000 in equity fund fee income partially offset by a $353,000 decrease in deposit fee income and a $214,000 decrease in loan fee income.

The company reported $187,000 in net securities gains during the first quarter compared with net gains of $83,000 in the trailing quarter.

Non-interest expense decreased $104,000 to $33.3 million during the first quarter compared to $33.4 million in the trailing quarter. The decrease in non-interest expense was due primarily to increases in other operating expenses of $633,000 and decreases in advertising expense of $443,000. The decrease in other operating expense was due to a $414,000 reduction in consultant expense and a $253,000 reduction in legal expenses.

Salary and employee benefit expense increased $475,000 or just about 3% sequentially primarily due to $541,000 in severance expense.

Intangible amortization expense increased $223,000 or 16.3% compared to the trailing quarter due primarily to the accelerated amortization of the core deposit intangible associated with an underperforming branch that was closed during the first quarter. That accelerated amortization was approximately $193,000.

Income tax expense increased $307,000 to $2.9 million in the first quarter compared to $2.6 million in the trailing quarter. The effective tax rate - again, excluding the impairment charge - was 24.7% for the first quarter compared to 26% for the fourth quarter of 2008. The decrease in the effective tax rate was principally the result of a larger proportion of the company's income being derived tax-exempt sources.

That concludes our overview and we can now open the call for any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Fitzgibbon - Sandler O'Neill & Partners LP.

Mark Fitzgibbon - Sandler O'Neill & Partners LP

Linda, I wondered if you could help us think about the margin as we go forward. As you begin to deploy that excess liquidity you have in cash and fed funds into loans and securities, should that have an immediate benefit to the margin?

Linda Niro

Actually, Mark, I think in the second quarter it's going to have an adverse impact. I would estimate that the margin may contract anywhere between 15 to 20 basis points in the quarter. It's going to take some time to deploy those funds. We're not going to just rush out and book assets, but certainly we're looking to see where we can get the best yield and the highest quality assets so it'll take a little time.

Mark Fitzgibbon - Sandler O'Neill & Partners LP

So is that because the liquidity came in late in the first quarter?

Linda Niro

Yes. It came in really throughout the whole quarter, but primarily towards the end. And we're not seeing any real outflow, so we expect it'll remain somewhat elevated.

Mark Fitzgibbon - Sandler O'Neill & Partners LP

And then secondly I wondered if you could share with us what the 30- to 89-day delinquencies are and if there's any areas that you're seeing an uptick in, any particular type of loan or geography of loan?

Linda Niro

Thirty to 89, Mark, are $35.2 million and that's up somewhat from year end; there were $27.6 million. Again, the bulk of that was due to the $4.4 million in commercial loans that moved into the delinquency category in the quarter, and we're seeing some residential uptick as well.

Mark Fitzgibbon - Sandler O'Neill & Partners LP

And then on the expense front, is it reasonable for us to think that expenses could be stable for the next few quarters or, given some of the higher costs from FDIC insurance and pension costs, etc., that it's going to be hard to hold the line on expenses?

Linda Niro

Yes, I think you're going to see them uptick a little bit maybe more towards $34 million, mostly because of the increase in FDIC insurance expenses.

Mark Fitzgibbon - Sandler O'Neill & Partners LP

And then the last question, the normalized tax rate, it sounds like you have a little bit more tax-exempt income; 25%, is that a good [inaudible]?

Linda Niro

Yes, between 25% and 26% we're estimating for the year.

Operator

Your next question comes from Richard Weiss - Janney Montgomery Scott LLC.

Richard Weiss - Janney Montgomery Scott LLC

I was wondering if you could just talk briefly about what are you seeing in terms of lending opportunities in your markets?

Chris Martin

Well, I think we have a nice pipeline of commercial, C&I; we're seeing a lot of opportunities. But we're again trying to keep the credit hand close to the vest and making sure we're not going and reaching. So we're seeing a lot because of the dislocation of some of the regional and national players and that continues.

Richard Weiss - Janney Montgomery Scott LLC

Chris, are you doing any construction lending? What's happening in that category?

Chris Martin

A little, Rick. We're seeing it. There are opportunities there also, but people that we've banked in the past and have been very successful and are finding things at a very low rate to get in, so we're very happy. Most of it has been in the multifamily type arena right now, certainly not in the one-to-four family area.

Operator

Your next question comes from Jason O'Donnell - Boenning & Scattergood Inc.

Jason O'Donnell - Boenning & Scattergood Inc.

You mentioned that you expect yet that the expenses will continue to rise. Is that a function of an increase in the regular rate in the second quarter from 12 basis points in the first to something higher or are you alluding to the special assessment?

Linda Niro

Really a little bit of both. The special assessment, I don't think we still know exactly what it's going to be, and also an increase in deposits. So that'll translate into higher expenses as well.

Jason O'Donnell - Boenning & Scattergood Inc.

And in terms of the special FDIC assessment, do you intend to take all that in the second quarter if we get clarity on the amount of the charge or do you intend to spread that across the second and the third quarter [inaudible] payment?

Linda Niro

It's probably going to be in the second half of the year because I believe it's going to be due on September 30th. So we'll know a little bit more about what that might look like in the second half.

Jason O'Donnell - Boenning & Scattergood Inc.

And then just finally, in terms of the severance expenses - $541,000 gross - I'm just wondering does that reflect a particular cost-cutting initiative and also what was that number in the fourth quarter?

Paul Pantozzi

We didn't have anything in the fourth quarter along those lines, but we did have several voluntary situations that were effective in the first quarter resulting in that number.

Operator

(Operator Instructions) Your next question comes from Matthew Kelley - Sterne, Agee & Leach.

Matthew Kelley - Sterne, Agee & Leach

Just getting back to Rick's question about the construction portfolio, could you just talk about the existing portfolio and how things are progressing there as you work down the credits or those projects get completed. It stands about $280 million. How are you feeling about the credit quality of that existing portfolio?

Chris Martin

Well, it's slow in the way of sales and you work with your borrowers as much as you can. It's paying down. We're seeing our exposure certainly coming down from where we were a year ago and two years ago. I think you have to be patient and let the sales try to continue. The entry points for our borrowers are certainly they have room to drop prices and still make some money, and so we've just been working with them. But it hasn't been to the point of a stress level that can't be handled. Some of them we're working on that will go ahead and try to do it on a rental basis, sort of save on the carry. So it's been moving along slowly.

Matthew Kelley - Sterne, Agee & Leach

The degree of restructuring, has that increased over the last quarter or two on that portfolio?

Chris Martin

No.

Matthew Kelley - Sterne, Agee & Leach

And then what about just on the commercial real estate portfolio - $1.3 billion there - how much of that is going to contractually mature this year and then what are those discussions like as loans come due?

Chris Martin

We'll get back to you on that, Matt. I don't think we have that, you know, what contractually - I think we always kind of try to get cash flows to be consistent and look at everything and not [inaudible] period in time. But we can get more data. We'd have to do a little bit of work on that.

Matthew Kelley - Sterne, Agee & Leach

Any just broad commentary on the commercial real estate market in terms of vacancies, income production, NOI and price points, just on the ground what you're seeing?

Chris Martin

Well, I think New Jersey is kind of like any other market, but not as bad as Florida and Arizona and California. You're seeing some leases coming up. You're seeing some strip centers that are new having problems filling. The seasoned players are still doing okay. Overall, performance has been fairly good, I think, but absent the economy I don't know what else you could say except the fact that you lend to people at good price points and they seem to be able to carry the debt and they have other sources of cash flow.

Matthew Kelley - Sterne, Agee & Leach

And then just a last question - any sense of what portion of the commercial real estate portfolio that's secured by retail-type collateral?

Chris Martin

We'll probably get back to you on that as well, Matt. We have those breakdowns. We don't have that detail right with us.

Operator

(Operator Instructions) At this time I'm showing no further questions. I would like to turn the call back over to our conductors for any closing remarks.

Paul Pantozzi

Well, we thank you very much for participating in this call and we look forward to hearing from you at the next quarterly call.

And obviously we continue to work and remain focused at our core business, and we expect things to improve for us certainly over the next several quarters.

So we thank you very much.

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Source: Provident Financial Services, Inc. Q1 2009 Earnings Call Transcript
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