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Provident Financial Services, Inc. (NYSE:PFS)

Q2 2013 Earnings Conference Call

July 26, 2013 10:00 am ET

Executives

Christopher Martin - Chairman, President and Chief Executive Officer

Thomas M. Lyons - Executive Vice President and Chief Financial Officer

Leonard G. Gleason - Senior Vice President and Investor Relations Officer

Analysts

Travis Lan - KBW

Matt - Sandler O'Neill

Matthew B. Kelley - Sterne Agee

Theodore Kovaleff - Informed Sources Service Group

Matthew C. Schultheis - Boenning & Scattergood

Ross L. Haberman - Haberman Management Corp.

Jason O'Donnell - Merion Capital Group

Jake Civiello - RBC Capital Markets

Operator

Good morning and welcome to the Provident Financial Services Second Quarter Earnings Release Conference Call. All participants will be in listen-only mode. (Operator instructions) After today's presentation, there will be an opportunity to ask questions. (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.

Leonard G. Gleason

Thank you, Jessica. Good morning, ladies and gentlemen. Thank you for joining us this morning. The presenters for our second quarter earnings call are Chris Martin, Chairman, President and CEO; and Tom Lyons, Executive Vice President and CFO.

Before we begin the 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 disclosure and disclaimer can be found in the text of this morning's earnings release. A copy of that notice and all of our SEC filings may be obtained by accessing the Investor Relations page on our website, www.providentnj.com or by calling Investor Relations at 732-590-9300.

With that, our Chief Executive Officer, Chris Martin, will offer his perspective on our second quarter financial results. Chris?

Christopher Martin

Thanks, Len, and good morning everyone. As many of you on the call may have come to expect, Provident Financial Services had another solid quarter, earning $19.2 million or $0.34 per share. All of our operating metrics showed improvement with the sole exception being the net interest margin which compressed 4 basis points from the trailing quarter.

During the quarter, the loan portfolio reached the $5 billion level due to focused efforts to increase our commercial loan portfolio which now represents 65% of total loans. Unfunded loan commitments now stand at $1 billion and our pipeline of potential new loans is as large as it's ever been. This reflects an improving outlook on the economy by our clients and is augmented by our relationship managers and strong back-office support, driving increased referrals and high customer satisfaction.

While competition continues to be intense, we have kept our pricing and credit disciplines intact. Of particular note is the continued improvement in asset quality during the quarter which was achieved without a bulk sale. Total nonperforming loans declined to $89 million at June 30, which is a reduction of 23% over the same period in 2012, and now measure only 1.78% of total loans. Loan delinquencies declined this quarter and the weighted average risk rating of our loan portfolio has improved.

We have maintained our balance sheet and its related cash flows to manage our interest credit risk. We have taken advantage of opportunities to match funds with several multi-family and commercial real estate loans with discounted long term borrowings from the Federal Bank of New York.

Our capital levels remained strong as we continue to build tangible capital through earnings. Ws announced in today's earnings release, the $0.14 dividend approved by our Board represents the payout ratio of 45.9% based on the last 12 months earnings per share. And as a community bank, the Basel III implementation in January of 2015 will not materially affect the manner in which we manage our capital levels.

Despite an increase in average interest earning assets and non-interest-bearing deposits year-over-year, net interest income could not overcome the compression in the margin. However, non-interest income improved as commercial loan prepayments and modifications continued the Company by [indiscernible] claim and net gain on the sale of investments. Operating controls kept cost contained and our efficiency ratio of 57.3% improved from the 59.1% reported during the same quarter last year.

Compensation and benefit cost have been managed as we added depth and breadth to our lending and sales teams without a material increase in back-office support, leveraging the talent we have in place. Our strategy of doing more with less is ingrained in our psyche as we consistently assess how we manage customer relationships and our processes to improve our span and scope.

With that, I will turn it over to Tom for some deeper analysis. Tom?

Thomas M. Lyons

Thank you, Chris, and good morning everyone. Our net income for the second quarter was $19.2 million or $0.34 per share, up from $17.8 million or $0.31 per share for the first quarter of 2013. Net interest income decreased $484,000 compared with the trailing quarter to $53.4 million as loan yields remained under pressure and the net interest margin declined 4 basis points to 3.29%.

Partially offsetting the impact of reduced loan yields on net interest income, funding costs decreased and the earning asset mix shifted with securities declining while net average loans outstanding grew by $28 million or 2.3% annualized for the quarter. As a reminder, we report our core margin. We record loan containment fees and non-interest income and do not consider them in the margin calculation.

As of quarter end, total loans increased $88 million or 7.2% annualized for the quarter, reaching the $5 billion mark for the first time. Growth in the commercial categories more than offset reductions in residential and consumer loans as multi-family mortgage, commercial real estate and for-rent construction drove the increase. The C&I pipeline is strengthened and we are optimistic that this area will be a larger contributor to growth in the second half of the year.

We provided $1 million to loan losses this quarter, a decrease from $1.5 million in the trailing quarter. Nonperforming loans decreased $10 million compared with March 31 to $89 million or 1.78% of total loans and classified loan levels early stage delinquencies and weighted average risk ratings, all showed continued improvement. Net charge-offs for the quarter were $4 million or 33 basis points on average loans.

The allowance for loan losses to total loans declined to 1.34% from 1.43% in March 31. However, the allowance coverage of nonperforming loans increased to 75% from 71% in March 31 as a result of the aforementioned improvements in credit quality. Our total nonperforming assets consisting of nonperforming loans and foreclosed assets decreased $9 million versus the trailing quarter to $103 million.

Nonperforming asset resolutions discontinued, and subsequent to quarter end, we thus far sold four residential properties with $771,000 book value and have another eight properties with a book value of $1.1 million under contract. We've also received payments of $1.9 million on loans reported but not accruing on June 30 and have recovered $700,000 on a previously charged off commercial mortgage loan.

Noninterest income increased $2.7 million compared to the trailing quarter, primarily due to the benefit claim on the Bank owned life insurance policy and increases in wealth management income, deposit fees, and gains on the sale of OREO. Noninterest expense increased $867,000 versus the trailing quarter to $37.8 million as a result of increased advertising and other expense.

Income tax expense was $8 million for the second quarter and our effective tax rate was 29.4%. We currently project an effective tax rate of approximately 30% for the remainder of 2013. We've noted in addition to this 30% projected affected tax rate, subsequent to quarter end, the Company has incurred additional income tax expense in the third quarter of 2013 of $3.9 million in connection with the write-off of the deferred tax asset related to the July 17 expiration of non-qualified stock options that were granted shortly after the Company's 2003 IPO.

That concludes our prepared remarks. At this point, we would be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Travis Lan with KBW.

Travis Lan - KBW

Could you just give us a little bit more detail on the loan pipeline in terms of maybe specific size and how it breaks down in your loan buckets?

Christopher Martin

We certainly have a bit of a CRE and multi-family deals pending. We have about, I think it's $350 million in CRE deals, the balance of that being a lot of C&I and for a total of about $800 million.

Travis Lan - KBW

Have you seen any forgiveness in the competitive loan pricing environment, and is there any, kind of with the move in rates, has there been any relief there?

Christopher Martin

When you say relief, how do you mean relief, Travis?

Travis Lan - KBW

Just I mean we've talked before about maybe multi-family or CRE yields down in the 350s, are you finding competitors raising rates, I mean are you able to follow or does kind of pressure continues in the market?

Christopher Martin

There are a couple of that that are still very aggressive in the market. We've seen as of late a little bit more rational pricing, at least where we are in the New Jersey, Eastern Pennsylvania market. I think that's going to continue as things progress and the tenure has moved up. I think we're coming to a transition period where customer perceptions are starting to change a little bit. We're starting to feel a little bit of relief in terms of the quest for refinances at lower rate. So that should help us a little bit going forward.

Travis Lan - KBW

Okay, and then Tom, just on the margin, I mean you guided before kind of 3 or 5 basis points down per quarter, do you think that still stands given where we are?

Thomas M. Lyons

I think so. Just as I said, even with a little bit of stabilization in new loan origination rates, there's still some pressure on the existing portfolio yields. So I think we're still looking at probably in the 3 or 5 range. There's not a lot of reflex on the funding side of things, maybe 1 basis points or 2 basis points at the most, it depends on a quarterly basis.

Travis Lan - KBW

Got you, and just two more, I think last quarter you had said that with the improvement in credit, you could see the allowance drop down to 130 of loans. Obviously with the continued improvement this quarter, is there an updated guidance total for that or you still think 130 is kind of where it stabilises?

Thomas M. Lyons

I still think that's pretty close to the stabilization level. You heard in the prepared remarks that we did have some nice revolutions already this quarter and that large recovery of $700,000 should help us to maintain a fairly low provision in Q3 I would think.

Travis Lan - KBW

Got you. And the last one, just on interest rate risk, and obviously most of your growth come in CRE and multi-family, beyond kind of the matched funding that you talked about before, have you guys taken any actions or is there anything specific that you think you can do to kind of address your interest rate risk position?

Thomas M. Lyons

I think there would be other easy things that we can do with demand integration and the securities portfolio. We've had a barbelled approach and we will put a little bit of pressure on yields and risk management techniques that comes at a cost, but we'll probably stay a little short around the securities book. We can swap loans, start commercial credits for suitable borrowers, commercial real estate credits and that's an area that we'll continue to explore.

Travis Lan - KBW

Very good, thanks very much.

Operator

The next question comes from Mark Fitzgibbon with Sandler O'Neill.

Matt - Sandler O'Neill

Good morning, this is actually Matt filling in for Mark. Just to follow-up on the last question, Tom, what was the weighted average duration of the securities portfolio at period end and how does that compare to the prior quarter and maybe year ago period?

Thomas M. Lyons

That's 3.6 years, we think fairly consistent, I think we're a little bit longer now with the rate uptick, the projections for the [indiscernible] mortgage-backed portfolio have extended a little bit, but we continue to be diligent about managing that portfolio and selling securities that we don't like the prepayment factors, the cash flow characteristics of in a rising rate environment as well as the declining rate environment. So pretty stable portfolio.

Matt - Sandler O'Neill

Okay, and can you tell us what prepayment penalty income was in the quarter?

Thomas M. Lyons

Yes, it was $1.5 million.

Matt - Sandler O'Neill

And how does that compare with the linked quarter?

Thomas M. Lyons

$1.1 million last quarter.

Matt - Sandler O'Neill

Okay, and then…

Thomas M. Lyons

I'm sorry, I was wrong, it was $1.8 million last quarter.

Matt - Sandler O'Neill

$1.8 million. And then just in terms of operating expenses going forward, do you think $38 million is a good run rate to use or we're going to start to see some of this maybe a little rundown?

Thomas M. Lyons

I think a little rundown, I'd say between $37 million, $37.5 million.

Matt - Sandler O'Neill

Okay, thank you very much.

Operator

The next question comes from Chris Jackson with Sterne Agee.

Matthew B. Kelley - Sterne Agee

It's actually Matt Kelly, all kind of stand-ins today. On the securities portfolio, that 23% of earning assets now, it's raised up a little bit. Is it going to stabilize at that level or are you still going to bring that down to fund loan growth?

Christopher Martin

We would see using that to fund loan growth unless there was an opportunity to leverage that certainly with borrowings as it spreads widely even more. Obviously the tenure has come back and we don’t really traffic in that space, we're with the average life of three or four years of good structure, but we would not really look to build that book unless it's really accretive.

Matthew B. Kelley - Sterne Agee

Okay, so in dollar terms, it will continue to drift down as well?

Christopher Martin

We see that, but two or four weeks into the safety level or where it does make some return on the risk adjusted basis.

Matthew B. Kelley - Sterne Agee

Got you. And then you had mentioned at the outset, you're doing some match funded funding of multi semi-loams, could you just walk through, I mean structure of the asset, structure liability when you talk about that?

Thomas M. Lyons

I think the assets we're probably talking about is 10-year fixed rate product and kind of maybe in the seven-year range, so it's not a perfect match with seven year funding.

Matthew B. Kelley - Sterne Agee

Got you, seven to seven-year fixed rate advances or anything with embedded options or…?

Thomas M. Lyons

No, it's entirely fixed rate advances.

Matthew B. Kelley - Sterne Agee

Okay, got it. And then what is the yield on the pipeline right now and kind of maybe give us a sense of how things are being priced just over the last four, five weeks here, how might it change versus the pipeline yield or the second quarter origination yield?

Christopher Martin

We don’t have a perfect pipeline yield, we don't have a weighted asset, but my speculation is it's probably in the [3.70 to 3.80] (ph) range.

Matthew B. Kelley - Sterne Agee

Okay, and how much was that up from your first quarter pipeline, are we talking equal?

Christopher Martin

In terms of the rate, I don’t think it is up, the volume is up but the rate is still down. I think we're in that transition period where [indiscernible].

Thomas M. Lyons

We have 60-day rate lock, so [indiscernible] you give them the rate lock and then there'll be time to get all the work done, credit work done, any appraisals and the like. So, you still have a little bit of kind of overhang that will come through. Hopefully, the next quarter will see some things start to tweak up.

Matthew B. Kelley - Sterne Agee

Right, so I mean deals that you're working on right now, how much higher are they than that level if any?

Christopher Martin

It could be up probably 10 to 15 basis points, nothing dramatic though.

Matthew B. Kelley - Sterne Agee

Okay, got you, thank you.

Operator

The next question comes from Theodore Kovaleff with Informed Sources Service Group.

Theodore Kovaleff - Informed Sources Service Group

I was wondering if you could comment at all about your taste for M&A at this juncture?

Christopher Martin

We try not to comment too much on M&A, but in our past, we always look at opportunities that are accretive to long-term shareholder value. We see the cost and the regulations in this business getting more and more, so it's going to be a little more problematic for smaller institutions. Our appetite has always been to be involved for the right reasons and that would be in either whole bank and/or wealth and asset management businesses. So we have not anything preordained or we look at everything as the opportunities exist.

Theodore Kovaleff - Informed Sources Service Group

And would it be more likely to expand the footprint or intensify it?

Christopher Martin

I think that's all conditions dependent. We probably would not go way out of our market and our contiguous, so I would think that somebody said you have a great deal in Texas, we probably would not be involved.

Operator

The next question comes from Matthew Schultheis with Boenning & Scattergood.

Matthew C. Schultheis - Boenning & Scattergood

Actually all of my questions have been answered, thank you.

Operator

The next question comes from Ross Haberman with Haberman Management Corp.

Ross L. Haberman - Haberman Management Corp.

Good morning, gentlemen, nice quarter. A quick question, we've been hearing that the backlog of the bankruptcies are beginning to clear up a little bit, are you seeing that or is that just sort of talk you might say, tidal speculation?

Christopher Martin

Are you looking at foreclosures and how the process is still going on, is it getting better?

Ross L. Haberman - Haberman Management Corp.

Yes.

Christopher Martin

It still takes a while. We certainly are seeing things come through the pipeline in the way of getting to the process, and I think it takes a long time, it's still taking upwards of three years but it's gotten better, there's some remediation going on with some short pays, people are trying to negotiate with us. So I think it's gotten better. I think that some of the things going on in the state are getting noticed nationally, so there's opportunities for things to approve and everyone to get through this process whenever possible.

Ross L. Haberman - Haberman Management Corp.

So you've not seen the three years go down to two years or less?

Christopher Martin

Not in the residential consumer front but certainly on the commercial side has moved along a lot faster.

Ross L. Haberman - Haberman Management Corp.

Okay, alright guys, nice quarter, thanks.

Operator

The next question comes from Jason O'Donnell with Merion Capital Group.

Jason O'Donnell - Merion Capital Group

Just following up the margin discussion a little bit here, it looks like the yield on your AFS portfolio came up a little in the second quarter on a linked-quarter basis, I'm wondering you can give us some color around the impact that changes in premium amortization expense is having on your trend, and if you have in front of you, I just wondered how much premium then we have in the second quarter versus the first quarter?

Christopher Martin

We were pretty flat I think on an overall securities yield, it was [220 versus 219] (ph) if I remember correctly. I think we're going to see a little bit of advantage in Q3 as a result of the rise in rates and the premium amortization slowing. I unfortunately do not have in front of me what the level of that amortization was for the last quarter, but I would suspect we probably pick up 2 to 3 basis points on the yield money on the portfolio.

Jason O'Donnell - Merion Capital Group

Okay, fair enough. Most of my questions have been answered, just one housekeeping item, and I apologize if I missed it, but how much did you have in the way of gains on sale of OREO, and then separately foreclosure expense?

Thomas M. Lyons

Gains on sale of OREO were $18,000 but it's an improvement because we had a loss of 215 in the first quarter. And I'm sorry, what's the other part, Jason?

Jason O'Donnell - Merion Capital Group

Foreclosure expense.

Thomas M. Lyons

Foreclosure expense was actually down to 773, it was 819 in the first quarter, NPA related expense, and I think we're going to see some continued relief there. Some of the larger, more challenging legal expense type credits are working their way through and coming to resolution.

Jason O'Donnell - Merion Capital Group

Great, thanks a lot guys, nice quarter.

Operator

The next question comes from Jake Civiello with RBC Capital Markets.

Jake Civiello - RBC Capital Markets

Did you see better pricing on new mortgage originations as the second quarter progressed?

Christopher Martin

In the consumer side, Jake?

Jake Civiello - RBC Capital Markets

Correct, yes.

Christopher Martin

We did raise pricing a bit, I think everybody was caught a little off-guard with the movement of the 10-year, where obviously people do a lot of sale of new production, 30 year data. So we moved our pricing up and everybody is following suit. Volumes have still been a little bit quiet in that area, we don't run really a mortgage banking shop like some others but we certainly do that for interest rate risk purposes, but rates have moved up and it's still steady as she goes.

Jake Civiello - RBC Capital Markets

Okay, but the consistent approximate 15 basis point decline in yields that you guys have been seeing on a quarter over quarter basis, that I imagine that we could start to see that abate as time goes on and assuming the yield curve stays where it is today?

Christopher Martin

Yes, that definitely would help as we see it improve.

Operator

With no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Christopher Martin for any closing remarks.

Christopher Martin

We thank you for your attention and we appreciate your support of PFS and we will talk to you next quarter. Please have a good day.

Operator

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

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