Provident Financial Services' (PFS) CEO Chris Martin on Q4 2015 Results - Earnings Call Transcript

| About: Provident Financial (PFS)

Provident Financial Services, Inc. (NYSE:PFS)

Q4 2015 Earnings Conference Call

January 29, 2016, 10:00 ET

Executives

Leonard Gleason - SVP & IR Officer

Chris Martin - Chairman, President, CEO

Tom Lyons - EVP & CFO

Analysts

Mark Fitzgibbon - Sandler O'Neill

Collyn Gilbert - KBW

Matthew Kelley - Piper Jaffray

Jake Civiello - RBC Capital Markets

Operator

Welcome to the Provident Financial Services Incorporated Fourth Quarter 2015 Earnings Conference Call and Webcast. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mr. Leonard Gleason, Senior Vice President and Investor Relations Officer. Please go ahead, sir.

Leonard Gleason

Thank you, Keri. Good morning ladies and gentlemen and thank you for joining us this morning. The presenters for our fourth quarter 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.providentnj.com. Now it's my pleasure to introduce Chris Martin who will offer his perspective on our fourth quarter's financial results.

Chris Martin

Thanks Lenny, good morning everyone. Provident continued its consistent and solid operating performance with record revenues totaling over $80 million and record net interest income for the fourth quarter of 2015. Our earnings for the quarter were strong at $21.5 million or $0.34 a share and the margin improved by 4 basis points to 3.17%, but our core margin remained flat versus our forecast of 2 basis points of compression.

Our return on average assets for both the quarter and the year was 96 basis points and our return on the average tangible equity was a respectable 11.1% for the same periods. We had record loan originations and 7.4% loan portfolio growth during the year. Loans totaled $6.5 billion at December 31, 2015, as diversified originations continued throughout all of our markets. With a robust pipeline and continued adherence to our existing credit parameters, we anticipate mid single-digit loan growth in 2016.

The yields on interest-earning assets remained stable during the quarter and we appear to be at or nearer the bottom regarding further yield compression. With 56% of our loans being adjustable or floating, we anticipate some increase in returns on our loan portfolio as interest rates rise. We have continued to invest in our relationship, sales teams and they are producing positive organic results.

Asset quality improved year over year with nonperforming loans declining 17% to $44.5 million or 0.68% of total loans at December 31, 2015, versus $53.9 million or 0.88% at year-end 2014. Net charge-offs for the fourth quarter were just 2 basis points of average loans and our allowance for loan losses as a percentage of loans remained at 94 basis points. As we move into 2016 we anticipate our provisions will continue to support loan portfolio growth. We do not currently see any signs or trends of credit deterioration within our portfolio.

Core deposit growth continued as we reached an historic level of non-interest-bearing deposits of $1.2 billion at December 31, 2015. Core deposits now represent 88% of total deposits and our all-in deposit costs were just 25 basis points for the quarter and our total funding costs have been maintained at a low 66 basis points for the quarter and the year. Although our CD portfolio is relatively small, we have adopted a pricing strategy that seeks to retain the core CD portfolio. Given the modest increase in rates from the Fed and the newly market expectations as to future increases, we have not experienced any noteworthy pressure on our deposit base.

Regarding interest rate risk, we have significantly reduced our adverse sensitivity to rising rates over the last 18 months and the volume of loan level swaps from fixed to adjustable rate has increased as of late. Based upon our latest model results, we estimate that net interest income would be impacted by less than 1% over the next 12 months, with rates rising by 100 basis points.

Tom will discuss further some of the volatile items in our non-interest income during the quarter, but suffice it to say that growth in our wealth management business represented the bulk of our year-over-year improvement in your core non-interest income. The acquisition of MDE which closed in April, has increased our revenue without adding to our asset base on the balance sheet. Obviously the equity markets have an impact on our wealth business as approximately 60% of the assets under management are invested in equities.

Our efficiency ratio remained below 60% as wealth management expenses impacted the ratio along with increased marketing expenses, as we transition to a new advertising firm. We have also had increased compensation expense with the addition of lending relationship managers, along with an increased accrual for incentive compensation in Q4.

We continue to asses our investment in new technologies and payment systems to meet the demands of our current and future customers. Our digital and mobile platforms must continue to evolve. In that regard, we expect to offer person-to-person or People Pay, Apple Pay and business mobile banking and check capture in the first quarter of 2016.

On the M&A front we remain disciplined in evaluating potential acquisitions. We will continue to seek out accretive wealth opportunities and whole bank deals that make sense to long-term stockholder value. We have a strong capital position and ample opportunities to grow organically. With a strong cash dividend we feel the best way to enhance our stockholder's value is to stay the course and continue to execute on our strategic plan.

For 2016 we continue to see the economy in our markets gradually improving and with a modest recovery we expect the Fed to exercise some patience and race rates twice in 2016. But the future remains bright for Provident's band of relationship community banking. Now I will ask Tom to go over the fourth quarter numbers in further detail. Tom?

Tom Lyons

Thank you, Chris and good morning everyone. As Chris noted our net income for the fourth quarter was $21.5 million, a 4% increase from $20.6 million for the trailing quarter. Earnings per share were $0.34 compared with $0.33 for the trailing quarter. The increase in earnings was driven by 7% annualized loan growth for the quarter and a 4 basis point improvement in the net interest margin to 3.17%.

Loan growth occurred in the C&I, multifamily and construction categories. The loan yield was helped by the accelerated recognition of $1 million in deferred fees on a prepaid CRE loan which contributed 5 basis points to the net interest margin. Funding costs remained stable and average non-interest bearing deposits increased 8% annualized, with core deposits now representing 88% of total deposits.

We provided $1.3 million for loan losses this quarter, compared with $1.4 million in the prior quarter as the portfolio's weighted average risk rating further improved. Nonperforming loans, however, increased $4.9 million from the trailing quarter to $45 million or 0.68% of total loans as a $6.9 million relationship that is adequately secured by commercial real estate moved to nonaccrual status.

Net charge-offs for the quarter were just $290,000 or an annualized 2 basis points of average loans. The allowance for loan losses for total loans was unchanged versus September 30 at 94 basis points and excluding acquired loans recorded at fair value the allowance was 1.01% of loans. Compared with the trailing quarter, changes in non-interest income and expense largely offset as seasonal and volatile items occurred in both areas.

Swap income increased by $2 million versus the trailing quarter, as a result of increased activity and loan fees increased by $600,000 as a result of increased prepayments. Additionally, gains on REO and loan sales each increased by $300,000 versus the trailing quarter. Non-interest expense increased $3.8 million versus the trailing quarter to $47.4 million, including an increase in year-end incentive accruals and commissions, increased advertising costs and an increase in legal fees and REO evaluation adjustments during the quarter.

Income tax expense was consistent with the trailing quarter at $9 million and our effective tax rate decreased slightly to 30.4% from 30.5%. We currently project an effective tax rate of approximately 30.5% for 2016. That concludes our prepared remarks and we would be happy to respond to questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from Mark Fitzgibbon of Sandler O'Neill. Please go ahead.

Mark Fitzgibbon

First question I had is on expenses, Tom, it looked like expenses this quarter were a couple of million bucks higher than the guidance you had given last quarter and I was trying to figure out what the big deltas were there? And also, I know Chris keeps a very tight lid on costs but if you could share with us, perhaps, what your outlook is for operating expenses in 1Q.

Tom Lyons

For the full-year 2016 I'm looking at about $183 million to $184 million. The increase year over year is largely driven by having MDE in place for the full year, so we'll see some revenue pickups to partially offset that. The run rate for Q1 I think $46 million to $46.5 million is probably right, it's going to taper down a little bit over the course of the year. The first quarter is always a little bit heavier because of seasonal utility costs, although they probably somewhat muted this year since the temperature has been so favorable. But payroll taxes reset and so we see heavier expense in Q1.

As far as unusual items in Q4, Mark, the last two quarters' incentive bonus accruals ticked up as we got greater certainty as to our year-end performance relative to the targets in the plans. Soft commissions were higher, corresponding to the increase in activity. We had some comp stock-based compensation expense adjustments that normally happen at year end.

I guess the biggest one was advertising, you can see that as a separate line item. We transitioned to a new advertising firm in Q3, so it's more that the Q3 expenses were kind of unusually low. That was about $888,000 and change and then there were some minor, smaller items from that point on. Legal costs related to REO resolution and then REO write-down, were about $350,000 and then a bunch of smaller stuff.

Mark Fitzgibbon

And then on the $6.1 million uptick in commercial delinquencies, was that just one or two loans or any particular concentration there? Could you give us any detail on the loan?

Tom Lyons

It was one relationship, $6.9 million, suffered some business reversals, nothing indicative of any kind of trend in credit deterioration, but it is a collateral dependent loan. We have a current appraisal, we're adequately secured as for that appraisal, so there is no reserve requirement related to it. But that's really the entire deterioration. Outside of that we actually improved further resolutions.

Mark Fitzgibbon

Okay. And then on the margin, if you back up the 5 basis points of the accelerated recognition, that gets you sort of 312 margin, it sounded like from Chris's comments you think the margin is bottoming out here, is that fair?

Tom Lyons

Yes, I think over the course of the year we stabilized at like a 310 level. So there's a little bit point here and there, depending on what the shape of the curve does. The Fed moved, we didn't really obviously see much benefit if any, given the lateness that it happened in the quarter. But with about 28% of our portfolio floating and I guess 55% overall that's either floating or adjustable, depending on when those things reset, we do see some pickup because we haven't seen any corresponding pressure on deposit costs yet. So I would say there's about $3 million worth of benefit a year in there if you offset the impact on overnight borrowings.

Mark Fitzgibbon

Okay and then lastly, could you just share with us what assets under management were at the end of the quarter and at the end of September 30 as well?

Tom Lyons

I think they were pretty consistent, I don't have the exact number in front of me, I think it's about $2.4 billion to $2.5 billion.

Chris Martin

I think it's $2.4 billion, Mark.

Mark Fitzgibbon

And then just curious why were wealth management fees down so much, I think 8% for the quarter?

Chris Martin

Wasn't one related to the intangible?

Tom Lyons

No

Chris Martin

A little bit of equity -- we're just going through a couple of items, a little bit of the equity downturn in the fourth quarter effected that, certainly we were still getting the same amount, we didn't lose any clients but it was really just the level of equity --

Tom Lyons

I think the valuation did make a difference, Mark, we're probably giving you rounded numbers, so there was some reduction in AUM. Also you do have volatile items within the wealth management business as well, things like wills and trusts depending on when certain items settle, you can see bumps one quarter versus another. The largest one's typically in Q2 and we have tax related fees, but there are some volatile items within that business as well. That contributed to it. I think it's only down $312,000 quarter over quarter.

Operator

Our next question comes from Collyn Gilbert of KBW. Please go ahead.

Collyn Gilbert

If you could, Chris just talk about your outlook for growth. Specifically this year, where you are seeing opportunity and then more specifically how you're managing this growth as you guys get close to the $10 billion threshold.

Chris Martin

Sure. We look at loan growth at approximately between 5.5% and 6%, certainly skewed a little bit more in the C&I than it is CRE, though we look at any opportunity. We have reduced any type of levels of syndication loans and correspondent loans as we move forward. We see organically getting to approximately around $9.4 billion if everything holds serve and our estimates are right and prepayments will slow down a little bit, though there will always be some that people are positioning 1031 and the like sales. So don't see us as reaching $10 billion certainly for the next two years, with organic growth. But you have to look at that and say you have to start to prepare and we have put some money away for our $10 billion preparation of approximately $350,000 in the budget for 2016.

Collyn Gilbert

Okay. Just high level, how you're thinking about crossing that, are you crossing it with ease, do you feel like you need a deal? Is there anxiety in that you've got to really built scale? Just sort of how you think about when you actually do cross it and to what capacity you do cross it?

Chris Martin

Yes, well I would probably say yes to all of what you've just said, but it goes to certainly our plan would be to grow organically but we always look for opportunities. I don't think we just want to go across the line and stay there. It wouldn't be good for our shareholders.

We would continue to evaluate good accretive opportunities in the bank space and certainly in the wealth space. We're not going to do a deal just to get to $12.6 billion and offset the revenue and costs, but we always are engaged in conversations to make sure what makes sense for our business going forward and we have a plan that if we did get a deal how we would accelerate being prepared for $10 billion and that's also in the works.

So not anxiety at all, we have a good group of people that are very solid and have already got the work in process when and if and we know we have a timeframe to get there. But we'd look at opportunities if people want to join up to a very stable company and be part of something really very solid, we would be more than happy to engage that conversation.

Collyn Gilbert

Okay. And then just the $350,000 that you talked about, that's in the budget for 2016, is that correct?

Chris Martin

Yes, that's correct.

Collyn Gilbert

Okay, do you expect that to ramp as you get closer to $10 billion, do you have a sense of where that level of expense can go?

Tom Lyons

Well it's certainly going to go up as we have to deploy more in the way of stress testing and modeling to adhere to some of the new regs that are coming out. We have already spent some money on that in the way of loan valuations and models to make sure we can do all the stress testing already in process and there will probably be some headcount and compliance additions to staff.

So we anticipate that, that number will have to grow. On the other hand, we also look at our operations and saying, what other efficiencies we're going to try to adopt and adapt to as we get to be $10 billion, because everything else will be coming out pretty fast.

Collyn Gilbert

Okay. And then just one final question just on your deposit comments, that you had indicated you are not necessarily seeing cost pressure yet, can you just talk a little bit about what you are seeing in the market and where your successes are coming in terms of deposit generation?

Tom Lyons

We've seen nice growth continued in non-interest-bearing deposits. Business advantage checking product has done quite well for us. Savings products have actually done reasonably well also, so it's still lower costs, we're not seeing a lot of pressure.

There are some high-rate, high-yield savings kind of offers out there that we've looked at, there's some high-yield money market offers out there. A lot of strings attached to many of them, so they haven't been putting a ton of pressure on us. I think as Chris noted in his comments, we have been a little more defensive in trying to hold onto what we consider to be core CD base, non-hot money retail products with more than one service when we're willing to negotiate price down a little bit to try and hold onto some of that. But not enough to change the all in deposit, still at 25 basis points.

Chris Martin

I would say also a lot of competitive factors going on there with a lot of conversions happening within our Pennsylvania and New Jersey markets that we stand ready with a couple of offers and there's always a little dislocation that will happen. The world is changing a bit in the banking space and so our looking at the branch environment and digital additional approach to the business are something we look at both sides of those and how we can be successful.

Collyn Gilbert

And just one final question on the deposit side and I know you guys have commented on the past but maybe just update us. On your thoughts on the loan to deposit ratio. Is that something you manage to, do you want to keep below a certain level? How are you thinking about that as you balance the growth going forward?

Tom Lyons

I think we were looking back five years and just in retrospect we were at 90% five years ago and now we're at 110%, so the in between we're probably right at 100%. I think we're comfortable where we're. We think we have enough capital to carry in to leverage and we're looking for opportunities, but in the flat and the yield curve it gets a little more difficult. I think we're pretty comfortable with that number at this stage.

We have a little bit more of a push on just going ahead to our customers that haven't really used us as their primary bank to try to get them to use more than just one service. And I think that's the way that we'd go about it as opposed to trying to just buy another company that has high deposits and paying a huge premium for those.

Chris Martin

Collyn, I are very comfortable with our liquidity position, if you look at other metrics outside of loans and deposit I don't think it's anything we need to manage down to. The 110% doesn't present any problems for us and if you look to the growth targets Chris kind of laid out earlier, maybe we get to 113% by the end of the year, I don't think there's anything to worry about there.

Operator

Our next question comes from Matthew Kelley of Piper Jaffray. Please go ahead.

Matthew Kelley

I was wondering if you could give us maybe a recap of the branches that you closed in 2015. What the deposit retention trend was and then your plans and thinking about branch closures over the next year or two and how that has changed with some of the technology comments that you mentioned earlier?

Chris Martin

Yes. Matt, it's Chris here. What we had in 2014, we closed and consolidated one branch in December of that year. In 2015 we had a reposition of a branch from where we were in Pennsylvania just about a mile away and we've had a lot of success, all of those deposits came over, much better location, in a better location in the way of, next to a Starbucks and a supermarket which is also helpful especially out in Pennsylvania.

We have one that's for sale, deposits that will be closed in March of this year. We sold the deposit to the location. So not really a location we wanted, we were trying to reposition it and we just didn't find a place in the market so we have a deal pending with some other company to take them on. We continue to look at opportunities of ones that are not performing up to scale and certainly saying well, we will throw the white flag up and make sure we do our normal branch rationalization as leases come due and/or even beforehand if it's not making our numbers.

Matthew Kelley

Okay got it. And then on the margin commentary, do you have any forward starting swaps that could become a headwind in the margin if rates do not increase, is that an issue for you folks?

Chris Martin

No

Operator

Our next question comes from Jake Civiello of RBC Capital Markets. Please go ahead.

Jake Civiello

Does the sequential increase in swap fee income imply that you were handling larger, more sophisticated credits in the fourth quarter compared to the third quarter?

Tom Lyons

I think it's the same borrower base that we've always pursued, just the timing on closings, just volatile items but we continue to work with similar size as we have in the past.

Jake Civiello

I guess I was more referring to the, on the loan side in terms of the size of those loans, were they lumpy I guess is what I am asking?

Tom Lyons

There were a sizable loan in the fourth quarter, actually two I think that, we like the swap environment but they get to more sophisticated. We just happened to be lucky enough that one of our larger clients closed the deal with us and they took the swap versus a fix which we would have done either with them. I think it was just more advantageous and they are sophisticated enough. So it's kind of serendipity when it happens, we love to have those. On the other hand, if we can structure a fixed rate deal over a shorter duration we don't mind those also.

Chris Martin

So, yes. It wasn't like there was a slower of smaller balance borrowers. There was some lumpiness to the composition in Q4. There was one deal in particular that was of a significant size.

Jake Civiello

Okay. And then year to date in January, are swap fees tracking along a similar path, ignoring that one credit?

Tom Lyons

Down a bit so far, but it's pretty early to tell. I don't think -- it's really tough to tell you what the quarter is going to do, but right now we're going to be lower level.

Chris Martin

Usually Jake, January's a very slow month. Everybody's getting back, they've got budgets, they are getting everything together from a client base so and closings just don't happen through the holidays. Everyone starts to get reoriented, so it's always a little slow in January.

Jake Civiello

And then last question, Tom does your expense guidance for the first quarter for $46 million to $46.5 million include tangible amortization?

Tom Lyons

Yes, it does.

Operator

And this concludes our question and answer session. I would like to turn the conference back over to Mr. Christopher Martin for any closing remarks.

Chris Martin

We thank you for your attention. We have experienced a great snow last week that has already half melted and we're looking forward to it being a mild winter until that, but everybody else has to deal with it. We're looking forward to a great year in 2016. We appreciate your attention and support. Have a great day.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your line. Have a great day.

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