Provident Financial Services' (PFS) CEO Chris Martin on Q2 2016 Results - Earnings Call Transcript

| About: Provident Financial (PFS)

Provident Financial Services, Inc. (NYSE:PFS)

Q2 2016 Earnings Conference Call

July 29, 2016 10:00 AM ET

Executives

Leonard Gleason - Investor Relations

Chris Martin – Chairman, President and Chief Executive Officer

Tom Lyons – Executive Vice President and Chief Financial Officer

Analysts

Mark Fitzgibbon – Sandler O’Neill

Matt Schultheis – Boenning

Collyn Gilbert – KBW

Matthew Breese – Piper Jaffray

Operator

Good morning, and welcome to the Provident Financial Services Second Quarter 2016 Earnings 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 Leonard Gleason, Investor Relations Officer. Please go ahead.

Leonard Gleason

Thank you, Amy. Good morning, ladies and gentlemen. Thank you for joining us on this fifth Friday in July. The presenters for our second quarter earnings call are Chris Martin, Chairman, President and CEO; and Tom Lyons, 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, provident.bank.

Now, I’m pleased to introduce Chris Martin, who will offer his perspective on our second quarter’s financial results. Chris?

Chris Martin

Thank you, Len. Provident produced continued strong operating performance during the quarter with net income of $21.4 million, or $0.34 per share, in the second quarter. Revenues totaled $77.7 million, and our net interest income was a record $63.9 million, up $841,000 from the trailing quarter.

Non-interest items contributed to the positive results and our return on average assets remained at 94 basis points. In addition, I’m pleased to announce that our board approved a cash dividend of $0.18 per share payable on August 31. The net interest margin remain steady at 3.11%, but as many of our financial institutions in our market is getting tougher to maintain the spread remits the ever flattening yield curve and aggressive lending by competitors.

We anticipate that the margin will be down slightly from current levels, but likely not more than 3 to 5 basis points over the next two quarters as lower for longer remains in effect. With the ten year U.S. Treasury hovering in the 150s, we may see an increase in refinance activity as borrower seek to lock in longer term fixed rate financing. While we will endeavor to swap out the interest rate risk exposure on longer term loans. And while the global markets were in disarray post Brexit, there has been no material impact on our business and our clients experienced only minimal disruption.

New loan production was diversified during the quarter and the loan pipeline remained strong. We saw a strong core deposit growth in the second quarter including non-interest bearing deposit balances. Average loan growth for the quarter of $85 million was more than fully funded by $231 million of average core deposit growth, enhancing our liquidity and helping to preserve our net interest margin.

We estimate that loan growth will be in the 4% to 6% range for the balance of 2016 and we just open a loan production office in King of Prussia at Pennsylvania and the results are already showing great progress. Our credit performance continues to strengthen with the provision recorded primarily as a result of loan portfolio growth. With many of our competitors taking on additional credit risk, we remain conservative on the deals we can bank that meet our return thresholds without waiving important covenants or structure.

We are not seeing any new adverse credit trends, just working the remaining problem loans through the laborious foreclosure and collection process. Criticizing classified loans declined $22 million during the quarter and as a percentage of loans are at pretty great recession levels. The cost of compliance and regulatory burdens is not ebbing, while our efficiency ratio remains below 60% better than peers. We also view our operating expenses to average assets as a focal measure, which is just slightly above 2% for Q2 2016.

With customers using our digital platform more and more, we are taking our delivery channels to yet another level to meet the changing desires of commercial and retail customers. As you have come to expect Provident is constantly reviewing its operations for further cost saves, while not cutting quarters on compliance or risk assessment. Our mobile offerings are continuously improving and acceptance by customers continues to grow.

With the $10 billion asset level on the medium-term horizon, we have initiated the process of meeting the requirements that threshold entails. Additional branch consolidations are always under review as leases come due, while assuring customer satisfaction remains paramount. We have the capital necessary to support the growth of our balance sheet and our strong cash dividend. We still have plenty of dry powder with over 3 million shares remaining in our buyback program.

Finally on M&A, while organic is our preferred method for growth, we have a strong capital position to support acquisitions whether it would be in bank or wealth management firms. Our culture and success and fully integrating acquisitions make this a viable and prudent use of capital and this consistent with our ability to leverage our relationship building philosophy with our operating platforms.

We always focus on acquisitions that will add markets with strong customer demographics, quality personnel and synergies that come from any combination. And our expectation is that the challenges of low interest rates in combination with the growing cost of regulatory compliance will make M&A volumes increased throughout our industry in the upcoming 12 to 18 months.

With that, Tom will take you into some more details.

Tom Lyons

Thank you, Chris, and good morning everyone. As Chris noted, our net income for the second quarter was $21.4 million, a 1.8% increase from $21 million for the trailing quarter. Earnings per share was $0.34 compared with $0.33 for the trailing quarter. Revenues increased $1.7 million with net interest income increasing $841,000. It’s average earning assets increased by $142 million and the net interest margin held steady at 3.11%.

Average loans grew to 5.2% annualized pace with originations accelerating towards the end of the quarter resulting in 8.6% annualized loan growth on a spot basis. Loan growth was driven by CRE multifamily and commercial lending. This growth was funded by a $231 million or 18% annualized increase in average core deposits. Average interest bearing demand savings and non-interest bearing deposits all increased during the quarter.

Non-interesting income was $806,000 greater than in the trailing quarter, as volatile swap income, loan prepayment fees, and gains on the sale of OREO all improved. We provided $1.7 million for loan losses this quarter an increase from $1.5 million in the trailing quarter as a result of portfolio growth.

Net charge-offs were $3 million or annualized 18 basis points of average loans. The net charge-offs were primarily attributable to one commercial loan relationship which was largely reserved for in the previous quarter and confirmed as a loss in the current quarter.

Non-performing loans decreased $7.6 million from the trailing quarter to $43 million or 0.63% of total loans. Criticized and classified loan levels in early stage delinquencies both improved during the quarter and the portfolio weighted average risk rating remained stable. The allowance for loan losses to total loans declined to 90 basis points to June 30 from 94 basis points at March, 31. Excluding the acquired loans recorded at fair value the allowance was 95 basis points of total loans.

Non-interest expense increased by $1 million from the trailing quarter to $45.9 million as improvements in occupancy, compensation and intangibles amortization were more than offset by increased other expenses, primarily the stock-based portion of annual directors fees and increased non-performing assets related expenses. Income tax expense increased from the trailing quarter to $8.8 million as a result of growth in pretax income. However, our effective tax rate decreased slightly to 29.1% from 29.4%, due to a greater proportion of income being derived from tax exempt sources.

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

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Mark Fitzgibbon with Sandler O’Neill.

Mark Fitzgibbon

Hey, guys good morning.

Chris Martin

Good morning.

Mark Fitzgibbon

Chris just a follow-up on one of your comments on M&A, you guys are – I think in a pretty good position to be picky because you don’t need to do a deal. So what would you be looking for in a bank acquisition, what would it need to have and what financial metrics would be critically important for you guys to meet evaluating a deal?

Chris Martin

For the most part Mark, we would be looking at obviously in market or contiguous to whether it would be Eastern Pennsylvania or North Central New Jersey. Besides that we certainly are sensitive to a tangible book value dilution earn back some of the deals have been a little bit aggressive in that space. The cost saves which ought to be there and certainly the accretiveness that make it worthwhile for us to get involved.

I think the other side of that is the cultures, and the symmetry of the organizations would really complement one another. So I think that’s where we would look at also.

Mark Fitzgibbon

So would it be less than a five year earn back you think on intangible book dilution or more than – better than that?

Chris Martin

It would have to be at a minimum that or better. We have a size constraint obviously we’re at $9.2 billion in assets. So that if we push over the $10 billion by doing a good deal that we think makes sense is something we would do. The size is relative of course the small ones take as much time and effort as the larger ones. So I think we look at that space in saying is the balance sheet what we would be looking at, is it an organic kind of origination of loans or is it – an organization that has very good core deposit growth and opportunities.

Mark Fitzgibbon

Okay. And then changing gears, given the regulatory focus on commercial real estate and the concentration you all have. I’m wondering is it likely that we’ll see commercial real estate growth slow in the quarters ahead?

Chris Martin

I think we’ve been at these levels and it’s kind of part of our business, it’s been there for a long history of Provident. I think we have the risk and the assessment of credits – in a manner that the regulators approve and appreciate. The other side of that would be I kind of go where the market goes and we look at the spreads and returns relative to others. So something that we’re not going to say, we’re going to diminish. On the other hand everybody is taking a little step back as the regulators are focusing on that more and more. Tom, do you have any other comment on that?

Tom Lyons

Yes, I guess just the content further that – are obviously our loss history has been pretty exceptional there. So I think we’ve demonstrated the quality of our internal controls in our underwriting processes. Also the guidelines that are out there while we’ve been over the 300% of total risk-based capital for a number of years, our three year growth rate is below the 50% guideline. And in addition, we don’t do any lending – really any lending in multi-family space in New York City in the boroughs which is where most of the concerns have been expressed.

So we’re pretty comfortable with our growth rate and our capabilities in that area. I guess just a further the comment that Chris was making about acquisition target. So that’s a consideration there as well, concentrations of credit risk in any target that you look at and what their growth rates have been.

Chris Martin

Mark, and just finishing up on that. This is Chris, the idea that – we think of it commercial real estate is an important part of the balance sheet. On the other hand, we have been in the C&I space for a while. It just doesn’t grow as fast as the CRE. But we have definitely put an emphasis on that business and we like that business because of its relationship that is really helps both sides of the balance sheet.

Tom Lyons

I guess furthering that middle market lending is a very strong pipeline at this point. We have a lot of loans approved pending closing. So we’re looking for some nice pick up in Q3 on the middle market side of things in C&I lending.

Mark Fitzgibbon

And then lastly on expenses, and I apologize if I missed this. But did you give an outlook for expenses in the back half of the year. Are they likely to track pretty close to that $45.9 million you had in 2Q?

Tom Lyons

I think a little bit lower, Mark. Probably in the $45 million to $45.5 million, I’m still good with about $183 million to $184 million for the full year.

Mark Fitzgibbon

Great, thank you.

Operator

The next question is from Matt Schultheis from Boenning.

Matt Schultheis

Hi, good morning.

Chris Martin

Good morning.

Matt Schultheis

Really quickly just looking at your loan to deposit ratio and looking at how you’re shifting your funding mix by attracting the right types of deposits. Are you comfortable with your loan to deposit ratio where it is, would you like to get a closer to 100? And what are you doing to attract deposits X leading with rate.

Chris Martin

Well, certainly Tom will discuss the loan to deposit ratio, we’re comfortable where it is – if its one that’s probably the pinnacle of where you’d like to be – so we subject to where the market is then where you’re – where you’re making your money. I would go the other side which is in the deposit market we have done well with noninterest bearing deposits as Tom alluded to in his comments. We’ve also been successful in winning some larger municipal deposits which is a market that we think we can do very well in because it does coincide with a full relationship with the Board of heads corporate cash management products and services and relationships related to it. So, I think that we can continue to grow that area without being the highest rate payer in the deposit space.

Tom Lyons

Yes. I’m more concerned with preserving margin than any quality concerns I'm very comfortable with loan to deposit ratio, likely to close the deposit to 27 basis points so all then inclusive with the noninterest bearing. Loans to deposit on an average basis actually came down a little bit this quarter based on that strong growth we saw in the core area. We’re about 107% on average, about 122% of core deposits, which is another metric that I look at rather than including the time deposit base, because I don't really draw much of a distinction between time deposits and wholesale borrowings.

And I guess the other thing I would point out is the capacity we have on the borrowing side only about 17% of assets there. So certainly ample liquidity there and we have significant unpledged securities portfolio so there's a lot of sources for us. In addition the time deposits, the total deposits were 88% core. So obviously we could pull in time deposits if you wanted to throw at a rate, but we’re trying to manage the margin.

Matt Schultheis

Okay. And then with regard to your LPO in King of Prussia, should we view this as sort of a test run, we could expect to see more of this going forward if this one successful or is this probably just a once off and leave it as it is.

Tom Lyons

I’d kind of where we look at it just trying to meet the market and we looked at the counties around there and having a few people on the ground was a lot more appropriate than having them work out of a different area. And certainly that helps as we – we are getting some loan volumes coming in from Philly, the Philly area. We don't think we’re going to be – going running into Philadelphia in the way of putting in branches and the like. But if customers are there and the ability to meet the needs of the market, we look at LPO as just an opportunity without opening up large branches. And we’ll see over time, if we see the LPO growing and the commercial business growing in the market, then we might look at augmenting it with a small location at best.

Chris Martin

We think its logical market expansion of the team capital markets that we acquired. We got it fully staffed at this point, we like the opportunities in the commercial lending side of things down there too. Just to note on the team capital loans, we’ve grown that about 11% since last year over the last year, the Pennsylvania market loans, so we’re looking to continue to expand in that area.

Matt Schultheis

Okay. Thank you very much.

Chris Martin

Thank you.

Operator

Next question is from Collyn Gilbert of KBW.

Collyn Gilbert

Thanks. Good morning guys.

Chris Martin

Good morning.

Collyn Gilbert

Just to follow-up on your comments about the King of Prussia LPO, are you guys sort of segregating the Philadelphia market at all in terms of where you want to go or where you see the opportunity? And I guess I'm asking for, is there interest or are you seeing business on the other side of the river, on the Jersey side or even southern Jersey or are you seeing most of the opportunity and do you anticipated staying in that Montgomery county, bucks county region? [Indiscernible]

Chris Martin

I would say it's really more of the Montgomery and that region not across the river into the Camden, lower area. We don't have anybody there. We don't really see much volume coming from there. Of course if our customers are going down there for some reason, we would follow them. But right now we don't see us going across the river into the markets that are contiguous to Philadelphia.

Collyn Gilbert

Okay. And Chris, just tying that in, I mean, you indicated that the LPO is kind of a more conservative way before opening branches. What about deals? I know you said obviously you’ve laid out the criteria for deals. But do you see more deal opportunity in the Philly market than you do up here?

Chris Martin

I don't know that we see more. I think in the eastern Pennsylvania area there are a lot of smaller institutions that have little – have market share in their little – their demographic. I would thing that we’re going to look at either – any of the above, whether it be New Jersey or P.A., I don't think that we see anything in the Philadelphia market direct that would be of interest for us, which you never can tell.

Collyn Gilbert

Okay, okay. And then if you could just shift to the loan pipeline, Tommy talked a little bit about this, but the mix, how the mix is shaking up, as we kind of close out second quarter or where the pipeline stands today relative to where what’s going into the quarter?

Chris Martin

Sure. We are down a bit. I think we are about $1.5 billion, at the end of last quarter. If I remember correctly, we’re down about $1.2 billion. Mix is pretty even between floating and fixed about 53% floating and 47% fixed rate. Projected close rate would be about a 3.63. So you can see that margin compression continues to be an issue for us, as well as the rest of the industry. New on-rates coming in, in the high 350s, low 360s.

Collyn Gilbert

Okay and then just a mix between say CRE multi-family versus C&I.

Tom Lyons

CRE, see I don't have it by percentages but CRE multi-family 131 – yes, of about 594 in projected pull through, about 132 million in CRE and – about 300 million say in C&I.

Collyn Gilbert

Okay. Okay, that’s helpful. And then, sorry to jump back. But just back to the M&A, the M&A discussion, obviously as you’re looking through your metrics cost saves were something that you’ve mentioned. I mean what do you – I know every bank is going to be different. Right, in terms of what the cost saves are you can extract. But is there a certain percentage that you guys think you should be able to do almost regardless just given, how you operate your bank and how efficiently you operate your bank relative to the target?

I mean I guess, and where I'm going with this is that maybe some would say a normal cost save ratio would be about 30%, but maybe now in the new era of regulation and such that we could see that bump up to 40% in kind of a traditional sense. Do you guys have a thought on kind of cost saves in a deal? And if you think you can extract more than your – than maybe the average buyer.

Chris Martin

Well, I’ll go, let’s be humble. I think between 25% and 35%, always contingent on the – where the organization is if it's in markets, there's definitely going to be a little bit more in the way of cost savings because you’re going to consolidate possibly some branches. If it’s outside or in new markets, you’re not going to have that opportunity. There are some that are putting out these very large cost saves, god bless them. But I don’t know how they can do that especially with the regulatory environment on branch closures getting a lot more scrutiny also.

So I think that we would always look at – we’d always – we don’t say under promise and over-deliver, but I think that we are always able to extract long-term the cost saves. And they come from both sides of an organization, not just the acquisition but it would be a combination in saying what’s best to breed and what we can go ahead in going forward.

Collyn Gilbert

Okay, okay. That’s helpful. And then just on the crossing of the $10 billion. So, how are you guys thinking about that? Maybe what – if you could – and I think maybe you touched a little bit on this, Tom, in your comments but just kind of quantify the expense initiative that you are seeing tied to that this year and then maybe even next year. And then also just remind us too what the loss of Durbin will do?

Tom Lyons

Sure. This year is relatively small. We have some systems work going in and some hiring that will come later as we progress through the process, but I think it’s between 250 and 350 budgeted for the full year this year. We’re about a $1 million in a quarter for each of the next two years. And once we’re fully phased in and we’re estimating if we go organically that happens in 2020, I guess the first reporting year. Durbin, it would be about $3.2 million loss to income.

Collyn Gilbert

$3.2 million. Okay. I’m sorry. Tom, in your internal budgets you guys don’t – you don’t have yourselves crossing the $10 billion organically until 2020?

Tom Lyons

We would be crossing $18 million in the first reporting period, 2020 something.

Collyn Gilbert

Okay, okay. Got it, got it. Okay. Okay, I’ll leave it there. Thanks guys.

Chris Martin

Thank you.

Operator

The next question is from Matthew Breese at Piper Jaffray.

Matthew Breese

Good morning, guys.

Chris Martin

Good morning.

Matthew Breese

Chris, I think you noted that and – your talk about commercial real estate of that, a lot of your peers are pulling back and I think that means yourselves. Can you just give us some specifics on how you’re pulling back? How you’re adjusting the dials? Some examples of what you’ve done in the way of tightening lending standards or just stepping way from some certain markets perhaps. Just some more detail there.

Chris Martin

Well, I think we look at certainly markets that are – we’re in the – but we’re not in the borough. So we look at multi-family in the areas across from Manhattan and the like. We’re watching how much construction is going on and making sure that the market absorbs some of the multi-family projects. We’ve also started putting floors on fixed rate deals, which we have done a number of years ago. And then there was no need. We’re going back to putting floors in place. There’s also some very aggressive fixed non-recourse financing going on in the multi-family and even industrial.

So, when you are talking about 15-year fixed debt, 3.90% or 4% in a quarter, with non-swapped C&I deal. There’s a lot of aggressive lending going on out there. And I’m not saying it is wrong or right or a different, it’s just not something we feel comfortable with. I think that we’re just like normal we have return on equity hurdles and we’re being more discerning in the deals that we want and I think that’s kind of what we’ve always done. We’re not taking anything off the table necessarily and not stopping CRE growth, it’s just a question of making sure that it meets all the parameters we expect.

Matthew Breese

Is that also implying that the geographic shift on commercial real estate has gone more from Jersey to Pennsylvania in anyway?

Chris Martin

There’s a little bit more industrial in both New Jersey and in Pennsylvania and that seems to be the market that’s going pretty well. The office retail market is always been a little bit slower and we think it will be there for a little bit longer, least in the office space. There’s still a lot of construction going on in Pennsylvania and we’ve followed our customers in the past. But there’s a little bit of that New Jersey too. So I don’t think we’re looking at one market versus the other being in competition.

Matthew Breese

Got it. Okay. And then going back to M&A, you mentioned both – you would consider both whole bank and wealth management platforms. As you think about acquisitions of both types, is there any difference in terms of the accretion and dilution math on EPS and book value and then the earn back period, because with the wealth management company – you take on a lot of goodwill. So is there any difference in the math and metrics that are acceptable?

Tom Lyons

Earn back is certainly loan grow on the wealth management acquisitions, really looking more for mid-to-high teens IRR on those. You get a lower IRR on the bank deals, but it shorter earn back. As Chris said, earlier I think certainly less than five years is where we target.

Matthew Breese

Right. So for wealth management is it the right number – 10 years or 7 years?

Tom Lyons

Yes.

Chris Martin

Yes. It is out there around seven years, as Tom alluded to because of the goodwill that’s put up. On the other hand, it’s a business that we like. It certainly helps grow earnings and doesn’t affect our balance sheet size.

Tom Lyons

And returns are still nice obviously, because there’s not capital hold against assets.

Matthew Breese

Yes. And how do you feel about your opportunities to find one of these platforms?

Chris Martin

We think it’s getting better. And as I mentioned, that’s going to continue I think with the DOL and there are new regulations. We think there will be more IRA’s available. On the other hand, it’s a process just like any other people going there, they may be shopping. We have to look at it, we have to do some diligence; and then they don’t show up or they don’t sell. So it’s a process that is ongoing. We’re always involved and we’re seeing a lot of opportunity. We just haven’t found the one that matches up.

Matthew Breese

Got it. Okay. That’s all I had. I appreciate taking my question. Thank you.

Chris Martin

Thank you.

Operator

This concludes the question-and-answer session and the conference call. Thank you for attending today’s presentation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!