Provident Financial Services, Inc. Q2 2008 Earnings Call Transcript

Jul.28.08 | About: Provident Financial (PFS)

Provident Financial Services, Inc. (NYSE:PFS)

Q2 2008 Earnings Call Transcript

July 24, 2008 10:00 am ET

Executives

Paul Pantozzi – CEO

Linda Niro – CFO

Chris Martin – President and COO

Analysts

Mark Fitzgibbon – Sandler O'Neill

Damon DelMonte – KBW

Rick Weiss – Janney Montgomery Scott

Matt Kelley – Sterne, Agee

Operator

Hello and welcome to the Provident Financial Services, Inc. second quarter 2008 earnings conference call. All participants will be in listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. (Operator instructions) Now, I'd like to turn the conference over to Paul Pantozzi. Mr. Pantozzi, please begin.

Paul Pantozzi

Thank you. Good morning, everyone. Welcome to our second quarter 2008 earnings call. I'll begin with our standard caution as to any forward-looking statements that maybe made in the course of our discussion. The full disclaimer can be found in the text of our earnings release and you can obtain a copy of that as well as all of our other releases and SEC filings by accessing our Web site providentnj.com or by calling our Investor Relations area at 201-915-5344.

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

Our second quarter net income of $10.4 million or $0.18 per diluted share reflects our ongoing efforts to increase net interest income while managing our overhead cost and credit risk. The Federal Reserve's rate cutting actions have resulted in among other things, the return to a positively sloped yield curve. We have stated consistently that we have been managing our balance sheet to benefit from this as the interest cost of liabilities has fallen faster than the yield on earning assets. As a consequence, our net interest margin expanded 23 basis points in the second quarter to 3.10%.

Competition for deposits in our market has remained intense, but we have held to our course of rationally pricing our time deposits and focusing our efforts on core deposit relationships. As of June 30, 2008, 63% of total deposits were core deposits with over 11% in non-interest bearing demand deposits. This has helped us fund continuing loan growth at favorable spreads.

New loan production during the second quarter remained fairly robust in every category as we continued to meet the demands of quality borrowers while maintaining our conservative underwriting standards. Our unfounded loan pipeline also increased during the quarter to 763 million, as compared to 672 million at the end of the previous quarter.

Regarding expenses, the ratio of non-interest expense to average assets increased in the second quarter to 2.11%, up from 2.03% in the first quarter. But this was largely attributable to the nearly $800,000 in employee severance expense recognized in the quarter as we continue to manage our cost structure for improved efficiency and productivity. All of our other expense categories remained consistent.

Turning now to asset quality, (inaudible) repeating that we have no subprime loans or collateralized debt obligations. However, the challenges posed by the overall economic environment continue to have a negative impact on our asset quality metrics.

As of June 30th 2008, non-performing assets were 0.67% of total assets, up from 0.48% at the end of the first quarter. I want to point out however, that the majority of non-performing assets are comprised primarily of a few commercial real estate credits that are being actively managed to resolution and that we have seen no notable deterioration in our residential or home equity loan portfolios.

I would like now to turn the call over to Linda, who will address this topic and the rest of our quarterly results in greater detail. Linda?

Linda Niro

Thank you, Paul. As Paul mentioned, the net interest margin increased 23 basis points to 310 during the quarter compared to 2.87% in the first quarter of 2008. The increase in the margin is due primarily to a decrease of 46 basis points in the average cost of deposit to 2.41% from 2.87% in the trailing quarter.

The cost of borrowed funds also decreased 22 basis points sequentially, resulting in an overall reduction in the cost of interest bearing liabilities of 40 basis points to 2.74%. The average yield on net loans decreased 14 basis points to 5.76% from 5.90%.

The decline in the average yield of the loan portfolio reflects decreases in short-term interest rates during the quarter and the composition of the commercial portfolio, which is approximately 52% floating or adjustable rates. Average yields on interest earning assets decreased 13 basis points to 5.5% from 5.63% in the trailing quarter.

Total investments increased 884,000 during the second quarter to $1.26 billion and represented approximately 20% of total assets at June 30. The investment portfolio consists primarily of agency guaranteed mortgage backed securities and bank qualified municipal bonds. There are no preferred or trust preferred equities in the portfolio. The portfolio had a weighted average life of 5.2 years and a duration of four years at June 3rd.

During the quarter, total loans increased $21.5 million or five-tenths of 1% sequentially. The largest increase in the portfolio was in residential mortgage loans, which increased $79.8 million. Commercial mortgage and multifamily loans increased 47 million or 4.8%. Construction loans decreased 63.7 million and commercial loans decreased 29.2 million sequentially. Commercial loans as a percentage of total loans were 45.1% at June 30 compared to 46.4% at March 31st 2008.

During the second quarter, sales of residential construction projects continued to be slow and continued declines in real estate values and the uncertain economic environment in addition to an increase in non-performing loans resulted in a provision for loan losses in the amount of $1.5 million.

Net charge-offs during the second quarter were $1.2 million. Total non-performing assets consisting of non-performing loans and foreclosed assets totaled $42.6 million or 0.67% of total assets compared to 30.6 million or 0.48% of total assets at March 31st. At June 30, a $16 million loan was 90 days plus past due and still accruing.

Subsequent to quarter-end, we have received the proceeds from several closing, the interest is current as of July 1st 2008 and in addition, 580,000 in principal reduction have been received. Excluding the $16 million loan that was 90 days past due and still accruing, at the end of the quarter, non-performing assets were $26.6 million or 48 basis points of total assets.

Total deposits decreased $60.4 million or 1.4% during the second quarter. Increases of $54.2 million in demand deposit balances were offset by decreases in savings balances of $45.5 million and higher cost time deposit balances of $69.1 million. At the end of the second quarter, core deposits as a percentage of total deposits were 63.3% compared to 62.2% at the end of the first quarter.

Non-interest income in the second quarter of 2008 decreased $2.1 million or 24% to $6.7 million from 8.8 million in the first quarter. Fee income declined $1.2 million or 20% as a result of a $1.3 million decrease in equity fund income compared to the trailing quarter. Other income decreased $1.1 million to $118,000 in the quarter, primarily as a result of non-recurring gain on the sale of a branch and the gain associated with the Visa initial public offering that was recorded in the first quarter.

Non-interest expense increased $1.3 million or 4.2% to $33.3 million during the quarter compared to $32 million in the trailing quarter. The increase in non-interest expense was due primarily to a $795,000 increase in advertising and promotion, a $751,000 increase in compensation and benefits, and a $215,000 increase in other operating expense, partially offset by decreases in intangible amortization, data processing and net occupancy expense.

The increase in advertising and promotion was attributable to core retail account promotions and business deposit product advertising, and the increase in compensation was due to 773,000 in pre-tax severance expense.

Income tax expense increased 62,000 to $4.1 million in the second quarter compared to 4 million in the trailing quarter. The effective tax rate was 28.3% in the second quarter of 2008 compared to 27.4% for the first quarter. The increase in the effective tax rate was due to a write-down of deferred tax assets resulting from the expiration of non-qualified stock options.

Now, I'll turn it back over to Paul for his additional comments.

Paul Pantozzi

Thank you, Linda. Everyone is aware that a main area of concern in the banking industry today is capital adequacy. As of June 30, 2008, all of our capital ratios at both the holding company and bank levels exceeded the regulatory threshold to be considered well capitalized. Also in order to conserve that capital while still maintaining a quarterly cash dividend, our share repurchase activity in the second quarter was negligible.

With that, I'll be happy to open up the call for any questions you may have.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Mark Fitzgibbon of Sandler O'Neill. Please go ahead.

Mark Fitzgibbon – Sandler O’Neill

Hey, guys. How are you?

Paul Pantozzi

Good morning.

Linda Niro

Good. How are you doing?

Mark Fitzgibbon – Sandler O’Neill

First question I had, I wondered if you could talk a little bit about your deposit strategy and how – whether you plan over time to fund more the long growth with deposits or with borrowings or be opportunistic and if the plan is to do it with deposits, maybe just share with us how that comes about, whether it's de novo branching or new marketing strategies or what have you?

Linda Niro

I think, Mark, it's a combination of both on the deposit side, that's our preferred method of funding loan growth to expand our deposit base and our market share. Again, we've talked repeatedly about our strategic business plan to expand core account relationships, not only on the retail side, but on the commercial and small business side by offering new products, by enhancing our Web site and internet banking capabilities. While de novo branching will be in the mix, where it makes sense, from a geographic location and market share, primarily it's going to be through expanding relationships with our customers and improving our core deposit mix.

Paul Pantozzi

Mark, this is Paul. We have several locations – de novo locations in the pipeline, they're not going to be coming online until much later this year and really into the first and second quarters of '09, but again, very selective locations hopefully to assist in the process.

Mark Fitzgibbon – Sandler O’Neill

Okay. And then the second question, could you break out for us, Linda, the prepayment penalty income in the first and second quarters? Do you know how much that was?

Linda Niro

Prepayment penalty on loans?

Mark Fitzgibbon – Sandler O’Neill

Well, you said prepayment penalty income in the press release was down, you attributed the lower non-interest income level partially to lower prepayment penalty.

Linda Niro

That was the equity fee income.

Mark Fitzgibbon – Sandler O’Neill

Got you.

Linda Niro

Yeah, reduction in the value of the equity fund.

Mark Fitzgibbon – Sandler O’Neill

Okay. And then on that $16 million credit that you have that you secured at the end of the – or after the end of the quarter, could you give us maybe a little more detail on that? Is – how much equity the principals have in it and that sort of thing?

Chris Martin

We don't – again, probably wouldn't want to say how much equity they have it, kind of private information. But that building had just been finished. We had some delays and some COs, just – the process that takes and now that everything are completed, there were some sales just waiting to get the COs to close the unit. Definitely, in a decent market and also a much cheaper price point than say Manhattan or on the gold coast of New Jersey, so there's a maybe a little bit more affordability index in this building. So, things are slow, but they've progressed and we're closing contracts as we speak.

Mark Fitzgibbon – Sandler O’Neill

Okay. And then, last question is on the margin, obviously you had talked a lot in the second quarter, do you think you can hold the margin here given what you see going on with liability pricing and the yield curve?

Linda Niro

I do, Mark. I think we're going to still be able to reduce our costs of funds, probably not as strongly as what occurred in the second quarter and we're looking for a pick up in asset yield as well.

Mark Fitzgibbon – Sandler O’Neill

Okay. And then just, very last question, just the tax rate, should we still assume around 28%?

Linda Niro

Yeah, we're still actually projecting around 27.

Mark Fitzgibbon – Sandler O’Neill

27%.

Linda Niro

Yeah.

Mark Fitzgibbon – Sandler O’Neill

Thank you very much.

Linda Niro

You're welcome.

Operator

Thank you. Our next question comes from Damon DelMonte of KBW. Please go ahead.

Damon DelMonte – KBW

Hi, good morning. How are you?

Paul Pantozzi

Good Morning.

Linda Niro

Good morning.

Damon DelMonte – KBW

Quick question regarding your outlook for charge-offs going forward and balancing that with your provision level. Charge-offs this quarter about 12 basis points, and the provision more than cover that, but the reserves pretty much stayed flat with – as a percent of total loans. How are you looking at – I guess, the provision and charge-offs going forward?

Linda Niro

It's going to be determined by our monthly and quarterly evaluations of the lending portfolio and the risks that we see at the end of the quarter determined by growth in the portfolio, the mix, its commercial loans, increased to an extent and also what happens with non-performing loans. Right now, we're not seeing any significant change in that number. And as we mentioned, the one $16 million loan really was just out there and non-performing really a timing issue. So, it's just really a result of our analysis and what we see when we get to quarter-end.

Damon DelMonte – KBW

Okay. And then, with regards to expenses, if we exclude that $773,000 severance related charge, is that a good run rate going forward?

Linda Niro

Yes, definitely. Probably be a little bit less, but you definitely want to pull that 773,000 out.

Damon DelMonte – KBW

Okay, that's all I have. Thank you very much.

Linda Niro

You're welcome.

Paul Pantozzi

Thank you.

Operator

(Operator instructions) Our next question is from Rick Weiss of Janney. Please go ahead.

Rick Weiss – Janney Montgomery Scott

Good morning.

Linda Niro

Good morning.

Paul Pantozzi

Good morning, Rick.

Rick Weiss – Janney Montgomery Scott

I was wondering if you could kind of give a big picture kind of guidance, talked to a lot of investors that compared this credit cycle to the last one or even the one in the 1980s, early '90s. What's your perception of economic credit conditions?

Linda Niro

Well, I think – I think this is somewhat worse than the late '80s and early '90s only because it's so widespread in terms of it being predominantly in the residential sector and not just residential, but you have home equity of credit cards and those sorts of things, but I think it looks from our standpoint hopefully things are turning around a little bit in our market area. Again, we just had bigger losses, I think.

Chris Martin

Just to add to that with the – to expand upon it, really would be the declining dollar, oil, the global environment, and the liquidity issues that have been – surfaced from all this. It's not just the United States having a problem, it's everybody that's bought this – bought into the paper and now, we have to undo and it's going to be a little bit longer process.

Paul Pantozzi

And Rick, this is Paul. Just should point out back in the last '80s, early '90s, we were not as diversified as we are today. We were pretty much in the early stages of getting into commercial lending back then and as the market was turning, we were sitting on the sidelines for maybe a year and a half to two years waiting for it to improve. So, completely different situation for us versus – a public company versus a mutual company just beginning to get into that business 17, 18 years ago.

Rick Weiss – Janney Montgomery Scott

That's true. Would you expect to see more bank failures specifically in New Jersey in the next year or two?

Paul Pantozzi

I think New Jersey represents a stronger segment of the market. There's been articles recently touting the strength of the industry, of the – the state chartered institutions or the institution headquartered in New Jersey, obviously, you have the larger players with significant presence here. They seem to be having some difficulty, but generally speaking, the banking sector in New Jersey is rather strong. I wouldn't expect to see any failures. I'd be surprised if you did.

Rick Weiss – Janney Montgomery Scott

Okay, and one final question, would the housing bill – I don't know if you got a chance to look at it or the bill that just passed the House, was – is that going to have any effect on Provident?

Paul Pantozzi

We haven't really looked at in any detail, but just hearing what we heard on the news this morning, I don't see it having any beneficial effect or adverse effect on our bank.

Rick Weiss – Janney Montgomery Scott

Okay. Thank you very much.

Operator

(Operator instructions) Our next question comes from Matt Kelley of Sterne Agee. Please go ahead.

Matt Kelley – Sterne, Agee

Yeah, hi guys. The question is on the home equity portfolio, looking at the latest kind of regulatory data, it looks like about 200 million in junior [ph] liens and about 83 million in revolving lines of credit. What kind of data points can you give us on kind of the underwriting there combined loan to values and just any kind of trends or commentary on that, that piece of your loan book?

Chris Martin

Matt, we go over that portfolio, and I can (inaudible) we feel good about the portfolio itself, we never went really above 80% loan to values, we were never players in 100% or 125%. We do – we score everybody, we look at the paper, it's not just okay, here's a score and go and the market, and we don't want anybody to be overextended. It doesn't help them and it doesn't help us. So, from that standpoint, we feel real good about that portfolio and draw downs were still in the low 40% utilization rate. So, though there might be people that will have to use it, we watch it, we're actually that we're seeing a lot of business come in from the larger banks that have documentation that shut people down in the middle of what they're doing. We're getting the advantage of them coming to us and albeit, we're not offering up the numbers that they probably had, but I think we're offering them a resolution to their issues and allowing them to still draw down some of the equity in their home.

Matt Kelley – Sterne, Agee

Okay. And then, along those lines, in the single family portfolio, do you – are you seeing kind of a significant pickup in origination activity and the potential for some more significant growth and balances in single family as some of the other larger players have pulled out of that market and opportunities for community institution like yourself to gain share?

Linda Niro

Yeah, we've been seeing that all year, Matt, as different players have exited the market, we're seeing people come back to community banks like Provident, and so we view it as an opportunity to put on additional residential loans, and again, it helps us core up sell and expand relationships with our customers, so.

Paul Pantozzi

We never stop lending, Matt. I think that's a key factor as well.

Matt Kelley – Sterne, Agee

And then, just a final question, what were the (inaudible) 30 to 89 day past due numbers for period ended at June 30th?

Linda Niro

The – hang on a second and I'll get that for you, Matt. Okay. 30 to 89 were approximately 23 million – 23.8 million.

Matt Kelley – Sterne, Agee

Okay, so only a small increase over the first quarter then?

Linda Niro

Right.

Matt Kelley – Sterne, Agee

Okay. All right. Thank you.

Linda Niro

Welcome.

Operator

We show no further questions at this time. I'd like to turn the conference back over to Mr. Pantozzi for any closing remarks.

Paul Pantozzi

Okay. Thank you very much. We appreciate your participation in this call, and we look forward to hearing from you on our next earnings call. Thank you. Have a great summer.

Operator

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

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