Provident Financial Services, Inc.
Q2 2019 Earnings Call Transcript

Published: 25 Oct 2019

[Operator:]

Good morning, welcome to the Provident Financial Services, Inc. Third Quarter 2019 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.I'd now like to turn the conference over to Len Gleeson, Investor Relations Office. Please go ahead.

[Len Gleeson:]

Thank you, Debbie. Good morning, ladies and gentlemen. Thank you for joining us today. The presenters for our third quarter earnings call are Chris Martin, Chairman, President and CEO; and Tom Lyons, Senior Executive Vice President and Chief Financial Officer.Before beginning the review of our financial results, we ask that you please take note of our standard caution as to any forward-looking statements made during the course of today's call. Our full disclaimer can be found in this morning's earnings release, which has been posted to the Investor Relations page on our website provident.bank.Now, it's pleased to introduce Chris Martin, who'll offer his part on our quarter. Chris?

[Chris Martin:]

Thank you, Len, and good morning everyone. Provident's operating results were impacted by margin compression, which is being experienced by number of financial institutions in this lower interest rate environment as Fed policy has been supporting continued expansion in the economy and tempering the impact of possible tariffs and geopolitical challenges.PFS's balance sheet remains strong and non-interest bearing deposit growth in the third quarter helped to ameliorate the margin compression. We have also re-priced negotiated deposit rates while being mindful of the overall business relationships we have with these customers.As Tom will detail, core margin impact was on the severe compared to the trailing quarter as we experienced a recovery in Q2, which had a onetime positive impact on the margin. Earnings per share improved in Q3, and our annualized return on assets was 1.26% for the quarter, while our return on average tangible equity is 12.97%.Margin compression will be the headwind going into 2020 as it appears that Fed's policy will continue to be more accommodative. Rates have been volatile and the yield curve is flattened significantly over the past year. As always, net interest income will be influenced by a number of factors including loan growth, pricing spreads, the level of rates and the slope of the yield curve.And because our loan portfolio leads to a more adjustable and variable rates versus fixed, we will be impacted by lower yields. We anticipate our net interest margin will decline by 2 to 4 basis points in the fourth quarter, given the impact of the September and possible October rate cuts.Deposit pricing dynamics remain very competitive in our market, but we're now seeing less money market and special CD promotions. Pricing discipline per deposits appears to have return to our markets, but loan terms and conditions continue to be aggressive. We continue to maintain our credit standards and set loan pricing based on total return assessments.As for loan growth, commercial payoffs continue to an elevated level with over a half refinanced away and the remainder paid off from the sales collateral property. The pipeline increased over the previous quarter although we have to issue more term sheets to achieve pull-through levels.The level of private equity and insurance company and GSE involvement has tempered our growth expectations. So, we select those opportunities that meet our return hurdles and credit criteria. And while we don't see a recession on the horizon anytime soon, we're being cautious in selected areas for new loan origination.Credit quality has been on even as we analyze relationships they're showing stress in particular industry sectors that will not perform well in the mature business cycle. We are mindful at some point the economy will experience a credit downturn and we remain disciplined in terms of our loan origination quality and our credit parameters, regardless of the competitive environment.Charge offs were elevated during the quarter as we wrote off the commercial relationships that have been fully reserved for in Q2. We're not seeing systemic issues that materially change our conservative credit perspectives for the balance of 2019 or 2020.As per CECL, we are still in the implementation phase and the ultimate effect will depend on the composition of our loan portfolio, the portfolios credit quality, and economic conditions at the time of adoption as well as any adjustments and alterations to our models, methodology and other material assumptions. We are not yet at a point where we can disclose any impact to capital reserve levels.On the deposit front average non-interest bearing deposits increased $56 million versus a trailing quarter, accompanied by increases in average time deposits, money market and brokers deposits partially offsetting decreases in average amount checking and saving deposits.Average borrowings increased in volume, net costs were lowered by five basis points despite the impact of the repo market dislocation in September, which closed the material increase in rates for several days. Core deposits represent 87.9% of total deposits as at quarter end.Non-interest income improved during the quarter with a majority coming from fees on low level swap transactions and loan prepayment fees. And our costs remain well contained with increases in comp and benefit costs largely offset by decrease FDIC insurance expense and data processing costs.Our efficiency ratio for the quarter at September 30 2019 was 54.31% and annualized net interest expense to average assets was 1.99% for the same time period. We continue to manage our senses, mindful that will be required by regulators to further build upon our risk and compliance series as we approached $10 billion in assets.We have also invested time and treasure in employing bots to perform repetitive processes along with operational and decision making improvements. We are investing in our digital channels to upgrade the customer experience and ability to self serve, along with enhanced access to alternate payment channels.Customer behaviors continue to evolve and we must adapt to compete with the large money center banks and financial intermediaries. As for M&A, we have been involved, but if you're not first, you’re left.Our disciplined approach to acquisitions has always been about the enhancement of the combined entity including management culture and franchise value, while ensuring accretion earnings and a reasonable earned back with a tangible book value dilution. We invest in ourselves by repurchasing over 670,000 shares of our stock this quarter during periods of market weakness.We evaluate the best use of our capital on a daily basis and continue to selectively look at many deal opportunities. We listen to and read our commercial clients and retail customers who continue to see moderate demand and no widespread misuse related to trade uncertainty and interest rate moves. Not that optimism range to premium, but the core economy continues to perform above the expectations of many. And we feel our balance sheet is well positioned and will continue to grow within the limits of the economy and consumer confidence.With that, Tom will go over more details on the quarter. Tom?

[Tom Lyons:]

Thank you, Chris, and good morning everyone. Our net income was $31.4 million or $0.49 per diluted share, compared to $35.5 million or $0.54 per diluted share for the third quarter of 2018, and $24.4 million or $0.38 per diluted share in the trailing quarter. Third quarter revenue was consistent with last year's quarter at $92 million.Our net interest margin contracted 19 basis points versus the trailing quarter and 15 basis points versus the same period last year. Recall that the trailing quarter margin was increased 10 basis points due to the recognition of $2.2 million and interest income from CBC non-accruable loans.Excluding the impact of the receipt of this non-accrual loan interest in the trailing quarter, our core margin which also excludes loan prepayment fees contracted 9 basis points versus the trailing quarter.To combat this margin compression, we've begun reprising deposit accounts with negotiated exception rates with roughly $16 million reduced by 25 basis points effective August 1st and another $300 million reduced by 25 basis points effective October 1st.We will continue to manage liability clusters as rate environment evolves and competition becomes more rationale. In addition, we continue to emphasize the acquisition of non-interest bearing deposits, which grew $56 million on average or an annualized 15% versus the trailing quarter to $1.5 billion.Quarter end loan totals decreased $27 million from June 30, as growth in CRE and construction loans was outpaced by net reductions in C&I, multifamily, consumer and residential mortgage loans. Loan originations excluding line of credit advances fell $56 million versus the trailing quarter to $354 million, and pay offs remain elevated with $37 million more paying off in the current quarter than in the trailing quarter.The pipeline at September 30 increased to $1.1 billion from $979 million at the trailing quarter-end. The pipeline rate however has decreased 45 basis points since last quarter to 4.11%. The lower pipeline reflects current market conditions in the declining treasury rates.We intend to manage the balance sheet through December 31, to stay below the $10 billion asset threshold to avoid the impact of interchange revenues in 2020. Our provision for loan losses was $500,000 for the current quarter compared to $9.5 million in the trailing quarter.Last quarter's elevated provisions is largely driven by a $5.7 million credit to a commercial contract that was fully reserved. The deterioration in that credit appears to then resolve to the borrower taking on larger projects, low payments from customers, and their prior completely defalcation.That balance was charged off in the current quarter, driving our quarterly annualized net charge offs as a percentage of average loans to 33 basis points. Overall, credit metrics were stable this quarter with non-performing assets totaling 42 basis points of total assets at quarter-end. The allowance for loan losses to total loans decreased to 79 basis points from 86 basis points from the trailing quarter as a result of the aforementioned charge off of a fully reserved balance.Non-interest income increased by $2.2 million versus the trailing quarter to $18 million, loan level swap income increased $1.8 million and loan prepayment these increased $644,000 versus the trailing quarter. Non-interest expenses were annualized 1.99% of average assets for the quarter. Expenses were flat at $49.7 million versus the trailing quarter helped by the recognition of the small bank assessment credit on FDIC insurance of $660,000 for the quarter.Our total remaining credit potentially realizable on future quarters is 1.8 million. Our effective tax rate decreased to 24% and 26.5% in the trailing quarter, the prior quarter tax rate was elevated as a result of increased provisioning related to the publication of the technical bulletin that specifies between real estate investment trusts and connection combined reporting from New Jersey corporate business tax services. We are currently projecting the federal tax rate of approximately 24% for the remainder of 2019 and thereafter.That concludes our prepared remarks. We will be happy to respond any questions.

[Operator:]

We will now begin the question-and-answer session. [Operator instructions] The first question comes from Mark Fitzgibbon with Sandler O'Neill and Partners. Please go ahead.

[Mark Fitzgibbon:]

Tom, just to clarify, did you say that there was 1.8 million in remaining FDIC assessment credit?

[Tom Lyons:]

That's correct.

[Mark Fitzgibbon:]

Okay, super. And then secondly, I wondered if you could kind of break out some of the major items in the fee and other income lines from the linked quarter. What were some of the big deltas there?

[Tom Lyons:]

Sure, really distribute in two categories, Mark, involves all categories prepayment fees on loans were up to a $1.5 million from 873,000 in the trailing quarter. So that's $644,000 of it. And then the big piece was in the profit on swaps $2.7 million for the current quarter versus 896,000 in the trailing quarter, so $1.8 million of improvements there.

[Mark Fitzgibbon:]

I know they're volatile items, but how are you thinking about them for the fourth quarter. I mean…

[Tom Lyons:]

Looking at it the other income overall, I'd say probably $16 million to $17 million just kind of the midpoint kind of range where we expect going forward.

[Mark Fitzgibbon:]

And then you said, you're going to keep the balance sheet under 10 billion for the rest of this year, which makes sense. Will you grow through it organically in the first quarter do you think assuming you don't find an acquisition?

[Tom Lyons:]

I do believe by the end of the first quarter we should be there. Yes.

[Chris Martin:]

Yes, Mark. This is Chris. We have modeled it looks like in the first quarter towards the end of that absent any extreme level of payoffs that we would go through in that first quarter. Timing of acquisitions as you know is serendipity, and we don't know when they'll happen; and if there is anything that there would make sense.

[Mark Fitzgibbon:]

Okay. And then I apologize if I missed it, but did you indicate how much a 25 basis point cut would mean to your margin?

[Tom Lyons:]

I think just Chris covered, when he said probably 2 to 4 basis points in the back half of the year, and that's expecting a cut next week and potentially one of the end of the period.

[Operator:]

The next question is from Russell Gunther with D.A. Davidson. Please go ahead.

[Russell Gunther:]

Chris could elaborate a little bit on what you were referring to in terms of some of the selective areas where you've become a little bit more cautious?

[Chris Martin:]

Sure, we certainly have looked at the contractor area, some contractors, we are we have pulled back over the last several months and some of them are doing fine. We just don't think the exposure makes sense in this late business cycle. And then also in the hospitality industry, specifically hotels watching that market a little bit. So, the economy may start to get a little struggle that kind of area we want to heading up. So, those are the two areas that we are pretty much looking at reducing and are keeping our exposure limit in the way of new originations.

[Russell Gunther:]

Got it. Okay, I appreciate your thoughts there. And then on just the flip side of that, obviously, it's been a bit of challenging environment for growth, which sounds you'll again you said across organically in the first quarter. Maybe just share a little bit about what the opportunities are in the loan growth outlook via an asset class or geography?

[Chris Martin:]

Well, we're still seeing pretty good growth in the industrial space especially in the warehouse area and that's continued to grow. We don't give a lot of the permanents on the multifamily through construction deals that we've been doing. So, we try the agencies are giving a lot more interest only period that we just something is prudent and we don't have that capacity. Those are the two main areas I think that we have been focusing in on, if there is opportunity in those spaces. And on that retail a little bit and then it is like a self storage areas, but I think and we kind of look at every package on its own merits and how its structured from a credit perspective.

[Russell Gunther:]

And then switching gears quickly, the release mentioned continued tech investments as well as around compliance. Just give us a sense for kind what the franchise investments relates to there? And how that may impact the expense run-rate going forward?

[Tom Lyons:]

I can comment to the run-rate. I think we're going to tick up a little bit in Q4 with some final CECL implementation related cost, so probably in the 15 to 15.5 kind of range for Q4. We expect to sustain that to the degree going forward. I think we're going to be able to offset with some of the improvements efficiency improvements, we've made to largely offset some of the increases in the technology spend.

[Chris Martin:]

Yes, I think this is Chris again. We look at we've been spending money and hiring people I think and adapting to already being a $10 billion company. The regulators are here and they already worked along with us to make sure that we're trying to adhere everything that they're expecting; and at that point, we have hired in the risk area, compliance area, certainly some scale. So we're already in some of our numbers to begin with.As Tom alluded to, it's going to deliver a little bit more CECL and then perfecting all of these items making sure, we're in a right place on the backend as I spoke to my comments. Using again some robotics to do some rudimentary things that are being done with a lot of people, we're able to do the better decisioning to our use of analytics and AI. And those are the expenses we like to actually put in, because we think they're going to result in the operational efficiency going forward.

[Operator:]

The next question is from Collyn Gilbert with KBW. Please go ahead.

[Collyn Gilbert:]

So Chris, just back to the comment you made on kind of loan growth and appetite. Along those lines, are the pipelines that you've got currently and you indicated kind of a 4 point, I think you said 4.11% loan yield. Can you just talk about sort of the mix of that the structure of that? And sort of how you see loan pricing trending as we kind of move into the next couple of quarters if rate hold where they are?

[Chris Martin:]

Sure, I'll start on that and then I'll let Tom talk about the yield. But it's pretty good mix and we like diversification. So, you're talking about CRE approximately $345 million in the pipeline a middle market of about $218 million pipeline. Business banking, meaning smaller type of C&I loan so 255 million. Our Pennsylvania area which has a blend of both of the C&I areas of 176 million and then revenue in consumer approximately of 100 million, so I guess it's to about a 1 billion, but the rate coming in is definitely lower as we look at continuing to originate variable rate loans. Tom maybe give some color on those the rate and return.

[Tom Lyons:]

Yes, and we hold to our return on equity targets, we use the loan pricing miles. It's very competitive out there. And I think that's one of the reasons why we have struggled a little bit, maybe we're a little bit more discipline than some other folks. We will compete on price. We always try to maintain structure, though, so that's why you saw the loan yields come in. And the old rates for the quarter were 422, that’s down from 462 last quarter. So, it's really reflecting current market conditions. I think the tenure was down 66 basis points on average and the one month LIBOR was down I think 44, something like that over the quarter.

[Collyn Gilbert:]

Are you seeing much I mean big variations among those loans segments as it relates to pricing? I mean, where are you kind of seeing your best pricing? And where are you seeing some of the lowest pricing?

[Tom Lyons:]

In terms of just the highest yields, consumer would be the highest and commercial real estate probably the best after that. In terms of return middle market CRE probably the best returns.

[Collyn Gilbert:]

Okay. And then just in terms of the comment about the pull through rate is declined. Just maybe talk a little bit about, what's driving at or what why that’s the case?

[Collyn Gilbert:]

Well, I certainly think that in our commercial real estate area, most of the time, if we've gone down a path on this term sheet, we pretty much faked it, we're going to get our clients know that they go down a path and we're pretty competitive. It's more on the C&I space. And it's geographically indiscriminate, meaning Pennsylvania and New Jersey. There are levels in the C&I space that we just can't figure out how people will do a deal.Just say for instance out in PA, somebody was doing something at prime minus 65 basis points and with non-recourse no covenants. We don't think that's prudent amounted may it would. But we think that our levels are trying to hold those people are undercutting them. We try to stick to what makes sense. If the returns are there will be involved Tom alluded to pricing, yes, structure, no.I think some of it's just not worth the return. You can get that growth that offset your NIM compression, but that will be short lived.

[Collyn Gilbert:]

And then just flipping to the funding side, you guys indicated where you're starting to drop pricing on $60 million and $300 million deposits. But is there more to do on that? Or how do you sort of -- how are you thinking about kind of the aggressiveness with which you're going to drop, deposits?

[Tom Lyons:]

We're currently evaluating November 1st for another look. There's about $700 million that has on negotiated pricing and that's not including the municipal portfolio. So there's some opportunities to bring rate there.

[Collyn Gilbert:]

Okay, just curious, what's the blended rate on your municipal book right now on the deposits?

[Tom Lyons:]

We don't have that color. I think it's probably a little over one.

[Collyn Gilbert:]

And then I guess just lastly. Chris, in your opening comments, I'm just going to try to quote you what you said, but on the M&A front. What did you say? You said, it's not first, your last. I'm just curious what you meant by that?

[Chris Martin:]

Okay. Basically, if you don't -- if you come in close second win anything by the deal, not getting a deal done. So, there is no second place maybe you win a deal or you don't win to deal. There are so many deals that you get called back in after the fact that. Okay, there is the possible acquirer messes up, and you get called back to the table. We have not seen that in a long history. So what I say is like we put in we think as prudent and aggressive as make sense, but they say what you were you were in second place that really doesn't make it suitable today.

[Collyn Gilbert:]

Got it, okay. So, it's just -- the pricing on the first bidder is so good that there's no further discussion among others?

[Chris Martin:]

Well, I guess the only goes back to what how the person that the maybe being acquired. Looks like all the things, they're supposed to, shareholder value, culture, management, positioning and the future because they're selling their interests to another entity. I think we match up to a lot of those, it just happens to be somebody a little bit more aggressive in their assumptions and or have a lot more better courses that we don't.

[Collyn Gilbert:]

To that point, do you think that the sellers are taking into consideration a lot of those qualitative factors that you're mentioning? Or do you think it is seems to be more of a quantitative decision?

[Chris Martin:]

I think quantitative has to be there, but I think qualitative is giving everybody an opportunity to say. I'd like a certain company or certain approach. So I think you have to have a good culture and a good management structure. I don't think anybody just doing something from that standpoint any longer.

[Collyn Gilbert:]

Okay. Okay. And then just last lastly. Just Tom, on the repurchases, you guys obviously bought a nice slug this quarter. Should we assume a similar level going forward? And then how do you want -- how should we be thinking about that in 2020 once you start to -- kind of restart the growth engine again?

[Tom Lyons:]

Really, it's been market condition dependent. We stepped in with the market pricing got hit a bit. We try to look at that as a tangible book value dilution versus the earnings accretion. Think about it in terms of creation or destruction of value using multiples on an earnings basis on a tangible basis and see where those normalizing the zero out, that's one way look at it. And then we're looking at give it a reasonableness assessment. Overall current prices the tangible book, we're paying back at and what earn back is on the service fee transactions. So, it really is market price dependent how much we step in.

[Operator:]

The next question is from Steven Duong with RBC Capital Markets. Please go ahead.

[Steven Duong:]

Just going back to the M&A, would you make that comment just particularly in a wealth management space or banking space?

[Chris Martin:]

Well, comments are mostly in the bank space of late.

[Steven Duong:]

And then I appreciate the color of the guide on the NIM. Can you remind us what your deposit beta was in the last cycle? And if you think it will behave similarly in this current cycle?

[Tom Lyons:]

I don't have my year to date with you because mostly direction. I didn't print it out in the 30s. Steve, but I can get back to you what the beta was through the rising cycle.

[Steven Duong:]

And then, just lastly, just back on the capital front. I guess you've done special dividends before. Is there a preference between special dividends versus buybacks?

[Tom Lyons:]

I think that's really just market price dependent. Yes, it makes the most sense to do.

[Operator:]

This concludes our question-and-answer session. The conference is now also concluded. Thank you for attending today's presentation. You may now disconnect.