Provident Financial Services, Inc.
Q3 2008 Earnings Call Transcript

Published: 4 Nov 2008

[Operator:]

Hello and welcome to the Provident Financial Services Inc. third quarter 2008 earnings conference call. (Operator Instructions) Now, I would like to turn the conference over to Mr. Paul Pantozzi.

[Paul Pantozzi:]

Thank you and good morning, everyone. Welcome to our third quarter 2008 earnings call. I’ll begin with our standard caution as to any forward-looking statements that may be 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 our other releases and SEC filings by accessing our website, providentnj.com or by calling our Investor Relations 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. Net income for the quarter ended September 30, 2008 was $13.2 million, or $0.23 per diluted share as compared to $8.3 million, or $0.14 per share for the third quarter 2007, and $10.4 million, or $0.18 a share for the second quarter of 2008. Each of the quarters I just cited had one-time charges that were particular to that quarter. The quarter just ended, other than temporary impairment charges of $869,000, net of tax were recognized on one debt security issued by Lehman Brothers Holdings Inc. and also on two equity holdings in accordance with Generally Accepted Accounting Principals. In the third quarter of 2007, we recorded employee severance charges of $1.9 million, net of tax. In the second quarter 2008, we recorded severance charges of $503,000, net of tax. I would like to emphasize, however, that our earnings performance in the most recent quarter was driven primarily by our ongoing focus on the fundamentals of our business; namely, expansion of our net interest margin and management of non-interest expenses. Linda will take us through the components of the net interest margin calculation. But regarding expenses, I would like to note that the ratio of non-interest expense to average assets for the past quarter was 1.9%. This represents a substantial decrease in the 2.11% reported for the trailing quarter and reflects our continuing efforts to effectively manage overhead costs. With respect to our balance sheet, new loan production proceeded at a respectable pace in the third quarter with particular emphasis on residential mortgage loans. On the liability side, we continue to build demand deposit balances while other high cost deposit categories declined. We have maintained the flexibility of fund loan growth with lower cost wholesale borrowings, and as a consequence, total borrowed funds at September 30, 2008 increased $103.8 million above the reported at June 30, 2008. We have continued to monitor our asset quality. At September 30, 2008, the ratio of non-performing assets to total assets, were 60 basis points as compared to 67 basis points at June 30, 2008. It bears repeating, we did not originate or hold any subprime mortgages, nor did we hold any collateralized debt obligations, trust preferred securities or common or preferred stock issued by Fannie Mae or Freddie Mac. But as the events of the past several weeks have emphasized, we are in a period of great economic uncertainty, and increases in both net charge-offs and loan loss provision were recorded in the third quarter in recognition of that fact. A further necessary safeguard in the face of uncertainty is maintaining a solid capital position, and as of September 30, 2008, we remain well capitalized according to all regulatory standards. With that, I would like to turn it over to Linda, who will take us through the quarter’s results in more detail.

[Linda Niro:]

Thank you, Paul. The net interest margin increased 17 basis points to 3.27% during the third quarter compared to 3.10% during the second quarter of 2008. The increase in the margin was due primarily to a decrease of 22 basis points in the average cost of deposits to 2.19% from 2.41% 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 19 basis points to 2.55% from 2.74% in the trailing quarter. The average yield on net loans increased 2 basis points to 5.78% from 5.76% and the average yield on investments decreased 7 basis points to 4.59% from 4.66% on a linked-quarter basis. The average yield on interest earnings assets was little changed at 5.51% compared to 5.5% in the trailing quarter. Total investments decreased approximately $30 million during the third quarter to $1.23 billion and represented just over 19% of total assets at September 30, compared to 19.7% 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 4.8 years and a duration of 3.9 years at September 30. During the quarter, total loans increased $101 million or 2.4% sequentially. The largest increase in the portfolio was in residential mortgage loans, which increased $66.1 million. Commercial mortgage and multi-family loans increased $36 million. Construction loans increased $6 million. Consumer loans increased $5.3 million, while commercial loans decreased $13.6 million sequentially. Commercial loans as a percentage of total loans were 44.7% at September 30, compared to 45.1% of the portfolio at June 30. The significant tightening of credit, the residual effects of subprime lending and continued declines in real estate values continue to have an adverse impact on the pace of sales for new construction projects and asset quality. The factors that are contributing to the current uncertain economic environment, in addition to an increase in non-accrual loans, resulted in a provision for loan losses in the amount of $3.8 million in the third quarter. Net charge-offs during the third quarter were $1.6 million compared to net charge-offs of $1.2 million in the second quarter. Total non-performing assets consisting of non-performing loans and foreclosed assets totaled $38.8 million, or 0.6% of total assets compared to $42.6 million or 0.67% of total asset at June 30. Non-performing loans decreased $1.4 million in the quarter. However, non-accrual loans increased $14.6 million in the third quarter to $35.3 million compared to $20.7 million in the second quarter. Balances at June 30 included a $16 million loan, which is greater than 90 days delinquent and still accruing, and net loan has since been brought current. Non-performing loans as the percentage of total loans was 81 basis points at September 30, compared to 86 basis points in the trailing quarter. During the third quarter, the increase in non-accrual loans is due mainly to construction loan in the amount of $9.8 million and a commercial mortgage loan in the amount of $1.6 million to the same borrower that were determined to be impaired during the quarter. Both of these loans are collateral depended and there were no impairment charges required at September 30, due to sufficient collateral value. Total delinquencies decreased to $45.6 million or 1.04% of the loan portfolio at September 30 from $60.7 million or 1.42% of the portfolio at June 30. Total deposits decreased $38.6 million or 0.9% during the third quarter of 2008. Increases of $36.3 million and demand deposit balances were offset by decreases in savings balances of $41.4 million and higher cost time deposit balances of $33.6 million. At the end of the third quarter, core deposit as a percentage of total deposits were 63.8% compared to 63.3% at the end of the second quarter. Non-interest income in the third quarter of 2008 increased $1.1 million, or 17%, to $7.8 million from $6.7 million in the second quarter. Fee incomes increased $2.4 million, or 49%, due mainly to a $1.2 million increase in the market value of equity fund holdings compared to a decrease of $1.3 million in the trailing quarter. Partially offsetting the increase in fee income, the company recognized net security losses of $966,000 during the third quarter compared with net gains of $305,000 in the trailing quarter. The third quarter net security losses included other than temporary impairment charges totaling $1.4 million pre-tax, recorded on a debt security issued by Lehman Brothers and the common stock of two publicly traded financial institutions. Non-interest expense decreased $1.3 million, or 4%, to $32 million during the third quarter compared to $33.3 million in the trailing quarter. The decrease in non-interest expense was due primarily to an $873,000 decrease in compensation and benefit expense. Total stock-based compensation expense decreased $800,000, or 35%, to $1.5 million in the third quarter, compared to $2.3 million in the second quarter as a result of the conclusion of vesting of options and awards granted after the company’s 2003 IPO during the third quarter of 2008. Income tax expense increased $114,000 to $4.2 million in the third quarter compared to $4.1 million in the trailing quarter. The effective tax rate was 24.2% for the third quarter of 2008 compared to 28.3% for the second quarter of 2008. The decrease in the effective tax rate was primarily due to the utilization of capital losses on securities transactions. That concludes our outline of the third quarter operating results. We would now like to turn the call back over to the operator for any questions you may have.

[Operator:]

Our first question comes from Mark Fitzgibbon - Sandler O’Neill and Partners.

[Mark Fitzgibbon:]

Thanks. First, and I apologize if you mentioned this because I hopped on the call a minute or two late, but do you plan to participate in the Treasury’s voluntary capital purchase plan?

[Paul Pantozzi:]

We have not made that determination yet, Mark. We’re taking it under advisement and doing the analysis as we speak.

[Mark Fitzgibbon:]

Okay. Then secondly, I noticed in your unfunded pipeline you had about $120 million of construction loans. Does it make sense to leave those unfunded given the market conditions, or are these real attractive loans that you feel like make a lot of sense to lend right now?

[Christopher Martin:]

We do lend to our customers who have been with us a long time. And they see opportunities, albeit it may be at cheaper levels, but then it may be outside of the New Jersey market out in Pennsylvania, primarily. Most of our loan documentation and our loans other than the ones that we have detailed in the Q would state that we’re still following our customers. There’s still some opportunity and I don’t think we can cut back on the unfunded. We just have to watch as things progress and things are slow out there, but still performing.

[Mark Fitzgibbon:]

Is it residential construction or commercial construction?

[Christopher Martin:]

Residential and commercial, but more residential.

[Mark Fitzgibbon:]

Okay. And then, I wondered if you could just give us a sense for how the 30 to 90-day delinquency trends are looking?

[Linda Niro:]

30 to 60 actually came down in the third quarter, Mark, to $21.2 million from just about $24 million in the second quarter.

[Mark Fitzgibbon:]

Okay. And then, last question, probably Linda, on the margin, obviously the trend was fabulous this quarter. Can you hold the margin at this level do you think?

[Linda Niro:]

We think we’ll still get a little bit more expansion in the fourth quarter, not 27 basis points. I think probably more five to seven.

[Mark Fitzgibbon:]

Super. Thank you very much.

[Operator:]

Our next question comes from Matthew Kelley - Sterne, Agee.

[Matthew Kelley:]

In the fee income, the $1.2 million increase in the market value of equity holdings?

[Linda Niro:]

Right

[Matthew Kelley:]

What was that?

[Linda Niro:]

We have equity funds that we hold at the holding company level and that’s the change in the fair value of those funds. It’s actually income that we earn, so it swung quarter-to-quarter.

[Matthew Kelley:]

So a couple hedge funds that were massively short and made the right call?

[Linda Niro:]

Let’s hope so.

[Matthew Kelley:]

Got you. Okay. Then you had mentioned that the OTTI was $1.4 million on the Lehman security and two other common stocks. What were the gains that helped offset that?

[Linda Niro:]

Okay. The $1.4 million was the total of all three of those.

[Matthew Kelley:]

Right

[Linda Niro:]

And we had $442,000 in gains on securities sales of other equities that we sold in the quarter at a gain.

[Matthew Kelley:]

Other common equity?

[Linda Niro:]

Other common equity, yes.

[Matthew Kelley:]

Got it. I missed those numbers on the stock-based compensation again. What was the total amount of the option vesting and restricted stock awards that will no longer be running through the P&L?

[Linda Niro:]

All of them vested, so we went from $2.3 million in the second quarter and $1.5 million in the third quarter. That was the decrease and probably going forward it will be about $1 million in the quarter.

[Matthew Kelley:]

Okay. So it will be a little bit more coming through?

[Linda Niro:]

Yes. Because the awards finished vesting in August and the options in July.

[Matthew Kelley:]

Got you. Then just getting back to the TARP, what are the elements of the TARP that still need consideration? What would prevent you from participating at this point? We’ve had some time now to review the details of the plan.

[Paul Pantozzi:]

We were actually preparing for this call in our Board meeting yesterday, so we reviewed certain elements of it with our Board yesterday. We’ll make that determination in the next week to 10 days.

[Matthew Kelley:]

Okay, all right. Thank you.

[Operator:]

Our next question comes from Richard Weiss - Janney Montgomery Scott.

[Richard Weiss:]

I was wondering if you could talk about the loan growth and why the growth came from residential mortgages? Are you seeing opportunities in the market?

[Linda Niro:]

We are. We’re actually seeing some home buying activity. I think some foreclosure data in New Jersey came out today that isn’t very positive, but there is certainly still areas of this state where there is buying going on. It’s slowing down. I don’t think you’re going to see that same level of activity in the fourth quarter.

[Richard Weiss:]

Are they mostly jumbo mortgages?

[Linda Niro:]

No.

[Richard Weiss:]

Okay. Conformant?

[Linda Niro:]

Yes.

[Richard Weiss:]

And second, with regard to fee income, it looks like it jumped up, was that deposit fees to the $7.3 million?

[Linda Niro:]

Again, it was change in the value of fees on equity funds that we hold.

[Richard Weiss:]

Okay. Finally, it’s probably more of a Mark Fitzgibbons question, but with respect to the tax rate, what would be a good rate to use going forward?

[Linda Niro:]

Rick, we are still targeting a 27% effective tax rate through year-end.

[Richard Weiss:]

Okay. Thank you very much.

[Operator:]

Our next question comes from Jason O’Donnell - Boenning & Scattergood.

[Jason O’Donnell:]

Congratulations on a good quarter. I just had a couple of quick questions. Back on the lending side, it looks to me like you’re experiencing a pickup in origination activity in the most recent quarters. Are there any particular competitors that you feel you’re competing more effectively with now than you have in the past?

[Christopher Martin:]

Certainly, the Wachovia impact and maybe a more of Sovereign coming up into the near term, are definitely not really paying attention to their customers and were becoming maybe one of the choices, where in the past we wouldn’t have seen that. Also, securitization and some of the Wall Street liquidity events that were made by putting these into the securities are now gone, so that is opening up opportunities for us to establish relationships with people that really wouldn’t have considered us or any other institution in the state. They were always going to the conduits, so those are the primary areas.

[Jason O’Donnell:]

Okay. And that’s mainly on the commercial side?

[Christopher Martin:]

Yes.

[Jason O’Donnell:]

Okay, and the other question I had, and I apologize if you broke this out in the beginning, and I just missed it. On the severance charges that you took, if you could just break out for me, if you didn’t already, what the charge was in the third quarter, and whether or not you expect any additional severance charges related to the voluntary resignation program that you initiated last year?

[Linda Niro:]

No, we took all of the charges last year in the third quarter for that voluntary resignation program that was in effect.

[Jason O’Donnell:]

Okay.

[Linda Niro:]

I’m sorry

[Jason O’Donnell:]

Okay, there were no severance charges for the third quarter?

[Linda Niro:]

No.

[Jason O’Donnell:]

Okay, great. Thanks very much.

[Operator:]

Our next question comes from Collyn Gilbert - Stifel Nicolaus.

[Collyn Gilbert:]

Thanks. Good morning. Could you just go through a little bit more detail on what you are seeing in terms of credit trends? Where you are seeing weakness or where you are concerned within the segments of your portfolio, or just kind of the general economic conditions in the market?

[Christopher Martin:]

We are really comfortable with our balance sheet. We know our customers very well. We meet and talk to them personally. Outside that spectrum, we can’t control what is going on in the market. I think that’s what we are watching and seeing, again, some evidence of some slowing out there. I don’t think that we are going to be abstained from that. The other side is a lot of it would be employment related, especially in the one- to four-family. If unemployment continues to crop up, we’re going to probably see some impact just like anybody else would. On the other side, we certainly have had some loans that either the notes have been bought by another customer or had paid off. So, we think that if anything we are still in good position with our customers as we know them today.

[Collyn Gilbert:]

Okay, so there’s nothing more on the commercial side that you are seeing stress on or that your have a heightened awareness of specifically?

[Paul Pantozzi:]

Nothing new at this point in time.

[Collyn Gilbert:]

Okay, and then could you just comment on, I know obviously, as you mentioned, you’re evaluating the potential on the TARP, but more so your appetite for M&A? It seems as if we are going to be in a consolidating environment, and you certainly have tapped into that as a source of growth in the past. What is your view on M&A now, as we look forward?

[Paul Pantozzi:]

I think that we’ll continue to be very selective in anything that we might look at in the future.

[Collyn Gilbert:]

And that’s just because of the risk that might come with an institution?

[Paul Pantozzi:]

That’s because of the risk profile that we operate within this company, and the consistency with which we do that.

[Collyn Gilbert:]

Okay, that was all. Thanks.

[Operator:]

Our next question comes from Tim [Brassler] - KBW.

[Tim [Brassler]:]

Good morning. My question is regarding the provision. It’s a little elevated from the past two quarters. Is this in regards to any particular credit or just general market trends?

[Linda Niro:]

It’s based on our evaluation of our loan portfolio at September 30, and the fact that we did have a slight increase in non-accrual loans. We had growth in the portfolio in the quarter, and yes, due to general economic conditions, and the uncertainty that goes along with the current environment that we operate in.

[Tim [Brassler]:]

Okay, so going forward, we could expect to see a slightly elevated provision than the normalized run rate?

[Linda Niro:]

I don’t think that would be unreasonable.

[Tim [Brassler]:]

Okay, great. Second question is in regards to the operating expenses. Should we be expecting any kind of seasonality in the fourth quarter?

[Linda Niro:]

I don’t think to any great degree. There is always accrual true-ups in the fourth quarter, but I don’t see anything much different in the fourth quarter than what you saw in the third.

[Tim [Brassler]:]

Okay, perfect. Thank you very much.

[Operator:]

Our next question comes from Ross Haberman - Harberman Funds.

[Ross Haberman:]

Two questions probably for Chris. Chris, did you have any exposure to trust preferreds either direct or pooled?

[Christopher Martin:]

None.

[Ross Haberman:]

Okay, thank you.

[Operator:]

We have a question from Matthew Kelley - Sterne Agee.

[Matthew Kelley:]

Just a follow-up on the tax rate. I know you said 27%, but what about if you think out longer term? How long could some of those tax benefits allow you to have an all-in tax rate below 30%?

[Linda Niro:]

We have been really consistent Mark with our effective tax rate. The only thing that would push it up, and I’m not really seeing it at this time, is that if there is a change in our mix of pre-tax income. Right now, greater proportion of it is in tax-exempt income. I wasn’t even really talking about the impact of the utilization of the capital losses that we were able to offset in the third quarter.

[Matthew Kelley:]

Okay, all right. It’s mostly the municipal type investments that are allowing you to have that rate?

[Linda Niro:]

That’s correct. Some of our tax-exempt income.

[Matthew Kelley:]

Okay, all right. Thank you.

[Operator:]

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

[Paul Pantozzi:]

We would like to thank you for joining us on this call. We look forward to hearing from you on our next call. Thanks very much.

[Operator:]

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