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Edited Transcript of PFS earnings conference call or presentation 27-Jul-18 2:00pm GMT

Q2 2018 Provident Financial Services Inc Earnings Call

Jersey City Mar 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Provident Financial Services Inc earnings conference call or presentation Friday, July 27, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher P. Martin

Provident Financial Services, Inc. - Chairman, President & CEO

* Leonard G. Gleason

Provident Financial Services, Inc. - Senior VP & IR Officer

* Thomas M. Lyons

Provident Financial Services, Inc. - Executive VP & CFO

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Conference Call Participants

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* Collyn Bement Gilbert

Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst

* Mark Thomas Fitzgibbon

Sandler O'Neill + Partners, L.P., Research Division - Principal & Director of Research

* Matthew M. Breese

Piper Jaffray Companies, Research Division - MD and Senior Research Analyst

* Russell Elliott Teasdale Gunther

D.A. Davidson & Co., Research Division - VP & Senior Research Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the Provident Financial Services Second Quarter Earnings Conference Call. (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.

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Leonard G. Gleason, Provident Financial Services, Inc. - Senior VP & IR Officer [2]

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Thank you, Andrea.

Good morning, ladies and gentlemen. Thank you for joining us today. 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 statement that may be 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 I'm pleased to introduce Chris Martin, who will offer his perspective on our quarter. Chris?

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Christopher P. Martin, Provident Financial Services, Inc. - Chairman, President & CEO [3]

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Thanks, Len, and good morning, everyone.

Provident's quarterly results were strong. We achieved record net interest income resulting from period-over-period growth in average loans outstanding and growth to both average noninterest and interest-bearing deposits, along with expansion of the net interest margin. Noninterest-bearing deposits were up and our core deposits remained strong at 90.3% of total deposits.

Our quarterly results were tempered by the charge-offs we took on 2 commercial loan relationships that both involved borrower fraud. As you would expect, we are pursuing every avenue available to us to try and recover some portion of these loan losses, although it's difficult to assess how successful we may be in this regard. We do not believe these charge-offs reflect any credit deterioration generally in our loan portfolio. And on balance, asset quality improved with nonperformers at 45 basis points of total loans as of quarter-end.

While loan originations met our expectations, we experienced greater-than-anticipated loan payouts as life companies, nonbank lenders and certain overcapitalized banks continued to compete at structured pricing levels that make little sense to us. We maintain that while competition may be losing their credit underwriting standards and credit structures and aggressively pricing their deals, we will continue to make loans that meet our credit and ROE hurdles and interest rate risk criteria. If our approach results in lower loan growth, we are willing to accept that. Despite this lack of net loan growth, we still see net interest income improving as we continue to benefit from rising rates on reinvested cash flows and variable-rate loans.

Expenses remained well controlled during the quarter. We will continue to invest in our business. And later this year, we expect to deploy the Zelle person-to-person payment solution, an improved digital account opening platform and a tech-driven small business loan product. The pace of change in banking is rapid, and we expect our management team to embrace change, deliver a great customer experience and achieve operating excellence and efficiencies through the smart deployment of technology.

On the financial reporting front, we continue our preparations for the implementation of CECL. The effects of the regulatory relief bill signed into law in the second quarter will likely not be felt for some time as regulations need to be proposed and finalized by the regulatory agencies. The removal of DFAST stress testing will save us some money, but we still will be employing a stress testing protocol commensurate with our risk profile as part of our enterprise risk framework. The industry still has a way to go to reduce the burdens and competitive challenges of Dodd-Frank on community banks. And we believe and we'll continue to make our case in Washington as we seek more relief for banks with assets in excess of $10 billion.

The general business outlook and sentiment remain positive with continued growth in GDP, which this morning came in at 4.1%. We anticipate more rate hikes in 2018 and '19.

With that, I will turn it over to Tom.

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Thomas M. Lyons, Provident Financial Services, Inc. - Executive VP & CFO [4]

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Thank you, Chris. And good morning, everyone.

Net income was $19.2 million for the second quarter of 2018 or $0.30 per share compared to $27.9 million or $0.43 per share for the trailing quarter. While our earnings were adversely impacted by increased provisioning related to 2 loan relationships that appear to have involved borrower fraud, we did see record interest income, net interest income and revenue for the quarter. The net interest margin expanded 3 basis points as the earning asset yield increased 8 basis points, while the cost of interest-bearing liabilities increased 6 basis points. Further helping the margin, average noninterest-bearing deposits grew $44 million or an annualized 12.5%. Our total cost of deposits increased 4 basis points to 41 basis points for the quarter.

While loan growth was again constrained by a high rate of payoffs, net outflows on lines of credit and maintenance of credit and pricing discipline, loan originations were 10% better than in the second quarter of 2017, and the pipeline remained strong at $1.1 billion. The pipeline rate has increased 2 basis points since last quarter to 4.67%, exceeding the loan portfolio rate of 4.26%.

Based on our strong loan pipeline, 90% core and noninterest-bearing deposit funding and the variable-rate nature of many of our assets, we anticipate a strengthening economy and additional fed rate increases will contribute to further expansion of our net interest margin throughout 2018.

As Chris discussed, we acted decisively and charged-off balances related to 2 commercial relationships, resulting in an uncharacteristically high annualized net charge-off rate of 106 basis points for the quarter compared with 17 basis points last quarter and 10 basis points for the year 2017. Credit metrics on the remaining portfolio, however, were strong, with nonperforming assets, delinquencies and the weighted average risk rating all improved. The allowance for loan loss-to-total loans decreased to 81 basis points from 86 basis points at March 31 as previously recognized specific reserves were charged off and asset quality strengthened.

Noninterest income was consistent with the trailing quarter at $14 million, while noninterest expenses remained well controlled in an annualized 2.01% of average assets, contributing to a 55% efficiency ratio for the quarter.

Expenses increased by $1.9 million to $48.8 million versus the trailing quarter, primarily as a result of director stock compensation, consulting and nonperforming asset-related costs.

Our effective tax rate was consistent with the trailing quarter at 19%. We are currently projecting an effective tax rate of approximately 20% for the full year 2018.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Mark Fitzgibbon of Sandler O'Neill + Partners.

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Mark Thomas Fitzgibbon, Sandler O'Neill + Partners, L.P., Research Division - Principal & Director of Research [2]

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I wonder if you could give us a little bit more color on those 2 other loans to the commercial borrower that you took a $4 million charge on this quarter. Any -- is there any residual exposure there? Or was it a complete write-off? And perhaps maybe what industry that -- those credits were in.

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Christopher P. Martin, Provident Financial Services, Inc. - Chairman, President & CEO [3]

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Well, yes, certainly, Mark. There is very limited, although it's involved within estate now being the borrower passed away. And so we're waiting for that to be -- a lot of work that just came on. So we're trying to find out what's underlying the assets and/or the liabilities that they're claiming there have been -- I guess a little bit more than we have -- would have thought. And I'm sure that the estate is saying the same thing. They did not know the liabilities were there. We do not have anything directly. There are a few other loans that this individual was involved with, but there are other guarantors on other projects that are doing fine, and he was not a major partner in those.

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Thomas M. Lyons, Provident Financial Services, Inc. - Executive VP & CFO [4]

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So Mark, these were 2 loans with $4 million. They were completely charged off. There is no additional exposure to him directly. As Chris indicated, the borrower did pass away, and that's what kind of uncovered the difficulties of significant undisclosed liabilities as we start to work through with the estate. These were loans to a real estate developer known to personnel at the bank for a long period of time, but they were around the business in an unsecured line.

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Mark Thomas Fitzgibbon, Sandler O'Neill + Partners, L.P., Research Division - Principal & Director of Research [5]

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Okay. Secondly, Tom, I wondered if you could share with us your thoughts on the margin. Do you think it continues to slowly grind higher?

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Thomas M. Lyons, Provident Financial Services, Inc. - Executive VP & CFO [6]

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I do. I think we're going to see 2 -- probably 2 basis points a quarter, maybe a little bit more if we're lucky, still got a significant asset repricing. We had about 24% floating rate. There's about $2 billion worth of loans that will reprice over the next 12 months, and we've done quite well in maintaining a deposit pricing discipline and holding up those -- the funding sources. So I'm still looking for more expansion.

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Mark Thomas Fitzgibbon, Sandler O'Neill + Partners, L.P., Research Division - Principal & Director of Research [7]

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Okay. And then I heard your guidance on the effective tax rate, but what do you think this new New Jersey tax surcharge means for you guys, or your effective tax rate going forward?

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Thomas M. Lyons, Provident Financial Services, Inc. - Executive VP & CFO [8]

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Not a big impact for the rest of 2018. The intercompany dividends will be taxed on -- 5% of them, I guess, will now be taxable at the 2.5% surcharge rate. So a little bit of pickup, but still, I'd say, within the 20% boundary we outlined for the rest of 2018. More impact for us in 2019 as you get to a unitary group reporting and we lose some benefits of our REIT. So we could be in the 27% range next year. Early guess. We're still working through it. But that's preliminary.

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Operator [9]

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Our next question comes from Collyn Gilbert of KBW.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [10]

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Just one housekeeping question first. Tom, the pickup in expenses that you had said were tied to some of the NPA issues you guys had during the quarter. Do you have that dollar amount? I mean, was it significant?

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Thomas M. Lyons, Provident Financial Services, Inc. - Executive VP & CFO [11]

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Sure. The actual -- the biggest contributor to the delta quarter-over-quarter was that annually, we paid a portion of our directors' stock -- directors' compensation in the form of stock, which is all expensed in the second quarter each year. So comparing Q2 for Q1, that was about an $856,000 pickup. So that's the biggest piece of the expense change.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [12]

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Okay, okay. That's helpful. And then just thinking about loan growth broadly, I mean, what -- given the dynamics that are certainly going on in the market competitively, paydowns, I know you indicated the pipeline was robust at $1.1 billion. I think it was at like $1.3 billion last quarter. Maybe some of that is just due to the seasonality. But just in general, sort of how are you thinking about loan growth for the rest of the year?

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Christopher P. Martin, Provident Financial Services, Inc. - Chairman, President & CEO [13]

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Well, Collyn, this is Chris. You know what, we still look at our -- the amount of originations we're doing that we're comfortable with. We certainly don't see the success factor when we do put out a term sheet that we used to where we would be high in the 60s or 70%. It's now like 40% or 45% as everybody is trying to compete for growth. On the backside of that, there are still life companies coming in and doing things at levels that we would not be able to do. We're talking -- and this is just current. We've had a couple come up in the last few days doing deals at the 10-year treasury plus 115. And that to us is just not -- and being 10-year fixed. We would not be able to do that business and really feel confident. It would be growth, but growth at what level and if rates keep going up. That's something we don't think is prudent. And they have interest-only periods of up to 3 years for established, old properties. So we're seeing this continue. And in our payoffs, I think they'll continue. I don't know about at the pace that they are. Sooner or later, the life companies will fill their buckets. But -- and they've also traffic-ed down into much smaller levels. Where in the past, it would be $15 million to $20 million, we're seeing them in the $5 million to $7 million range.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [14]

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Okay, okay. Does this dynamic cause you to rethink your asset generation strategy? Or do you think more about M&A? And I guess -- because I'm asking -- as we kind of flow through this lower asset base now that you guys are running off of it, earnings growth is going to be, I think, if we're modeling correctly, a lot less. So I'm just trying to see how you're kind of measuring or balancing growth with stickiness of some of the financial targets that you've tried to achieve. Or just how you're thinking about it in a, kind of, more broadly strategic way?

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Thomas M. Lyons, Provident Financial Services, Inc. - Executive VP & CFO [15]

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Sure. Well, so far, Collyn, we are making up the volume in rate. Those loans are not -- we're not really dropping significantly. I guess it's basically flat for the quarter. But we have replaced with higher-rate loans. So we're still getting the book enough for the production that we like to at least hold serve and pick up a little incremental yield. Production -- originations this quarter are actually about 10% better than they were in Q2 of '17. If I look at last year, we did about 38% of the full year's production in the fourth quarter. So it seems that the life companies are certainly in lower -- at lower levels and in for a little bit longer this year, but we remain hopeful that we're going to see production and, therefore, growth pick up further in the back half of the year.

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Operator [16]

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Our next question comes from Russell Gunther of Davidson.

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Russell Elliott Teasdale Gunther, D.A. Davidson & Co., Research Division - VP & Senior Research Analyst [17]

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Just a follow-up on the expense conversation. The $48.8 million this quarter was kind of towards the high end of a range we talked about on the call last quarter. First, that $8.5 million in others, is that run rate? Or is there anything you'd pull out of there? And then second, any thoughts you could share on where 3Q is headed?

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Thomas M. Lyons, Provident Financial Services, Inc. - Executive VP & CFO [18]

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Sure. The $8.5 million is one time in nature, but I think it will be replaced to a degree by some ramp-up in growth-related costs, things around CECL and enhanced stress testing and some data analytic work that we're doing. So I'm looking for about $48.5 million to $49 million in the third quarter as well.

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Russell Elliott Teasdale Gunther, D.A. Davidson & Co., Research Division - VP & Senior Research Analyst [19]

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Okay, great. That's helpful. And then circling back to the margin conversation. You talked about expectations for rising rates alongside your NIM expansion guide. What are you guys kind of modeling in for the back half of this year in terms of fed fund increases? And then any thoughts on '19?

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Thomas M. Lyons, Provident Financial Services, Inc. - Executive VP & CFO [20]

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I think we just had September in at this point.

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Christopher P. Martin, Provident Financial Services, Inc. - Chairman, President & CEO [21]

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Right. We used to have September and December, Russell. And now we're looking at just September. I think that the fed does not want to invert the curve artificially. They certainly are dealing with a bunch of things with unwinding that huge balance sheet, which they're only doing through amortization of the -- and reduction of the current flow. I think that we're going to be continuing to think that they'll probably come back in the first half of 2019 with some more if they see growth continue to accelerate.

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Russell Elliott Teasdale Gunther, D.A. Davidson & Co., Research Division - VP & Senior Research Analyst [22]

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Okay. And then last for me. Just an update on the CD promo that you guys are running, the 13-month success with that and whether you'd expect it to continue.

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Thomas M. Lyons, Provident Financial Services, Inc. - Executive VP & CFO [23]

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That was quite good actually. We pulled in about $73 million. Obviously, it's trailed off. We haven't been actively promoting that any further. That was a targeted marketing effort to noncustomers. But it's done quite well for us. We may do more of that type of an effort in the back half of the year. I would expect to see that. Overnight funding is up about (technical difficulty). So there's significant spread between wholesale funding and some of the CD rates that we can offer.

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Operator [24]

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Our next question comes from Matthew Breese of Piper Jaffray.

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Matthew M. Breese, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [25]

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Just a couple of quick ones. If loan growth is going to remain sluggish for a bit here, might we see a change in strategy on the securities portfolio?

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Thomas M. Lyons, Provident Financial Services, Inc. - Executive VP & CFO [26]

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I don't -- wouldn't expect to see anything dramatic. I mean, we've always managed the securities portfolio for liquidity and cash flows, which is why we're seeing some pickup in terms of reinvestment. But I wouldn't expect a dramatic expansion just given the flatness of the curve.

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Matthew M. Breese, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [27]

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Okay, okay. And then on the tax rate, I think you said 27% for next year. Is that accurate? And does that carry through to 2021?

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Thomas M. Lyons, Provident Financial Services, Inc. - Executive VP & CFO [28]

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That is an early look, and I believe that would be the going forward kind of run rate, yes, '19 and forward.

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Operator [29]

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

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Christopher P. Martin, Provident Financial Services, Inc. - Chairman, President & CEO [30]

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Well, again, we thank you for being on the call. We're very pleased that our board increased the cash dividend, showing confidence in the company on a go-forward basis. And we hope you enjoy the balance of the summer. Thank you very much.

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Operator [31]

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