Q2 2023 Provident Financial Services Inc Earnings Call
Participants
Adriano M. Duarte; Executive VP, CAO & IR Officer; Provident Financial Services, Inc.
Anthony J. Labozzetta; President, CEO & Director; Provident Financial Services, Inc.
Thomas M. Lyons; Senior EVP & CFO; Provident Financial Services, Inc.
Bill Young; Assistant VP; RBC Capital Markets, Research Division
Manuel Antonio Navas; VP & Research Analyst; D.A. Davidson & Co., Research Division
Mark Thomas Fitzgibbon; MD & Head of FSG Research; Piper Sandler & Co., Research Division
Michael Anthony Perito; MD; Keefe, Bruyette, & Woods, Inc., Research Division
Presentation
Operator
Thank you for standing by. At this time, I would like to welcome everyone to the Provident Financial Services, Inc. Second Quarter Earnings Conference Call. (Operator Instructions) Thank you. Adriano Duarte, Investor Relations Officer. You may begin your conference.
Adriano M. Duarte
Thank you, Cheryl. Good morning, everyone, and thank you for joining us for our second quarter earnings call. Today's presenters are President and CEO, Tony Labozzetta; and Senior Executive Vice President and Chief Financial Officer, Tom Lyons.
Before beginning their review of our financial results, we ask that you please take note of our standard caution as to any forward-looking statements that may be made during the course of today's call. Our disclaimer -- our full disclaimers contained in last evening's earnings release, which has been posted to the Investor Relations page on our website, provident.bank.
Now it's my pleasure to introduce Tony Labozzetta, who will offer his perspective on our second quarter. Tony?
Anthony J. Labozzetta
Thank you, Adriano. Good morning, everyone, and welcome to the Provident Financial Services earnings call.
The disruption to the banking system and result and volatility that we all experienced in the first quarter has abated and Provident Bank fared well through the instability. These events, however, combined with more rate hikes by the Federal Reserve gave rise to new headwinds for the banking industry in the form of funding challenges as we headed into the second quarter. These funding challenges included more demands by customers for higher rates, needs for more insurance, a disintermediation from low-cost deposits to higher-yielding time deposits and certain deposits shifting to treasury securities.
Consequently, we experienced higher deposit betas for the quarter, which increased our funding costs and compressed our net interest margin. Despite these unfavorable market conditions, Provident produced good financial results this quarter, which once again demonstrates the strength of our franchise and talented management team. As a result, we reported earnings of $0.43 per share, an annualized return on average assets of 0.93% and a return on average tangible equity of 10.75%.
Excluding merger-related charges and normalizing the CECL provision for stabilized economic forecast, we estimate our core return on average assets was approximately 1.07% for the second quarter. Our capital is strong and comfortably exceeds well capitalized levels.
Tangible book value per share expanded 3.6% during the first 6 months to $15.66 on the strength of our earnings. Our tangible common equity ratio on June 30, was 8.72%. As such, our Board of Directors approved a quarterly cash dividend of $0.24 per share payable on August 25.
Presently, our uninsured and uncollateralized deposits were $2.7 billion or approximately 26% of our total deposits. Our on-balance sheet liquidity plus borrowing capacity is $3.8 billion or 140% of uninsured deposits. Our core deposits are a valuable component of our franchise. During the quarter, our core deposits decreased $55 million or 0.7%, which we attribute to normal business activity and customers seeking higher yields on their deposits.
For the second quarter, our deposit beta was 148%, with the rising rate cycle to date deposit beta was about 25%. Consequently, our total cost of deposits increased and in large part, drove our total cost of funds up 50 basis points to 1.71% and compressed our net interest margin 37 basis points.
Our commercial lending team closed approximately $516 million of new commercial loans during the second quarter. Prepayments decreased 56% to $125 million as compared to the trailing quarter. Our credit metrics remained strong in the second quarter, and we continue to maintain prudent underwriting standards, particularly in CRE lending.
As part of our normal CRE monitoring processes, we have performed targeted in-depth analysis to evaluate portfolio and loan level risks. Our line of credit utilization percentage increased 4% in the second quarter to 35%, which is approaching our historical average of approximately 40%. As a result of the improved production reduced prepayments and increased line utilization, our commercial loans grew $315 million or 3.6% for the quarter. For the 6 months, we grew $296 million or 3.4%, which is pacing at an annualized growth rate of about 6.7%.
The pull-through in our commercial loan pipeline during the second quarter was good, and the gross pipeline remained strong at approximately $1.7 billion. The pull-through adjusted pipeline, including loans pending closing, is approximately $1 billion, and our projected pipeline rate increased 47 basis points to 7.24%. We are encouraged by the strength and quality of our pipeline. In addition, payoffs have slowed, as a result, we expect to achieve our commercial loan lending growth targets for the remainder of 2023.
Our fee-based businesses performed well this quarter. Provident Protection Plus had an outstanding second quarter with 82% organic growth, which resulted in a 34% increase in revenue and an 87% increase in operating profit as compared to the same quarter last year. The conditions in the financial markets were more stable in the second quarter. And as a result, Beacon Trust experienced growth and market value of assets under management and related fee income.
Beacon's fee income remained stable compared to the trailing quarter, as the increase in advisory fees was mostly offset by a reduction in trust revenue. With respect to our previously announced merger with Lakeland Bancorp, we continue our engagement with the regulators and have provided additional information in order to further support our application for approval of the merger.
The companies have made significant progress in various integration initiatives through outstanding teamwork from both banks. We look forward to receiving regulatory approval and combining our 2 great franchises into the best bank in New Jersey.
As we look forward, we remain focused on growing our business. However, staying disciplined and committed to our risk management principles is critical during these challenging times. In addition, we expect to close and integrate merger with Lakeland Bank in the near future, which we believe will create value for all of our stakeholders.
Now I'll turn the call over to Tom for his comments on our financial performance. Tom?
Thomas M. Lyons
Thank you, Tony, and good morning, everyone. As Tony noted, our net income for the quarter was $32 million or $0.43 per share compared with $40.5 million or $0.54 per share for the trailing quarter and $39.2 million or $0.53 per share for the second quarter of 2022.
Nontax deductible charges related to our pending merger with Lakeland Bancorp totaled $2 million in the current quarter and $1.1 million in the trailing quarter. Excluding these merger-related charges, pretax pre-provision earnings for the current quarter were $55.3 million or an annualized 1.6% of average assets.
Revenue totaled $118 million for the quarter compared with $130 million for the trailing quarter and $120 million for the second quarter of 2022. Our net interest margin decreased 37 basis points from the trailing quarter to 3.11%. Yield on earning assets improved by 10 basis points versus the trailing quarter as floating and adjustable rate loans repriced favorably and new loan originations reflected higher market rates. This improvement in asset yields, however, was more than offset by an increase in interest-bearing funding costs.
Increased funding costs reflected current market conditions, which resulted in an increase in borrowings accompanied by a decrease in deposits. Certain noninterest-bearing balances also moved to our interest-bearing and insured cash sweep product in order to obtain increased deposit insurance.
In addition, lower costing demand and savings balance has shifted to higher costing time deposits. The average total cost of deposits increased 37 basis points to 1.42%, this brought our rising rate cycle-to-date beta to 25%. The average cost of total interest-bearing liabilities increased 59 basis points in the trailing quarter to 2.13%. The prolonged inverted yield curve, ongoing deposit competition and an increase in the attractiveness of investment alternatives continue to impact funding costs.
As a result, we expect to see some continued net interest margin compression to the balance of 2023 and project the margin will stabilize at around 3%. Period end total loans grew $306 million with commercial loans increasing $315 million for the quarter. Our pull-through adjusted loan pipeline increased $109 million from last quarter to $1 billion with a weighted average rate of 7.24% versus our current portfolio yield of 5.24%.
The provision for credit losses on loans increased $4.4 million for the quarter to $10.4 million, primarily due to a worsened commercial property price index forecast. As a result, the allowance for credit losses on loans increased to 97 basis points of total loans at June 30 from 91 basis points at March 31.
Current credit metrics, however, were stable and annualized net charge-offs were just 4 basis points of loans for the quarter. Noninterest income decreased $2.8 million versus the trailing quarter as a $2 million gain related to a prior quarter's sale of REO was realized upon the satisfaction of post-closing conditions in the trailing quarter.
In addition, deposit fees were down $612,000 versus the trailing quarter, and insurance agency income, while ahead of plan for the second quarter was $255,000 less than the seasonally strong first quarter. Excluding provisions for credit losses on commitments to extend credit and merger-related charges, noninterest expense decreased $4.5 million versus the trailing quarter, with $3.5 million of that decline coming in compensation and benefits expense as incentive accruals, stock-based compensation and employer payroll tax expense were all lower than the trailing quarter.
Adjusted operating expenses were an annualized 1.83% of average assets for the current quarter compared with 2% in the trailing quarter and 1.92% for the second quarter of 2022. The efficiency ratio was 53.29% for the second quarter of 2023 compared with 51.85% in the trailing quarter and 53.83% for the second quarter of 2022.
That concludes our prepared remarks. We would be happy to respond to questions.
Question and Answer Session
Operator
(Operator Instructions) Your first question is from Mark Fitzgibbon of Piper Sandler.
Mark Thomas Fitzgibbon
Tony, I wondered if there's anything left that you all need to do or provide to the regulators? Or have you sort of done all that? And do you have any rough sense what the timing might look like for closing on the Lakeland deal?
Anthony J. Labozzetta
Yes. I mean what I can say to that is that -- we have weekly meetings with -- calls with the FDIC to ensure that any questions that are open or anything that's pending has been provided. So we -- when I look at this is like we're on the back end of that, right? We've given them everything that they need to process the application. Will a question or 2 arise during their what I would call a final analysis, short. But from my perspective, and I know I get guided by counsel not to be to forward on this. It just appears that everything is there and they have to go through their process. And so I'm expecting it to happen relatively soon.
Mark Thomas Fitzgibbon
Great. And then second question, Tom, on the expense trends, obviously, they were great this quarter. And it sounded like expenses might tick up a little bit in the third quarter. Did I hear that correctly?
Thomas M. Lyons
I think we'll be able to maintain in the $64 million to $65 million range, Mark. It seems like a lot of our peers were cognizant of the pressure net interest margin is put on earnings, and we're looking carefully at all our expenses.
Mark Thomas Fitzgibbon
Okay. And I heard your comments also on the margin sort of bottoming out around 3%. Is that assumed in the third quarter?
Thomas M. Lyons
Yes, I think so, Mark, comes in around 3% and stays there.
Mark Thomas Fitzgibbon
Okay. And with the strong pipeline that you have and given sort of the softening economic situation, how are you thinking about provisioning levels for the back half of the year?
Thomas M. Lyons
No. I think about the total coverage at 97 basis points, and I don't really see it going much higher than that. That was really responsive to the economic forecast, in particular, the commercial property price index, rely on Moody's baseline for economic forecast. And I think they were a little bit slower than some other forecasters may be in catching up on their view of what CRE potential losses. That said, our own book is quite strong, as you saw really strong in the asset quality metrics overall and no concerns reflected in the current book.
Operator
Your next question is from Bill Young of RBC Capital Markets.
Bill Young
Can you hear me, okay?
Anthony J. Labozzetta
Perfectly.
Bill Young
Great. Maybe kind of a 2-part question here to start. First, on loan growth, it looks like you're set up to have continued nice growth into the third quarter with the stronger adjusted pull-through pipelines. Kind of what are your thoughts -- I guess, what are your thoughts on growth in the back half of the year? And then secondly, can you give us an update on your thoughts on funding going forward from here, particularly given the loan-to-deposit ratio at close to 103%?
Anthony J. Labozzetta
Sure. I might give it a long-winded answer on the 2-part question. So with regards to our lending, we think we -- the pacing that I mentioned during the call at around 6.7% is something that is in the wheelhouse. We still guide to that 5% to 6% growth rate. Pipeline is strong. The activity is strong. Our underwriting is strong. So we feel pretty good about that sector.
One of the things to point out that in the first half of the year, we've seen a substantive growth on the C&I side of the book as well. So there's not that -- which is consistent with our plans. So not to rely so heavily on CRE lending. So if you -- just to give you a quick metric on that, we did about 40% of our production was in C&I versus 27% last year at the same time. So the teams are doing a good job executing on that, and I'm feeling really good.
In terms of funding, I guess our expectation, if I were to just throw it out there on a macro basis is that our aim is to probably try to keep deposits stable for the rest of the year. There are -- I don't think it's prudent to have strategies that are to attract because it's very expensive to do that. That being said, we still grow a lot of our deposits through our business banking program. So we still expect some good activity there and growth.
On the municipal side, I think that we had new norms and a lot of the excess money that was in municipalities through stimulus has gone out. So therefore, that we don't expect a lot of growth in that sector. And we're aiming to maintain consumer deposits on a level basis. And I think if we can do that, it's a good achievement.
That being said, how do you funnel the growth? We're going to fund it through our business banking growth in terms of deposits. We're going to probably go to the wholesale market. If needed, given that it's a better pricing play than trying to incrementally price your deposits through some campaign. And lastly, we'll use some securities cash flows that come in to divert those into the lending sector.
I think that we're cognizant of loan-to-deposit ratios not going out of bounds, but our estimates show that they're still within the bands that we want to operate in. So we're comfortable pushing for that 5%, 6% as long as it's good, responsible growth because it will also come with some self-funding in that category.
Thomas M. Lyons
I was just going to add with some of our peers stepping back a bit in the lending arena, it affords us the ability to continue to be selective, both with regard to pricing and structure. So we're getting looks at some quality loans.
Anthony J. Labozzetta
Exactly. Long-winded answer, Bill. Hopefully, I gave you what you needed.
Bill Young
You did. And it wasn't long winded at all. And this, I guess, second question to kind of follow up on Mark's questioning on the margin. It sounds like -- does it kind of feel like some of the deposit pressures that we saw in the second quarter or normalizing or getting better so far in the third quarter? It sounds like we're pretty close to the margin bottoming here. And if the Fed's hike earlier this week was the last month for this year, do you guys feel better about your ability to kind of incrementally see margin expansion as we get further out from this?
Thomas M. Lyons
I do think that's the case, Bill. I think a lot of the industry and ourselves included have caught up to a degree on the lag that we had on deposits were much closer to or add in market rates. So I think the funding pressure will abate some. I think we've been conservative in our NIM modeling in the assumptions around shift in composition within that portfolio to the higher costing CDs, which we've seen on the consumer side and recognizing the ICS product, which has a rate to it as being 1 of the areas where we've seen growth as well. And then the beta that we've applied to the most current hike is pretty significant to capture the rest of that lag, I think.
Anthony J. Labozzetta
Yes. And I would just add on that we're hearing that from the business lines as well. So if you kind of look back at the second quarter, the delta between what we -- where we were pricing and where the markets have moved just kind of widened to a place where customers became extremely aware and obviously, what happened in the first quarter with -- around liquidity.
So every time there was a Fed hike, the customers were almost ahead of the Fed hike looking for what's going to happen on their account. It hasn't happened this go around. So this Fed hike that was silence. And so we're seeing a much I'm not suggesting that there's not any of it happening, but it was happening network-wide and now it might be small pieces.
So the expectation is, and I think it's consistent with some of what we're hearing from our peers is that that slow down. So the customers close the gap between -- or the delta between market and where we were pricing. So it kind of feels like it's leveling off.
Secondly, we're not seeing any unusual irrational behaviors from our competition in the marketplace that would result in any dynamic of pricing going into the third and fourth quarter. So that also gives me a little bit of solids to say, yes, we are kind of plateauing in that space.
So I think Tom's projection on the margin given that all of it is coming nearly from the funding side pressure is -- that's why we can make that statement. Secondly, there is another element here in terms of the Fed's hike that Tom and I talk about and that is that our assets will continue to price up. And if the behavior on the deposits kind of subsided, we might see -- we might add a little bit of benefit in that category to stabilize any further.
Thomas M. Lyons
On the asset side, within the loan book, 52% of that is variable rate with 24% within that being floating. We saw the on-rate move up to 6.38% I think it was roughly in the second quarter. We saw the portfolio rate at 7.24% and the -- I'm sorry, the pipeline rate and the portfolio yield currently 5.24%.
If you look at the average balance growth in loans versus the spot balance, too, you can see the average balance is lagging. So some of that production we saw in Q2, we're going to see greater benefit from in Q3. So all those things are helping to maintain that margin by some nice improvement in asset yield over the projection.
Anthony J. Labozzetta
But I just -- I think it's probably a good time for me to also express that as an organization, we're very cognizant on risk, and we're not doing anything from a standpoint of trying to stretch in any areas to make up for this margin pressure. We're just going along, doing our strong business. We like the nature and quality of the loans that we're putting on, and we feel good about a lot of things, except just that the funding cost is market-driven. And other than that, we're staying resilient to our risk management processes.
Operator
Your next question is from Michael Perito of KBW.
Michael Anthony Perito
Tom, are you able to maybe rehash or update us on kind of where -- obviously, sometimes pass rates have changed. Do you have new kind of pro forma capital ratios for the bank assuming late closes in the back half of the year at some point or a range or just some guideposts around how you're thinking about that?
Thomas M. Lyons
Really trying to look where we stand versus total risk-based capital at the bank level. That's the weakest ratio among there, where we're in excess of well-capitalized levels on our pro forma projections. So they have improved over the course of the years, both companies have managed their capital and had good earnings over the course of the first 6 months.
Michael Anthony Perito
So relative to what you guys communicated when the deal was announced, it sounds like they'd be modestly higher, just based on the capital build at both institutions?
Thomas M. Lyons
That's correct.
Michael Anthony Perito
Okay. And I wanted to also just ask on the noninterest income side, if you have any -- apologies if I missed this, but if you have any kind of thoughts on the near-term outlook here. And then, Tony, maybe a bigger picture question. I don't know coming up, but there was a [midwest] that actually sold its insurance unit for what I thought was a very, very healthy revenue multiple. I know it's a business historically, you've been pretty dedicated to and happy with.
But just curious about what your thoughts are there, particularly if we're in a position where your loan growth is good and a little extra capital would have hurt. Is that an option you would consider now? And then just, again, to reiterate, just any thoughts on the near-term noninterest income guide would be great.
Anthony J. Labozzetta
Sure. It's not -- we recognize the value of our insurance entity. However, they're producing somewhere around 40% return on that investment. We don't see this strategy peaking out. I think it can continue to elevate and it's part of our strategic plan to have a greater percentage of our revenue be comprised of nonspread income.
So I think it's an important part of our strategic planning direction. And while that's out there, and I'm aware of it, I think it's -- and it's also a great value add for our customers. So that's something that is entwined in there, and it's very hard to decouple relative to our strategy. So -- while that's out there, I think right now, it's not a strong probability, but just -- you can't ever say no to anything in our business.
Thomas M. Lyons
Yes. I mean we like the diversified revenue stream. We got a 35% EBITDA margin. The business is contributing nicely. I wouldn't touch it. Yes. Just to add to that, Beacon Trust, though also had a nice quarter. We see AUM back up to $3.7 billion at the end of the period, $3.6 billion for the quarter. Net new clients of 8, about a 22.5% net margin on that business, too. So also contributing nicely.
Anthony J. Labozzetta
Correct.
Thomas M. Lyons
As far as outlook with the total noninterest income, I'm probably being a little conservative, but I just kind of pegged at about $20 million a quarter in the near term.
Michael Anthony Perito
Okay. That's very helpful. Appreciate it.
Operator
Your next question is from Manuel Navas of D.A. Davidson.
Manuel Antonio Navas
As the NIM stabilizes -- is that -- or do you think the NII dollar trough in the third quarter or more in the fourth quarter? On a core basis so Lakeland [will ship] things.
Thomas M. Lyons
Yes. Yes, everything gets thrown off when the deal closes. But I think fourth quarter is when we were looking for the (inaudible)
Manuel Antonio Navas
Okay. And then what's the rough cash flows on securities, if that's part of the funding profile?
Thomas M. Lyons
Typically throws off between $16 million and $20 million a month.
Manuel Antonio Navas
And with the kind of the movement of the NIM, what do you -- in the NIM trajectory? What are you kind of assuming through-the-cycle deposit betas and kind of where noninterest-bearing deposit mix ends up?
Thomas M. Lyons
Yes. We're at 25% through the cycle thus far. I think we're assuming something around 32% for the full projection period. Sorry, what was the other question?
Manuel Antonio Navas
Noninterest-bearing deposit mix percentage. Like where does it kind of settle out? How much more...
Thomas M. Lyons
Probably 23, 24.
Anthony J. Labozzetta
I would agree.
Manuel Antonio Navas
That's really helpful. It's probably early. Do you have any thoughts on kind of how the environment may have shifted kind of the combined targets for Lakeland or were kind of more to come on that, I guess. But just any initial thoughts on that?
Thomas M. Lyons
Yes. I think it's a little too early to go out there until we get the balance sheet combined and see where the environment stands at that combination date would be too speculative.
Manuel Antonio Navas
Okay. Very fair. I appreciate the comments.
Operator
There are no further questions at this time. I will now turn the call over to Tony Labozzetta for closing remarks.
Anthony J. Labozzetta
Thank you. Well, thank you, everyone, for being on the call. As we know, these are challenging times, but I feel really confident in the management team at Provident. And I think we'll tackle these challenges head on and outperform. So to that end, we look forward to getting together next quarter and sharing with you our results. Have a good day.
Operator
This concludes today's conference call. Thank you for your participation. You may now disconnect.
