Provident Financial Services Inc Q1 FY2020 Earnings Call

Good morning. And welcome to the Provident Financial Services First Quarter Earnings Conference Call. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mr. Leonard Gleason, SVP and IRO of Provident Financial Services. Please go ahead.

Thank you, Sabrina. Good morning, ladies and gentlemen. Thank you for joining us on our first quarter earnings call. Today's presenters are Chris Martin, Chairman, President and CEO; and Tom Lyons, Senior 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 regarding any forward-looking statements that may be made during the course of today's call. Our full disclaimer is contained in this morning's earnings release, which has been posted to the Investor Relations page on our website provident.bank. Now it's my pleasure to introduce Chris Martin, who will offer his perspective on our first quarter. Chris?

Thank you, Len, and good morning. We hope that you and your families are well and coping with this most unusual environment. First, I would like to applaud our employees who continue to provide exceptional service to our customers under difficult conditions. We have continued to deliver on our brand promise and commitment to the customer while conducting our business in a safe and sound manner. I'm extremely proud of the way our team members from various disciplines have met the challenge of the onslaught of requests for Paycheck Protection Program loans. We have directly secured 820 PPP loans for a total of $378 million, and also offered customers the opportunity to apply for a FinTech option. Now this was a great team effort. Like most companies in our industry, our first-quarter financial results were adversely impacted by the shutdown of our economy due to the pandemic, along with our adoption of CECL as of January 1. We reported earnings of $0.23 per share with a core pre-tax, pre-provision return on average assets of 1.47% for the quarter, excluding $463,000 in merger-related professional fees. We announced our planned merger of SB One Bancorp in March and have already filed our applications with the bank regulatory agencies. The integration teams from both banks have been meeting virtually and planning for an anticipated third-quarter closure. Total assets as of March 31, 2020 increased to $10.1 billion, as we finally crossed the $10 billion asset threshold. Our outstanding loan balances at March 31 were $7.37 billion, with loan originations of $355 million for the quarter. We believe our loan portfolio has stalled, but there are some commercial customers and industries that have been hit hard by COVID-19. We are keeping a close eye on loan customers in the retail, hotel, and restaurant industries where our combined exposures were approximately $995 million, $234 million, and $65 million at March 31, 2020, respectively. The level of requests for deferrals of principal or P&I rose quickly after the economy shut down in mid-March. We require detailed documentation of the hardship before agreeing to any deferrals, none of which were granted for longer than 90 days. Today, we have processed and documented 363 payment deferral requests on commercial loans totaling $820 million in principal balances. These are loans to good customers and are for the most part secured by real estate and other business assets, which should mitigate losses in the event a borrower cannot recover. Turning to our residential mortgage and consumer loan portfolio, we had approved hardship payment deferrals to 275 borrowers who have been impacted by job losses due to COVID-19 for loans totaling $69 million in principal balances. Regulators have encouraged banks to work with borrowers and have afforded greater flexibility in terms of making payment deferrals and modifications without triggering TDR accounting or other adverse consequences. On the funding side, deposit growth continued, and our core deposits as a percentage of total deposits remained strong at over 90%, while we price down our cost of borrowings and extend their duration. We believe we still have the ability to incrementally lower costs over the next quarter on our core and time deposit accounts. Liquidity remains satisfactory and there has been no deposit runoff; although growth from the PPP and stimulus checks will likely inflate balances in the near term. On the margin outlook, we expect to see some pressure over the next couple of quarters, primarily due to the timing and extent of changes in interest rates. The rapid decline in rates to zero has impacted loan pricing, and we continue to require floors on many loans. A major impact to our earnings in Q1 was our adoption of CECL as of January 1. The $15.7 million provision for credit losses in the first quarter reflects the negative economic outlook impacted by the pandemic. We can expect that the economic forecast used in our CECL model will likely worsen in the second quarter. Non-interest income increased $4.8 million from the same period in 2019, with the T&L acquisition having been completed on April 1, 2019, along with higher loan-level swap fees in the current quarter. However, several key income items will likely come under pressure due to the economic slowdown. Our wealth management fees, largely driven by assets under management, will likely decrease in the near term as asset values decline in the current market. Overdraft fees and interchange fee income may also continue to compress as consumers comply with shelter-in-place orders and limit their spending to essential services. On the expense side, there were costs related to the acquisition and executive severance expenses recognized in the first quarter. Tom will provide more detail on our financial results. Tom?

Thank you, Chris, and good morning everyone. As Chris noted, our reported net income was $14.9 million or $0.23 per diluted share compared to $30.9 million or $0.48 per diluted share for the first quarter of 2019 and $26 million or $0.40 per diluted share in the trailing quarter. Earnings for the current quarter were adversely impacted by elevated provisions for credit losses under the CECL standard and the recessionary economic forecast attributable to the COVID-19 pandemic. Pre-tax, pre-provision earnings were $36.4 million excluding $15.7 million in provisions for credit losses on loans and commitments to extend credit, and $463,000 of professional fees related to the pending SB One merger. This compares to $39.6 million in the trailing quarter, excluding expense recorded to increase the contingent liability related to the Tirschwell & Loewy acquisition and $38.8 million for the first quarter of 2019. Our net interest margin contracted 1 basis point versus the trailing quarter and 20 basis points versus the same period last year, as declining market interest rates drove reductions in asset yields. To combat margin compression, we continue to reprice deposit accounts with negotiated exception rates and maturing time deposits. This deposit rate management, coupled with a continued emphasis on attracting non-interest-bearing deposits resulted in a 3 basis point decrease in the total cost of deposits this quarter to 62 basis points. Non-interest-bearing deposits averaged $1.5 billion or 21% of total average deposits for the quarter. Average borrowing levels also decreased by $31 million, and the average cost of borrowed funds decreased by 18 basis points versus the trailing quarter. We will continue to thoughtfully manage liability costs as the rate environment evolves. Quarter-end loan totals increased by $39 million or 2.1% annualized from December 31, as growth in C&I and residential mortgage loans is partially offset by net reductions in CRE, construction, consumer, and multi-family loans. Loan originations excluding line of credit advances totaled $355 million, a 21% increase versus the first quarter of 2019. The pipeline at March 31 increased to $1.3 billion from $906 million at the trailing quarter end. The pipeline rate has decreased by 81 basis points versus last quarter to 3.16% at March 31. The lower pipeline rate reflects current market conditions and declining treasury rates. Our provision for credit losses on loans under CECL was $14.7 million for the current quarter compared to the $2.9 million under the incurred loss model in the trailing quarter. The adoption of CECL resulted in a $7.9 million increase in the allowance for credit losses on loans recognized through equity upon the January 1 adoption of the standard. The increase in the provision reflects model estimates for life of loan losses impacted by the current severe economic forecast. Our annualized net charge-offs as a percentage of average loans were 16 basis points for the quarter and 26 basis points for the trailing quarter. Non-performing assets declined to 39 basis points of total assets from 44 basis points at year-end. The allowance for credit losses on loans to total loans increased to 1.02% from 76 basis points in the trailing quarter. Non-interest income decreased $734,000 versus the trailing quarter to $17 million as increased swap fee income was more than offset by lower bank-owned life insurance benefits and loan prepayment fees. Including provisions for credit losses on commitments to extend credit and acquisition-related professional fees, non-interest expenses were an annualized 2.13% of average assets for the quarter. These core expenses increased $1.7 million versus the trailing quarter. This comparison excludes the $2.8 million expense recorded to increase the contingent liability related to the Tirschwell & Loewy acquisition from the trailing quarter. The increase in core expenses versus the trailing quarter was attributable to over $1 million of executive severance and normal first-quarter increases in compensation and related payroll taxes. We did once again benefit from the FDIC insurance small bank assessment credit, resulting in no expense for the quarter. Our total remaining credit potentially realizable in future quarters is $267,000. Our effective tax rate increased to 26% from 23.6% for the trailing quarter as a result of the discrete item related to the vesting of stock compensation. We're currently projecting an effective tax rate of approximately 25% for the second quarter and 24% for the balance of 2020. That concludes our prepared remarks, and we would be happy to respond to questions.

We will now begin the question-and-answer session. [Operator Instructions]. The first question is from Mark Fitzgibbon of Piper Sandler. Please go ahead.

Thank you and good morning. I wondered if you could start by giving us an update on asset flows in your wealth management business and what AUM was as of 12/31 and 3/31?

Sure. Mark, it's Tom. The ending balance in AUM at 12/31 was $2.4 billion. At March 31, that had declined to $2.8 billion. We're not seeing much in the way of client losses; those are really market conditions driving that. In terms of average balances for the two quarters, which drive the fee income, it was about $3.3 billion in Q4, down to $3.2 billion in Q1. So, we really saw the decrease in market value toward the end of the period. So, if I think about it in terms of income at risk going forward, if we were to remain at the March 31 levels as an average for Q2, it would be about $1 million lighter in terms of income in Q2.

Okay. And then secondly, of the $890 million of loans that you granted payment deferrals on this quarter, I was wondering what did the breakdown of that look like by category?

CRE loans are about $548 million, multi-family is $37 million, construction is about $18 million, C&I is about $217 million, for total commercial type loans is $820 million, and then in the residential and consumer it's about $69 million.

Okay. And then Tom, I apologize if you mentioned this in your comments but that $1 million charge that went through expenses was off-balance sheet credit exposure, could you just give us a little more detail on that?

Yes, that's the reserve on commitments to extend credit that's required under CECL. So that runs through the non-interest expense section. If it had to come to provisions for loan losses, that's why the total provision for credit losses is $15.7 million, but the piece that's attributable to the increase in the allowance for loan losses really is just the $14.7 million, that's the difference.

Okay. And then your pipeline looks really strong, and I think $1.3 billion. How much of that would you expect to actually close in, let's say the second quarter?

We get about a 52% pull-through rate. If you had pull-through just the rate on that pipeline, it actually picks up a little bit to 3.23%, I think I quoted as 3.16% as the overall pipeline rate.

The next question comes from Peter Kowalski with High Street Advisors. Please go ahead.

Hi, Chris, Tom, how are you? I was a little disappointed I wasn't able to -- we weren't able to get together at the Annual Meeting, but hopefully next year things will be back to normal.

We would agree. Virtual helps, but doesn't help.

Yeah, first question. Cash dividend, I see you declared one for this quarter. Going forward, is the Board committed to maintaining its cash dividend for shareholders like myself, who rely on dividend income to pay the bills?

Certainly, I know our Board looks at that as just part of our return for our shareholders in this environment with limited buyback opportunities. We look at that as something that is very important to our shareholders, and it is always evaluated quarter-to-quarter. However, we're in a very strong capital position and, again, with a review of our balance sheet, loans, and the like, I would think that is stable. But obviously, quarter-to-quarter, we don't still know what happens next quarter. If we get things started again, the economy should bring more stability just to the messages by itself.

And another question. Unfortunately, the timing of your SB One acquisition was unfortunate. I mean, I guess maybe six years ago was the last time you did the bank deal with Team Capital. Question I have, if this lockdown ends up being longer than expected and the economy gets weaker? In the merger agreement, is there a material adverse change clause that if SB's asset quality deteriorated significantly that you can reevaluate the transaction?

If you review the document, there is a material adverse impact in that document that has been filed. We envision this still as a very solid transaction, with two strong companies getting together and two like management teams and Boards. So I wouldn't see that as an issue. On the other hand, you have to watch and see. I think they released earnings yesterday, and we didn't end up seeing any asset quality changes that we would be worried about right now. To your point, things go on, go forward, but I think we're still in a good place. We look forward to this combination. But all antennas up from both sides.

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

Thank you, Sabrina. Our financial industry will be operating in a challenging environment for a while, as we are all susceptible to economically emotional stress brought on by the pandemic. However, the strength of our capital base and balance sheet, along with the dedicated efforts of our employees and our underlying culture, will continue to be a differentiating factor over time. We thank you all for your continued confidence and support and look forward to better and brighter days ahead. Stay well and thank you very much.

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