Provident Financial Services Inc Q1 FY2022 Earnings Call

Hello and welcome to the Provident Financial Services, Inc First Quarter Earnings Release Call. My name is Alex, and I'll be coordinating the call today. I will now hand over to your host, Adriano Duarte, Investor Relations Officer for Provident. Over to you, Adriano.

Thank you, Alex. Good morning, and thank you for joining us for our first 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 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 Tony Labozzetta, who will offer his perspective on our first quarter. Tony?

Thank you, Adriano, and good morning, everyone. We are very pleased with Provident's strong financial performance for the first quarter with earnings of $0.58 per share. Our performance was driven by growth in our key business lines, resulting in the deployment of some of our excess liquidity into more desirable asset classes. The growth and improved asset mix combined with an expanding net interest margin bolstered net interest income, which drove the increase in quarterly revenue. In addition, improvements in credit metrics and the economic forecast supported a negative provision for the quarter. This produced an annualized rate of return on average assets of 1.3% and a return on average tangible equity of 14.58%. Our Board approved the quarterly cash dividend of $0.24 per share. During the quarter, we also repurchased approximately 1.3 million shares of common stock at an average price of $23.36 per share. Our capital position remains strong and comfortably exceeds both capitalized levels. Our focus is to continue to build our best-in-class customer experience and grow all of our business lines, especially commercial lending. Our commercial lending group continues to be very active, and in the first quarter, we closed approximately $502 million of new loans, a 61% increase from the same quarter last year. Prepayments for the quarter adjusted for PPP included certain anticipated payoffs, which offset some of our strong production. A line of credit utilization percentage increased 3% for the first quarter to 31%, which remains below our historical average of about 40%. Our production continues to be robust; consequently, we grew our commercial loan portfolio, excluding PPP, at an annualized rate of 8.3%. We had good pull-through in our commercial loan pipeline during the first quarter, yet our gross pipeline remains healthy at approximately $1.4 billion. The pull-through adjusted pipeline including loans pending closing is approximately $810 million, and our expected pipeline rate increased 55 basis points from the last quarter to 4.15%. Despite the competitive market and rising interest rates, we continue to see vibrant lending activity. We expect solid pull-through in our pipeline, and if the prepayments are normal, we should have strong loan growth throughout 2022. Our core deposits remain stable, and we continue to see growth. Our non-interest bearing deposits grew at an annualized rate of 8.7% this quarter and presently comprised about 25% of our total deposits. The total cost of deposits for the quarter declined 2 basis points to 19 basis points and is amongst the best in our peer group. We deployed excess liquidity into commercial loans and investments and continued to reduce our cost of funds, which helped drive a 7 basis points improvement in our net interest margin. We anticipate the Federal Reserve will continue to hike interest rates in 2022. Provident is moderately asset sensitive and we have a stable, low-cost deposit base. Therefore, we believe we are well positioned for rising interest rates. Our fee-based businesses are important to us. SB One Insurance had a strong quarter with revenue increasing 26.4% compared to the same quarter last year. The performance was driven largely by healthy organic growth, a 37.1% increase in contingent income, and a retention ratio of 99.8%. Given the unfavorable conditions in the financial markets, Beacon Trust experienced a decline in the market value of assets under management, and as a result, the income decreased $376,000 or 4.8% for the quarter compared to the trailing quarter. As we look forward, our goal is to grow our business lines and further improve our asset mix. We also expect the rising interest rates will continue to improve our margin, which when combined with our growth will have a positive impact on our net interest income in the upcoming quarters. In addition, we have a number of digital initiatives being implemented and will modernize certain business processes, improving efficiency and the customer and employee experience. Lastly, our strong first-quarter performance was due in large part to our talented colleagues' commitment to our guiding principles and their continued pursuit of a high-performing and innovative culture. I want to thank them for their dedication. We look forward to growing our business and achieving more financial success built on our commitment to our employees, customers, communities, and shareholders. With that, I'll turn the call over to Tom for his comments on our financial performance.

Thank you, Tony, and good morning, everyone. As Tony noted, our net income for the quarter was $44 million or $0.58 per diluted share compared with $37.3 million or $0.49 per share for the trailing quarter and $49.8 million or $0.63 per share for the first quarter of 2021. Pre-tax pre-provision earnings for the quarter were $50.4 million or an annualized 1.49% of average assets. We had record revenue that exceeded $114 million for the third consecutive quarter on the strength of record net interest income. Our net interest margin increased 7 basis points from the trailing quarter to 3.02% as interest-bearing cash was deployed to fund higher yielding loans invested in higher-yielding securities and borrowings were replaced with lower costing deposits. Income recognized from PPP loan forgiveness fell $700,000 versus the trailing quarter to $1.1 million, and remaining deferred PPP fees totaled $354,000 at March 31. Meanwhile, we drove funding costs down again as average deposits increased and average borrowings declined. Average non-interest bearing deposits increased $26 million versus the trailing quarter, and the total cost of deposits declined another 2 basis points to just 19 basis points. Excluding the impact of PPP loans and purchase accounting adjustments, the core net interest margin increased 11 basis points in the trailing quarter to 2.95%. The pull-through adjusted loan pipeline at March 31 increased $134 million from the trailing quarter to $810 million, while the pipeline rate increased 55 basis points since last quarter to 4.15%. Excluding PPP loans, period-end commercial loan totals increased $165 million or an annualized 8.3% versus December 31. Loan growth occurred primarily in the CRE and C&I categories. Net of runoff in the residential and consumer loan portfolios, total loans excluding PPP loans grew $147 million or an annualized 6.2% for the quarter. The allowance for credit losses on loans decreased $4.5 million for the quarter as a result of a $6.4 million negative provision for credit losses on loans and $1.9 million of net recoveries. Asset quality metrics, including non-performing loan levels, total delinquencies, criticized and classified loans, and related ratios again improved versus the trailing quarter. Non-performing assets decreased to 39 basis points of total assets from 42 basis points at December 31. Excluding PPP loans, the allowance represented 79 basis points of loans, a reduction from 85 basis points at the trailing quarter end as a result of a decrease in impaired credits and improvements in the economic forecast. Non-interest income decreased $506,000 versus the trailing quarter as an increase in insurance agency income was more than offset by lower benefit claims on bank-owned life insurance, lower loan prepayment fees, and other loan fees and lower wealth management fees as a result of a decrease in the market value of assets under management. Excluding provisions for credit losses on commitments to extend credit for all periods, operating expenses were an annualized 1.9% of average assets for the current quarter compared with 1.81% in the trailing quarter and 1.95% for the first quarter of 2021. The efficiency ratio was 56.05% for the first quarter of 2022 compared with 54.74% in the trailing quarter and 56.19% for the first quarter of 2021. The operating expenses are typically elevated in the first quarter as employer payroll tax limits reset and seasonal occupancy costs are incurred. In the most recent quarter, there were also increases in stock-based compensation, data processing, and advertising and promotions expense when compared with the first quarter of 2021. Our effective tax rate declined to 25.7% versus 28.4% for the trailing quarter. The trailing quarter included a discrete item for additional tax expense related to the apportionment of income subject to state income taxes. We are currently projecting an effective tax rate of approximately 25.75% for the remainder of 2022. That concludes our prepared remarks. We'd be happy to respond to questions.

Thank you. We will now begin the Q&A. Our first question for today comes from Mark Fitzgibbon from Piper Sandler. Mark, your line is now open.

Gentlemen, good morning.

Good morning, Mark.

Hi, Mark. How are you?

Terrific. Thank you. I guess the first question I had, Tom, could you share with us what the impact of accretable yield was this quarter and last quarter, let's say?

The last quarter was 7 basis points and 6 basis points in the current quarter, Mark.

Okay. Great...

And then PPP was 5 last quarter and 2 in the current quarter.

Okay. Great. And then secondly, what was assets under management at the end of the quarter, and what were the net flows?

At the end of the quarter, we had $3.9 billion in assets under management. On average, we are down $59,000, bringing the average for the quarter to 4.03. This is primarily driven by market valuation. We also added 7 clients during the quarter, and the fee rate remains around 77 basis points.

Okay. Tom, it seems that the margin might decrease slightly in the short term due to the reduction in PPP income and the decline in accretable yield. Should we expect the reported margin to dip a bit in Q2 and then start to recover in the latter half of the year?

No, Mark. I think we're actually going to see it continue to build into Q2. PPP, as I said, only contributed 2 basis points this quarter. There's about $28 million worth of principal left and just $354,000 left in deferred fees, so that noise will go away. But we have a modestly asset-sensitive balance sheet as we've discussed. And we're currently modeling seven rate hikes over the course of the year, 50 basis points in May, and then 25 in June, July, August, September, November, and December. So, our models have given us kind of a 3.12 to 3.15 for next quarter on the NIM, getting up into the low 3.20s by the end of the year.

Okay. Great. I was wondering, I didn't see anything in the release about it. Are you hiring any lenders from other banks due to the consolidation happening around you? If that's the case, how many have you hired and how many do you plan to consider this year? Thank you.

Yes, Mark. The answer is affirmative on several points. If I remember correctly, I believe we've brought on nearly 19 new Relationship Managers this year. Not all of these hires are a result of the recent intermediation, but we are definitely seeing some activity. We've certainly captured our share of it, possibly even more in the New York area, including Westchester and Rockland. As for the loan sector, I would say we have likely expanded our portfolio. I don't have an exact figure at the moment, but I am confident that we have gained certain advantages in terms of loan productivity as well.

Thank you.

Thank you. Our next question comes from Michael Perito from KBW. Michael, your line is now open.

Thank you. Good morning, guys.

Good morning, Michael.

Good morning, Michael.

I wanted to ask on the reserve, as we kind of think of the mechanics of that moving forward here, I mean, it seems like the credit environment for you guys is pretty benign and strong. But I imagine on the CECL front, as we move through the year here, even if it doesn't prove to be true, there'll probably be some increased weightings for some more negative economic scenario. So, is it fair to think, especially with the low growth pipeline where it is and everything I just said that the reserve here on a percentage basis will probably be close to the low point? I'm curious if you guys are growing the priority context around that commentary as well.

I believe we are nearing the lowest point. As you mentioned, future provisioning will mostly depend on growth, although there might be a slight adjustment for more negative forecasts if recession fears become reality. Currently, looking at the most recent economic outlook from Moody's, the April forecast actually indicated some improvement compared to March, suggesting the possibility of additional smaller releases in the second quarter.

Okay. That's helpful. I apologize if I'm jumping around here, but regarding operating expenses, do you have any insights on where the run rate might be heading in the near term? Anthony, you mentioned some digital investments your team is making. Could you provide some context on the pace of those investments? Is it increasing? Will it become a larger portion of your operating expenses in the future? I'm interested in your high-level thoughts on this as well as the expected near-term operating expense run rate.

I'll start, and then Tony will follow. In terms of expense run rate for dollars, excluding provisions on off-balance sheet credit losses or exposures, I believe we are likely in the $63 million to $64 million range for the next quarter. It becomes a bit less certain as we look further ahead, but that seems like a reasonable figure to use. Regarding our digital investments, I think we are quite stable. If you consider it as a percentage of revenue, the total digital platform expenses run between 7.3% and 8%. I don't anticipate any significant changes.

Yeah. I think they're embedded in the number that you already gave guidance on and nothing is drastic in there. I think a lot is really to make us more efficient and perhaps reduce the run rate as we go forward or handle more units of business with the same level of better efficiency. So, I wouldn't characterize it as we should see a big boost in our expense spending as a byproduct of the things I mentioned.

Got it. And Tony, are you willing to provide a little bit more detail about some of the things you're looking at on that front? Is it third-party vendors? Is it more like operational and organization on your side and making things more efficient that way, or just love a little bit more color?

We are implementing a new loan origination system that will enhance efficiency in how loans process through our bank, improve the customer journey, and streamline the employee experience in managing credits. This should lead to increased productivity and better reporting within our organization as we grow. Additionally, we are exploring a new small business lending platform that offers better automation and analytics. We are also developing internal tools to automate repetitive processes. All of these initiatives aim to enhance efficiency and improve both customer and employee experiences, which we believe will lead to greater productivity. Tom, did I leave anything out?

No, not at all. Actually, I just wanted to correct a scenario that I made when I misspoke; I was thinking about occupancy expense in terms of the percentage of cost to revenue. It's more about 5% on the IT side.

Great. And then just one last one for me and I'll step back. Just Tony, on capital deployment, just a pretty simple question. Just curious if you could provide us with maybe some updated thoughts, obviously, the valuations on the banking sector are pulled in here, but it sounds like near term you guys have a pretty good line of action. Just curious how you guys are thinking about overall capital deployment as we kind of move into the balance of the year here?

I'll start first, and then let Tom finish. This is a conversation that we have almost periodically that balancing, seeing us undervalued and being a good buyback versus the growth plans that we have and deploying that. So, it's a continuing balancing act for us to make sure that we can execute both of those, right? So...

Yeah. And I think that's why we target the 45% to 55% range for the regular recurring cash dividend because that gives us sufficient capital formation to support our current expectations of growth, and we assess that periodically. In terms of what we like to be, I think we've talked before about trying to work the TC down to around 8.5%. We think that's a comfortable level. But, as Tony said, we've never been programmatic in our approach to buybacks; it's really been opportunistic. And as you noted, when we have a clear kind of view of our comfort level with earnings projections, we take advantage of market conditions.

Cool. Thank you, guys. Very much appreciate you taking my questions.

Thank you.

Thank you. Our next question comes from Billy Young of RBC. Billy, your line is now open.

Hey, good morning, guys. How are you?

Good morning, Bill.

So, first question on maybe the loan growth outlook for the year. It seems like loan growth is accelerating, and it's good to see your pipelines are up from year-end. On the core, it does seem like growth is tracking to your previously guided 5% to 6%. And it also sounds like prepayment activity was generally as expected. I know in the past, you've spoken to maybe some moderation in that payoff activity in the back half of the year. Do you still see some room for that to happen? And if so, how do you think about potential lift to growth as we progress further in the year?

I want to provide a detailed response because our growth this quarter in commercial loans was about $8.3 million on an annualized basis. However, we plan to exit roughly $98 million in loans, which we anticipated and encouraged to happen. If we exclude that, our annualized growth rate for the quarter would have exceeded 13%. Over the past several quarters, we have ramped up our activities by hiring new staff and increasing our focus, resulting in significant activity. There are market conditions to consider, which I'll discuss shortly. We also experienced some prepayments this quarter that balanced our figures. We closed $510 million this quarter, with about $300 million being paid off. As I mentioned, $100 million was planned prepayments, while nearly $200 million occurred unexpectedly. Of that, about $150 million was refinanced elsewhere, and the rest came from property sales. Looking at our pipeline, organizational capacity, and current activity, we are optimistic, especially as we look ahead to the second quarter. The third quarter typically softens due to summer months, and we are cautiously observing potential economic downturns affecting the fourth quarter. Nonetheless, indicators right now suggest we could experience solid loan growth in the upcoming quarters. When compared to last year, most of our growth occurred in the second half. In contrast, this year, we are seeing most of our growth in the first half, which is promising for our net interest income if this trend continues. I appreciate your interest, and I want to assure you that we are still experiencing strong activity, particularly in the C&I sector. For this quarter, around 70% of our loans were in that space, with 30% in C&I, which is a more favorable ratio for us at Provident than we have seen in a while. If I didn't fully address your questions, please feel free to ask for clarification.

No, that was great. There was a lot to unpack there. And then separately, my follow-up is just on, I guess, expenses. It seems your margin performance this quarter was very strong and it seems like the outlook is even stronger than what we were thinking three months ago. As your margin accelerates higher, do you see some opportunity there to maybe accelerate investment in your business and some of your initiatives?

I don't think in a material fashion just because of internal resource constraints. There is some flexibility there. Usually, the flexibility is more on the discretion side to withhold some spending; as you said, the favorable margin performance gives us the ability to continue full speed ahead. But I don't know that there's that much opportunity to pull additional expenses forward.

You also have organizational capacity. We have a number of projects underway to build for the future, and it's a matter of what we can handle. So, I don't think anything is constraining our thinking in terms of just continuing to execute on our plan.

Great. Thank you very much. I'll step back.

Thanks, Bill.

Thank you. Our next question is from Erik Zwick of Boenning & Scattergood. Erik, your line is now open.

Thanks. Good morning, guys. How are you?

Good morning, Erik.

Good morning.

First, I'm curious about the net interest margin. Tom, I appreciate your insights regarding the outlook for Q2. Can you share how you assess your excess liquidity and how you plan to deploy it in the upcoming quarters? Also, was this consideration included in the guidance you mentioned earlier?

Yeah. It's much less an excess liquidity story than an asset repricing story at this point. We've deployed the bulk, if not all of the excess liquidity last quarter. We do have good cash flows just off the investment portfolio returns about $30 million a month that we'll continue to reinvest into the rising rate environment. And as you know, we have a significant floating rate loan portfolio that will be adjusting with the increases in LIBOR over the course of the next quarter as well.

Great. Thanks for the clarification there. And then just thinking about the non-interest income and the fees. A number of banks have recently kind of reconsidered how they assess non-sufficient fees, overdraft charges, and things of that nature. Just curious how you guys feel about your assessment strategy today and whether you'd anticipate any changes?

We're comfortable right now. It's something we continue to evaluate and keep our eye on the marketplace. We think our processes are appropriate and fair to our customers. So, we don't see any immediate action there.

Agreed. And I think we'll continue to keep an eye on what's happening in the marketplace and reassess if we deem it necessary.

Understood. And then, Tom, maybe just sticking on the non-interest income for one quick follow-up. Any thoughts on kind of the run rate going forward if Q1 is a good kind of starting point or if there's other things to consider as we think about Q2 and beyond?

I think it's a pretty good starting point. There's volatile items in there around gains on loan sales, particularly in the SBA; it depends on the origination and what the current market gain on sale margins are. Prepayment fees are volatile. BOLI income obviously jumps around. But, the 2021 kind of range seems like a safe number to work off of as a core. There are concerns about what the market performance does on the wealth management side of things, but I don't think that's a material detriment and the insurance business continues to look strong for us. So, all in, I'd say that's a safe number, $20 million to $21 million, with hopefully some upside potential.

And then just one last one, I guess, maybe a bigger picture question. Tony, since you've joined, you've had a hand in kind of reemphasizing the importance of corporate culture with both regard to the employee and the customer experience. Curious just on your thoughts today on your current positioning and initiatives from kind of that ESG perspective across the franchise in light of kind of proposals for enhanced disclosure in some of your filings?

There were a couple of questions in there. The first was about the employee and customer experience culture. I believe there are a lot of positive aspects. I see a lot of energy and collegiality. It doesn't mean those qualities didn't exist before; we've just enhanced them. The storyline is starting to extend beyond Provident, as evidenced by the number of people who are expressing interest in our openings, reflected in the resumes we receive and the talent eager to join our banks. These are initial indicators that our efforts are yielding positive outcomes. Regarding ESG, our team is analyzing the disclosures and studying what other institutions are doing. As we gain more insights into what needs to be addressed, we will implement the necessary disclosures. Overall, I would say we are proud of our organizational diversity and the metrics we share with our Head of HR. While there is always more work to be done, we feel positive about our current standing as an organization.

Great. Thanks for taking my questions today.

Thank you.

Thank you. Our final question for today comes from Russell Gunther from D.A. Davidson. Russell, your line is now open.

Hey, good morning, guys.

Good morning, Russell.

I just wanted to follow up on the margin discussion. Tom, could you provide some insight on what you are assuming regarding deposit beta? Additionally, could you describe any changes from the first 100 basis points to the second 100 basis points and how you expect to perform?

Yeah. The all-in deposit beta is about 23%. Interest-bearing, I think, is closer to 31%, if you back the CDs out because they kind of come in pieces: it's more like an 18.5%, 19% kind of range. So, that's what's built into the margin expectations currently.

Okay.

In terms of lag…

There's potential for some upside there because we don't really build a lag in.

Okay. Yeah, you took kind of the words out of my mouth and it sounds like you might be able to outperform that in the earlier innings of rate hikes. So, I appreciate the color there, Tom. And then just last one for me, would be back to the fee vertical. So, I appreciate your thoughts on the organic growth outlook there. But, any commentary in terms of your acquisitive appetite in wealth management or insurance and likelihood something to come to fruition?

Sure. As we have previously mentioned, we are always seeking situations that align with our culture and strategic goals across various areas, including wealth management. We are actively exploring opportunities there, although the market is quite competitive with private equity firms. The same applies to insurance, and we are working to enhance both of those segments, as well as our banking operations. While there are limitations on what I can share during these calls, I can say that both our Chairman, Chris, and I are engaging with our colleagues to identify potential strategic partnerships. This is a regular aspect of our business approach. I hope this gives you some insight, even if I can’t provide a lot of specifics, but we are certainly looking at opportunities.

Yeah. It's very helpful. And Tony and Tom, thank you, guys, for the help. That's it for me.

Thanks, Russ.

Thank you.

Thank you for joining today's call. You may now disconnect.