Provident Financial Services Inc Q3 FY2022 Earnings Call

Good morning. Thank you for joining today’s Provident Financial Services, Inc. Third Quarter Earnings Conference Call. My name is Alexis, and I will be your operator for this call. All lines will be muted during the presentation, with a chance for questions and answers at the end. I will now pass the conference call to Adriano Duarte, Investor Relations Officer of Provident Financial Services. You may proceed.

Thank you, Alexis. Good morning and thank you for joining us for our third 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.

Thank you, Adriano and good morning, everyone. In the third quarter, Provident delivered a strong financial performance, once again producing record revenues, resulting in earnings of $0.58 per share. Our performance was driven in large part by the strength and stability of our funding base, growth in loans, and an expanding net interest margin. The expanding net interest margin drove a 10.1% increase in net interest income over the trailing quarter. This resulted in an annualized return on average assets of 1.26% return on average tangible equity of 14.96%. Our solid earnings performance continues to positively impact our capital, which remains strong and comfortably exceeds well-capitalized levels. Our board of directors approved a quarterly cash dividend of $0.24 per share. We remain committed to furthering our goal of delivering a best-in-class customer experience, which creates advocates for life and will help build our business, all of our business lines. Commercial lending continues to be our primary focus. And in the third quarter, we closed approximately $533 million of new loans. Our line of credit utilization percentage decreased 3% from the second quarter to 33%, which is trailing our historical average of about 40%. In addition, prepayment increased approximately 17% to $265 million as compared to the second quarter. Approximately two-thirds of the payoffs are due to the sale of the underlying collateral. As a result of our production and the levels of prepayments, we grew our commercial loan portfolio, excluding PPP at an annualized rate of 3.9% for the quarter and 10% for the first nine months of 2022. Pull-through in our commercial loan pipeline during the third quarter was as expected. We also replenished our gross pipeline, which remains strong at approximately $1.5 billion. Pull-through adjusted pipeline, including loans pending closing is approximately $963 million and our projected pipeline rate increased 112 basis points from the last quarter to 6.11%. Through the first nine months of 2022, we had record commercial loan production and growth, despite the competitive market and rising interest rates. We are also encouraged by the activity that replenishes our pipeline, and we expect normal pull-through in the fourth quarter, which should result in good commercial loans. However, we remain watchful of rising interest rates and the potential impact that may have industry-wide on pipeline pull-through. Stability of our core deposits is a valuable component of our franchise. During the quarter, the average balance of our core deposits increased $89 million or 3.6% annualized. Total cost of deposits for the quarter increased 15 basis points to 35 basis points. For the third quarter, our deposit beta was 10%, while the rising rate cycle-to-date deposit beta was about 5%. Stability of our core deposits and relatively low betas, combined with the growth and improved yields on earning assets, particularly commercial loans, helped drive a 30 basis point improvement in our net interest margin. Given our moderately asset-sensitive balance sheet, our stable core deposits, and our prospective loan growth, we expect more improvement in the net interest margin in the near term. Our fee-based business lines are an essential component of our community banking model. Provident Protection Plus formerly SB One Insurance, had a solid third quarter, with a 19% increase in revenue and a 31% increase in operating profit as compared to the same quarter last year. The unfavorable conditions in the financial markets persisted in the third quarter, and as a result, Beacon Trust experienced a decline in market value of assets under management and related fee income. Beacon Trust fee income decreased $239,000 or 3.4% as compared to the trailing quarter. As we move forward and organically build our business lines, we are conscious of the potential deteriorating market conditions. Provident for remains committed to its strong risk management culture. In September, we announced the merger of Lakeland Bancorp with Provident. We are excited about this partnership, which will form a powerhouse super community banking organization in the Tri-state region. We begin planning the next steps with our new colleagues, and the collective enthusiasm about the combination of the two organizations continues to grow. I would like to express a special thank you to the Provident team this quarter, not only for their commitment and dedication but for remaining focused on producing strong financial results while working diligently on the prospective merger transaction. I also want to thank Tom Shara and the Lakeland bank team for their professionalism and camaraderie during the merger negotiations. I look forward to growing our business lines and creating value for 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 $43.4 million, or $0.58 per diluted share, compared with $39.2 million or $0.53 per share for the trailing quarter and $37.3 million or $0.49 per share for the third quarter of 2021. Third quarter results included $2.9 million of non-tax deductible charges related to the recently announced definitive merger agreement with Lakeland Bancorp. Including these merger-related charges, pre-tax pre-provision earnings for the quarter was $73 million or annualized 2.12% of average assets. We again achieved record revenue this quarter, totaling $138 million on the strength of record net interest income of $109 million and an $8.6 million gain on the sale of a foreclosed multi-tenanted office building to a purchaser who will reposition the property to industrial use. Our net interest margin increased 30 basis points from the trailing quarter to 3.51%. Yield on earning assets improved by 47 basis points versus the trailing quarter as floating and adjustable rate loans repriced favorably and new loan originations reflected higher market rates. Meanwhile, increases in funding costs continue to lag the improvement in asset yields with the average total cost of deposits increasing 15 basis points to 35 basis points. This represents deposit betas of 10% for the current quarter and 5.3% for the rising rate cycle-to-date. The average cost of total interest bearing liabilities increased 23 basis points in the trailing quarter to 2.54%. Pull-through adjusted long pipeline in September 30th increased $138 million from the trailing quarter to $963 million, while the pipeline interest rate increased 112 basis points since last quarter to 6.11%. Including PPP loans, period-end commercial loan total increased $83 million on an annualized 3.9% versus June 30th. Net of runoff in residential and consumer loans, total loans excluding PPP loans grew $65 million or an annualized 2.6% for the quarter. The for your credit losses on loans increased $9.6 million for the quarter as a result of an $8.4 million provision for credit losses on loans and $1.2 million of net recoveries. The increase provision in the current quarter was primarily attributable to deterioration in the economic forecast and the $2.4 million increase in specific reserves on impaired commercial loans. Non-accrual loans increased $19.1 million including a single $18.2 million loan collateralized by an office building in Philadelphia for which a $2.1 million specific reserve was established. While the deterioration in this credit has caused asset quality metrics to worsen slightly from the trailing quarter, non-performing loan and asset levels total delinquencies criticizing classified loans and related ratios remain strong and are improved versus the same quarter last year. Non-performing assets were 45 basis points of total assets, up from 36 basis points at June 30th. Including PPP loans, the allowance represented 0.88% of loans, up from 79 basis points of loans at the trailing quarter end. Non-interest income increased $7.5 million versus the trailing quarter, driven by an increase in gains on sales of REO, partially offset by decreases in BOLI income, wealth management income, loan prepayment fees, gains on loan sales, swap income, and gains on securities transactions. Including provisions for credit losses on commitments to extend credit and merger-related charges, operating expenses were an annualized 1.89% of average assets for the current quarter compared with 1.92% in the trailing quarter and 1.85% for the third quarter of 2021. Efficiency ratio was 47.11% for the third quarter of 2022 compared with 53.83% in the trailing quarter and 54.51% for the third quarter of 2021. Our effective tax rate increased to 27.7% versus 26.8% for the trailing quarter. However, excluding non-deductible merger-related charges, the effective tax rate was stable at 26.5%. That concludes our prepared remarks. We'd be happy to respond to questions.

First question is from Billy Young with RBC. You may proceed.

Hey, good morning, guys.

Good morning.

Good morning, Billy.

Just to comment on I guess we'll start with loan growth. It sounds like there's optimism here that growth will improve in the fourth quarter, given the higher adjusted pipeline. I guess what gives you confidence that the more elevated prepayment activity this quarter won't continue over the next couple of quarters?

Sorry, what won't continue?

Elevating prepayments.

The rising rates are not conducive to refinancing with other institutions. About two-thirds of our prepayments came from the sale of collateral tied to the loan. While we cannot predict specific sales, we anticipate that prepayments, particularly refinancings, will significantly decline. Regarding your question about loan growth in the fourth quarter, I do expect an increase. It's important to note that the third quarter is typically our lowest production quarter of the year, which is why I mentioned that the pull-through was as expected. However, we are looking forward to an uptick in activity in the fourth quarter, and we are already seeing signs of that in October, supporting my outlook. Therefore, I feel optimistic about loan growth as we move into the fourth quarter.

Thank you for that. My next question is about the deposit betas; previously, you expected them to be around 23% through the cycle, but currently, it's tracking closer to 10%. Do you still consider 23% a reasonable estimate? Are you anticipating a potential outperformance or an acceleration as we approach year-end with these betas?

I mean, I think it's a conservative number through the cycle, Bill. We do expect to see some acceleration obviously, for the industry as a whole repricing activities picked up, certainly more competitive environment out there as liquidity kind of drains from the system. And for that end, I guess I still think that 23% is a good number. So, we have increased our models on deposit betas for the remaining part of the cycle up to about 40% weighted average beta excluding CDs, including non-interest bearing. I think that's a conservative number. I don't know if we get there, but that would get us to 23% in fairly short order.

Great, great. And just to follow-up there, do you have any perhaps updates thoughts on the deposit strategy or deposit mix? Would there be any appetite to maybe add more CDs over time since are pretty low levels today and the loan to deposit ratio is moving up? And can you also remind us, you know what your goals are on the longer term loan to deposit ratio?

There isn't much interest in significantly building our CD book, as we are primarily a core funded bank, which is one of our key strengths. Currently, our CDs sit at 6.4%. We do have some promotional options available that provide a cheaper funding alternative compared to wholesale rates. Our deposit base is largely price insensitive, with commercial demand around 15% to 17% and municipal deposits showing a bit more volatility, although they typically reprice infrequently. The majority consists of core consumer accounts that don't demonstrate significant price sensitivity. We believe we have suitable alternatives available and can maintain lower deposit payment levels moving forward. Regarding our loans to deposit ratio, we have strong off-balance sheet liquidity and adequate borrowing capacity. Our on-balance sheet liquidity meets regulatory expectations, and we could likely reach a ratio of 100 to 105. Historically, we've been at 113 and 115, but it ultimately depends on our external borrowing capacity to ensure we remain comfortable with overall liquidity. Currently, we've stress-tested our liquidity metrics and are quite content with our position.

Great. Thank you for taking my questions, guys.

Thank you, Billy.

Thank you.

Thank you, Mr. Young. The next question comes from the line of Mark Fitzgibbon with Piper Sandler. You may proceed.

Hey, guys, good morning. Tom, I wondered if you could share with us your thoughts on the outlook for expenses?

We are currently in the budget process. I will be able to provide more information on 2023 as we move forward. However, for the fourth quarter, I believe we mentioned that we were approximately between $64 million and $65 million, excluding any provisions for off-balance-sheet commitments.

Okay. Great. And then secondly, any color on the uptick in non-accruals in the commercial real estate book? Is that one credit, several credits, anything unique there?

Yes. I'll start and then Tom will sort of jump in. I think we had the one credit that Tom mentioned. It appears to be a one-off. But in this case, it truly appears to be a one-off from the sense that our team has done some deeper analysis on related type assets. And at this stage, we see no indication that there's any other deterioration in that sector albeit we still pay attention. And Tom, do you want to add to that?

Yeah. Again, Mark that was an office building which experienced some vacancy in Western Philadelphia suburb. We have been monitoring the office portfolio as one that's an area where we might see some stress as an industry. Total is about $544 million, exclusive of that $18 million credit we referred to so $560 million roughly all in. We've gone through an extensive analysis and we continue to monitor the portfolio in terms of outstanding balances, medical, non-medical, single-tenant, multi-tenant, rollover risk, upcoming maturities. We've been pretty thorough in our evaluation and we're not seeing anything of immediate concern, nothing that indicates any kind of systemic weakening in the portfolio.

True. And the one thing I would add to that, this is a customer that we also have other business with, and they just happen to lose a tenant and so it's really a matter of whether we can get that building repurposed or re-tenanted. So we're working in tandem to see, to get to a good resolution.

Okay. Great. And then could you share with us what assets under management were and net flows this quarter?

Yeah. So another management fell to about $3.2 million, $3.3 million this quarter, unfortunately, as a result of market conditions. Flows, the average AUM was $3.5 million. That's down from $3.8 million in the trailing quarter. We did lose a couple of clients on a net base that 10 clients. So that's a little bit of concern. But overall, up for last year by 24 clients. Again, is still about $3.2 million in margin on the business is about 26.5%.

The 10 clients that left, what was the approximate amount of assets related to that? I can follow up with you, Tom, if you don't have the information.

On this nine months.

Okay. Great. And lastly, on the provision, I know a lot of moving parts and it will depend on loan growth. But how should we be thinking about the provision for the next quarter or two?

Largely dependent on the economic outlook, I don't believe we are witnessing any significant deterioration. In fact, our criticized and classified levels are the best they've been in some time, at only about 2.4% or 8% of total loans. It really comes down to the forecast. I think Moody's has played a bit of catch-up this quarter. I know they've experienced some deterioration in October compared to September, but I don't anticipate the same rate of deterioration next quarter as we saw this quarter or from September to June. I expect that to moderate a bit. However, if I had to estimate, I would say provisions might be around $3 million to $5 million.

Great. Thank you.

Thank you, Mr. Fitzgibbon. The next question comes from the line of Michael Perito with KBW. You may proceed.

Hey, good morning, guys. Thanks for taking my questions.

Hey, Mike. How are you?

Doing well. So I wanted to follow up on the prior question around fees. So I mean, with the wealth management run rate probably a step lower here, I mean, I think, Tom, you had kind of talked about a $20 million to $21 million run rate prior. I mean it sounds like between that and maybe there's room for that to drift a smidge lower. Is that fair at least near term here?

Maybe a little bit, the insurance business continues to run strong. And the core banking fees have all been consistent and growing. So I think we're holding our own despite the reduction in the value on the assets under management to get maybe a million dollars less near term.

Okay. Tony, I appreciate the detailed information on the pipeline and growth expectations. Are you noticing any specific areas or customer segments where commercial clients are becoming more cautious about their growth or considering taking on less debt? Has that started to emerge yet?

Well, I mean, I would say the construction sector. I mean, if you look at that I think that's has our clients thinking about the cost of the projects and the viability. So, I would say because of rising interest rates and the rise in inflationary pressures, I personally have spoken to some clients on certain projects that maybe they're pausing on only because of the viability of the returns that they can get. So, but in terms of our C&I space, of which I should note that this quarter, we had pretty impressive growth in the C&I space was approximately 34% of our production was in C&I. That seems to be humming along. I mean, obviously, everybody's got cautions on what the economic outlook looks like, and the effects of interest rate rises, but the activity is still there.

Helpful. And then just kind of another big picture question. I mean, I think part of the optimism for you guys around growth historically has been a lot of the dislocation in your market stemming from other M&A transactions. Obviously, you guys now have your own M&A transaction that will hopefully close next year, just wondering if you guys are starting to put any kind of blueprint around how to try to keep some of the organic momentum that I mentioned, you and Lakeland were both experiencing as from some of this other disruption, while you also integrate your own transaction? And I'm kind of a qualitative question. I'm just curious if there's any thoughts you're willing to provide there?

Oh, absolutely. That's something we talk about often. I mean, it really all begins with the cultural integration and the employee experience. I mean, the employees are the synapse to the customer, right. So usually when you disrupt that the customer loses the connectivity. I know we like to say their company, but those relationships are critically important. I think the teams are doing an extraordinary job in the dynamic and how we're communicating together in the beginning of this process and how we’re sharing ideas and we have a very light-minded approach to credit and the way we manage our customer relationships. So I think that there should be some dislocation during this new disruptive way. And I think we can only tighten and make things better. So I'm really expecting that this might be a merger that has as minimal disruption as possible during the combination, and it's only on us to drop the ball, but I think the teams will do a good job.

Great. That's it for me. Thank you guys for taking my questions. Have a good weekend.

Thank you.

Thank you, Mr. Perito. There are currently no further questions in the queue. I will now pass the line back to the management team for closing remarks.

Thank you, and thanks everyone for joining us on the call and asking good questions. We look forward to a solid fourth quarter and be safe and have a great day.

That concludes the Provident Financial Services, Incorporated third quarter earnings conference call. Thank you for your participation. You may now disconnect your line.