Provident Financial Services Inc Q2 FY2024 Earnings Call

Call started abruptly. I would now like to turn the call over to Adriano Duarte, Head of Investor Relations. Adriano, please go ahead.

Thank you, Greg. Good morning, everyone, and thank you for joining us for our Second Quarter Earnings Call. Today's presenters are President and Chief Executive Officer, Tony Labozzetta; and Senior Executive Vice President and Chief Financial Officer, Tom Lyons. Before beginning the 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 yesterday 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 the second quarter. Tony?

Thank you, Adriano. Good morning, everyone, and welcome to the Provident Financial Services earnings call. Before we discuss our quarterly results, I am happy to note that as of the 16th of May, we closed the Provident Lakeland merger and officially welcomed the Lakeland team into Provident. We'd like to congratulate and thank our team members who have worked diligently to complete the merger. As we combine our banks and our cultures, we are excited by the opportunities to offer our expanded customer base access to our valuable products and services, especially those of our insurance, wealth management and treasury management businesses. We continue to build momentum and our team is well prepared for systems integration in September. Please bear in mind that our financial statements this quarter reflect combined results beginning on May 16th and include one-time costs related to the merger transaction. Moving on to our quarterly results. The second quarter was characterized by steady economic growth, continued high interest rates and an environment of mixed results in the banking sector. Thanks to the efforts of the Provident team, now reinforced by talented members from the former Lakeland Bank, we continue to build our core businesses and maintain strong credit quality. We are on track to achieve our projected merger cost savings and we are well positioned for the future. As expected, we reported a net loss of $11.5 million or $0.11 per share, reflecting the impact of merger-related transaction costs. If we were to exclude these expenses, earnings per diluted share would have been $0.44 for the quarter. We can see that our underlying performance remains strong as our pre-tax, pre-provision return on average assets was 1.47% for the second quarter compared to 1.28% for the trailing quarter. While market conditions in the first half of the year constrained loan growth, our fundamentals remain strong and we expect to achieve our projected growth for the second half of the year. At quarter end, our capital is healthy and exceeded levels deemed to be well capitalized, especially following the issuance of $225 million in subordinated notes on May 9th, which was well subscribed. As part of the merger, we committed to maintain a minimum Tier 1 leverage ratio of 8.5% and a minimum total risk-based capital ratio of 11.25%. At quarter end, we have exceeded these requirements with a Tier 1 leverage ratio of 9.36% and a total risk-based capital ratio of 11.66%. Tangible book value per share was $13.09 and our tangible common equity ratio was 7.34%. As such, our Board of Directors approved a quarterly cash dividend of $0.24 per share payable on August 30th. During the quarter, our total cost of deposits remained relatively low at 2.27%. Our total cost of funds, which was further impacted by the issuance of our subordinated debt, was 2.56%. Overall, our net interest margin increased 34 basis points to 3.21%. In our first full month as a combined company, our net interest margin was 3.38%, which exceeded our expectations. Moving forward, we are optimistic about the stability and improvement to our net interest margin and expect it to be between 3.35% and 3.40% in the upcoming quarter. Our commercial lending team closed approximately $307 million of new commercial loans during the second quarter. Of note, 54% of these new originations were part of our commercial and industrial lending business. Our ratio of commercial real estate loans to total capital was 477%. We project that by the end of the year, this ratio will be approximately 470%. Our credit quality was strong for the second quarter as evidenced by our non-performing loan ratio of only 36 basis points. The allowance for credit losses on loans represents 1% of total loans compared to 0.98% in the trailing quarter and 0.99% at the end of 2023. Once again, I would like to express that our strong credit quality metrics reflect the conservative underwriting culture and portfolio management standards. We see improved activity in our combined commercial lending pipeline, which increased during the second quarter to approximately $1.67 billion. The weighted average interest rate is 7.53% compared to 7.42% in the trailing quarter. The pull-through adjusted pipeline, including loans pending closing, is approximately $1 billion. We remain very optimistic regarding the quality of our pipeline. Our fee-based businesses performed very well. Despite the persistence of a hard insurance market, which has driven commercial insurance rates higher, Provident Protection Plus had a great second quarter with 19% organic growth as compared to the same quarter last year, and a retention rate of over 100%. Favorable market conditions helped grow Beacon Trust assets under management to about $4.1 billion at quarter end, compared to $3.7 billion in the same quarter last year, which improved fee income 3.8% as compared to the trailing quarter. For the first six months of 2024, Beacon produced $168 million in new business compared to $107 million for the same period last year. We are pleased by the success of our fee-based businesses and are enthusiastic about the prospects of enhanced growth from our expanded customer base. As we move into the second half of 2024, our attention will be on completing all aspects of the merger, integrating our systems smoothly and becoming the preeminent community bank in our market. We expect to achieve synergies and deliver even more value to our customers, employees and stockholders. Now, I'll turn the call over to Tom for his comments on our financial performance. Tom?

Thank you, Tony, and good morning, everyone. As Tony noted, we reported a net loss for the quarter of $11.5 million or $0.11 per share due to merger-related activity. Total charges related to our merger with Lakeland Bankcorp were $86.9 million in the current quarter, consisting of initial CECL provisions on non-PCV acquired loans and commitments to extend credit of $65.2 million, transaction costs of $18.9 million and a $2.8 million loss realized on the sale of Lakeland subordinated debt from Provident's investment portfolio prior to the merger. The remaining provision for credit losses on loans and commitments to extend credit was also somewhat elevated at $4.5 million for the quarter despite strong asset quality and a stable economic forecast. This increase in the organic provision for loan losses was due to the development of new quantitative models for the combined bank, which resulted in changes in projected loss factors for all loan segments. In addition, qualitative adjustment ranges were recalibrated in connection with the development of the new merged bank models. This brought our allowance coverage ratio to 1% of total loans. Excluding merger-related charges, pre-tax, pre-provision earnings for the current quarter was $70.1 million or an annualized 1.47% of average assets. Revenue increased to $163.8 million for the quarter, reflecting 46 days as a combined company and our net interest margin increased to 3.21%. For the quarter, the margin included 47 basis points of purchase accounting accretion. We projected NIM in the 3.35% to 3.40% range for the remainder of 2024, increasing to around 3.45% over the course of 2025. Our projections include two rate reductions in 2024 and another two rate cuts in 2025. Regarding interest rate risk, our newly combined balance sheet remains largely neutral. However, we expect little benefit on deposit costs from the first two rate cuts. We completed a successful regulatory capital raise through the issuance of $225 million of 9% subordinated debt in the quarter, which increased funding costs. However, the impact to the margin was partially offset by the sale of $550 million of securities acquired from Lakeland and the repayment of a similar amount of overnight borrowings and broker deposits. Excluding the $7.91 billion of acquired loans, period-end total loans were essentially flat for the quarter. Within the portfolio, commercial and industrial loans increased by $90 million and commercial real estate loans decreased by $75 million. Our pull-through adjusted loan pipeline at quarter end was $1 billion with a weighted average rate of 7.5% versus our current portfolio yield of 6.05%. Deposits increased to $18.4 billion at June 30th, including $8.62 billion acquired from Lakeland. Excluding municipal deposits that are subject to cyclical outflows and broker deposits, which were paid down with the proceeds of security sales, organic deposits increased $123 million for the quarter and our loans-to-deposits ratio decreased to 102%. Asset quality remains strong with non-performing loans declining to 36 basis points of total loans and total delinquencies declining to just 44 basis points of loans. Criticized and classified loans did increase modestly but remained relatively low at 2.6% of total loans. Net charge-offs were just $1.3 million or an annualized 4 basis points of average loans this quarter. With strong asset quality and a stable economic outlook, we expect future provisions to be driven primarily by loan growth and expect the coverage ratio to remain at approximately 1%. Excluding the loss on security sales, non-interest income increased to $25 million this quarter, reflecting the Lakeland combination, strong performance from our wealth management and insurance agency subsidiaries and an increase in BOLI income. As Tony noted, we are on track to achieve our targeted merger cost saves and project non-interest expenses of approximately $120 million for Q3 of 2024, declining to approximately $107 million in Q4 following our Labor Day core systems conversion. Our effective tax rate this quarter was impacted by several unusual items, including merger-related charges, the imposition of a 2.5% New Jersey transit fee surcharge and the related revaluation of deferred tax assets. We currently project our effective tax rate for the remainder of 2024 to be approximately 29.5%. Regarding projected 2025 financial performance, we remain on track to meet or exceed our targeted total combined merger charges of $95 million and projected cost saves of 35%, unchanged from the deal announcement. Our net interest mark on the acquisition totaled approximately $480 million and our core deposit intangible was 4.98% of core deposits excluding municipal deposits. We currently project a net interest margin of approximately 3.35% to 3.45% for the full year 2025, including approximately 65 basis points of purchase accounting accretion. With fully phased-in cost saves, we estimate 2025 return on average assets of approximately 1.1% and return on tangible equity of approximately 15% with an operating expense ratio of approximately 1.75% and an efficiency ratio of approximately 52%. That concludes our prepared remarks. We'd be happy to respond to questions.

Operator instructions. And it looks like our first question today comes from the line of Mark Fitzgibbon from Piper Sandler.

First, I wondered if you could give us a little more detail, Tom, on the timing of the cost synergies. I see you got about a $13 million difference from third to fourth quarter. Will all the cost synergies be in, do you think, by the end of this year?

We do.

And then in what areas do you see potential revenue synergies with Lakeland, and are there any sort of early surprises on the deal?

Areas that we see revenue opportunities are the things I mentioned earlier, which are: try to get more integrated activity between our insurance and our wealth businesses; enhance the asset-based lending business that Lakeland has; overlay more treasury management functions not only within the Lakeland customer base but more broadly. I think all of those are elements where we could achieve some revenue enhancements, and also changing the funding mix to try to get back to roughly 25% noninterest-bearing deposits. Those are activities we're going to be looking to do, as well as growing our normal business.

And since you marked all of Lakeland's loans, I guess I was curious if there's any plan to sort of sell commercial real estate or office loans to maybe try to reduce that CRE concentration some more?

At this time, Mark, there's not an active plan to sell off assets for our CRE ratio because the CRE ratio will come down naturally as we accrete the merger mark, and it will get to levels that are more satisfactory for us. What we are doing is actively managing the book. If you see why the loan growth this quarter was a little bit flat, there's also some management in there, where roughly $100 million plus of loans have been managed out because they had characteristics we didn't want to renew. So it's active management, but there's nothing that says we have to sell because we have super high concentrations in office or any subsector. When you subsegment our book, we're very comfortable that there's no individual concentrations that would require further action to reduce that.

To follow up on that, we're very comfortable with our pre-lending practices, underwriting standards and the rest. In those projections that we have for the CRE ratio being managed down to a lower level, it still considers growth in the CRE portfolio of approximately 5% a year.

Well said.

And then lastly, I wondered if you could share with us if you had a target capital ratio in mind and maybe how you feel about stock buybacks at some point — maybe early next year?

The nonstandard conditions to the merger required us at the bank level to keep a Tier 1 leverage ratio in excess of 8.5% and a total risk-based capital ratio of 11.25%. So use those as goalposts for now in terms of threshold levels. The targets obviously will be slightly above that so that we have appropriate buffers in the event that we approach those limits.

Yes, that's well said. You would think that with a little buffer on the upside.

The buyback thoughts would play into that just based on our expectations around capital formation, which are strong. As Tony said, that's why we see the CRE ratio coming down naturally. It's something to consider opportunistically, but no broad-based plans in the current environment.

And our next question comes from the line of Tim Switzer from KBW.

We appreciate all of the forward guidance you provided, very helpful. Could you discuss some of the areas that can maybe drive some upside or downside? And then if there are any changes to the macro environment — if we enter a slower economic cycle — how could that potentially impact your earnings?

I'll start from the business side and then let Tom jump in on the rate environment and modeling. The things that can really drive upside on revenue would be growth in loans, meaning achieving our growth objectives for the rest of the year with complementary funding sources. Penetrating our insurance business into the legacy Lakeland portfolio has good upside impact and could drive strong growth in insurance as well as penetration of the Beacon Trust business. Treasury management is a big area because it provides the balances required for some of that growth, so we plan to deepen that. We also plan to enhance our SBA and asset-based lending businesses. It's not just one item; a number of management initiatives will play into overachieving our expectations.

As far as rates go, I think everybody assumes the next move is probably down. As we talked about, the balance sheet is quite neutral at this point. We don't see us getting tremendous benefit from the first 50 basis points of rate cuts but we do see some enhancement to the margin beyond that level. In terms of overall business activity being slower, obviously that would impede growth. We'd have to look even more closely at efficiencies, which we do as a matter of course.

We can also look at the funding mix as some CDs run off and consider pricing strategy around those, which could give us some benefit as well.

Now that the deal has closed and you have been able to talk to some of the customers on both the consumer and commercial side, what has the response been overall? Are there any new products or services you're offering them that they've been more excited about?

Early indications on a macro level have been positive. From the commercial banking side, we've already had roughly 14 to 16 referrals from the commercial bank into the insurance group and a few referrals into the wealth group. That activity has picked up as those products are now available to the new customer base, as well as treasury management enhancements. From the Lakeland side, we're trying to deepen relationships into SBA — small business will play a big factor, and Lakeland had a sound platform for expanding that and the deposit-gathering function. Customers are done with the delay in the merger and we're talking business. As long as we deliver a great experience, it's going to be exciting for us.

And our next question comes from the line of Billy Young with RBC Capital Markets.

First, I just want to echo the thanks on the deck and outlook this morning. It's extremely helpful. Just to follow a thread from the previous question and maybe to expand on your thoughts on the trajectory of the core margin moving forward. In the past, you've said the core kind of stabilizes at 2.85% to 2.90%. Does that still hold as we're tracking a little below that today? You mentioned improving the CD and funding mix, but do you see a big opportunity for the loan book repricing to be an opportunity for margin expansion?

I have to reset the core expectation a little because the 2.87% to 2.90% was Provident legacy stand-alone. Back in March, Lakeland's margin was 2.46% versus Provident's 2.87%. So on a blended basis, the core margin has come in. Pre-purchase accounting marks, I'd say the core piece would be about 2.70% to 2.75%, with purchase accounting adjustments of about 65 to 75 basis points a quarter. That's where we get into the 3.35% to 3.45% range over the course of the rest of this year through 2025.

And the 65 basis points of accretion from here through the end of 2025 — that's all scheduled accretion. Is that correct?

Yes, a lot of it's level yield, so it could move a bit with the cash flows, but that's our expectation.

Just moving to a separate topic. You mentioned municipal deposit flows had an impact on reported growth this quarter. Can you remind us of the timing of those flows and when this typically flows back in?

It moves with real estate tax receipts largely. We're starting to see the money come back in the beginning of August, which is typical. When we price it we consider that we have to fund the trough with short-term overnight or weekly funding; it's all considered as part of the valuation of the profitability of the relationship.

We're seeing that inflow start right now and it'll flow into the beginning of August.

And then just my last question, more broadly — I see a 4% to 5% target in the back half of the year. Can you comment on how you're feeling about customer activity and sentiment in recent weeks? How are customers feeling and what are they concerned about? A lot of peers have commented they expect growth to move materially up in the back half. Are you seeing similar sentiment?

Our pull-through adjusted pipeline is about $1 billion. We're seeing similar things to peers, but we have an active pipeline. Some of the growth reduction was contained by us as we completed the merger work — we did a lot of enhanced portfolio management which let some runoff occur. The activity and quality in our pipeline remain strong. From conversations with our team, we can achieve the 4% to 5% growth in the second half of the year if we can get these loans closed. There is a possibility some can run into the first quarter, but right now we're expecting the 4% in the second half.

And our final question today comes from the line of Manuel Navas from D.A. Davidson. Calling in for Manuel is Sharanjit Cheema.

This is Sharanjit on for Manuel. I was wondering what current talent retention looks like across the combined company?

Talent retention across the company is exceptional. There haven't been any major surprises; you'll always have one-offs for people advancing their careers or moving. Executive teams and senior management teams are working very well together and cultures are fusing nicely. There's no toxic environment and people enjoy being here. Retention rates are really high and our continued attraction of new talent is robust. I'm feeling very strong about the culture and our ability to attract and retain talent.

That concludes our Q&A session. With that, I would like to turn the call back over to Tony Labozzetta for closing comments. Tony, the floor is yours.

Great. Thank you, everyone, for your questions and for joining the call. We look forward to speaking to you all again next time. Have a great weekend and enjoy your summer. Thank you.

Ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect.