Provident Financial Services Inc

NYSE:PFS

Earnings Call Analysis

Provident Financial Q3: Strong Earnings and Optimistic Growth Outlook

In the third quarter, Provident Financial reported net earnings of $46.4 million, or $0.36 per share, driven by robust economic growth and improved margins. The completion of the Lakeland Bank merger has facilitated cost savings and revenue opportunities. Key metrics include a net interest margin increase of 10 basis points to 3.31% and a tangible book value increase of 4.5% to $13.66. Looking ahead, they anticipate continued margin improvement, projecting net interest margins between 3.3% and 3.35% through 2024, aiming for around 3.45% in 2025. The company remains optimistic about loan growth, with a pipeline of $1.2 billion and overall solid credit quality.

Positive Signs Post-Merger Integration

Provident Financial Services recently completed the merger with Lakeland Bank, marking a significant milestone by integrating their core systems. The leadership expressed optimism regarding the combined operation, stating that they've successfully retained virtually all legacy Lakeland customers. This seamless integration is crucial as it allows for cost savings, margin expansion, and fresh revenue generation opportunities. The management believes that this momentum will contribute positively to the company's growth moving into 2025.

Solid Financial Performance

In the third quarter, Provident reported net income of $46.4 million, equating to $0.36 per share. Excluding merger-related charges, core earnings were stronger, amounting to $57.7 million or $0.44 per share, and demonstrating a core return on average tangible equity of 14.53%. Revenue also increased to $210.6 million, reflecting an improved net interest margin, which grew by 10 basis points to 3.31% in the trailing quarter.

Loan Portfolio and Pipeline Growth

The company reported a pull-through adjusted loan pipeline increase to $1.2 billion at the end of the quarter, indicating strong future lending potential. The average rate on the pipeline loans is 7.24%, compared to a current portfolio yield of 6.21%. This is promising, especially as commercial and industrial loans were up by $94 million. However, Provident experienced a slight decrease in construction loans, which dropped by $97 million during the quarter.

Adapting to Economic Changes

The quarter was characterized by a favorable economic environment with a first interest rate cut in over four years, contributing to heightened optimism. As the overall sentiment among clients improves—largely due to lower rates—there is an expectation of increased lending activities and project engagements. This shift offers a potential boost to loan growth, which the management is optimistic about moving forward.

Cost Management and Margin Expansion

Average total deposits grew by $22 million to $18.4 billion this quarter, while the average cost of those deposits rose to 2.36%. Looking ahead, Provident anticipates that the current peak in deposit costs suggests a stabilization in this area, while the net interest margin is projected to remain in the range of 3.3% to 3.35% for the remainder of 2024, and target around 3.45% in 2025. The management's ability to maintain disciplined cost management during this transitional period is crucial in achieving these margins.

Asset Quality and Credit Management

Despite an increase in nonperforming loans, which now represent 47 basis points of total loans, the overall asset quality remains stable. The management highlighted that the rise was mostly concentrated in one specific commercial credit with an anticipated resolution soon. The significance of maintaining strong underwriting standards is emphasized, with overall charge-offs remaining low relative to peer institutions.

Looking Ahead

With the merger fully absorbed and promising growth in their pipeline, Provident's leadership is looking forward to capitalizing on synergies post-merger. The projections for 2025 include a return on average assets of approximately 1.15%, a return on tangible equity of around 16%, an operating expense ratio of about 1.8%, and an efficiency ratio of 52%. Given these insights, the company expects favorable growth conditions in the coming quarters.

Earnings Call Transcript 2024-Q3

[Operator]

Thank you for standing by. I would like to welcome everyone to the Provident Financial Services, Inc. third quarter earnings conference call.

I would now like to turn the call over to Adriano Duarte, the Investor Relations Officer. Please go ahead, sir.

[Adriano Duarte, executive]

Thank you, Dustin. Good morning, everyone, 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 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 third quarter. Tony?

[Anthony Labozzetta, executive]

Thank you, Adriano, and welcome, everyone, to the Provident Financial Services earnings call. Before we discuss our quarterly results, I am pleased to announce that as of September 3, the conversion of Lakeland Bank's core system was completed, and we are now operating as a fully united organization.

Our cultures are combining well and we have successfully retained virtually all legacy Lakeland customers. We are grateful to all the team members whose hard work and diligent preparation allowed us to have a smooth systems integration. We are already seeing the benefits of the merger through cost savings, expansion in our margin and more revenue enhancement opportunities, and we are excited to carry this momentum into 2025.

Moving on to our quarterly results. The third quarter was characterized by stronger-than-expected economic growth. The first interest rate cut in more than 4 years, and an optimistic outlook for the banking sector despite weak loan demand and higher deposit costs. The Provident team achieved solid core profitability, highlighted by core margin expansion, growth in the loan pipeline, significant contributions from our fee-based businesses and improved operating efficiency.

During the quarter, we reported net earnings of $46.4 million or $0.36 per share on an annualized adjusted return on average assets of 0.95% and a return on average tangible equity of 14.53%. Our adjusted pretax pre-provision return on average assets was 1.48% for the third quarter. As we move forward, we expect to continue to leverage synergies and further enhance earnings going into 2025.

At quarter end, our capital was healthy and exceeded levels deemed to be well capitalized. Our tangible book value per share increased 4.5% to 13.66%, and our tangible common equity ratio was 7.68% compared to 7.34% for the trailing quarter. As such, our Board of Directors approved a quarterly cash dividend of $0.24 per share payable on November 29.

During the quarter, our average cost of total deposits increased 9 basis points to 2.36%. Our deposits grew by $22 million this quarter, largely in short-term certificates of deposits. Our total cost of funds increased 6 basis points to 2.62% and remains favorable relative to our peer group.

Overall, our net interest margin increased 10 basis points to 3.31% and we expect to see continued improvement over the next several quarters. During the third quarter, our commercial lending team closed approximately $489 million of new commercial loans. We experienced approximately $227 million in loan payoffs, resulting in a net growth of about $39 million.

This quarter's production consisted of 35% commercial real estate, 43% in commercial and industrial lending and 22% in specialty lending. Despite a slight deterioration in nonperforming loans, primarily due to 1 commercial real estate credit, for which we anticipate a near-term resolution with no expected loss.

Our credit quality remains strong for the third quarter, as evidenced by our nonperforming loan ratio of 47 basis points. We do not see any systemic weakness in our loan portfolio and remain confident in our underwriting and portfolio management standards. This is further supported by lower levels of net charge-offs relative to our peer group. We have seen an increase in our total loan pipeline which grew during the third quarter to approximately $2 billion.

The weighted average interest rate is 7.18% compared to 7.53% in the trailing quarter. The pull-through adjusted pipeline, including loans pending closing, is approximately $1.2 billion. We are optimistic regarding the strength and quality of our pipeline, and as such, we expect good growth over the next 2 quarters.

This quarter, Provident's fee-based businesses performed very well. Provident Protection Plus had 13% organic growth in the third quarter as compared to the same quarter last year, which was the highest third quarter growth rate in its history. In addition, it had 16% organic growth year-to-date and its retention rate was 99% even as insurance rates continue to rise.

Beacon Trust assets under management grew by 4% for the quarter to a record high of $4.2 billion, which represents a 10% year-to-date growth. This growth was driven largely by good investment performance. And as a result, fee income improved 9% as compared to the third quarter of 2023.

As we move towards the end of the year, we are increasingly optimistic about the prospects for future performance as we anticipate a more favorable operating environment, growth in our business lines, continued revenue enhancement opportunities, strong credit quality and improving operating efficiency which will help us deliver even more value to our customers, employees and stockholders.

Now I will turn the call over to Tom for his comments on our financial performance. Tom?

[Thomas M. Lyons, executive]

Thank you, Tony, and good morning, everyone. As Tony noted, we reported net income of $46.4 million or $0.36 per share for the quarter. Excluding charges related to our merger with Lakeland Bancorp, core earnings were $57.7 million in the current quarter or $0.44 per share with a core ROA of 95 basis points.

Further adjusting for the amortization of intangibles, our core return on average tangible equity was 14.53% for the quarter. Excluding merger-related charges, pretax pre-provision earnings for the current quarter were $90.1 million or an annualized 1.48% of average assets. Revenue increased to $210.6 million for the quarter, reflecting our first full quarter combined with Lakeland and our net interest margin increased 10 basis points in the trailing quarter to 3.31%.

For the quarter, our margins included 53 basis points of purchase accounting accretion. Excluding purchase accounting for both periods, our core margin expanded 4 basis points versus the trailing quarter to 2.78%. We project the NIM in the 3.3% to 3.35% range for the remainder of 2024, increasing to around 3.45% over the course of 2025.

Our projections include 2 additional 25 basis point rate reductions in 2024 and another 3 rate cuts in 2025. Period-end total loans were essentially flat for the quarter. Within the portfolio, C&I loans increased by $94 million and multifamily loans increased by $37 million, while construction loans decreased by $97 million.

Our pull-through adjusted loan pipeline at quarter end has increased to $1.2 billion with a weighted average rate of 7.24% versus our current portfolio yield of 6.21%. Deposits totaled $18.4 billion at September 30, consistent with the trailing quarter. Our loans to deposit ratio remained stable at 102%. The average cost of total deposits increased to 2.36% this quarter, reflecting a full period combined with Lakeland. We expect that this represents the cyclical peak in deposit costs.

While metrics worsened slightly during the quarter, overall asset quality remained strong with nonperforming loans representing just 47 basis points of total loans, NPAs to assets at 41 basis points. Total delinquencies at 56 basis points of loans and criticized and classified loans totaling 2.74% of loans.

The increase in nonperforming loans this quarter was largely driven by 1 $19.7 million credit secured by an industrial property that has a current loan-to-value ratio of approximately 39%. There is an active near-term resolution plan and we expect to incur no loss on this credit.

Net charge-offs were $6.8 million or an annualized 14 basis points of average loans this quarter. Charge-offs were primarily driven by 1 commercial credit, which carried a specific reserve of $4.4 million at June 30. The remaining collateral securing this relationship is scheduled to be auctioned in November with full resolution expected in the fourth quarter.

The provision for loan losses increased to $9.6 million this quarter reflecting specific reserve requirements and some deterioration in the macroeconomic variables that drive our CECL estimate. This increased our coverage ratio to 1.02% of loans at September 30. Noninterest income increased to $27 million this quarter, reflecting the combined with the Lakeland combination, strong performance from our wealth management and insurance agency subsidiaries and an increase in BOLI income.

Noninterest expenses, excluding merger-related charges, were in line with our expectations at $120 million, with expenses to assets at 1.98% and the efficiency ratio at 57.2% for the quarter. We have currently realized the majority of our targeted merchant cost saves, and we project noninterest expenses of approximately $110 million for the fourth quarter of 2024.

We currently project our effective tax rate for the remainder of 2024 and 2025 to approximate 29.5%. Regarding projected 2025 financial performance with fully phased-in cost saves -- we currently estimate 2025 return on average assets of approximately 1.15% and return on tangible equity of approximately 16% with an operating expense ratio of approximately 1.8% and an efficiency ratio of approximately 52%.

That concludes our prepared remarks. We'd be happy to respond to questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Mark Fitzgibbon from Piper Sandler.

[Unknown Analyst]

It's [indiscernible] stepping in for Mark at the moment. First question, one of your competitors just announced that was selling a large pool of commercial real estate loans to drive their concentration down. Is this something that you guys would also consider doing?

[Anthony Labozzetta, executive]

No. It's not even in our discussions here. We don't have a lot of transactional accounts, relationship-oriented institution. We like our book. There's no systemic deterioration in there. It's all within our concentration risk levels that meet our tolerances from a risk -- concentration risk perspective. So there's no business or strategic reason for us to entertain that at this time. .

[Unknown Analyst]

Okay. And then lastly, what are your thoughts on the securities portfolio restructuring?

[Thomas M. Lyons, executive]

Again, not anticipated at this time. We're happy with the quality content and performance of the securities portfolio as well.

[Anthony Labozzetta, executive]

We did a minor reshift or...

[Thomas M. Lyons, executive]

We did. When we bought Lakeland, as you know, we -- it was about $550 million that we restructured out and paid down...

[Anthony Labozzetta, executive]

And reinvested some of that. Yes.

[Operator]

Our next question comes from the line of Billy Young from RBC Capital.

[Bill Young, analyst]

Just kind of looking at next year's margin guide, the 3.35% to 3.40%. Can you just maybe comment on what type of Fed rate actions you would need to see to kind of get to the upper end of that range. I guess a follow-on to that is, does that matter? Or do you have enough natural repricing ability on the deposit book to kind of get there?

[Thomas M. Lyons, executive]

Yes. But I think it's less about the Fed's actions as we've discussed, we're pretty neutral in terms of interest rate risk and more about the repricing of the organic book. So I think we're looking at probably core margin expansion in the 3 to 5 basis points range per quarter over the course of the next several quarters and that 54 or 55 kind of purchase accounting that we saw this quarter is probably representative of the future, subject to some volatility depending on the cash flows that underlie that.

So depending on the loan prepayments -- so I think we're moving towards like a 3.45% number or closer to the end of the year -- the year 2025.

[Anthony Labozzetta, executive]

Maybe you want to share the core margin movement, some of the betas that we had on our deposits that we worked a little bit better than what we thought. .

[Thomas M. Lyons, executive]

And in terms of...

[Anthony Labozzetta, executive]

Repricing with the Fed's rate loans.

[Thomas M. Lyons, executive]

Yes. So again, a lot of what goes into the quality of the margin expansion is how effectively and aggressively we can manage deposit funding costs. Our stated rates are typically pretty low relative to the peer group. So that's the concern. There's not a lot of room for movement there. But there's a fair amount of exception pricing in the book as well as there is with most institutions.

We're very successful in this first round, and you'll see it effective with the October 1 rate of repricing some of those down about $2.3 billion worth of deposits at an average of about 37, 38 basis points reduction that we saw effective October 1. So again, that's what's going to influence our ability to outperform going forward is how effectively we're able to manage those funding costs.

[Anthony Labozzetta, executive]

While retaining the deposit balances. .

[Bill Young, analyst]

Appreciate it. Just moving on to a different topic. The -- your updated expense guide is tracking a little higher than the $107 million you previously guided to. So can you just maybe elaborate what areas you might be seeing incremental expense pressure? And I apologize if I missed this, but can you just kind of help clarify what you're kind of assuming in terms of the expense growth run rate target for next year?

[Thomas M. Lyons, executive]

Yes. The $110 million, I think we talked about a $107 million last quarter for Q4. Some of that's just a little bit of the timing on the realization of the remaining cost saves on the merger. So that's what's given us a little bit more -- little bit more of a delay in fully realizing that those benefits.

For next year, I'm thinking in the first couple of quarters, at least, it will probably pick up a little bit from there. As you know, there's typically seasonal expenses, compensation increases, payroll taxes on the employer side and whatever weather-related costs that come into play. So I'm thinking something like a $112 million to $115 million for the first quarter or 2.

[Bill Young, analyst]

Got it. And just my last question, I guess, is just to touch on your positive commentary on kind of loan pipelines that you seem to be kind of gaining momentum here. So can you -- I guess can you just a broader comment, are you starting to see the inflection point in terms of underlying demand and client activity. We've talked about some of the macro headwinds that have kind of plagued the industry for the last couple of quarters.

Are you starting to see that inflect now that we're kind of getting some of that behind us? I know we have the election next week, but are you starting to see any change in sentiment here?

[Anthony Labozzetta, executive]

Yes, it's a good question. There's a couple of things. I think we had a dynamic that affected Provident, that is just outside of normal rates and market conditions. We had a merger integration happening -- and as hard as you try, there's always going to be a little bit of a disruptive factor there.

So it's hard to gauge what percentage that was. But suffice to say that as we got through, the merger got approved and we got through our conversion, the momentum picked up on both sides of the legacy organizations. And we are seeing a great deal of activity. The sentiment from the clients today is great that rates went down and is starting to trigger more activity.

I think we're in a space now where people are being active with projects because the specter of rising rates isn't there. So they can say, okay, we don't have to worry about variable rates continuing to move. And I can do this project over the short term and 3 years from now, I can refinance it at a lower cost. So there's that sentiment.

There's also the discussions out there in certain industrial sectors that people are waiting for what happens with the selection depending on policy changes and how it might affect their business. For Provident, we're also seeing a little bit of a pull down from the bigger banks. There's been a little disruption in the market, and we're getting a lot more activity coming in from the top banks on down.

So suffice to say that I think there's some guarded optimism out there. We do expect -- we see the pipeline building and a lot of activity. And as we're more focused now that the conversion is behind us, despite what the market is, I think, will fare better.

But if market conditions improve, we'll be -- I think we'll be able to exceed our normal projected loan growth. And I think the fourth quarter is looking nice right now for us. And we're going to keep that momentum going into 2025.

[Operator]

Our next question comes from the line of Tim Switzer from KBW.

[Timothy Switzer, analyst]

I have a follow-up on the margin outlook here. The purchase accounting accretion didn't move up much versus the previous quarter -- and I'm kind of curious on what the dynamics were there. I know there's a lot that kind of goes into the estimates and calculations for that. But could you kind of walk us through the -- why, I guess, it wasn't higher given the Q2 number? And then -- do you expect it to be stable over the near term instead of like kind of slowly moving down? How should we model that out?

[Thomas M. Lyons, executive]

Yes, Tim, I think the primary driver was just the assumptions we were using around cash flows on the loan. So the prepayments on the loans came in lower than expected. And I think that is a reasonable run rate to use going forward. I would keep it stable. I mean, ultimately, there will be some decrease in that over time, but I don't see a dramatic decrease in the first year or so.

[Anthony Labozzetta, executive]

I think it's important to point out that the core margin also improved, and that's without consideration for this rate card and the benefits that we'll see in October. So the core operating margin, Tim, has improved. And it's nothing more -- nothing further to look at in that margin change than prepayment speeds that we anticipated. So in essence, if those speeds pick up as rates continue to come down, we could actually see it go higher than what Tom and AD are guiding to. But I think Tom's guidance is to just keep it stable because just -- it's the right thing to...

[Thomas M. Lyons, executive]

Appropriate baseline.

[Anthony Labozzetta, executive]

Correct.

[Timothy Switzer, analyst]

Yes. No, that makes a little sense. And then another quick 1 on the run rate for amortization expense is around $12 million this quarter. Is that a good run rate going forward? And also, is that included in your ROTCE projection.

[Thomas M. Lyons, executive]

It is added back to the ROTCE and it is a good run rate.

[Timothy Switzer, analyst]

Okay. Okay. That's helpful. And then could you maybe provide just a quick review of what's the impact of more aggressive Fed cuts or less aggressive Fed cuts to your margin and NII outlook?

[Thomas M. Lyons, executive]

I think you pick up a little bit on the margin because I think we will be able to be effective in the funding cost, and there's a fair amount of -- when we see what the number is -- we have $4.5 billion worth of maturing funding over the next 12 months at a rate of about 4.26%. So to the extent we get to reprice that down, that will certainly help us quite a bit, slope of the yield curve will help as well in terms of reinvesting those funds. So there's opportunity -- greater opportunities with more dramatic decreases. .

That said, we are fairly neutral from an interest rate risk perspective. So regardless, we should be just fine.

[Operator]

And our last question comes from the line of Manuel Navas from D.A. Davidson.

[Manuel Navas, analyst]

That's great about the deposit cost declines in October. Is that similar deposit betas expected across '25 you're extending that out -- and has there been any pushback at the moment to those cuts?

[Anthony Labozzetta, executive]

I think our team did an outstanding job prepping the customers. We didn't just do it and let the customers find out there was a lot of outreach, a lot of communication and they were able to successfully get about 38 basis points of the 50 basis point cut. We've conditioned our customers on expectation as we move forward. .

There's always those relationships that produce a lot of value that you make accommodations for. But I think the team is -- along with the treasury group is doing a fine job of preparing in advance rate cuts in terms of customer communication. So I really expect that we should get similar betas, but it's really hard to predict what the next -- how far -- but I would say I'm pretty comfortable that it should be relatively close.

[Thomas M. Lyons, executive]

Yes. And I can share what we're modeling recognizing the timing of the maturing funding. So in our modeling for next year, we have a weighted average interest -- sorry, weighted average beta on the interest-bearing deposits of a little over 31%. And on total deposits, about 24%, so including the noninterest-bearing. So that also includes the CDs, again, repricing as they come to maturity.

[Manuel Navas, analyst]

That's by year-end next year, that's the right tough process?

[Thomas M. Lyons, executive]

Yes, that's over the course of the year next year. Yes.

[Manuel Navas, analyst]

Okay. I appreciate that clarity. And can you just speak to potential fee revenue synergies. You've talked about it a bit already. But just kind of -- now that the deal is closed, where could insurance, wealth management all kind of be stronger together than where it was before.

[Anthony Labozzetta, executive]

That's a great question. I did mention that in my written notes and we had a great deal of time, I would give you a lot of the factual or anecdotal information that we're seeing. Suffice to say that there's been a great reception across the 2 legacy organizations in terms of the businesses that we contributed.

For instance, we're seeing a lot of commercial activity going into our insurance from the legacy Lakeland side. We've actually had even our wealth business for a commercial client over to our bank. We're seeing insurance refer -- the activity has picked up tremendously. And I think part of that is the excitement as we go in. I think we're just touching the beginning stages of what we do as a culture of working on an integrated basis.

But the storylines are there some -- in addition to how we're referring business across the channels, you also have what we mentioned earlier on a few calls ago, that as a large organization, we're able to accommodate certain transactions that we were not. So I mean just this quarter alone, I can point to about 2 or 3 transactions that the legacy Provident couldn't have done unless we had the combined scale -- and it gave us the capacity to do more treasury management business and other activity in insurance as a byproduct of that.

So all of those are the revenue enhancement things that we referred to and just watching that customer experience that goes back and forth between the teams. It's pretty exciting for me. We just have to keep that momentum going.

[Operator]

That now concludes our question-and-answer session. I will now turn the call over back to our CEO, Anthony Labozzetta for our closing remarks.

[Anthony Labozzetta, executive]

Well, thank you, everyone, for your questions and for joining the call. It has been a very productive and eventful quarter for us, and we hope that you all have a great rest of the year and holiday season. We look forward to speaking to all of you in the new year. Thank you very much. .

[Operator]

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