Provident Financial Services Inc

NYSE:PFS

Earnings Call Analysis

Margin Outlook and C&I Growth Insights

The company forecasts a margin range of $285 million to $295 million for the year, balancing liabilities and deposit cost expectations alongside Moody's rate decrease projection. They project 3 rate decreases out of a Moody's estimated 4, influencing 2024 margins. Key drivers of solid loan growth, particularly in commercial and industrial (C&I) lending, were tactical shifts in focus, such as fostering deposit relationships and adjusting loan ownership levels. While deposit costs are stabilizing, the margins may vary. Expectations for 2024 include a loan growth rate of 4% to 5%.

Overview of Fourth Quarter Performance

In the context of moderate economic growth and fluctuating interest rates, Provident Financial Services reported steady core financials, signaling the stability and resilience of the franchise. Earnings stood at $0.36 per share with an annualized return on average assets of 0.77%, and an impressive return on average tangible equity of 9.47%. Factoring out certain charges, the pre-tax pre-provision return on average assets was 1.25% for the quarter. The firm's Board approved a quarterly cash dividend of $0.24 per share, capital remained robust, and tangible book value per share grew by 5.9% to $16.32.

Capital and Dividend Declaration

Provident's capital exceeded well-capitalized thresholds, with tangible common equity ratio reaching 8.96%. The increase in tangible book value per share to $16.32 reflects a solid fiscal standing. The Board's approval of a quarterly cash dividend of $0.24, payable on February 23, illustrates the company's commitment to returning value to shareholders.

Deposit Stability and Net Interest Margin

The bank maintained its stable average core deposits, with a low deposit beta of 33.5%, indicating a robust deposit base and competitive cost of deposits despite market trends. The total cost of funds witnessed a rise to 2.23%, slightly compressing the net interest margin to 2.92%. This pressure on margins reflects industry-wide challenges in funding and interest rates.

Commercial Lending Growth

The commercial lending sector remained dynamic, closing $450 million in new loans and achieving a net growth of approximately $212 million (9.2% annualized) this quarter. Despite competitive payoffs, the commercial loan portfolio expanded to $641 million (7.3% annualized) for the year. The strong pull-through in the commercial loan pipeline, with a projected pipeline rate of 7.17%, demonstrates the bank's effective lending strategy and continued customer trust.

Fee-based Business Success

The fee-based businesses have shown resilience with Provident Protection Plus experiencing a significant 81% organic growth. This translated into a substantial 19.7% increase in revenue and a 4.1% rise in operating profit in comparison to the same quarter last year. Beacon Trust also contributed to revenue stability with assets under management increasing to $3.9 billion, setting the stage for potential revenue growth in the coming quarter.

Merger with Lakeland Bancorp

Efforts for the proposed merger with Lakeland Bancorp continue, with regulatory approvals pending. Despite the uncertainty in timelines, both entities are actively preparing for integration. Provident is focused on reinforcing its commitment to business growth, deposit expansion, and operational efficiency as it looks ahead to 2024.

Financial Performance Highlights

Net income for the quarter was $27.3 million, with a slight decrease in earnings per share from the preceding quarter and year's corresponding quarter. Transaction charges stemming from the pending Lakeland Bancorp merger affected earnings by approximately $0.03 per share. Revenue remained stable despite fluctuations, and the expected stabilization of interest margins in the 2.85% to 2.90% range is anticipated to be a key measure of future performance.

Loan Portfolio and Asset Quality

The end-of-period total loan portfolio exhibited healthy growth, particularly in commercial, industrial, real estate and multi-family mortgage loans, with non-performing loans representing only a small fraction of total loans. The bank's asset quality indicators, such as low net charge-offs, support a strong credit environment and the strength of underlying loan assets.

Provision for Credit Losses

The bank's provision for credit losses on loans was reduced to a conservative $500,000, influenced by an improved economic forecast. Consequently, the allowance for credit losses on loans decreased slightly to 99 basis points of total loans. Provident's prudent managerial approach and rigorous credit risk assessment warrant investor confidence in the health of its loan portfolio.

Income Stability and Future Tax Rate Projection

Non-interest income demonstrated constancy at $19 million with non-recurring charges contributing to an elevation of non-interest expense. A unique tax event impacted the effective tax rate, which is foreseen to normalize at around 26.5% going into 2024. These figures underline Provident's adept management of income streams and fiscal planning.

Earnings Call Transcript 2023-Q4

[Operator]

Thank you for standing by, and welcome to the Provident Financial Services, Inc. Fourth Quarter 2023 Earnings Conference Call.

I would now like to welcome, Adriano Duarte, Investor Relations Officer, to begin the call. Adriano, over to you.

[Adriano Duarte, executive]

Thank you, Mandeep. Good morning, everyone, and thank you for joining us for our Fourth 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 disclaimer is contained in last 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 quarter. Thanks. Tony?

[Anthony Labozzetta, executive]

Thank you, Adriano. Good morning, everyone, and welcome to the Provident Financial Services Earnings Call.

The fourth quarter was characterized by moderate economic growth, fluctuating interest rates and continued industry-wide funding challenges, resulting in reduced profits for many regional banks. Provident has navigated these complexities with resilience, bolstered by a commitment to our robust risk management and customer-centric approach. Provident produced good core financial results this quarter, which once again demonstrates the stability of our franchise and the strength of our management team.

As such, we reported earnings of $0.36 per share, an annualized return on average assets of 0.77%, and a return on average tangible equity of 9.47%. Excluding merger-related charges and contingent litigation reserves, our pretax pre-provision return on average assets was 1.25% for the fourth quarter.

At quarter end, our capital was strong and exceeded well-capitalized. Tangible book value per share increased 5.9% to $16.32. Our tangible common equity ratio was 8.96%. As such, our Board of Directors approved a quarterly cash dividend of $0.24 per share, payable on February 23.

During the quarter, our average core deposits remain very stable. Our rising rate cycle-to-date deposit beta was approximately 33.5%, which is well below average based on available data and we believe is among the best in our peer group. Our deposit beta and steady deposit levels reflect the quality of our deposit base. Our total cost of deposits increased as expected, given market trends, but remained among the best in our peer group.

The total cost of funds grew 19 basis points to 2.23%, compressing our net interest margin 4 basis points to 2.92%. We expect a continued easing in the rate of increase in our total cost of funds, which should stabilize the net interest margin.

Our commercial lending team closed approximately $450 million of new commercial loans during the fourth quarter. Payoffs remained relatively low at about $95 million, which is consistent with the trailing quarter. Our credit metrics continue to be strong in the fourth quarter, and we are maintaining prudent underwriting standards, particularly in our CRE lending portfolio.

As a result of our production and low level of prepayments, our commercial loans grew approximately $212 million or 9.2% annualized for the quarter. For the year, we grew $641 million or 7.3%. The pull-through in our commercial loan pipeline during the fourth quarter was in line with our expectations, and the gross pipeline remained strong at approximately $1.1 billion. The pull-through adjusted pipeline, including loans pending closing, is approximately $671 million, and our projected pipeline rate is 7.17%. And we remain optimistic regarding the strength and quality of our pipeline.

Our fee-based business has performed well. Despite a hardened insurance market, Provident Protection Plus has strong fourth quarter, with 81% organic growth, which resulted in a 19.7% increase in revenue, and a 4.1% increase in operating profit as compared to the same quarter last year.

Fee income at Beacon Trust remained stable. Improved market conditions drove an increase in assets under management to $3.9 billion at year-end, which should drive improved fee income in the first quarter of 2024.

With regard to our prospective merger with Lakeland Bancorp, we are continuing our engagement with the regulators and await final approval of the merger. While regulatory approval is not within our control and is not guaranteed, preparations for our merger with Lakeland continues to progress, as both companies eagerly await approval.

As we move into 2024, our focus will be on growing our business lines with an emphasis on deposit growth. In addition, we will continue to strengthen the fundamentals of our business with a particular attention towards operational efficiency, pricing discipline and risk management.

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, our net income for the quarter was $27.3 million or $0.36 per share compared with $28.5 million or $0.38 per share for the trailing quarter, and $49 million or $0.66 per share for the fourth quarter of 2022.

Transaction charges related to our pending merger with Lakeland Bancorp totaled $2.5 million in the current quarter or approximately $0.03 per share, and $2.3 million in the trailing quarter. Excluding these merger-related charges and a $3 million charge for contingent litigation reserves, pretax pre-provision earnings, for the quarter were $44.4 million or an annualized 1.25% of average assets.

Revenue totaled $115 million for the quarter compared with $116 million for the trailing quarter, from $132 million for the fourth quarter of 2022. Our net interest margin decreased 4 basis points from the trailing quarter to 2.92%. The yield on earning assets improved by 15 basis points versus the trailing quarter, as floating and adjustable rate loans repriced favorably and new loan originations reflected higher market rates.

This improvement in asset yields, however, was more than offset by an increase in interest-bearing funding costs. Increased interest expense reflected current market conditions and funding requirements, which resulted in an increase in average borrowings, despite an increase in average deposits. Average noninterest-bearing balances also decreased as some balances moved to our interest-bearing insured cash suite product in the trailing quarter, in order to obtain increased deposit insurance. The shift from noninterest bearing to the ICS product has greatly diminished in the fourth quarter.

In addition, whilst average balances and rates paid on interest-bearing demand and time deposits increased during the quarter. The average total cost of deposits increased 21 basis points in the trailing quarter to 1.95%, this is a deceleration from the trailing quarter, but the increase towards our rising rate cycle to date, total deposit cost beta to 33.5%. The average cost of total interest-bearing liabilities also increased 21 basis points in the trailing quarter to 2.71%.

The prolonged inverted yield curve and ongoing deposit competition continued to impact funding costs. This is expected to largely offset future improvements in asset yields, and we currently project the margin will stabilize in the 2.85% to 2.90% range.

Period-end total loans grew $206 million, driven by C&I, CRE and multi-family mortgage loans. Our pull-through adjusted loan pipeline at year-end was $671 million with a weighted average rate of 7.17% versus our current portfolio yield of 5.5%.

Asset quality remains strong, with non-performing loans totaling 46 basis points of total loans, and criticized and classified loans representing 2.2% of total loans. Net charge-offs were $863,000 or an annualized 3 basis points of average loans this quarter, bringing our full year net charge-offs to just 8 basis points.

The provision for credit losses on loans decreased to $500,000 for the quarter due to a modestly improved economic forecast within our CECL model. As a result, the allowance for credit losses on loans decreased to 99 basis points of total loans at December 31 from 1.01% at September 30.

Non-interest income remained steady this quarter at $19 million. Excluding provisions for credit losses on commitments to extend credit, merger-related charges and the establishment of a $3 million contingent litigation reserve related to a previously disclosed matter, non-interest expense increased to $70.4 million for the quarter and included 2 additional notable items that are not expected to recur. These items consisted of a $2 million write-down of an REO property and a $775,000 special FDIC assessment.

Our effective tax rate was also impacted by an unusual discrete item this quarter as a deferred tax asset related to performance-based stock compensation was written down by $1.9 million. We currently project our 2024 effective tax rate to return to approximately 26.5%.

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 with Piper Sandler.

[Mark Fitzgibbon, analyst]

Tony, I wonder if you guys could explain that contingent litigation reserve, what it relates to and how that flows?

[Anthony Labozzetta, executive]

Yes, Mark, that's pending litigation that we disclosed in our last quarter 10-Q, in the contingency footnote. There's greater detail available there, but it's an estimate of a potential settlement or ultimate damage outcome.

[Mark Fitzgibbon, analyst]

And I just don't have that in front of me. What does it relate to, Tom?

[Thomas M. Lyons, executive]

Yes. It's a class action -- part of a class action lawsuit around approved positive settle negative overdraft fees, with respect to debit card transactions.

[Mark Fitzgibbon, analyst]

Got you. Okay. And then secondly, it looked like there was about a $19.6 million uptick in non-performing commercial loans. Any color you could provide on those?

[Thomas M. Lyons, executive]

Yes, the flows for the quarter were actually positive, absent one large loan moving into nonperforming category. We had about $10 million of favorable resolutions and then we had a 19 -- a little over $19 million loan move into the nonperforming category. We have -- at this point, we deem adequate collateral coverage, and we're working through a resolution on that borrowers cooperative winding down operations and looking to market the underlying collateral properties.

[Anthony Labozzetta, executive]

It's a C&I loan.

[Thomas M. Lyons, executive]

It's a C&I loan, yes.

[Mark Fitzgibbon, analyst]

Okay. And then, Tom, any thoughts on sort of expense growth this year, excluding the impact of Lakeland?

[Thomas M. Lyons, executive]

Yes, I think we'd be about $68 million to $69 million a quarter. It usually weighed a little heavier in the first quarter, first quarter and a half of the year Mark, just because of the usual seasonal items in payroll tax resets.

[Mark Fitzgibbon, analyst]

Okay. And then lastly, could you share with us AUM and maybe net flows for the quarter?

[Thomas M. Lyons, executive]

AUM closed at $3.9 billion, really we saw the big pickup in the last month of the year, looking at averages, at September 30, it was $3.6 billion, $3.551 billion, went down to $3.4 billion, $3.7 billion and $3.9 billion at the end of the period. So in terms of flows, a pretty good pickup in terms of organic growth over the course of the year. Nothing notable to bring your attention in terms of outflows.

[Mark Fitzgibbon, analyst]

So in the fourth quarter, there were positive flows, positive net flows?

[Anthony Labozzetta, executive]

That's correct.

[Operator]

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

[Bill Young, analyst]

I guess just to touch on the margin guidance, the $285 million to $295 million range for the year. I guess, can you just help us parse through what gets you to kind of the top end of the range? And then what you're assuming are rate cuts. I think last quarter, you're assuming 2 out of 4 cuts, pointing closer to 6. So how did that kind of change your margin expectations?

[Thomas M. Lyons, executive]

Yes. The softest part of the estimate, Bill, is probably on the funding side as we try to anticipate, absent any rate movement or even in the face of a declining rate environment, how much further the liability cost could go up, particularly on the deposit side because we are pretty low relative to our peer group. So we don't see that necessarily stopping just because rate movements have plateaued.

In terms of what's model, we work off the Moody's baseline forecast as a kind of a default and adjust it if we deem it necessary. So that's what's built into our model right now. They had 425 basis point rate increases in there, but the last one is in December. So figure 3 that would be meaningful to 2024.

[Anthony Labozzetta, executive]

Yes. I would just add on to that, that some of the trends that we're seeing in terms of -- on the deposit side and the cost rising are very much stabilized. But I think what Tom is mentioning is that given where we are in terms of cost of deposits, the dynamics may occur that could show us on the lower end of that margin. But if they don't, we should be on the higher end of our expectation.

[Thomas M. Lyons, executive]

That's correct. And Bill, I misspoke. I said rate increases, obviously, I meant rate decreases.

[Bill Young, analyst]

Right. Okay. Okay. And then I guess as a follow-up to that, obviously, your deposit betas screened very well versus peers in the industry. Like you said, and I guess there was -- and maybe we have a slight lag on the way up, kind of thinking, I guess, beyond 2024 a little bit, how do you think deposit betas should behave on the way down?

[Thomas M. Lyons, executive]

Again, if the terminal rate is lower than the competitive environment, it would probably slow down in terms of -- meaning that we wouldn't be able to decrease quite as quickly on the way down as you would, if we were up to full market pricing. Hopefully, we're conservative in that. That's how we're modeling it.

[Bill Young, analyst]

Okay. Got it. And then switching gears, C&I growth was nice and pretty strong this quarter. Can you just speak to kind of what were some of the drivers there that you saw? And how are you feeling about the opportunities going to 2024 here?

[Anthony Labozzetta, executive]

Well, the drivers were tactical. That was our focus internally, how we drove not only parts of our incentive plan, but our focus, even reducing the levels of -- in the CRE side, in terms of how much we would own on an individual loan and some of the qualitative nature.

More importantly, one of the drivers was how we attach the total relationship to it, meaning the deposit side. So naturally, you would see a lot of transactional CRE not happening at Provident over the last couple of quarters, and you'll see more of a focus on the deposit relational side, which comes largely on the C&I. But even on the CRE side, the stuff that we've been putting on has been coming on with deposit relationships.

So again, I think that's a focus internally and our team rose to the challenge. And we see that happening again, market conditions are considered. We see that focus moving into 2024 even more acutely.

[Thomas M. Lyons, executive]

The other factor that helped loan growth in Q4, Bill, was a reduction in prepayments. I think we're going to see a little bit of pickup. I know for the first couple of weeks of this quarter, some of the things that we expected to pay off in Q4 didn't pay off until Q1. So I think looking forward in terms of the loan growth rate, something in the 4% to 5% range makes sense for us for 2024.

[Operator]

Our next question comes from the line of Michael Perito with KBW.

[Michael Perito, analyst]

Just one quick follow-up on the last line of questioning, just around loan growth. 4% to 5% for the year seems very reasonable. But any areas of upside to that? I mean, like, for example, maybe on the construction side, where there still seems to be a lot of supply issues, particularly on the residential construction side in your markets. Just any areas where you think there maybe could be a pickup if we kind of continue to kind of glide to the soft landing on the macro side?

[Anthony Labozzetta, executive]

Yes. I will answer that in a little bit of unusual way because I think there's an upside in all of our lending categories that we choose to be in. I think this year, we were very contained in our lending. We tightened down a lot of our underwriting standards in anticipation of what might happen in the marketplace. We deemphasized certain concentrations we had, and we spent a good amount of time altering some of those, including the construction portfolio.

So from our perspective, had it been business as usual, we could have had a substantial growth in 2023. Our folks are out there. I think if market conditions are prevalent that allow for loan growth, I think we'll get our fair share, and we can certainly meet or exceed the expectations that Tom just mentioned. But all within the credit underwriting standards that we have in place.

[Michael Perito, analyst]

Got it. Helpful, Tony. And a little bit of a conceptual question here. But obviously, in '23, it kind of was a bit of a challenging year, right? You had the macro and rate uncertainty. You had the pending deal. Just as we think about kind of at the onset of '24 here, assuming that the Lakeland deal closes at the end of the quarter here.

What -- how do you kind of attack the strategic priority list? What are some of the top -- on the other side of that, where do you guys focus? What should we be mindful of, as you guys move past the rate hikes and the pending deal?

[Anthony Labozzetta, executive]

I mean I can give you some color on that. I mean, first, arching back to '23 and see that our Provident team, despite all the delays with the merger and so much work that we put into it, still managed to do a fair job producing some good results.

I think when we look into '24, we're optimistic that we'll get the deal closed as soon as possible, and then our focus will be on a number of things. One, primarily, is looking at our business lines and figuring out how we deepen and share across both the organizations since we have complementary services, and building our businesses would be a big focus, principally, on the funding side. I think, individually, I think both Lakeland and us are focused on growing our funding base. And together, I think we're going to look to deepen that.

Lastly, I think we've spent a good amount of calories preparing this bank for it to be $25 billion already. And I think the remaining -- putting together these 2 banks, achieving our efficiencies, getting it ready technologically as we move into our future. I think those are the things that we're going to be paying a lot of attention to pricing disciplines and things of that nature.

But a big focus on building our businesses, operational efficiency. And again, I think we're going to have the combined team that's going to be more than capable of rising to that challenge. So I'm excited and optimistic once we get this deal closed.

[Operator]

I would now like to turn the call over to Tony Labozzetta for closing remarks.

[Anthony Labozzetta, executive]

Thank you. Thank you, everyone, for joining the call. As we all know, '23 -- 2023 was a very difficult year. I think as we enter '24, as I mentioned earlier, I think we're all optimistic that we're going to get the merger closed and focus on building our businesses and the efficiencies I mentioned. The team is ready to meet those challenges, and I look forward to talking to you in the quarter and speaking again in the future.

Thank you very much, and have a great day.

[Operator]

This concludes today's call. You may now disconnect.