Provident Financial Services - Q1 2024

Transcript

Operator (participant)

Thank you for standing by. My name is Alex. I will be your conference operator today. At this time, I would like to welcome everyone to the Provident Financial Services Incorporated First Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remark, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. I would now like to turn the call over to Adriano Duarte, Investor Relations Officer. Please go ahead.

Adriano Duarte (Head of Investor Relations)

Thank you, Alex. Good morning, everyone, and thank you for joining us for our First Quarter Earnings Call. Today's presenters are President and CEO Tony Labozzetta and Senior Executive Vice President and Chief Financial Officer Tom Lyons. Before beginning their review of our financial results, we ask that you please take note of our standard caution as to any forward-looking statements that may be made during the course of today's call. Our full disclaimer is contained in 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 first quarter. Tony.

Tony Labozzetta (President and CEO)

Thank you, Adriano. Good morning, everyone, and welcome to the Provident Financial Services Earnings Call. Before I go on to discuss the results for the quarter, I am delighted to say that as of the 11th of April, we have received all regulatory approvals to complete our merger with Lakeland Bancorp. We are grateful for the efforts of the members of our team and the Lakeland team who worked tirelessly to achieve this milestone and who continue to work diligently to plan for the merger and integration of our two exceptional banks. We expect to complete the merger this quarter, promptly following the subordinated debt raise that is a condition to close. This merger will bring together two high-performing institutions with like-minded cultures, an unwavering commitment to the employee and customer experience, and a dedication to excellence.

The scale and strong financial performance of our combined organizations will allow us to better invest in our future, compete for market share in the highly attractive and densely populated New Jersey, New York, and Pennsylvania markets, and serve our customers and communities while creating value for our shareholders. It will further aid us in attracting and retaining top talent and providing even better technological solutions for our customers and employees. We expect that Provident's two fee-based business lines, insurance and wealth management, will augment the broad product and service offerings available to the Lakeland Bank customers. Provident will also bring its strength in treasury management, while Lakeland brings its capabilities in healthcare and asset-based lending to our combined institutions. Both institutions have talented management teams and boards, and important past experience navigating mergers and whose joint skill sets will bring even greater strength to our combined talent pool.

Moving on to our quarterly results, the first quarter was characterized by continued economic growth, stubbornly high interest rates, and persistently difficult environment for the banking sector. Thanks to the efforts of the Provident team, our customer-centric culture and robust risk management, we have performed very well. Provident produced strong financial results this quarter, which once again demonstrates the strength and discipline of our management team. We reported earnings of $0.43 per share, an annualized return on average assets of 0.92%, and a return on average tangible equity of 10.4%. Excluding merger-related charges, our pre-tax, pre-provision return on average assets was 1.28% for the first quarter. At quarter end, our capital was strong and exceeded levels deemed to be well capitalized. Tangible book value per share remained steady at $16.30, and our tangible common equity ratio improved to 9.05%.

As such, our board of directors approved a quarterly cash dividend of $0.24 per share payable on May 31st. During the quarter, our average deposits, excluding broker deposits, increased approximately 3% annualized as compared to the trailing quarter, and our total cost of deposits was impressive at 2.07%. The total cost of funds grew 9 basis points to 2.32%, which compressed our net interest margin 5 basis points. Our commercial lending team closed approximately $275 million of commercial loans during the first quarter. As expected, commercial loan payoffs increased $77 million to $173 million when compared to the trailing quarter. Our credit metrics continued to improve in the first quarter, and the economic forecast and our CECL model modestly improved, resulting in a reduced provision for credit losses. We continue to maintain prudent underwriting and portfolio management standards, particularly in our CRE lending portfolio.

Furthermore, our CRE portfolio is comprised of well-diversified exposure levels concentrated within favorable asset classes. Overall, our total commercial loan portfolio remained relatively flat. However, we had good productivity in our C&I lending, which grew approximately $72.1 million, or 11.5% annualized for the quarter. In addition, our construction loans grew approximately $58.2 million, or 8.9% annualized, due to funding of existing commitments. The pull-through in our commercial loan pipeline during the first quarter was in line with our expectations, and the gross pipeline remained steady at approximately $1.1 billion. The pull-through adjusted pipeline, including loans pending closing, is approximately $561 million, and our projected pipeline rate is 7.46%. We remain optimistic regarding the strength and quality of our pipeline. Our fee-based businesses performed exceedingly well.

Despite the continuation of the hard insurance market, Provident Protection Plus had a strong first quarter, which resulted in a 17.4% increase in operating profit as compared to the same quarter last year. Better market conditions helped increase Beacon Trust assets under management to about $4 billion at quarter end, which helped grow fee income 9.4% as compared to the trailing quarter. As we move further into 2024, our attention will, of course, be on completing all aspects of the merger and becoming the preeminent community bank in our market. We will also focus on growing our business lines with an emphasis on deposit growth, achieving operational synergies, and other revenue enhancement opportunities resulting from our merger. Now, I will turn the call over to Tom for his comments on our financial performance. Tom.

Tom Lyons (EVP and CFO)

Thank you, Tony. Good morning, everyone. As Tony noted, our net income for the quarter was $32.1 million, or $0.43 per share, compared with $27.3 million, or $0.36 per share for the trailing quarter, and $40.5 million, or $0.54 per share for the first quarter of 2023. Transaction charges related to our pending merger with Lakeland Bancorp totaled $2.2 million in the current quarter, or approximately $0.03 per share, and $2.5 million in the trailing quarter. Including these merger-related charges, pre-tax, pre-provision earnings for the current quarter were $44.9 million, or an annualized 1.28% of average assets. Revenue totaled $114.5 million for the quarter, consistent with $114.7 million for the trailing quarter, but a decrease from $130.5 million for the first quarter of 2023. Our net interest margin decreased 5 basis points in the trailing quarter to 2.87%.

The yield on earning assets improved by 2 basis points versus the trailing quarter. However, this was more than offset by an increase in the interest-bearing funding costs. Increased interest expense reflected current market conditions and funding requirements, which resulted in an increase in average borrowings and increased deposit costs. The average total cost of deposits increased 12 basis points in the trailing quarter to 2.07%. This is a further deceleration from 21 basis points in the trailing quarter, but the increase brought our rising rate cycle to date total deposit cost beta to 35.8%. The average cost of total interest-bearing liabilities also increased 9 basis points in the trailing quarter to 2.80%, as the prolonged inverted yield curve and ongoing deposit competition continue to impact funding costs. We expect deposit costs to continue to stabilize over the next several quarters.

Period-end total loans decreased $31 million, as increases in C&I construction and multifamily mortgage loans were more than offset by decreases in CRE, residential mortgage, and consumer loans. This was an expected decline from strong growth in the trailing quarter, as several loan repayments originally expected to occur last year were pushed out into the current quarter. Our pull-through adjusted loan pipeline at quarter-end was $561 million, with a weighted average rate of 7.46% versus our current portfolio yield of 5.51%, and we continue to project full-year net loan growth of 4%-5%. Asset quality remained strong, with non-performing loans declining to 44 basis points of total loans and criticized and classified loans representing 2.1% of total loans. Net charge-offs were just $971,000, or an annualized 4 basis points of average loans this quarter.

The provision for credit losses on loans decreased to $200,000 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 98 basis points of total loans as of March 31st, from 99 basis points as of December 31st. Non-interest income increased to $21 million this quarter. Insurance agency income increased $2 million versus the trailing quarter as a result of new business growth and the cyclical first quarter recognition of contingency income. Wealth management income also increased $645,000 versus the trailing quarter, as assets under management grew to $4 billion. Excluding provisions for credit losses on commitments to extend credit and merger-related charges, non-interest expense decreased to $69.6 million for the quarter, even after including an additional $195,000 special FDIC assessment.

Our effective tax rate was 25.3% for the quarter, aided by the lapse of the New Jersey corporate business tax surcharge. We currently project our 2024 effective tax rate to approximate 25.5%. Regarding post-Lakeland merger projected financial performance, we will provide enhanced estimates and additional pro forma and projected combined company financial metrics in the coming weeks. As I'm sure you can appreciate, we are somewhat limited in our disclosures ahead of the upcoming subordinated debt offering. However, we can offer the following general insights into the combined company's expected performance. Total combined company merger charges of $95 million and projected cost saves of 35% remain unchanged from deal announcement. Increases in interest rates have brought the estimated net interest margin to approximately $540 million and increased estimated core deposit intangibles to 3.25% of core deposits.

As a result, we currently project a combined company net interest margin of approximately 3.25%, including approximately 65 basis points of purchase accounting accretion. With full savings and cost savings, we estimate 2025 return on average assets of approximately 1.10% and return on tangible equity of approximately 15.25%, 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 (participant)

Thank you. We will now begin the question and answer session. If you have dialed in and would like to ask a question, please press star one on your telephone keypad to raise your hand and join the queue. If you would like to withdraw your question, simply press star one again. If you are called upon to ask your question in our listening via loudspeaker on your device, please pick up your handset and ensure that your phone is not on mute when asking your question. Again, press star one to join the queue, and your first question comes from the line of Mark Fitzgibbon with Piper Sandler. Please go ahead.

Mark Fitzgibbon (Managing Director)

Hey, guys. Good morning.

Tony Labozzetta (President and CEO)

Good morning, Mark.

Mark Fitzgibbon (Managing Director)

Tom, just to clarify, so you said once the deal's closed, you're going to sort of provide an update with deal marks and accretion numbers. Are you planning to do a call for that, or are you planning to put that out in a slide presentation, or what's your plan?

Tom Lyons (EVP and CFO)

I think both of those will happen, Mark. The expectation is we'll do some form of investor day post-deal to describe the forward-looking performance expectations.

Mark Fitzgibbon (Managing Director)

Okay. And any update at all on timing now that you've gotten all the approvals?

Tony Labozzetta (President and CEO)

Yeah. I think the timing right now is probably between the 10th and the 15th of May, is when we're aiming to get the deal closed.

Mark Fitzgibbon (Managing Director)

Okay. Great. And then could you share with us AUM and AUA at quarter end and maybe how flows looked in the wealth at Beacon?

Tom Lyons (EVP and CFO)

Yeah. AUM was $4 billion, $30 million at the end of the quarter. Flows were actually a little bit negative. We had about $77 million in new inflows and about $83 million in net outflows. So market appreciation drove the rest of the increase.

Mark Fitzgibbon (Managing Director)

Okay. Great. And then it looked like you closed about 57% of your pipeline as of 12/31. Is that sort of what we should sort of expect going forward from a pull-through rate, Tony?

Tony Labozzetta (President and CEO)

I would suspect so. I think you can still aim at that 4%-5% loan growth for the year. I think we had a good closing in the fourth quarter, which obviously drained some of that activity, and the pipeline is starting to rebuild now. I think it's still safe to say that about 50%-60% pull-through rate.

Tom Lyons (EVP and CFO)

Well, actually, we were a little conservative in the estimates here. We pulled back the expected closing pipeline. That's where you get the $561 million versus the $1.09 billion or $1.08 billion, I think, in gross pipeline. So we're down to a projection for the current quarter of about 39%.

Tony Labozzetta (President and CEO)

This quarter?

Tom Lyons (EVP and CFO)

Yeah. But longer term, you're right, Tom. That's typically where we are is in the 50 kind of range.

Mark Fitzgibbon (Managing Director)

Great. Thank you.

Tom Lyons (EVP and CFO)

50-60.

Operator (participant)

Your next question comes from the line of Billy Young with RBC. Please go ahead.

Billy Young (Investment Advisor)

Hey. Good morning, fellas. How are you?

Tony Labozzetta (President and CEO)

Good morning, Billy.

Billy Young (Investment Advisor)

First, just to clarify, Tom, the comment on the combined company NIM of 325, is that what we should be expecting for the first full run rate quarter in three-Q?

Tom Lyons (EVP and CFO)

No. Every number I gave is a preliminary estimate already dependent on where the marks land at deal closing. So that assumed the marks that I disclosed. And yeah, that would be the first quarter of full closing, I guess, Q3, if the assumptions hold true.

Billy Young (Investment Advisor)

Got it. Understood. Thank you. And then is this? I know you had commented that you expect deposit costs to stabilize over the next few quarters, but can you just give us a comment on maybe what you're seeing in the deposit pricing environment today across your markets? We've heard a few mixed messages from your peers about pricing getting a little more competitive as of late. Is that kind of what you're seeing, and what are your expectations if rates stay higher for longer as we progress through 2024?

Tom Lyons (EVP and CFO)

Yeah. We're not feeling that same pressure right now. Through the cycle to date, beta is about 35.8%, or we modeled a terminal beta of about 37.1 ahead of the first rate cut. So we feel like the margin's going to continue to standalone company margin, which continue to stabilize in the 285-290 range.

Tony Labozzetta (President and CEO)

Yeah. So far, we've been holding steady on our pricing. We haven't seen those competitive pressures, and we've been holding steady in terms of our deposit flows. I mean, if you look at our activity, we haven't seen very little deposit account closures. More of our deposit I would characterize it that we're seeing non-interest bearing moving into the interest-bearing classes, which is affecting our cost of deposits more so than deposits leaving and having to be replaced with external funds. So I think that's why we're saying we think it's going to hold steady as we go forward.

Tom Lyons (EVP and CFO)

Yeah. In terms of higher for longer, Billy, I don't think it has a dramatic impact on us. I know you're aware that we've managed to a pretty neutral interest rate risk position, slightly asset-sensitive at this point. Given that about 27% of our deposit base is sub 350, we don't see a lot of benefit in the initial rate cuts, at least we're conservatively modeling that way. I think the effective beta we're modeling is about 10% on the overall deposit base for the first couple of cuts. We shouldn't see a dramatic shift if rates hold.

Billy Young (Investment Advisor)

Got it. Thank you for that. Just moving to a separate topic, I know obviously, credit quality has been relatively pristine for you guys over the last several quarters, but do you have any updated thoughts on kind of where you'd like to maintain reserve levels moving forward, particularly following the Lakeland close? Do you see the need to build ratios longer term with a bigger balance sheet? Thanks.

Tom Lyons (EVP and CFO)

Really all model-driven. I don't expect a change. If anything, I would think that the coverage ratio would come in a bit post-acquisition.

Tony Labozzetta (President and CEO)

Yeah. I mean, when we're looking at Lakeland's portfolio, it kind of emulates ours in terms of credit quality. So that expectation is that we would remain constant.

Billy Young (Investment Advisor)

Got it. Thank you for taking my questions, guys.

Tom Lyons (EVP and CFO)

Thank you.

Operator (participant)

Your next question comes from the line of Tim Switzer with KBW. Please go ahead. Hello, Tim. I think your line is unmuted.

Tony Labozzetta (President and CEO)

Morning, Tim. You might be on mute.

Operator (participant)

All right. Since we're not hearing anything, we will now move to the next question. So the next question we have comes from the line of Manuel Navas with D.A. Davidson. Please go ahead.

Manuel Navas (Senior Research Analyst)

Hey. Good morning. Could you speak a little bit about the balance side or the volume side of deposit growth channels, just kind of where you're going to see improvement there? You talked about in the quarter that there was some payoff of brokered and there was some CD outflows, but just kind of where you expect to see deposit inflows going forward?

Tony Labozzetta (President and CEO)

So if you look at this quarter, I think, like I mentioned earlier, there wasn't any account closure activity that was of note. Most of the dynamics were normal activity in our non-interest bearing accounts, which is cash flowing out for whatever business purposes and some disintermediation going into other accounts. Where we're seeing the growth moving forward, and we're experiencing some of that, we're observing it, is largely in the business banking side. So we're seeing a lot of compensating balances and things of that nature. Also, the municipal accounts should flow back in as we move forward. And we have other targeted activities that we're doing to deepen the share with our existing customers as well as obtaining new ones as well. So that's where we expect it to be.

However, I do think it'll still represent a challenge for us moving forward because we expect the lending growth levels to go back to their normal course. And so you'll have that little bit of a gap as we move forward.

Manuel Navas (Senior Research Analyst)

I appreciate that. Just on a separate topic, I just wanted to confirm, the numbers so far with the deal do not include revenue synergies at the moment?

Tom Lyons (EVP and CFO)

That's correct. Correct.

Manuel Navas (Senior Research Analyst)

That would be helpful with the insurance business and with ABL and the things you highlighted at the beginning.

Tom Lyons (EVP and CFO)

Yeah. We're excited about the opportunities there, but we have not included those in our model. Correct.

Manuel Navas (Senior Research Analyst)

That's great. That's great. Looking forward to hearing that update. Thank you.

Tom Lyons (EVP and CFO)

Great. Great. Thanks.

Operator (participant)

All right. For the last question, we have Tim Switzer with KBW. Please go ahead.

Tim Switzer (VP)

Hey. Sorry about that, guys. My headset messed up.

Tom Lyons (EVP and CFO)

No problem. Hey. Good morning.

Tim Switzer (VP)

Good morning. Thank you for all the updated financials impact. Do you guys have a projection on where capital levels will end up at the end of Q2 once you guys close the deal, particularly TCE and the total regulatory capital ratio?

Tom Lyons (EVP and CFO)

Yeah. I don't know if we can go into much more detail than we already disclosed, Tim. I can assure you that there'll be a comfortable cushion over the required limits that we agreed to as part of the non-standard conditions.

Tim Switzer (VP)

Okay. Are you able to provide any kind of framing around if rates continue to rise, how that would impact capital levels, and then maybe some of the other NIM purchase accounting you provided?

Tom Lyons (EVP and CFO)

Yeah. I guess all I can say is I don't have a sensitivity analysis in front of me, but rates are up the five years about 60 basis points higher than deal announcement. And you can kind of do a ratio and figure out what changed versus there. I think we were about $400 million at deal announcement. We're up to $540 million now, so you could straight-line it that way.

Tim Switzer (VP)

Okay. And that purchase accounting, the 65 basis points, was that the number with rates at the end of the quarter or as of this week?

Tom Lyons (EVP and CFO)

Current rates.

Tim Switzer (VP)

Okay. Great. Have you guys gotten any indications yet on where pricing on the sub debt raise could fall, a range or something?

Tom Lyons (EVP and CFO)

Yeah. We really can't speak on anything on the offering until it's there as it happens, Tim.

Tim Switzer (VP)

Okay. That's understood. The last question I have is, historically, you guys have done a really good job of keeping your efficiency ratio pretty low compared to the industry, 52% efficiency ratio in 2025. Over the long term, as you combine these two companies, where do you think the efficiency ratio could land over the long term?

Tom Lyons (EVP and CFO)

Well, that efficiency ratio just combines our current earning power, right? I think if you look at what happened to the efficiency ratio over the last 12-18 months, it's been more the compression in NIM and the revenue drivers. So as those things get back to normal, we expect that the efficiency ratio will continue to improve downward from where it is on a pro forma basis.

Tony Labozzetta (President and CEO)

Yeah. I guess you'd have to figure what the projected margin expansion is beyond the 325 and continue to maintain that roughly 175 expense ratio to average assets.

Tim Switzer (VP)

Okay. Great. Thanks for taking my questions, and congrats on getting the final approvals.

Tom Lyons (EVP and CFO)

Thank you very much.

Tony Labozzetta (President and CEO)

Thank you, gentlemen.

Operator (participant)

That concludes our Q&A session. I will now turn the conference back over to Tony Labozzetta for closing remarks.

Tony Labozzetta (President and CEO)

Thank you, everyone, for your questions and for joining the call. I'd like to once again thank the Provident and Lakeland teams for the successful merger approval. I speak for everyone when I say that we can move forward into 2024 with optimism and vigor. We look forward to talking to you all throughout the quarter and speaking to you all again next time. Have a great weekend.

Operator (participant)

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