Provident Financial Services, Inc. (NYSE:PFS) Q4 2023 Earnings Conference Call January 26, 2024 10:00 AM ET
Company Participants
Adriano Duarte – IR Officer
Anthony Labozzetta – President & CEO
Tom Lyons – SEVP & CFO
Conference Call Participants
Mark Fitzgibbon – Piper Sandler
Bill Young – RBC Capital Markets
Michael Perito – KBW
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
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
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 pre-tax 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?
Tom Lyons
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, pre-tax 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 non-interest-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 non-interest-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 two 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.
Question-and-Answer Session
Operator
The floor is now open for your questions. [Operator Instructions] Our first question comes from the line of Mark Fitzgibbon with Piper Sandler. Please go ahead.
Mark Fitzgibbon
Hey, guys. Good morning. Happy Friday.
Anthony Labozzetta
Mark, how are you?
Mark Fitzgibbon
Good. Thanks. Hey, Tony. I wonder if you guys could explain that contingent litigation reserve, what it relates to and how that flows?
Anthony Labozzetta
Yeah, 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
And I just don’t have that in front of me. What does it relate to, Tom?
Tom Lyons
Yeah. 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
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?
Tom Lyons
Yeah. The flows for the quarter were actually positive, absent one large loan moving into non-performing category. We had about $10 million of favorable resolutions and then we had a $19 million — a little over $19 million loan move into the non-performing 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
It’s a C&I loan.
Tom Lyons
It’s a C&I loan, yes.
Mark Fitzgibbon
Okay. And then, Tom, any thoughts on sort of expense growth this year, excluding the impact of Lakeland?
Tom Lyons
Yeah. 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
Okay. And then lastly, could you share with us AUM and maybe net flows for the quarter?
Tom Lyons
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
So in the fourth quarter, there were positive flows, positive net flows?
Anthony Labozzetta
That’s correct.
Mark Fitzgibbon
Okay. Great. Thank you.
Operator
Our next question comes from the line of Billy Young with RBC Capital Markets. Please go ahead.
Bill Young
Hey. Good morning, guys. How are you?
Anthony Labozzetta
Good morning, Bill.
Bill Young
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 two out of four cuts, pointing closer to six. So how did that kind of change your margin expectations? Thanks.
Tom Lyons
Yeah. 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 three that would be meaningful to 2024.
Anthony Labozzetta
Yeah. 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.
Tom Lyons
That’s correct. And Bill, I misspoke. I said rate increases, obviously, I meant rate decreases.
Bill Young
Right. 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?
Tom Lyons
Again, if the terminal rate is lower than the competitive environment, it would probably slowdown 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
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
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.
Tom Lyons
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.
Bill Young
Great. Appreciate it, guys. That’s all I’ve got.
Tom Lyons
Thank you.
Operator
Our next question comes from the line of Michael Perito with KBW. Please go ahead.
Michael Perito
Hey, guys. Good morning. Thanks for taking my question.
Tom Lyons
Good morning, Mike.
Michael Perito
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
Yeah. 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
Got it. Helpful, Tony. Thanks. 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
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 two 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.
Michael Perito
That was perfect. Thanks, Tony. Good update. Appreciate you guys taking my question. Have a good weekend.
Tom Lyons
Thank you. You too.
Anthony Labozzetta
Thank you.
Operator
I would now like to turn the call over to Tony Labozzetta for closing remarks.
Anthony Labozzetta
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.
