Provident: An Old Local Bank With Growth Potential After Lakeland Bank Merger (NYSE:PFS)

Company Overview

It’s still early in the trading week and while on the hunt for a hidden gem in the recently embattled regional banking sector, I came across a relatively under-covered local bank based in New Jersey, which I will be rating today, Provident Financial Services (NYSE:PFS), the parent company of Provident Bank.

What sets this company’s profile apart for me is that Provident has been around since 1839, is trading on the NYSE for under $16 today, and has a diversified business spanning across personal and business banking as well as investments and selling/managing foreclosed properties.

In the latest round of bank earnings results, Provident released its numbers recently on January 25th, and today we’ll dive into some of those figures, using data from the company Q4 results, income statement, balance sheet, and dividend info.

WholeScore Rating:

My approach uses the following WholeScore table to help get to a buy, sell, or hold decision. It holistically considers past performance, dividend income, future expected performance, fair valuation and risks. The rest of the article goes into more detail and is tailored to this specific stock and industry, providing evidence to support my investment thesis today.

The matrix below adds a point to each category that supports the rating (buy, sell, hold), and the rating with the highest score is chosen.

From the matrix, my investment thesis today calls for a buy on this stock.

To summarize my supporting evidence: although Provident has seen declining YoY revenue growth and earnings impact from net margin squeeze and higher provisions for credit losses, it has a low risk profile in terms of loan losses and office property exposure, as well as having a 6% dividend yield and expected future EPS and revenue growth higher than some regional bank peers.

I also determined that the current share price presents a fair value for buying this stock.

Recent Performance: Revenue Growth

In considering the most recent performance results, the firm saw revenue declining in Q4 to $114MM vs $129MM a year prior, an 11.6% YoY decline.

I can see from the income statement a key driver of this is flat or declining net interest income, as the trend indicates interest expenses rising. The company in their commentary also confirmed “the net interest margin decreased four basis points to 2.92% for the quarter ended December.”

Although the bank also has non-interest income, such as trust income, the YoY growth was insignificant to make a major impact to revenue.

My impression is that with 84% of its revenue tied to net interest income, ($96MM), it could use more diversification and has likely been impacted by the increasing costs of deposits in this high interest rate environment.

Recent Performance: Earnings Growth

Additionally, earnings (net income) also saw a decline in Q4 to $27.3MM, vs $49MM prior, a 44% YoY decline.

In their comments, the company attributed this to the following factors:

Decrease in lower-costing deposits and an increase in borrowings, combined with unfavorable repricing of both deposits and borrowings, in addition to increased provisions for credit losses primarily due to a worsened economic forecast compared to the prior year. Transaction costs related to our pending merger with Lakeland Bancorp.

Agan, as already mentioned the higher cost of deposits in this interest-rate environment has put a squeeze on this bank so far, and as far as the merger I consider that a short-term charge but significant to mention.

Important to note is the latest merger news is that it has been extended until the end of March, and if it ultimately finalizes the combined bank will operate under the Provident brand, which I think is a plus for this bank as it does not lose its longstanding brand recognition in that region, but also an opportunity to expand its customer base.

Recent Performance: Balance Sheet

In this category I am looking for positive equity growth and I found it. This bank grew equity to $1.69B in Q4 vs $1.59B prior, for a modest 6% YoY growth.

The bank saw balance sheet expansion on both the assets and liabilities side. On the assets side, for instance, it saw growth in loans (an asset to a bank).

According to commentary, “the company’s total loan portfolio increased $206.1 million, or 7.7% annualized, to $10.87 billion.”

I think this is a sign of continued loan demand, despite the high interest rate environment and elevated cost of debt. The elevated loan demand is continuing into 2024, which was confirmed by a February article in Reuters:

U.S. banks anticipate an increase in demand for loans as interest rates fall this year, even as they further tighten credit standards on some types of loans, according to a Federal Reserve survey.

So, I think this could lead to continued balance sheet expansion for Provident looking ahead, and potentially continued growing equity.

Dividend Income: Dividend Yield vs Peers

For my readers who are dividend-income investors or building a dividend portfolio like I am, here I will talk about what kind of yield we can get from this stock vs its peers in the regional banking space.

For comparables, I picked New York Community Bancorp (NYCB) and Valley National Bancorp (VLY), two regional banks also with a market presence in the NYC/NJ market, just like Provident.

I must mention that NYCB is showing a nearly 14% yield likely due to its massive price drop lately after a less than stellar earnings result, so it may be skewing these results. Provident at 6% yield easily beats Valley National’s yield of just under 5%.

Although they are much larger banks, if you also compare with Bank of America (BAC) with a yield of 2.74% and Wells Fargo (WFC) with a yield of 2.76%, Provident wins again. All three, however, have market penetration in the NYC/NJ local market through their branch network.

So, I think Provident could present a strong dividend play at this point.

Dividend Income: Dividend 5 Year Growth

Next, I am looking at proven dividend growth at this bank, as a sign that they have been committed to return capital back to shareholders.

What the data tells us is that the dividend went from $1.12/share/annual in 2019 to $0.96/share/annual in 2023, a 14.2% decline over 5 years.

Further, going into 2024 the last quarterly dividend hike was in August 2021, remaining at $0.24/share since then.

The firm has had uninterrupted quarterly payouts, however, and even had “special/other” payouts in 2017 and 2019.

My impression is that this stock is not a great dividend grower so far, and that potential dividend hikes in 2024 could be impacted if a similar scenario occurs as happened at NYCB, when they dropped their dividend to just $0.05 after recent results. However, with Provident it depends on what the next few quarters will look like, so that leads me into my next topic which is the future performance outlook.

Future Performance: EPS Growth Estimates

What the data from the analyst consensus tells me is that there is expectation for 1.6% EPS growth by December, and a nearly +25% growth by Dec. 2025. Unfortunately, revisions data shows that 0 analysts had upward revisions while 4 had downward revisions.

I think that the first half of the year could continue impacting earnings due to the interest margin squeeze, as well as further merger-related and integration charges if the Lakeland Bank merger finalizes, and consider that rate tracker CME Fedwatch shows a high probability the Fed keeps rates the same after its March meeting.

Provident, although a very low expected EPS growth, actually beats its peer NYCB whose projection is for a nearly -11% EPS decline. As for fellow New Jersey-native bank Valley National, the consensus is calling for a -5% EPS decline.

Future Performance: Revenue Growth vs Peers

In this category, I want to compare future expected revenue growth vs a few peers in the regional banking sector, using the Seeking Alpha comparison tool.

In this comparison, I also added a few larger regional banks like KeyCorp (KEY) the parent of KeyBank, as well as Huntington Bancshares (HBAN) and Texas-based Cullen/Frost Bank (CFR), the parent of Frost Bank.

In this comparison, our target stock Provident actually leads the pack with forward (expected) revenue growth of nearly +19%.

I think this is significant to mention, considering it easily wins over much larger regionals like KeyBank and Huntington.

My impression as to what could be driving this is the growth in the loan portfolio, which can be a driver of future interest payments on those loans. Also, acquiring Lakeland Bank could lead to an even bigger loan book later on, and hence revenue growth on that loan book.

Valuation: Is it Fairly Valued?

Now I will talk about whether I think this stock is fairly priced and valued right now. First, let’s look at the price chart, from yCharts:

As of the writing of this article, the share price is $15.94, trading 3.1% below its 200-day simple moving average. I can tell from the trend that it dipped during the spring crisis in regional banks, struggled to recover, and then took another dip below the average most likely during the recent headwinds to this sector after the NYCB earnings release. So, this chart tells me this stock is affected when stress occurs in the overall banking sector.

Now, let me talk about where the market is valuing this stock in relation to forward earnings and book value, from valuation data.

Its forward P/E ratio is 15.73 today, nearly 45% above its sector average. This tells me the market is bullish on future earnings potential growth. I think the current valuation is fair since the EPS YoY growth estimate is 1.6% YoY growth by December (as already mentioned) yet the share price today is trading around 6% lower now than this past December. I think a fair share price is up to $17.34 for this stock (December price range + 2% forward EPS growth).

As for forward P/B ratio it is 0.72, around 31% below its sector average. This tells me the market is more bearish about future equity growth at Provident. Since I am expecting equity growth due to balance sheet expansion (driven by growth in loans, and acquiring Lakeland Bank), I think the market here is overly cautious. We know from the balance sheet the book value per share is $22.56, so I think a fair price for this stock is $22.56 + 1-2%.

Considering today it is under $16, it presents an attractive valuation case.

Key Risks: Micro & Macro Risk Profile

Specific to the type of business Provident is in, a sector I have written about at great length on this website since last summer, banks are of course exposed to the risk of the loans in their portfolio.

This has especially come to the public light with recent media coverage of the risk of office loan defaults in the post-pandemic remote work era.

Just last week an article in Inc Magazine spoke to this reality:

With $117 billion of CRE loans maturing this year amid falling rent prices — and part of $560 billion due by the end of 2025 — lenders move to hedge default risks.

This is not exactly news, however, as back in last April’s article in Forbes we learned that major real estate company Brookfield defaulted on millions in office loans. Here is what Forbes said then:

High office vacancy and interest rate hikes have contributed to a string of defaults this year and fueled concerns of a commercial real estate debt crisis.

This is what Provident had to say in their commentary about their CRE and office loan exposure risk:

CRE loans related to office properties totaled $483.1 million, compared to $483.3 million at September 30, 2023. This portfolio constitutes 4.5% of total loans. Approximately 35% of our office loans are to medical offices and we do not have significant central business district exposure. Delinquencies in the office portfolio at December 31, 2023, were limited to one loan totaling $825,000.

Further, their Q4 release data shows non-performing loans overall are just 0.46% of total loans, actually down from the 0.57% figure in Dec. 2022.

I can also see from their table below that in terms of loans that are 60 to 80 days past due, $3.3MM of the total loan book is in this category, and none of it from commercial mortgages.

So, this potential downside risk is something to keep an eye on in this sector, but for now I don’t see reason to ring the alarm bells at Provident, due to very low exposure to offices (under 5% of the portfolio) and low rates of bad loans. I think this points to efficient loan underwriting standards at this bank.

This risk study could be considered both a macro issue (overall trend of office defaults driven by lower demand for office space in the economy) and a micro issue (affecting the specific loan book of this bank).

Concluding Thoughts

To summarize, this stock’s positive factors outweighed the few negatives, and I am going long on this stock. As part of a dividend-income portfolio strategy, the 6% yield is especially a great addition to such a portfolio that generates quarterly income. For non-dividend investors, however, who only are looking for capital appreciation, I think this share price has lots of upside potential which will be driven by the Lakeland takeover and resulting business expansion.

In the event the Lakeland Bank merger fails, I think that Provident has held up well on its own for 100+ years and the case I presented today shows it has potential to continue doing so.

In terms of further price dips due to potential sector headwinds at other regional banks and their office loan exposure, my evidence shows this bank’s share price has already been tested twice with such stress (last spring and this January) and has rebounded in both cases so far.