PROVIDENT FINANCIAL SERVICES INC annual report, FY2016

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Provident Financial Services, Inc. — 2016 Form 10-K

Business context and reporting period. This is the annual report for the fiscal year ended December 31, 2016, not a standalone fourth-quarter filing. Provident is a bank holding company operating Provident Bank, with 87 branches in New Jersey and eastern Pennsylvania. It also provides wealth and asset management services.

Financial performance and condition

  • Scale and growth: Total assets rose 6.6% to $9.50 billion. Net loans increased 7.2% to $6.94 billion; deposits increased 10.6% to $6.55 billion. Stockholders’ equity rose 4.7% to $1.25 billion.
  • Earnings: Net income was $87.8 million, up 4.9% from $83.7 million; diluted EPS was $1.38 versus $1.33. Income before tax was $124.8 million. The effective tax rate was 29.6%, down from 30.3%.
  • Interest income and margins: Net interest income increased 3.5% to $258.6 million, while net interest margin declined 9 basis points to 3.11% and the average interest-rate spread fell to 2.98% from 3.07%. Average interest-earning assets grew 6.3%; their yield decreased to 3.64% from 3.73%.
  • Other income and expenses: Non-interest income was $55.4 million, roughly flat year over year; wealth management income increased to $17.6 million. Non-interest expense increased 1.8% to $183.8 million, with compensation and benefits up $6.5 million. The efficiency ratio improved to 58.54% from 59.19%.
  • Credit quality: Provision for loan losses rose to $5.4 million from $4.4 million; net charge-offs were $4.9 million. The allowance was $61.9 million, or 0.88% of total loans, versus 0.94%. Non-performing assets declined to $50.4 million, or 0.53% of assets, from $55.1 million, or 0.62%. Non-performing loans were $42.4 million, or 0.61% of loans.
  • Liquidity, funding and debt: Cash and cash equivalents were $144.3 million, compared with $102.2 million. Operating cash flow was $127.3 million, up from $114.9 million; investing activities used $580.8 million and financing activities provided $495.6 million. Core deposits reached $5.90 billion, 90.1% of deposits. Borrowed funds fell 5.6% to $1.61 billion. The filing states the Bank manages liquidity daily and expects sufficient cash for funding needs; it does not give a single liquidity coverage ratio.
  • Capital and shareholder returns: The Bank’s Tier 1 leverage ratio was 8.42% and total risk-based capital ratio was 11.46%; both the Bank and Company were reported well capitalized. The Company paid $45.4 million in cash dividends and repurchased 149,688 shares during 2016. The board declared a $0.19 quarterly dividend in January 2017, subject to relevant conditions.

Material changes versus the prior comparable period

  • Asset growth was led by loans and investments. Commercial real estate loans increased $262.6 million, commercial loans $196.6 million, and multifamily loans $168.1 million. Commercially oriented loans represented 75.3% of the portfolio, up from 72.1%.
  • Deposit growth helped replace wholesale funding: deposits increased $629.6 million, while borrowings decreased $94.9 million. Core deposits increased to 90.1% of deposits from 87.5%.
  • Annual net income and EPS improved, but margin compression continued. The increase in net interest income reflected loan and deposit growth despite lower asset yields and a narrower spread.
  • Asset-quality measures generally improved, although non-performing commercial mortgage loans rose to $7.5 million from $1.3 million. The allowance-to-loans ratio declined as management cited improved overall asset quality.
  • Fourth-quarter 2016 net income was $22.6 million and diluted EPS was $0.35, versus $21.5 million and $0.34 in fourth-quarter 2015. Fourth-quarter net interest income was $66.6 million versus $63.7 million.

Outlook, management commentary, risks and unusual items

  • Outlook: The filing provides no specific earnings or growth guidance. Management described a strategy of expanding customer relationships and core deposits, growing commercial real estate, multifamily and commercial lending, and managing credit and interest-rate risk.
  • Interest-rate exposure: The modeled 12-month net interest income declines 2.2% ($6.0 million) under a gradual 300-basis-point rate increase and 3.2% ($8.7 million) under a 100-basis-point decrease. An immediate, sustained 300-basis-point increase was modeled to reduce economic value of equity by 10.9% ($150.2 million). These are model estimates with stated assumptions, not forecasts.
  • Concentration and regulatory risks: Commercial real estate lending equaled 451% of risk-based capital; the portfolio had not grown 50% or more over the prior 36 months, but regulators may scrutinize concentrations. Assets of $9.50 billion put the Company near the $10 billion threshold, at which additional regulatory requirements and costs apply.
  • Other principal risks: Management identifies interest-rate and liquidity risk, credit losses, local economic and real-estate conditions, competition, cyber and operational risks, and potential impairment of goodwill. Goodwill was $411.6 million; the 2016 annual qualitative impairment test found no impairment.
  • Contingencies and unusual items: Management said ordinary-course legal actions and commitments were not expected to materially affect financial condition or results. The MDE acquisition earn-out could reach $12.5 million if revenue targets are met; no contingent consideration liability was required at year-end based on management’s projections. The 2016 adoption of stock-compensation accounting guidance reduced income tax expense by $158,000.
  • Assurance: KPMG issued unqualified opinions on the financial statements and internal control over financial reporting. Management reported effective disclosure controls and internal controls as of year-end.

Important facts for investors to verify

  • Whether loan growth and deposit mix can sustain earnings if net interest margin continues to compress, and how actual rate sensitivity compares with the filing’s modeled scenarios.
  • Performance and collateral coverage of the larger criticized or non-performing commercial relationships, including the fitness-club relationship and the $3.0 million defaulted retail-property loan.
  • Whether the 0.88% allowance-to-loans ratio remains adequate as the portfolio shifts further toward commercial lending and off-balance-sheet commitments rise.
  • Progress toward the $10 billion asset threshold, including the timing and financial impact of associated regulatory requirements.
  • Funding and liquidity capacity against $1.83 billion of commitments and letters of credit, and the maturities and collateral requirements of $1.61 billion in borrowings.
  • Potential impacts of future impairment assessments, contingent acquisition consideration, and the federal tax audit noted in the filing.