PROVIDENT FINANCIAL SERVICES INC quarterly report, Q2 FY2012

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Provident Financial Services, Inc. — Q2 2012 Form 10-Q

Business context and reporting period. The unaudited filing covers the quarter and six months ended June 30, 2012, compared with the same 2011 periods; balance-sheet comparisons are with December 31, 2011. The company is a bank holding company operating through The Provident Bank. Amounts below are in millions unless stated otherwise.

Financial results and condition

  • Q2 earnings: Net income was $16.0 million, or $0.28 per diluted share, versus $14.0 million, or $0.25, in Q2 2011. For the first half, net income was $34.4 million, or $0.60 per diluted share, versus $26.9 million, or $0.47.
  • Interest income and margin: Q2 net interest income rose 0.7% to $54.6 million; first-half net interest income increased 1.7% to $109.4 million. Net interest margin was 3.39% in Q2, down from 3.53% a year earlier and 3.42% in Q1; first-half margin was 3.41% versus 3.52% in 2011. Lower asset yields more than offset lower funding costs.
  • Credit costs: Provision for loan losses was $3.5 million in Q2 and $8.5 million in the first half, versus $7.5 million and $15.4 million, respectively, in 2011. First-half net charge-offs were $10.5 million, compared with $11.8 million.
  • Other income and expenses: Non-interest income was $9.3 million in Q2 and $22.1 million in the first half; first-half results included $2.2 million in gains from securities sales. Non-interest expense increased 5.1% to $37.8 million for Q2 and 4.6% to $74.5 million for the first half. Higher compensation and benefit costs were the main pressure. Effective tax rates were 29.4% for Q2 and 28.9% for the first half.
  • Balance sheet and funding: Total assets were $7.13 billion, up 0.5% from year-end. Gross loans reached $4.74 billion, up $81.6 million; deposits were $5.21 billion, up $49.4 million. Borrowed funds declined $36.0 million to $884.2 million. Core deposits were 80.2% of deposits, compared with 78.1% at year-end. Cash and cash equivalents were $77.2 million.
  • Credit quality: Allowance for loan losses was $72.4 million, or 1.53% of loans, versus $74.4 million, or 1.60%, at year-end. Non-performing loans declined to $115.2 million, or 2.43% of loans, from $122.5 million, or 2.63%. Non-performing assets were $129.1 million, or 1.81% of assets. Total impaired loans were $115.5 million, including $80.0 million in troubled debt restructurings; one modified loan of $903,000 subsequently defaulted during Q2.
  • Cash flow and capital: First-half operating cash flow was $55.4 million; investing activities used $48.9 million and financing activities provided $1.1 million. Cash and equivalents decreased $7.6 million during the half. The company reported regulatory capital ratios above minimums: company Tier 1 leverage 8.96% and total risk-based capital 14.52%; bank ratios were 7.78% and 12.78%, respectively. Stockholders’ equity was $974.5 million.

Material changes versus comparable periods

  • Profit increased year over year in both Q2 and the first half, mainly reflecting lower loan-loss provisions and higher net interest income. First-half earnings also benefited from securities-sale gains.
  • Funding costs fell materially, but asset yields declined faster, contributing to lower net interest margin. Core deposit growth supported loan growth and reduced reliance on borrowed funds.
  • Non-performing loans and the allowance balance declined from year-end; however, commercial and multi-family mortgage lending contributed to overall loan growth and commercial real estate, commercial, and construction loans represented 60.2% of the portfolio.
  • First-half operating cash flow improved from $41.0 million in 2011, while investing cash flow shifted from a $68.6 million source to a $48.9 million use, reflecting loan growth and securities activity.

Outlook, commentary, risks and unusual items

  • The filing provides no specific earnings or revenue guidance. Management says results for the first half are not necessarily indicative of full-year 2012 results.
  • Management identifies economic weakness, declining real estate values, unemployment, commercial-property vacancies and possible interest-rate increases as risks to borrower repayment and future credit costs. Allowance estimates are judgmental and may change; regulators may require additional reserves or write-downs.
  • Interest-rate modeling projected a 5.2% decrease in 12-month net interest income under a gradual 300-basis-point rate increase, and a 1.5% decrease under a 100-basis-point decline. An immediate, sustained 300-basis-point increase was modeled to reduce present value of equity by 13.7%. Management cautions that model assumptions may differ from actual outcomes.
  • The securities portfolio included four private-label mortgage-backed securities with $13.0 million amortized cost and $804,000 in unrealized losses; three were below investment grade. The company recorded no other-than-temporary impairment in 2012 and said it did not intend, nor expect to be required, to sell securities before recovery. It noted market illiquidity and potential future impairment risk.
  • Beacon, acquired in August 2011, expanded wealth-management operations. The former parent may receive up to $10.5 million in additional cash consideration based on acquired-company performance over three years. Q2 expenses included a $213,000 software-contract termination charge related to integration; first-half expenses also included $162,000 related to consolidating four underperforming branches.
  • Management said routine legal claims are not expected to have a material adverse effect. The filing reported no material changes to previously disclosed risk factors and no material change in internal control over financial reporting.

Important facts for investors to verify

  1. Whether lower credit provisions and improving non-performing loan metrics persist, particularly given the rise in impaired loans and TDR balances.
  2. Whether net interest margin stabilizes as asset yields continue to reprice and deposit costs approach lower levels.
  3. The performance of commercial real estate and commercial lending, and the adequacy of reserves under changing economic and collateral conditions.
  4. Whether securities valuations, especially private-label mortgage-backed holdings, remain recoverable amid market illiquidity and below-investment-grade exposure.
  5. How Beacon’s wealth-management contribution and integration costs develop, including any contingent acquisition payment.