Provident Financial Services, Inc. — Q2 2011 Form 10-Q
Business context and reporting period. The company and its wholly owned subsidiary, The Provident Bank, report consolidated results for the quarter and six months ended June 30, 2011. The bank’s business includes taking deposits and originating residential, commercial real estate, commercial, and consumer loans. Income-statement and cash-flow amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net interest income | $54.2 | $52.1 | $107.6 | $102.9 |
| Provision for loan losses | $7.5 | $9.0 | $15.4 | $18.0 |
| Non-interest income | $8.0 | $8.0 | $15.2 | $16.0 |
| Non-interest expense | $35.9 | $33.9 | $71.3 | $68.7 |
| Income before taxes | $18.8 | $17.2 | $36.2 | $32.2 |
| Net income | $14.0 | $12.9 | $26.9 | $24.1 |
| Diluted earnings per share | $0.25 | $0.23 | $0.47 | $0.43 |
- Net interest margin was 3.53% for Q2, versus 3.48% a year earlier; the six-month margin was 3.52%, versus 3.42%. Management attributed improvement mainly to lower funding costs, partly offset by declining yields on earning assets.
- At June 30, 2011, total assets were $6.88 billion, loans $4.45 billion, deposits $4.99 billion, borrowed funds $891.1 million, and stockholders’ equity $938.5 million. Compared with December 31, 2010, assets rose 0.8%, loans 1.0%, deposits 2.4%, and equity 1.8%; borrowed funds declined 8.1%.
- Cash and cash equivalents were $187.3 million, up from $52.2 million at year-end. For the first six months, operating cash flow was $41.0 million, investing cash flow was $68.6 million, financing cash flow was $25.5 million, and cash increased $135.1 million.
- Allowance for loan losses was $72.3 million, or 1.62% of loans, compared with $68.7 million, or 1.56%, at year-end. Non-performing loans rose to $121.3 million (2.72% of loans) from $97.3 million (2.21%); non-performing assets rose to $128.2 million (1.86% of assets) from $100.1 million (1.47%).
- Regulatory capital exceeded minimum requirements. Bank ratios were 7.56% Tier 1 leverage, 11.39% Tier 1 risk-based, and 12.65% total risk-based; company ratios were 8.82%, 13.30%, and 14.55%, respectively.
Material changes versus comparable periods
- Q2 net interest income increased 3.9% and six-month net interest income increased 4.6%, as reductions in deposit and borrowing costs more than offset lower interest income. Total interest expense fell 21.3% for Q2 and 23.7% for the six months.
- Net income increased to $14.0 million for Q2 and $26.9 million for the six months. Lower loan-loss provisions contributed, but higher non-interest expenses partially offset the improvement.
- Credit deterioration is a key countertrend: non-performing loans and assets increased from year-end, impaired loans rose to $82.3 million from $47.2 million, and troubled debt restructurings increased to 21 loans totaling $24.3 million from six loans totaling $7.6 million.
- Core deposits grew 4.7% from year-end and reached 75.5% of total deposits, while time deposits declined 4.3%. Management said it was replacing wholesale funding with core deposits and allowing some higher-cost time deposits to run off.
- Cash rose substantially, while total investments declined 7.1%, largely due to mortgage-backed security repayments and maturities. Stockholders’ equity increased $16.8 million, reflecting earnings and other items, partly offset by $13.9 million in dividends.
Outlook, commentary, risks, and unusual items
- No quantified earnings or revenue guidance is provided. Management said it intended to continue focusing on commercial loan originations and cultivating core deposit relationships. Results for the first half are not necessarily indicative of full-year results.
- On May 19, 2011, the bank announced an agreement to acquire Beacon Trust Company and Beacon Global Asset Management. Consideration may be up to $10.5 million, tied to acquired-company performance over the three years after closing; completion was subject to regulatory approval and expected in Q3 2011. Combined pro forma assets under management were estimated at approximately $1.65 billion.
- Interest-rate models estimated that a gradual 300-basis-point increase would reduce 12-month net interest income by 3.9%; an immediate, sustained 300-basis-point increase was projected to reduce economic value of equity by 17.1%. Management cautioned that model assumptions may differ from actual outcomes.
- Credit risks include economic weakness, real-estate value declines, unemployment, commercial-property vacancies, and possible rate increases. The allowance estimate is especially sensitive to management assumptions and economic conditions. Specific credit exposures noted include adversely classified shared national credit participations and delinquent Alt-A, junior-lien, and marine loans.
- The securities portfolio included three below-investment-grade private-label mortgage-backed securities with $15.9 million amortized cost and $1.5 million unrealized losses. The company recorded $302,000 of net securities impairment in Q2 and the first half; it said it did not intend to sell securities in temporary loss positions and was not likely to be required to sell them before recovery.
- Unusual expenses included an $807,000 first-quarter impairment of premises and equipment tied to relocation and anticipated sale of a former loan center. Two former administrative facilities were held for sale; related carrying costs continued. The company also recorded increased expenses associated with resolving non-performing assets.
- After quarter-end, S&P downgraded U.S. sovereign debt on August 5, 2011, and certain agency-related debt on August 8. The filing warns these actions could affect securities values and the availability or cost of funding secured by affected instruments.
- Management reported that ordinary-course legal matters were not expected to have a material adverse effect. It reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether the increase in non-performing loans, impaired loans, and TDRs continues, and whether the allowance remains adequate relative to charge-offs and portfolio risks.
- Progress and final terms of the Beacon acquisition, including regulatory approvals, closing timing, and the performance-based consideration.
- Whether core deposit growth and lower funding costs can continue to offset pressure on asset yields and support the net interest margin.
- Potential effects of the U.S. and agency credit-rating downgrades on securities valuations, collateralized borrowing, and liquidity.
- Whether held-for-sale premises are sold as expected and whether relocation and non-performing-asset costs remain elevated.