PROVIDENT FINANCIAL SERVICES INC quarterly report, Q3 FY2010

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Provident Financial Services, Inc. — Q3 2010 Form 10-Q

Reporting period: Three and nine months ended September 30, 2010. Unaudited consolidated results are for Provident Financial Services, Inc. and its wholly owned bank subsidiary. Dollar amounts below are in millions unless noted.

Financial performance

  • Q3 net income: $13.5 million, or $0.24 per diluted share, versus $8.7 million, or $0.15, in Q3 2009.
  • Nine-month net income: $37.6 million, or $0.66 per diluted share, versus a $128.6 million loss, or $2.29 per share, in 2009. The prior-year result included a $152.5 million goodwill impairment charge; excluding that charge, 2009 net operating income was $23.9 million, or $0.43 per share.
  • Net interest income: Q3 was $53.0 million, up 17.0%; nine-month total was $155.9 million, up 17.8% year over year. The Q3 net interest margin was 3.50%, versus 3.01% a year earlier; the nine-month margin was 3.45%, versus 3.02%.
  • Other income and expenses: Q3 non-interest income was $7.8 million, down from $8.6 million; non-interest expense was $34.1 million, down from $36.0 million. Nine-month non-interest income was $23.8 million versus $24.4 million. Non-interest expense was $102.8 million, compared with $259.9 million, which included the 2009 goodwill charge; excluding that charge, 2009 expense was $107.4 million.
  • Credit costs: Provision for loan losses was $8.6 million in Q3 and $26.6 million for nine months, versus $6.5 million and $18.1 million in the corresponding 2009 periods. Nine-month net charge-offs were $18.6 million, compared with $10.1 million.
  • Cash flow: Nine-month operating cash flow was $81.0 million, investing cash flow was $13.1 million, and financing cash flow was negative $110.4 million. Cash and cash equivalents declined $16.3 million to $107.4 million.

Financial position, liquidity and capital

  • Total assets were $6.78 billion at September 30, down $53.9 million from year-end 2009. Net loans were $4.28 billion, down $47.6 million; available-for-sale securities were $1.38 billion, up $42.6 million.
  • Deposits were $4.90 billion, nearly unchanged from year-end. Core deposits rose 5.4% to $3.57 billion and represented 72.9% of deposits, while time deposits declined 11.8% to $1.33 billion.
  • Borrowed funds declined $95.6 million to $903.6 million, or 13.3% of assets. The company reported no outstanding borrowings on its two $100 million FHLB-NY credit lines at quarter-end.
  • Stockholders’ equity increased 4.1% to $921.0 million. Book value per share was $15.37 and tangible book value per share was $9.45. The company and bank exceeded stated regulatory capital requirements; company total risk-based capital was 14.17% and bank total risk-based capital was 12.07%.

Material changes and credit quality

  • Non-performing loans increased to $103.5 million, or 2.38% of loans, from $84.5 million, or 1.93%, at year-end. Non-performing assets were $109.2 million, or 1.61% of assets, up from $90.9 million, or 1.33%.
  • The increase in non-performing commercial loans was a principal driver of higher problem assets; non-performing commercial loans reached $28.5 million, compared with $12.5 million at year-end. Non-performing residential mortgages rose to $38.3 million from $28.6 million.
  • The allowance for loan losses was $68.8 million, or 1.58% of loans, compared with $60.7 million, or 1.39%, at year-end. Management cited higher non-performing loans, credit-rating downgrades, and a greater commercial-loan share as reasons for increased provisions.
  • Loan mix shifted toward commercial real estate, multifamily, construction and commercial lending: these categories were 54.3% of the portfolio, compared with 52.5% at year-end. Total loans declined modestly, with commercial mortgage and multifamily balances increasing while residential, construction, commercial and consumer balances decreased.
  • Core-deposit growth and reduced higher-cost time deposits and borrowings lowered funding costs. The company attributed improved net interest income primarily to liability repricing and deposit mix; average interest-bearing deposit cost for Q3 fell to 1.05% from 1.73% a year earlier.

Outlook, risks and unusual items

  • No specific earnings or financial guidance was provided. Management said results for the interim periods are not necessarily indicative of full-year 2010 results.
  • Management identified economic weakness, falling real-estate values, unemployment, commercial-property vacancies and possible interest-rate increases as risks to borrowers’ repayment capacity and future loan-loss provisions. Allowance estimates are judgmental and could require adjustment as conditions change.
  • The investment portfolio includes private-label mortgage-backed securities. Five such securities, all below investment grade, had $27.5 million amortized cost and $2.1 million of unrealized losses. Management considered remaining loss positions temporary and stated it did not intend, and was not more likely than not required, to sell those securities before recovery. It cautioned that weak liquidity and deterioration in mortgage credit could lead to future impairment.
  • Interest-rate models estimated that a 300-basis-point rate increase would reduce projected 12-month net interest income by 4.2% ($8.8 million); an immediate and sustained 300-basis-point increase was modeled to reduce economic value of equity by 16.6% ($203.5 million). Management cautioned that model assumptions may differ from actual outcomes.
  • The 2009 goodwill impairment was a significant non-cash unusual item. The September 2010 annual impairment test, completed in Q4 2010, indicated reporting-unit fair value exceeded carrying value by 27.9%, with no additional impairment indicated.
  • Management reported disclosure controls as effective and no material change in internal control over financial reporting. Routine legal claims were not expected to have a material adverse effect. The filing reported no material change to previously disclosed risk factors.

Important facts for investors to verify

  • Whether non-performing loans, charge-offs and the allowance continue to rise, especially in commercial and residential mortgage portfolios.
  • Whether lower funding costs and core-deposit growth can sustain net interest margin as asset yields and market rates change.
  • Whether private-label mortgage-backed securities or other investments incur further impairment or valuation losses.
  • How loan growth and the shift toward commercial lending affect credit concentration, capital and future provisions.
  • Whether liquidity, regulatory capital and interest-rate sensitivity remain within management’s stated risk tolerances.