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Provident Financial Services Inc (NYSE:PFS)
Q2 2020 Earnings Call
Jul 30, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Provident Financial Services, Inc. Second Quarter Earnings Conference Call. [Operator Instructions]

I would now like to turn the conference over to Mr. Leonard Gleason, Investor Relations Officer. Please go ahead.

Leonard G. Gleason -- Senior Vice President and Investor Relations Officer

Thank you, Carrie. Good morning, ladies and gentlemen. Thank you for joining us for our Second Quarter Earnings Call. Today's presenters are Chris Martin, Chairman, President and CEO; and Tom Lyons, Senior Executive Vice President and Chief Financial Officer. Before beginning their review of our financial results, we ask that you please take note of our standard caution as to any forward-looking statements that may be made during the course of today's call. Our full disclaimer is contained in this morning's earnings release, which has been posted to the Investor Relations page on our website, provident.bank.

Now I'm pleased to introduce Chris Martin, who will offer his perspective on our second quarter. Chris?

Christopher Martin -- Chairman, President and Chief Executive Officer

Thanks, Len, and good morning, everyone. As we begin the summary of our second quarter, it is our sincere hope that you and yours are safe and healthy. Second quarter earnings were impacted by COVID and CECL as the provision for loan losses and expenditures related to providing a safe environment for our customers, employees took priority as we phased our staff-back-to-office process and afforded our customers full branch access. On a positive yet related note, we had expenses for the planned acquisition of SB One of $683,000 during the quarter and look to complete the closing tomorrow. We remain comfortable with our capital structure and balance sheet strength. Our capital ratios continue to be strong, given our business mix and risk management processes. In view of our capital and pre-tax pre-provision earnings expectations, the Board approved a $0.23 cash dividend. Net income for the quarter was $14.3 million or $0.22 per share. Net interest margin decreased 23 basis points linked quarter to 2.97% as the impact of lower rates and higher cash balances was partially offset by lower deposit costs and above-average growth in noninterest-bearing deposits. The impact of PPP loans on our margin was two basis points. And we continue to experience a reduction in our all-in cost of deposits to 41 basis points for the quarter ended June 30, 2020, versus 62 basis points from the trailing quarter. Borrowing costs also improved to 1.31% from 1.80% in the trailing quarter.

The decrease in earning asset yields of 45 basis points linked quarter reflects falling benchmark interest rates on adjustable rate loans, accompanied by modest growth in new originations at lower rates and the $403 million in PPP loans. And of the PPP loans, we are assuming that approximately 75% to 80% will be forgiven once the government provides the vehicle and forms to complete this. The impact on our net interest margin from the short end of the curve is now largely behind us, but historically low long-term rates will continue to put pressure on asset yields as our loan and investment portfolio is repriced at lower coupons. The loan pipeline remains robust at $1.3 billion, and activity continues to provide us with growth potential as payoffs have added during COVID. We are also placing interest rate floors on most of our commercial loans. Residential mortgage originations have spiked as rates hit historical lows and neighborhoods experience an upsurge in activity with more individuals working from home and assimilating to the new work environment, which we see as continuing well into the future. Unlike some banks, we did not experience a high level of line draws during the course of the economic shutdown as line usage remained at 36%. We view this as indicative of the stability of our customer base and their assurance in our capacity to support their funding needs. Now Tom will go into more details on loan deferrals. But suffice it to say, the initial phase of 90-day deferrals peaked at approximately $1.3 billion or 16.8% of the loan portfolio. This has been reduced to $395 million or 5.1% of loans.

This includes second deferrals to date of $343 million. The increase in deposits is difficult to parse as much of the growth can be attributed to PPP loans, along with stimulus checks from the government. But in any event, significant growth in noninterest-bearing deposits helped reduce our funding costs. Noninterest expense declined during the quarter due to decreased deposit-related fees as much of our market was under the stay-at-home executive orders, which impacted debit card revenue due to reduced volumes. Wealth management income was also affected by the market declines in the value of assets under management, which has since recovered. On the noninterest expense front, the majority of the $5.6 million increase was due to CECL and the credit loss expense for off-balance sheet credit exposure of $5.3 million in the quarter. We also had increases in data processing expenses related to our digital platform improvement, along with transaction costs associated with the SB One acquisition. Asset quality improved, and we experienced net recoveries for the quarter. Our allowance for credit losses now stands at 1.11% of total loans from 0.76% at December 31, 2019. The provision in the quarter was significantly impacted by Moody's baseline economic forecast, including a negative shift in the outlook for commercial real estate. Exposures to hotels, retail, restaurants and skilled nursing facilities are under heavy scrutiny. On June 30 June 30 reported credit metrics remained remarkably stable given the ongoing level of economic stress, as borrowers were aided by the impact of government stimulus and loan modification and deferral programs. We envision continued pressure on credit as we anticipate the continuation of a challenging business environment due to the pandemic. And we anticipate meeting all of our cost saves from the combination of SB One Bancorp, which closes tomorrow, and all of them we'll provide to our customers and our employees while also increasing long-term growth and stockholder value.

Now Tom will provide more detail on our financial results. Tom?

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

Thank you, Chris, and good morning, everyone. As Chris noted, our reported net income was $14.3 million or $0.22 per diluted share compared to $24.4 million or $0.38 per diluted share for the second quarter of 2019 and $14.9 million or $0.23 per diluted share in the trailing quarter. Earnings for the current quarter were again adversely impacted by elevated provisions for credit losses under the CECL standard and the recessionary economic forecast attributable to the COVID-19 pandemic. In addition, we incurred costs specific to our COVID response, including supplemental pay for customer-facing employees, PPE equipment and security costs and costs related to the upcoming merger with SB One. Core pre-tax pre-provision earnings were $35.9 million, excluding $16.2 million in provisions for credit losses on loans and commitments to extend credit, $1 million of COVID costs and $683,000 of professional fees related to the SB One merger. This compares with $36.4 million in the trailing quarter, excluding provisions for credit losses, and merger-related charges and $42.7 million for the second quarter of 2019. Our net interest margin contracted 23 basis points versus the trailing quarter and 45 basis points versus the same period last year. As declining market interest rates, cash collateral pledged against that and money swaps, excess liquidity and PPP loans all produced lower earning asset yields. To combat margin compression, we continue to reprice deposit accounts downward.

This deposit rate management, coupled with a continued emphasis on attracting noninterest-bearing deposits, resulted in a 21 basis point decrease in the total cost of deposits this quarter to 41 basis points. Noninterest-bearing deposits averaged $1.8 billion or 25% of the total average deposits for the quarter. This was an increase from $1.5 billion in the trailing quarter with a sizable portion of that growth attributable to PPP and stimulus funding. Noninterest-bearing deposit levels remained elevated at $1.9 billion on June 30. Average borrowing levels increased $92 million, and the average cost to borrow funds decreased 49 basis points versus the trailing quarter to 1.31%. We will continue to thoughtfully manage liability costs as the rate environment evolves. Quarter end loan totals increased $294 million versus the trailing quarter as growth in C&I, CRE, multifamily and residential mortgage loans was partially offset by net reductions in construction and consumer loans. The growth was largely driven by PPP loans, which totaled $400 million at June 30. Loan originations, excluding line of credit advances, totaled $774 million for the quarter. The pipeline at June 30 was consistent with the trailing quarter at $1.3 billion. Pipeline rate has increased 26 basis points since last quarter to 3.43% at June 30. Our provision for credit losses on loans was $10.9 million for the current quarter compared with $14.7 million in the trailing quarter. The decrease in the provision reflects the significant reserve build required in the trailing quarter, and CECL model estimates for life of loan losses as impacted by the ongoing severe economic forecast.

We had annualized net recoveries as a percentage of average loans of one basis point this quarter compared with annualized net charge-offs of 16 basis points for the trailing quarter. Nonperforming assets declined to 37 basis points of total assets from 39 basis points at March 31. The allowance for credit losses on loans to total loans increased to 1.11% or 1.17%, excluding PPP loans from 1.02% in the trailing quarter. Loans with short-term COVID-19 payment deferrals declined from their peak of $1.31 billion or 16.8% of loans to $395 million or 5.1% of loans. Loans and deferral consists of $52 million that are still in their initial deferral period and another $343 million that have been or are expected to be granted a second 90-day deferral. Included in this total are $130 million of loans secured by hotels with a pre-COVID weighted average LTV of 53%, $124 million of loans secured by retail properties with a pre-COVID weighted average LTV of 66% and $25 million of loans secured by restaurants with a pre-COVID weighted average LTV of 59%. Of the $912 million of loans that have concluded their deferral period, $380 million have resumed regular contractual payments with the majority of the remainder expected to resume payments at their August one due date. Noninterest income decreased $2.6 million versus the trailing quarter to $14 million as reductions in deposit and wealth fees resulting from consumer restrictions from COVID mitigation efforts and volatile asset values and lower swap fee income was partially offset by greater bank loan life insurance benefits and gains on sales of real estate owned.

Excluding provisions for credit losses on commitments to extend credit, COVID-related costs and acquisition-related professional fees, noninterest expenses were an annualized 1.86% of average assets for the quarter. These core expenses decreased $4.4 million versus the trailing quarter. The decrease in core expenses versus the trailing quarter was primarily attributable to $1 million of executive severance and normal first quarter increases and compensation and related payroll taxes recognized in the trailing quarter. And increased deferral of salary expense related to PPP loan originations in the current quarter. This improvement was partially offset by increased FDIC insurance costs as the remaining $267,000 in small bank assessment credit was utilized in the current quarter. Our effective tax rate decreased to 20.6% from 26% for the trailing quarter. As a result of reduced forecast of taxable income in the current quarter, and an adverse discrete item related to the vesting of stock compensation in the trailing quarter. We are currently projecting an effective tax rate of approximately 23% for the balance of 2020.

That concludes our prepared remarks. We'd be happy to respond to questions.

Questions and Answers:

Operator

[Operator Instructions] First question will come from Mark Fitzgibbon of Piper Sandler.

John LaViol -- Piper Sandler -- Analyst

It's John LaViola on for Mark this morning. Wondered if we could just start by potentially giving us an update on asset flows in your wealth management business? And just remind us what AUM was as of March 31 and then as of the end of the most recent quarter?

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

Sure, John. AUM at March 31 was $2.8 billion. And at the end of June, $3.2 billion. So we've recovered. But on an average basis for the quarter, we're down about $100 million, $3.2 billion to the average in Q1 versus I guess, $3.2 billion to the average in Q1 versus $3.1 million in Q2.

John LaViol -- Piper Sandler -- Analyst

Got it. Got it. And then the pipeline does look strong, down just a touch quarter-over-quarter to $1.3 billion. How much would you expect to close in 3Q? I think you normally are looking at a 50%-ish pull through rate.

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

Yes. 58% is the expected pull-through rate at a yes, the rate of about 3.43.

John LaViol -- Piper Sandler -- Analyst

Okay. Fantastic. And I appreciate the initial color on the margin, but I was hoping we could maybe dig a little bit deeper on the outlook specifically for the back half of the year. Given not only the closing of SB One tomorrow, but also the blend of PPP fees through NII, there's just a lot of moving parts. If you could provide any clarity on that, that would be great.

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

Sure. So inclusive of the fee income, I think PPP is about $325 million. I believe that was discussed in the earnings release, too. So that's assuming the regular accretion. If you're going to take the accelerate the forgiveness and book more in Q3 and Q4, which is the expectation, I think, about 75% is what we're projecting will be paid this year. Obviously, you see the bump on that. So the total fee income was $11.5 million collected. And we recorded about 2.5 months' worth of that was accreted into income. So about $480,000 a month for 2.5 months in Q2.

John LaViol -- Piper Sandler -- Analyst

Okay. Okay, great. And then I guess just one last one on credit. With the reserves, as you mentioned, now around 1.17% of total loans, ex PPP, do you feel comfortable with this moving forward? Or do you think maybe it could be conservative to build this a little bit higher over time? I know it's subject to so many different moving parts, but...

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

It's largely model-driven at this point. I mean there's a little bit of flexibility in the qualitative factor assessment. And that's where we're trying to account for institution-specific things or things that you think might be outliers in the model depending on what's happened in the world versus the last baseline forecast. But we're going to adhere to the process. I'm comfortable with where we are. I think it's the appropriate reserve level. I don't see a huge build unless it so much depends on the pandemic. We saw some ugly numbers as expected on GDP. Employment numbers are looking a little bit weak. So we'll have to see what comes.

Christopher Martin -- Chairman, President and Chief Executive Officer

This is Chris. I think on the deferral, it's going to be the second wave of this to say how much of this is part of the pandemic and how much of the businesses are going to continue to struggle, obviously, opening up the economy in New Jersey. We've been holding back a little bit for our own protection. Pennsylvania is the same. So I think the third quarter, we'll start to see who's going to be surviving and who's going to be struggling, and that will probably add to the qualitative factors that we'll be looking at between Q3 and Q4.

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

We had some encouraging discussions and some good news in terms of the number of folks that have already returned to a regular payment status. But so much dependent on whether or not we remain in an open position to continue to do that.

John LaViol -- Piper Sandler -- Analyst

Thank you, gentlemen. That's all I had.

Operator

Thank you. The next question comes from Erik Zwick of Boenning and Scattergood.

Erik Zwick -- Boenning and Scattergood -- Analyst

Good morning, guys.

Leonard G. Gleason -- Senior Vice President and Investor Relations Officer

Good morning.

Erik Zwick -- Boenning and Scattergood -- Analyst

With the SB One transaction scheduled to close tomorrow, are there any updates you can share on the loan mark and then CECL assumptions you plan to record relative to the original expectations?

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

Unfortunately, Erik, we're still in a lot of the throes of that and really aren't prepared to discuss any of those assumptions at this point.

Erik Zwick -- Boenning and Scattergood -- Analyst

Okay. And then given that SB One hasn't released 2Q results at this point. And I'm assuming like most other banks, they've likely seen a buildup of liquidity during the quarter. Curious, can you just provide any expectations for what the average earning assets in 3Q will look like, kind of including the two-month contribution from SB one?

Christopher Martin -- Chairman, President and Chief Executive Officer

I think when you look at the we're talking about earning asset returns, slight...

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

Levels.

Christopher Martin -- Chairman, President and Chief Executive Officer

Yes, levels as they...

Erik Zwick -- Boenning and Scattergood -- Analyst

The balance of average earning assets.

Christopher Martin -- Chairman, President and Chief Executive Officer

Yes. I think when you look at where they were, for the first quarter and second quarter, I don't see a dramatic increase. We're looking at maybe about and commercial loan growth around 6.7%, 6.9% annualized. Their portfolio has held up fairly well. Prepayments have been not really that extreme. So we're looking forward to be kind of contiguous to what we are.

Erik Zwick -- Boenning and Scattergood -- Analyst

Okay. And then turning to the deferrals, and I'm curious about the $130 million in hotels. Can you provide a mix of those hotels in terms of use, kind of business versus leisure? And then any updates you have on current occupancy rates?

Christopher Martin -- Chairman, President and Chief Executive Officer

Well, I think of the loans that we have, that are certainly not levered in the way of loan-to-value. Certainly, the RevPAR is off on those. There are several we have a few hotels right in the Newark airport area that have struggled because obviously, business travel is down. We hope that, that will improve. But with our the Governor shutting down most of the areas that you can travel to, that will hold those off a little bit. They've been on the books for one of them is right across from the hotel, has been on the books a long, long time. So we think that they'll get through this. It will just be a longer time frame to recover.

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

It's really a mix of business and leisure portfolio. And I'd say, occupancies are averaging in the 30% to 50% range, again, pretty dispersed.

Erik Zwick -- Boenning and Scattergood -- Analyst

A pretty even mix between business and leisure then, Tom?

Christopher Martin -- Chairman, President and Chief Executive Officer

Yes. Leisure, yes.

Erik Zwick -- Boenning and Scattergood -- Analyst

Okay. Great. And then just kind of last one for me. Curious if you can talk about your strategy for dealing with the loans that at the end of the second deferment period still may need some sort of accommodation, and how you're thinking about the treatment in terms of nonaccrual or TDR accounting? And I guess, ultimately, what that might imply for risk rating changes and the calculations for the loan loss provisions?

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

So we've been risk rating loans appropriately from a level of maintaining scrutiny internally, but as it affects the risk rating or the allowance calculation, those are really captured in the economic forecast deterioration until the point when they might become impaired and they get pulled out with that individually. We are looking at the pool of second deferrals and trying to make some sense from there. I would think might go to a potential TDR, meaning that, as you indicated, they might not be able to come back to a normalized status at the end of the deferral period. Best guess, maybe $132 million that would be subject to some kind of TDR and longer-term resolution.

Erik Zwick -- Boenning and Scattergood -- Analyst

Okay. Just to make sure I understood that correctly. It seems like any potential risk rating migration you've accounted for already in the economic outlook. So even as we move into late 3Q and 4Q, you may not need big adjustments to the provision for some of those loans. Is that the right way to interpret that?

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

That's the expectation. CECL works the way it's supposed to. That's the expectation. I guess that will be back-tested further if those loans become impaired and they get individually evaluated for impairment.

Erik Zwick -- Boenning and Scattergood -- Analyst

Great, thanks for taking my questions.

Christopher Martin -- Chairman, President and Chief Executive Officer

Thank you.

Operator

Thank you. The next question is from Russell Gunther of D.A. Davidson.

Russell Gunther -- D.A. Davidson -- Analyst

Hey, good morning guys. Just a quick follow-up on the deferral question. The 5%, give or take, kind of pro forma number. Do you have a sense for what that could shake out when we fold in the SB One deal, kind of pro forma percentage deferrals to the total loans?

Christopher Martin -- Chairman, President and Chief Executive Officer

I'm just looking at, again, on official conversations in the way of they had in the first quarter or first round of, we'll call it, a pandemic assistant program to deferrals about hit about 20% of the portfolio. We're looking at removing of those, about 12%. And the second go around, we're looking at only about 2% in a second deferral. At this stage, there's still some that are in within the first deferral that they still have to evaluate. So the numbers have come down dramatically from where they were and we were also.

Russell Gunther -- D.A. Davidson -- Analyst

Okay. That's great, Chris. And then with the deal closed, anything you can share in terms of I heard you loud and clear that you expect to get all the cost saves recognized. But just remind us in terms of the timing of when you'd expect that recognition? And then any thoughts around what a good pro forma expense run rate would be when those are fully recognized?

Christopher Martin -- Chairman, President and Chief Executive Officer

Again, I think with the cost saves, we estimated 30% cost saves, though, we will exceed that. We're very comfortable. I think it was 80% of that and the balance in the following year. And that's with both companies. As we look at it, it's not just SB One, it's also ours as we look at putting two good companies together. And I think we have evaluated that and very comfortable where we are. And the deal cost, the same thing coming in slightly under what we thought. So that's those are positives going forward.

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

If you remember that the deal book, I mean, Russell, is about $13.5 million expected plus saves of SB One space, and they run at about $3.8 million a month as a run rate for their expenses. So 30% off of that.

Russell Gunther -- D.A. Davidson -- Analyst

Great, thank you both. That's it for me.

Operator

Thank you. The next question is from Steven Duong of RBC Capital Markets.

Steven Duong -- RBC Capital Markets -- Analyst

Hey, good morning guys. Can you guys just go over just like the economic activity that you're seeing with reopening, how materially have things improved in the past couple of months?

Christopher Martin -- Chairman, President and Chief Executive Officer

Well, I think first and foremost, a lot of our clients, we have when you look at retail exposure, a lot of them are anchored by grocery stores or essential businesses such as Walmarts and the pharmacies. Yes, Home Depots and Lowe's. So the anchors have been supporting some of this the other parts of those centers, we don't do large box. That said, restaurants, if they can do outdoor dining, I think everybody is getting that model in line. It's difficult to get the saturation and the number of customers you used to get, but you're seeing that doing better. I don't think it's kind of see of everything else. So hotels, I think we talk about that being difficult if nobody is traveling, everybody's in staying in place. That's not going to help if we can't open up the other areas of the United States to flowing economy. The other side would be kind of the gyms, fitness and wellness areas have been closed by the Governor. And until that opens up, those businesses will still struggle. And we hope that they're able to come back. Those are the question marks that I have. I don't know if Tom has anything else in that regard.

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

I think you covered it, Chris. Thanks.

Steven Duong -- RBC Capital Markets -- Analyst

Great. And just any idea on latest rent collection numbers from your borrowers?

Christopher Martin -- Chairman, President and Chief Executive Officer

I don't have that number at all. I'm just trying to we're just checking a couple of things real quick. Yes, for that one, Steve, we'll have to get back to you on that one.

Steven Duong -- RBC Capital Markets -- Analyst

Sure, sure. No problem. And just the BOLI picked up this quarter. Should we expect it to kind of just track back down to where it was in the prior quarter?

Christopher Martin -- Chairman, President and Chief Executive Officer

Yes. That BOLI event, there was one somebody who passed that came into the process. I think it was doing social security searches, they found out that someone who had been not with the bank for a long period of time, they had passed. So that came in this quarter. So BOLI will go back to normal. And hopefully, nobody is passing it in. So..

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

I'm sorry, on the prior question, I was able to get a little information. They're running about 90% in terms of collections on industrial and multifamily.

Steven Duong -- RBC Capital Markets -- Analyst

Okay. Great. That's good to hear. And then just last one for me. If we were to going forward, I guess, strip out the PPP impact, where do you think loan yields would kind of hover around?

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

So again, I guess the quick way to do that was PPP was about $400 million for the quarter, let's say, maybe $330 million on average, perhaps, kind of at a yield of about $235 million.

Steven Duong -- RBC Capital Markets -- Analyst

Great. All right. I appreciate the color. Thank you.

Operator

Thank you. And this concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Martin for any closing remarks.

Christopher Martin -- Chairman, President and Chief Executive Officer

Thank you very much. And as we've been experiencing, any economic recovery will not be smooth regardless of the political outcomes in November. Much of the economy is partially closed or beginning to open with supply chain issues continuing. The pace and level of restrictions imposed by our political leaders at times seems out of touch. But many industries will take years to recover. And sadly, some will never make it. But we stand ready to assist our clients in any manner that promotes growth, yet with safety, for you, our stockholders, and we appreciate your attention. Stay well and stay safe. Thank you.

Operator

[Operator Closing Remarks]

Duration: 28 minutes

Call participants:

Leonard G. Gleason -- Senior Vice President and Investor Relations Officer

Christopher Martin -- Chairman, President and Chief Executive Officer

Thomas M. Lyons -- Senior Executive Vice President and Chief Financial Officer

John LaViol -- Piper Sandler -- Analyst

Erik Zwick -- Boenning and Scattergood -- Analyst

Russell Gunther -- D.A. Davidson -- Analyst

Steven Duong -- RBC Capital Markets -- Analyst

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