Good day and welcome to the Provident Financial Services Second Quarter Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Leonard Gleason, Investor Relations Officer. Please go ahead..

Thank you, Andrea. Good morning, ladies and gentlemen. Thank you for joining us today. The presenters for our second quarter earnings call are Chris Martin, Chairman, President and CEO and Tom Lyons, 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 maybe made during the course of today’s call.

Our full disclaimer can be found in this morning’s earnings release, which has been posted to the Investor Relations page on our website provident.bank. Now, I am pleased to introduce Chris Martin who will offer his perspective on our quarter.

Chris?.

Thanks, Len and good morning, everyone. Provident’s core quarterly results were strong. We achieved record net interest income, resulting from period-over-period growth in average loans outstanding and growth of both average non-interest and interest-bearing deposits, along with expansion of the net interest margin.

Non-interest bearing deposits were up and our core deposits remain strong at 90.3% of total deposits. Our quarterly results were tempered by the charge-offs we took on two commercial loan relationships that both involve borrower fraud.

As you would expect, we are pursuing every avenue available to us to try and recover some portion of these loan losses, although it’s difficult to how successful we maybe in this regard.

We do not believe the charge-offs reflect any credit deterioration generally in our loan portfolio and on balance, asset improved with non-performers at 45 basis points of total loans as of quarter end.

While loan originations met our expectations, we experienced greater than anticipated loan payoffs as and life companies, non-bank lenders and certain overcapitalized banks continue to compete at structure or pricing levels that make little sense to us.

We maintain that while competition maybe losing their credit underwriting standards and credit structures and aggressively pricing their deals, we will continue to make loans that meet our credit on ROE hurdles and interest rate risk criteria. If our approach results in lower loan growth, we are willing to accept that.

Despite this lack of net loan growth, we still see net interest income improving as we continue to benefit from rising rates on reinvested cash flows and variable rate loans. Expenses remained well-controlled during the quarter.

We will continue to invest in our business and later this year we expect to deploy the Zelle person-to-person and improved digital account opening platform and a tech-driven small business loan product.

The pace of change in banking is rapid and we expect our management team to embrace change, deliver great customer experience and achieve operating excellence in the efficiencies through the smart deployment of technology. On the financial reporting front, we continue our preparations for the implementation of CECL.

The effects of the regulatory relief bill signed into law in the second quarter will likely not be felt for some time as regulations need to be proposed and finalized by the regulatory agencies.

The removal of DFAST stress testing will save us some money, but we still will be employing a stress testing protocol commensurate with our risk profile as part of our enterprise risk framework. The industry still has a way to go to reduce the burdens and competitive challenges of Dodd-Frank on community banks.

And we believe and we will continue to make our case in Washington as we seek more relief for banks with assets in excess of $10 billion. The general business outlook and sentiment remain positive with continued growth in GDP, which this morning came in at 4.1%. We anticipate more rate hikes in 2018 and ‘19. With that, I will turn it over to Tom..

Thank you, Chris and good morning everyone. Net income was $19.2 million for the second quarter of 2018 or $0.30 per share compared to $27.9 million or $0.43 per share for the trailing quarter.

While our earnings were adversely impacted by increased provisioning related to two loan relationships that appear to have involved borrower fraud, we did see record interest income, net interest income and revenue for the quarter.

The net interest margin expanded 3 basis points as the earning asset yield increased 8 basis points, while the cost of interest-bearing liabilities increased 6 basis points. Further helping the margin, average non interest-bearing deposits grew $44 million or an annualized 12.5%.

Our total cost of deposits increased 4 basis points to 41 basis points for the quarter.

While loan growth was again constrained by a high rate of pay-offs, net outflows on lines of credit and maintenance of credit and pricing discipline, loan originations were 10% better than in the second quarter of 2017 and the pipeline remains strong at $1.1 billion.

The pipeline rate has increased 2 basis points since last quarter to 4.67%, exceeding the loan portfolio rate of 4.26%.

Based on our strong loan pipeline, 90% core and non-interest bearing deposit funding and the variable rate nature of many of our assets, we anticipate a strengthening of economy and additional Fed rate increases will contribute to further expansion of our net interest margin throughout 2018.

As Chris discussed, we acted decisively in charged off balances related to two commercial relationships resulting in an uncharacteristically high annualized net charge-off rate of 106 basis points for the quarter compared with 17 basis points last quarter and 10 basis points for the year 2017.

Credit metrics on the remaining portfolio however were strong with nonperforming assets, delinquencies and the weighted average risk rating all improved. The allowance for loan losses to total loans decreased to 81 basis points from 86 basis points at March 31 as previously recognized specific reserves were charged-off in asset quality strengthened.

Non-interest income was consistent with the trailing quarter at $14 million, while non-interest expenses remained well controlled at an annualized 2.01% of average assets contributing to a 55% efficiency ratio for the quarter.

Expenses increased by $1.9 million to $48.8 million versus the trailing quarter primarily as a result of directors’ stock compensation, consulting and non-performing asset related costs. Our effective tax rate was consistent with the trailing quarter at 19%. We are currently projecting an effective tax rate of approximately 20% for the full year 2018.

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

[Operator Instructions] And our first question comes from Mark Fitzgibbon of Sandler O’Neill & Partners. Please go ahead..

Hey, guys. Happy Friday..

Hey, Mark..

I wondered if you could give us a little bit more color on those two other loans to the commercial borrower that you took a $4 million charge on this quarter.

Is there any residual exposure there? Was it a complete write-off and perhaps maybe what industry those credits were in?.

Well, certainly, Mark, there is very limited. Although it’s involved within the state now being the borrower passed away.

And so we are awaiting for that to be a lot of work that just came on, so we are trying to find out what’s underlying the assets and/or the liabilities that they are claiming there, they have been, I guess, little bit more than we have would have thought and I am sure that the estate is saying the same thing they did not know the liabilities over there.

We do not have anything directly. There are few other loans that this individual has involved, but there are other guarantors on other projects that are doing fine and he was not a major partner in those..

So, Mark, these two loans with $4 million, they were completely charged-off. There is no additional exposure to him directly. As Chris indicated, the borrower did pass away and that’s what kind of uncovered the difficulties of significant undisclosed liabilities as we start to work through with these states.

These were loans to a real estate developer known to personnel at the bank for a long period of time. They were around the business in an unsecured line..

Okay.

Secondly, Tom, I wondered if you could share with us your thoughts on the margin, do you think it continues to slowly grind higher?.

They do. I think we are going to see probably 2 basis points a quarter, maybe a little bit more for lucky, still got a significant asset re-pricing, we got about 24% floating rate.

So there is about $2 billion worth of loans that were priced over the next 12 months and we have done quite well in maintaining deposit pricing discipline and holding up the funding sources. So I am still looking for more expansion..

Okay.

And then I heard your guidance on the effective tax rate, but what do you think this new, New Jersey tax surcharge means for you guys or your effective tax rate going forward?.

Not a big impact for the rest of 2018.

The intercompany dividends will be taxed on – 5% of them I guess will now be taxable at the 2.5% surcharge rate, so a little bit of pickup, but still I would say within the 20% boundary we outlined for the rest of 2018, more impact for us in 2019 as you get to unitary group reporting and we lose some benefits of our REIT.

So, we could be in the 27% range next year. Early guess, we are still working through it, but that’s preliminary..

Thank you..

Our next question comes from Collyn Gilbert of KBW. Please go ahead..

Thanks. Good morning, guys.

Just one housekeeping question first, Tom, the pickup in expenses that you had said were tied to some of the NPA issues you guys had during the quarter, do you have that dollar amount, I mean, was it significant?.

Sure. The biggest contributor to the delta quarter-over-quarter was that annually we paid a portion of our directors’ stock – directors’ compensation in the form of stock, which is all expensed in the second quarter each year, so comparing Q2 for Q1 that was about an $856,000 pickup. So, that’s the biggest piece of the expense change..

Okay, that’s helpful.

And then just thinking about loan growth broadly I mean what given the dynamics that are certainly going on in the market competitively pay-downs, I know you indicated the pipeline was robust at $1.1 billion, I think it was like $3 billion last quarter, maybe some of that is just due to the seasonality, but just in general sort of how are you thinking about loan growth for the rest of the year?.

Collyn, this is Chris. We still look at the amount of originations we are doing that we are comfortable with. We certainly don’t see the success factor when we do put out a term sheet that we used to where we would be high in the 60s or 70%, it’s now like in 40% or 45% that everybody is trying to compete for growth.

On the backside of that, there are still life companies coming in and doing things at levels that we would not be able to do. We are talking – and this is just current, we have had a couple come up in the last few days, so doing deals at the 10-year treasury plus 115 and that to us is just not being 10-year fixed.

We would not be able to do that business and really feel confident. It will be growth, but growth at what level and if rates keep going up, that’s something we don’t think is prudent. Then they have interest-only periods of up to 3 years for established, old properties. So we are seeing this continue.

And in our payoffs, I think they will continue, I don’t know about the pace that they are, sooner or later, the companies the life companies will fill their buckets and they have also trafficked down into much smaller levels, where in the past, it will be $15 million to $20 million, we are seeing them in the $5 million to $7 million range..

Okay, okay. Does this dynamic cause you to rethink your asset generation strategy or do you think more about M&A? And I guess because I am asking as we kind of flow through this lower asset base now that you guys are running off of it, earnings growth is going to be, I would say, if we are modeling correctly, a lot less.

So just trying to see how you are kind of measuring or balancing growth with sticking to some of the financial targets that you have tried to achieve or just how you are thinking about it kind of more broadly strategic way?.

Sure. Well, so far, Collyn, we are making up the volume in rate. Those loans are not – we are not really dropping significantly. I guess we are basically flat for the quarter, but we have replaced with higher rate loans. So we are still getting the book enough for the production that we like to at least hold serve and pickup a little incremental yield.

Originations this quarter were actually about 10% better than they were in Q2 of ‘17. If I look at last year, we did about 38% of the full year’s production in the fourth quarter.

So, it seems that the life companies are certainly at lower levels and in for a little bit longer this year, but we remain hopeful that we are going to see production and therefore growth pickup further in the back half of the year..

Okay, that’s very helpful. I will leave it there. Thanks guys..

Thank you..

Our next question comes from Russell Gunther of Davidson. Please go ahead..

Hi, good morning guys..

Good morning, Russell..

Just a follow-up on the expense conversation, the $48.8 million this quarter was kind of towards the high end of a range we talked about on the call last quarter.

First, that $8.5 million in others is that run-rate or is there anything you would pull out of there and then second, any thoughts you could share on where 3Q is headed?.

Sure. The $8.5 million is one-time in nature, but I think it will be replaced to a degree by some ramp-up in growth-related costs, things around CECL and enhanced stress testing and some data analytic work that we are doing. So I am looking for about $48.5 million to $49 million in the third quarter as well..

Okay, great. That’s helpful.

And then circling back to the margin conversation you talked about expectations for rising rates alongside your NIM expansion guide, what are you guys kind of modeling in for the back half of this year in terms of Fed Fund increases and that any thoughts on ‘19?.

I think we just had September in it at this point..

Right. We used to have September and December, Russell. And now we are looking at just September, I think that the Fed does not want to invert the curve artificially.

They certainly are dealing doing with a bunch of things with unwinding that huge balance sheet, which they are only doing through amortization of the – and the reduction of the current flow.

I think that we are going to be continuing to think that they will probably come back in the first half of 2019 with some more if they see growth continue to accelerate..

Okay.

And then thanks for that last for me, just an update on the CD promo that you guys are running at 13-month success with that and whether you would expect it to continue?.

That was quite good actually. We pulled in about $73 million. Obviously, it’s trailed off. We haven’t been actively promoting that any further, that was a targeted marketing effort to non-customers, but it’s done quite well for us. We may do more of that type of an effort in the back half of the year. I would expect to see that.

Overnight funding is up about [Technical Difficulty] so there is significant spread between wholesale funding and some of the CD rates that we can offer..

Yes, that makes sense. Okay, great. That’s it for me. Thank you both..

You’re welcome..

Our next question comes from Matthew Breese of Piper Jaffray. Please go ahead..

Good morning, everybody. Just a couple of quick ones.

If loan growth is going to remain sluggish for this year, might we see a change in strategy on the securities portfolio?.

I wouldn’t expect to see anything dramatic and we have always managed the securities portfolio for liquidity and cash flows, which is why we are seeing some pickup in terms of reinvestment, but I wouldn’t expect the dramatic expansion just given the flatness of the curve..

Okay.

And then on the tax rate, I think you said 27% for next year, is that accurate and does that carry through to 2021?.

That is an early look and I believe that would be the going forward kind of run-rate, yes, ‘19 and forward..

Okay, understood. Alright, that’s all I had. Thank you..

Thank you..

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Christopher Martin for any closing remarks..

Well, again we thank you for being on the call. We are very pleased that our Board increased the cash dividend, showing the confidence in the company on a go forward basis and we hope you enjoy the balance of the summer. Thank you very much..

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect..