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PFS > SEC Filings for PFS > Form 10-Q on 8-Nov-2013All Recent SEC Filings

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Form 10-Q for PROVIDENT FINANCIAL SERVICES INC


8-Nov-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Forward Looking Statements
Certain statements contained herein are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "estimate," "anticipate," "continue," or similar terms or variations on those terms, or the negative of those terms. Forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset-liability management, the financial and securities markets and the availability of and costs associated with sources of liquidity.
The Company cautions readers not to place undue reliance on any such forward-looking statements which speak only as of the date made. The Company also advises readers that the factors listed above could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. The Company does not have an obligation to update any such statements to reflect any subsequent events or circumstances after the date of this statement. Critical Accounting Policies
The Company considers certain accounting policies to be critically important to the fair presentation of its financial condition and results of operations. These policies require management to make complex judgments on matters which by their nature have elements of uncertainty. The sensitivity of the Company's consolidated financial statements to these critical accounting policies, and the assumptions and estimates applied, could have a significant impact on its financial condition and results of operations. These assumptions, estimates and judgments made by management can be influenced by a number of factors, including the general economic environment. The Company has identified the following as critical accounting policies:
Adequacy of the allowance for loan losses

Goodwill valuation and analysis for impairment

Valuation of securities available for sale and impairment analysis

Valuation of deferred tax assets

The calculation of the allowance for loan losses is a critical accounting policy of the Company. The allowance for loan losses is a valuation account that reflects management's evaluation of the probable losses in the loan portfolio. The Company maintains the allowance for loan losses through provisions for loan losses that are charged to income. Charge-offs against the allowance for loan losses are taken on loans where management determines that the collection of loan principal is unlikely. Recoveries made on loans that have been charged-off are credited to the allowance for loan losses.
The Company's evaluation of the adequacy of the allowance for loan losses includes a review of all loans on which the collectibility of principal may not be reasonably assured. For residential mortgage and consumer loans, this is determined primarily by delinquency and collateral values. For commercial real estate and commercial loans, an extensive review of financial performance, payment history and collateral values is conducted on a quarterly basis. As part of the evaluation of the adequacy of the allowance for loan losses, each quarter management prepares an analysis that categorizes the entire loan portfolio by certain risk characteristics such as loan type (residential mortgage, commercial mortgage, construction, commercial, etc.) and loan risk rating.
When assigning a risk rating to a loan, management utilizes a nine point internal risk rating system. Loans deemed to be "acceptable quality" are rated 1 through 4, with a rating of 1 established for loans with minimal risk. Loans deemed to be of "questionable quality" are rated 5 (watch) or 6 (special mention). Loans with adverse classifications (substandard, doubtful or loss) are rated 7, 8 or 9, respectively. Commercial mortgage, commercial and construction loans are rated individually and each lending officer is responsible for risk rating loans in their portfolio. These risk ratings are then reviewed by the department manager and/or the Chief Lending Officer and the Credit Administration Department. The risk ratings are also confirmed through periodic loan review examinations, which are currently performed by an independent third party and periodically, by the Credit Committee in the credit renewal or approval process.


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Management assigns general valuation allowance ("GVA") percentages to each risk rating category for use in allocating the allowance for loan losses, giving consideration to historical loss experience by loan type and other qualitative or environmental factors such as trends and levels of delinquencies, impaired loans, charge-offs, recoveries, loan volume, as well as, the national and local economic trends and conditions. The appropriateness of these percentages is evaluated by management at least once each calendar year and monitored on a quarterly basis, with changes made when they are required. In the second quarter of 2013, management completed its most recent evaluation of the GVA percentages. As a result of that evaluation, GVA percentages for the multi-family loan portfolio were disaggregated from the commercial real estate portfolio, as the portfolio has increased significantly over the last several years and its risk profile has become more differentiated. Other GVA percentages were updated, where appropriate, based upon the current analysis of historical loss experience.
Management believes the primary risks inherent in the portfolio are a continued decline in the economy, generally a decline in real estate market values, rising unemployment or a protracted period of unemployment at current elevated levels, increasing vacancy rates in commercial investment properties and possible increases in interest rates in the absence of economic improvement. Any one or a combination of these events may adversely affect borrowers' ability to repay the loans, resulting in increased delinquencies, loan losses and future levels of provisions. Accordingly, the Company has provided for loan losses at the current level to address the current risk in its loan portfolio. Management considers it important to maintain the ratio of the allowance for loan losses to total loans at an acceptable level given current economic conditions, interest rates and the composition of the portfolio.
Although management believes that the Company has established and maintained the allowance for loan losses at appropriate levels, additions may be necessary if future economic and other conditions differ substantially from the current operating environment. Management evaluates its estimates and assumptions on an ongoing basis giving consideration to historical experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. Such estimates and assumptions are adjusted when facts and circumstances dictate. Illiquid credit markets, volatile securities markets, and declines in the housing and commercial real estate markets and the economy generally have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods. In addition, various regulatory agencies periodically review the adequacy of the Company's allowance for loan losses as an integral part of their examination process. Such agencies may require the Company to recognize additions to the allowance or additional write-downs based on their judgments about information available to them at the time of their examination. Although management uses the best information available, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short-term change.
The Company evaluates goodwill for impairment on an annual basis, or more frequently if events or changes in circumstances indicate potential impairment between annual measurement dates. The Company qualitatively determines whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount before performing Step 1 of the goodwill impairment test. If an entity concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the entity would be required to perform Step 1 of the assessment and then, if needed, Step 2 to determine whether goodwill is impaired. However, if it is more likely than not that the fair value of the reporting unit is more than its carrying amount, the entity does not need to apply the two-step impairment test. For this analysis, the Reporting Unit is defined as the Bank, which includes all core and retail banking operations of the Company but excludes the assets, liabilities, equity, earnings and operations held exclusively at the Company level. The guidance provides certain factors an entity should consider in its qualitative assessment in determining whether it is more likely than not that a reporting unit's fair value is less than its carrying amount. The factors include:
Macroeconomic conditions, such as deterioration in economic condition and limited access to capital.

Industry and market considerations, such as increased competition, regulatory developments and decline in market-dependent multiples.

Cost factors, such as increased labor costs, cost of materials and other operating costs.

Overall financial performance, such as declining cash flows and decline in revenue or earnings.

Other relevant entity-specific events, such as changes in management, strategy or customers, litigation and contemplation of bankruptcy.

Reporting unit events, such as selling or disposing a portion of a reporting unit and a change in composition of assets.

The Company may, based upon its qualitative assessment, or at its option, perform the two-step process to evaluate the potential impairment of goodwill. If, based upon Step 1, the fair value of the Reporting Unit exceeds its carrying amount, goodwill of the


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Reporting Unit is considered not impaired. However, if the carrying amount of the Reporting Unit exceeds its fair value, an additional test must be performed. The second step test compares the implied fair value of the Reporting Unit's goodwill with the carrying amount of that goodwill. An impairment loss would be recorded to the extent that the carrying amount of goodwill exceeds its implied fair value.
At September 30, 2013, the carrying value of goodwill was $352.6 million. The Company completed its annual goodwill impairment test as of September 30, 2013. Based upon its qualitative assessment of goodwill, the Company concluded it was more likely than not that the fair value of the reporting unit exceeded its carrying amount, goodwill was not impaired and no further quantitative analysis (Step 1) was warranted.
The Company's available for sale securities portfolio is carried at estimated fair value, with any unrealized gains or losses, net of taxes, reported as accumulated other comprehensive income or loss in Stockholders' Equity. Estimated fair values are based on market quotations or matrix pricing as discussed in Note 7 to the consolidated financial statements. Securities which the Company has the positive intent and ability to hold to maturity are classified as held to maturity and carried at amortized cost. The Company conducts a periodic review and evaluation of the securities portfolio to determine if any declines in the fair values of securities are other-than-temporary. In this evaluation, if such a decline were deemed other-than-temporary, the Company would measure the total credit-related component of the unrealized loss, and recognize that portion of the loss as a charge to current period earnings. The remaining portion of the unrealized loss would be recognized as an adjustment to accumulated other comprehensive income. The fair value of the securities portfolio is significantly affected by changes in interest rates. In general, as interest rates rise, the fair value of fixed-rate securities decreases and as interest rates fall, the fair value of fixed-rate securities increases. Turmoil in the credit markets resulted in a lack of liquidity in certain sectors of the mortgage-backed securities market. Increases in delinquencies and foreclosures have resulted in limited trading activity and significant price declines, regardless of favorable movements in interest rates. The Company determines if it has the intent to sell these securities or if it is more likely than not that the Company would be required to sell the securities before the anticipated recovery. If either exists, the decline in value is considered other-than-temporary. In this evaluation, the Company did not recognize an other-than-temporary impairment charge on securities for the three and nine months ended September 30, 2013 or 2012, respectively.
The determination of whether deferred tax assets will be realizable is predicated on the reversal of existing deferred tax liabilities, utilization against carryback years and estimates of future taxable income. Such estimates are subject to management's judgment. A valuation allowance is established when management is unable to conclude that it is more likely than not that it will realize deferred tax assets based on the nature and timing of these items. At September 30, 2013, the Company maintained a valuation allowance of $242,000, related to unused capital loss carryforwards.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2013 AND DECEMBER 31, 2012 Total assets increased $57.3 million to $7.34 billion at September 30, 2013, from $7.28 billion at December 31, 2012, primarily due to increases in total loans, partially offset by a decrease in total investments.
Total loans increased $178.4 million, or 3.6%, to $5.08 billion at September 30, 2013, from $4.90 billion at December 31, 2012. Loan originations totaled $1.3 billion and loan purchases totaled $22.0 million for the nine months ended September 30, 2013. The loan portfolio had net increases of $136.0 million in multi-family mortgage loans, $70.4 million in construction loans, predominately multi-family apartment projects, $25.4 million in commercial mortgage loans, and $25.1 million in commercial loans, which were partially offset by net decreases of $72.3 million and $4.5 million in residential mortgage and consumer loans, respectively. Loan growth was tempered somewhat by the repayment of $17.3 million on two shared national credits during the nine months ended September 30, 2013. Commercial real estate, commercial and construction loans represented 65.2% of the loan portfolio at September 30, 2013, compared to 62.4% at December 31, 2012.
The Company does not originate or purchase sub-prime or option ARM loans. Prior to September 30, 2008, the Company originated "Alt-A" mortgages in the form of stated income loans with a maximum loan-to-value ratio of 50% on a limited basis. The balance of these "Alt-A" loans at September 30, 2013 was $7.6 million. Of this total, 4 loans totaling $387,129 were 90 days or more delinquent. General valuation reserves of 6.5%, or $25,163, were allocated to such loans which were 90 days or more delinquent at September 30, 2013. The Company participates in loans originated by other banks, including participations designated as Shared National Credits ("SNCs"). The Company's gross commitments and outstanding balances as a participant in SNCs were $60.1 million and $40.4 million, respectively, at September 30, 2013. No SNCs were 90 days or more delinquent at September 30, 2013.
The Company had outstanding junior lien mortgages totaling $229.4 million at September 30, 2013. Of this total, 31 loans totaling $2.2 million were 90 days or more delinquent. General valuation reserves of 10%, or $223,000, were allocated to such loans which were 90 days or more delinquent at September 30, 2013.


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At September 30, 2013, the Company had outstanding indirect marine loans totaling $34.9 million. No indirect marine loans were 90 days or more delinquent at September 30, 2013. Marine loans are currently made only on a direct, limited accommodation basis to existing customers.
The following table sets forth information regarding the Company's non-performing assets as of September 30, 2013 and December 31, 2012 (in thousands):

                              September 30, 2013     December 31, 2012
Mortgage loans:
Residential                  $             22,729               29,293
Commercial                                 26,921               29,072
Multi-family                                  412                  412
Construction                                8,561                8,896
Total mortgage loans                       58,623               67,673
Commercial loans                           19,573               25,467
Consumer loans                              3,388                5,850
Total non-performing loans                 81,584               98,990
Foreclosed assets                           7,282               12,473
Total non-performing assets  $             88,866              111,463

The following table sets forth information regarding the Company's 60-89 day delinquent loans as of September 30, 2013 and December 31, 2012 (in thousands):

                                    September 30, 2013    December 31, 2012
Mortgage loans:
Residential                        $             5,248               11,986
Commercial                                         318               12,194
Total mortgage loans                             5,566               24,180
Commercial loans                                    36                   70
Consumer loans                                   1,628                1,808
Total 60-89 day delinquent loans   $             7,230               26,058

At September 30, 2013, the allowance for loan losses totaled $66.0 million, or 1.30% of total loans, compared with $70.3 million, or 1.43% of total loans at December 31, 2012. Total non-performing loans were $81.6 million, or 1.60% of total loans at September 30, 2013, compared to $99.0 million, or 2.02% of total loans at December 31, 2012. The $17.4 million decrease in non-performing loans consisted of a $6.6 million decrease in non-performing residential loans, a $5.9 million decrease in non-performing commercial loans, a $2.5 million decrease in non-performing consumer loans, a $2.2 million decrease in non-performing commercial mortgage loans and a $336,000 decrease in non-performing construction loans.
At September 30, 2013, the Company held $7.3 million of foreclosed assets, compared with $12.5 million at December 31, 2012. The decrease was largely attributable to the completed sale of a $5.5 million improved land parcel during the quarter ended September 30, 2013. Foreclosed assets at September 30, 2013, consisted of $5.2 million of residential real estate, $2.0 million of commercial real estate and $65,000 of marine vessels.
Non-performing assets totaled $88.9 million, or 1.21% of total assets at September 30, 2013, compared to $111.5 million, or 1.53% of total assets at December 31, 2012.
Total investments decreased $106.6 million, or 6.4%, to $1.55 billion at September 30, 2013, from $1.66 billion at December 31, 2012, largely due to principal repayments on mortgage-backed securities, maturities of municipal and agency bonds, and the sale of certain mortgage-backed securities which had a heightened risk of prepayment, partially offset by purchases of mortgage-backed and municipal securities.
Cash and cash equivalents decreased $8.5 million to $95.3 million at September 30, 2013, from $103.8 million at December 31, 2012. The decline in cash was attributable to a decrease in total deposits and an increase in total loans, partially offset by an increase in total borrowings and a decrease in total investments.
Total deposits decreased $172.6 million, or 3.2%, during the nine months ended September 30, 2013 to $5.26 billion. Core deposits, which consist of savings and demand deposit accounts, decreased $61.0 million, or 1.4%, to $4.41 billion at September 30, 2013.


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Much of the core deposit decrease was in government money market deposits, largely related to the cyclical outflow of municipal deposits. It also included certain anticipated outflows resulting from customer tax planning considerations earlier in the year. Time deposits decreased $111.6 million, or 11.7%, to $845.9 million at September 30, 2013, with the majority of the decrease occurring in the 9-, 12- and 60-month maturity categories. Core deposits represented 83.9% of total deposits at September 30, 2013, compared to 82.4% at December 31, 2012. Borrowed funds increased $213.2 million, or 26.5% during the nine months ended September 30, 2013, to $1.02 billion, as longer-term wholesale funding was added to mitigate interest rate risk, and shorter-term wholesale funding was used to manage the cyclical outflow of municipal deposits. Borrowed funds represented 13.8% of total assets at September 30, 2013, an increase from 11.0% at December 31, 2012.

Stockholders' equity increased $15.4 million, or 1.6% during the nine months ended September 30, 2013, to $996.7 million, due to net income earned for the period, partially offset by dividends paid to stockholders, common stock repurchases and a decline in unrealized gains on securities available for sale. Common stock repurchases for the nine months ended September 30, 2013 totaled 397,483 shares at an average cost of $14.80 per share. At September 30, 2013, 3.7 million shares remained eligible for repurchase under the current stock repurchase program authorized by the Company's Board of Directors. At September 30, 2013, book value per share and tangible book value per share were $16.64 and $10.69, respectively, compared with $16.37 and $10.40, respectively, at December 31, 2012.
Liquidity and Capital Resources. Liquidity refers to the Company's ability to generate adequate amounts of cash to meet financial obligations to its depositors, to fund loans and securities purchases, deposit outflows and operating expenses. Sources of funds include scheduled amortization of loans, loan prepayments, scheduled maturities of investments, cash flows from mortgage-backed securities and the ability to borrow funds from the FHLB-NY and approved broker-dealers.
Cash flows from loan payments and maturing investment securities are fairly predictable sources of funds. Changes in interest rates, local economic conditions and the competitive marketplace can influence loan prepayments, prepayments on mortgage-backed securities and deposit flows.
As of September 30, 2013, the Bank and the Company exceeded all current minimum regulatory capital requirements as follows:

                                                 September 30, 2013
                                          Required                Actual
                                       Amount     Ratio      Amount      Ratio
                                               (Dollars in thousands)
Bank:
Regulatory Tier 1 leverage capital   $ 275,767    4.00 %   $ 571,452     8.29 %
Tier 1 risk-based capital              198,871    4.00       571,452    11.49
Total risk-based capital               397,741    8.00       633,647    12.74

Company:
Regulatory Tier 1 leverage capital     275,767    4.00       646,988     9.38
Tier 1 risk-based capital              198,849    4.00       646,988    13.01
Total risk-based capital               397,697    8.00       709,176    14.27

In July 2013, the Federal Deposit Insurance Corporation and the other federal bank regulatory agencies issued a final rule that will revise their leverage and risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain "available-for-sale" securities holdings to be included for purposes of calculating regulatory capital unless a one-time opt-out is exercised. Additional constraints will also be imposed on the inclusion in regulatory capital of mortgage-servicing assets, defined tax assets and minority interests. The rule limits a banking organization's capital distributions and certain discretionary bonus payments if the banking organization does not hold a "capital conservation buffer" consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The final rule becomes effective for the Bank on January 1, 2015. The capital conservation buffer


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requirement will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer requirement will be effective.
COMPARISON OF OPERATING RESULTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
General. The Company reported net income of $16.1 million, or $0.28 per basic and diluted share for the three months ended September 30, 2013, compared to net income of $16.2 million, or $0.28 per basic and diluted share for the three months ended September 30, 2012. For the nine months ended September 30, 2013, the Company reported net income of $53.1 million, or $0.93 per basic and diluted share, compared to net income of $50.6 million, or $0.89 per basic and diluted share for the same period last year.
Earnings for the three and nine months ended September 30, 2013 were adversely impacted by the write-off of a deferred tax asset related to non-qualified stock options issued shortly after the Company's 2003 initial public offering. Those options expired unused in July 2013 and the related $3.9 million deferred tax asset was written-off via a $3.2 million charge to income tax expense and a $735,000 charge to equity. Conversely, earnings for the three and nine months ended September 30, 2013 were aided by a continued improvement in asset quality and a related reduction in the provision for loan losses compared with the same periods last year. Year-over-year growth in both average loans outstanding and . . .

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