Thursday, May 12 2022

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The topline of Provident Financial Services, Inc. (NYSE: NYSE: SPF) is expected to grow strongly this year amid rising interest rates and an economic recovery. On the other hand, the normalization of provisions is likely to drag net income. Overall, I expect Provident Financial to declare its earnings of $1.91 per share in 2022, down 13% year over year. Compared to my last report on PSF, I have revised my earnings estimate for 2022 upwards due to an upward revision of the net interest margin and a downward revision of the provisions. The year-end target price suggests a decent upside from the current market price. Accordingly, I maintain a Buy rating on Provident Financial Services.

Low-single-digit loan growth likely

Provident Financial’s loan growth exceeded my expectations in the last quarter of 2021, with the result that the loan portfolio declined by 2% for the full year. In the last conference call, management was quite confident about loan growth in 2022. MManagement was also confident in the rebuilding of its pipeline due to the increased number of deals passing through its deal screening committees. Overall, management believes loan growth of 5% to 6% is easily achievable.

In my view, management is being overly bullish as historically loan growth has been well below the aforementioned 2022 target. Additionally, Provident Financial’s operating markets are lagging the rest of the country. in terms of labor market performance. Provident Financial operates in New Jersey, New York and Pennsylvania, all of which had unemployment rates below the national average in March 2022.

Chart
Data by YCharts

However, economic growth in the three states has been quite impressive during the fourth quarter of 2022. According to official sources, New Jersey recorded GDP growth of 7.4%, New York recorded GDP growth of 4.8% and Pennsylvania recorded GDP growth of 6.4% for the last quarter of 2021.

Given these factors, I expect the loan portfolio to grow by 3% by the end of 2022 compared to the end of 2021. Meanwhile, I expect the other elements of the balance sheet increase more or less in line with the loans. The following table shows my balance sheet estimates.

EX17 EX18 FY19 FY20 FY21 FY22E
Financial situation
Net loans 7,266 7,195 7,277 9,721 9,501 9,789
Net loan growth 4.7% (1.0)% 1.1% 33.6% (2.3)% 3.0%
Other productive assets 1,567 1,600 1,487 1,745 2,736 2,819
Deposits 6,714 6,830 7,103 9,838 11,234 11,575
Loans and sub-debts 1,743 1,442 1,125 1,210 671 692
Common equity 1,299 1,359 1,414 1,620 1,697 1,770
Book value per share ($) 20.1 20.9 21.8 21.1 22.2 23.1
Tangible BVPS ($) 13.6 14.5 15.1 15.0 16.1 17.1

Source: SEC Filings, Author’s Estimates

(In millions of dollars, unless otherwise indicated)

Fixed deposit costs to help margin grow in a rising interest rate environment

Provident Financial’s net interest income is moderately sensitive to changes in interest rates. This sensitivity is largely attributable to the costs of sticky deposits. As mentioned on the conference call, the weighted average deposit beta is only 23%. This means that a 100 basis point increase in interest rates can only increase the average cost of deposits by 23 basis points.

Management’s interest rate sensitivity analysis shows that a 200 basis point increase in interest rates can increase net interest income by 4.1% year-over-year. The following table from the 10-K filing gives the results of the interest rate sensitivity analysis.

Interest Rate Sensitivity Provident Financial

Filing 10-K 2021

The above analysis is based on the December 2021 balance sheet. I believe Provident Financial has the opportunity to further improve its balance sheet positioning this year. Provident Financial nearly doubled its short-term investments last year, giving the company liquidity to quickly adjust to rate changes.

Given these factors, I expect the net interest margin to increase by 12 basis points in 2022. In my last report on Provident Financial, I estimated the margin to be virtually unchanged this year. I have revised my margin forecast upwards due to economic releases which now favor a more hawkish monetary policy.

Better-than-expected credit performance requires revised estimates

Provident Financial’s credit performance surprised me in the fourth quarter of 2021. Overall, for the full year of 2021, Provident Financial’s portfolio performed much better than I had expected. , with the result that the company reported a net provision reversal of $24 million for 2021, compared to my expectation of $10 million given in my last PFS report.

Due to the better than expected performance, I have decided to revise down my estimate of the net provision expense for 2022. Previously, I expected a net provision expense of $32 million for this year, whereas now I expect a net provision charge of only $20 million. The updated estimate of provisioning expense represents 0.20% of average loans in 2022. In comparison, the ratio of provisioning expense to total loans also averaged 0.20% from 2017 to 2019.

Upward revision of my earnings estimate for 2022

Due to the upward revision of the margin estimate and the downward revision of the provision expense estimate, I have revised upward my earnings estimate for 2022. I expect what Provident Financial is reporting earnings of $1.91 per share this year, compared to my previous estimate of $1.70 per share.

Earnings for 2022 are likely to fall 13% year-over-year as provision charges trend towards a more normal level this year after a year of increased provision reversals. The following table shows my income statement estimates.

EX17 EX18 FY19 FY20 FY21 FY22E
income statement
Net interest income 278 301 298 313 366 391
Allowance for loan losses 6 24 13 30 (24) 20
Non-interest income 56 59 64 72 87 85
Non-interest charges 188 192 202 228 250 261
Net income – Common Sh. 94 118 113 97 168 146
BPA – Diluted ($) 1.45 1.82 1.74 1.39 2.19 1.91

Source: SEC filings, earnings releases, author’s estimates

(In millions of dollars, unless otherwise indicated)

Actual earnings may differ materially from estimates due to the risks and uncertainties associated with the COVID-19 pandemic and the timing and magnitude of interest rate increases.

Maintaining a Buy rating due to an impressive expected total return

Provident Financial offers a dividend yield of 4.3% at the current quarterly dividend rate of $0.24 per share. Earnings and dividend estimates suggest a payout ratio of 50% for 2022, which is close to the five-year average of 56%. Therefore, the earnings outlook poses no threat to the dividend payout.

I use historical price/book tangible (“P/TB”) and price/earnings (“P/E”) multiples to value Provident Financial. The stock has traded at an average P/TB ratio of 1.48 in the past, as shown below.

EX18 FY19 FY20 FY21 Medium
T. Book value per share ($) 14.5 15.1 15.0 16.1
Average market price ($) 25.9 25.1 15.6 22.8
Historical P/TB 1.79x 1.66x 1.04x 1.42x 1.48x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/TB multiple by the expected tangible book value per share of $17.10 yields a target price of $25.20 for the end of 2022. This price target implies an upside of 13.6% compared to the April 14 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

Multiple P/TB 1.28x 1.38x 1.48x 1.58x 1.68x
TBVPS – Dec 2022 ($) 17.1 17.1 17.1 17.1 17.1
Target price ($) 21.8 23.5 25.2 26.9 28.6
Market price ($) 22.2 22.2 22.2 22.2 22.2
Up/(down) (1.8)% 5.9% 13.6% 21.3% 29.0%
Source: Author’s estimates

The stock has traded at an average P/E ratio of around 12.6x in the past, as shown below.

EX18 FY19 FY20 FY21 Medium
Earnings per share ($) 1.82 1.74 1.39 2.19
Average market price ($) 25.9 25.1 15.6 22.8
Historical PER 14.3x 14.4x 11.2x 10.4x 12.6x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple with the expected earnings per share of $1.91 yields a target price of $24.00 for the end of 2022. This price target implies an upside of 8.1% over at the April 14 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

Multiple P/E 10.6x 11.6x 12.6x 13.6x 14.6x
EPS – 2022 ($) 1.91 1.91 1.91 1.91 1.91
Target price ($) 20.2 22.1 24.0 25.9 27.8
Market price ($) 22.2 22.2 22.2 22.2 22.2
Up/(down) (9.1)% (0.5)% 8.1% 16.7% 25.3%
Source: Author’s estimates

Equal weighting of target prices from both valuation methods gives a combined result target price of $24.60, implying a 10.9% upside from the current market price. Adding the forward dividend yield gives an expected total return of 15.2%. Therefore, I maintain a buy rating on Provident Financial Services.

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