PFS - Provident Financial: Higher Provisioning Likely To Undermine Strong Topline Growth

• The loan portfolio will likely continue to grow thanks to strong regional job markets.
• The topline is only moderately sensitive to interest rate changes due to the large balance of savings, money market, and NOW deposits.
• Higher provisioning is likely following the change in Moody's economic outlook.
• The December 2022 target price suggests a small upside from the current market price. Further, PFS is offering a good dividend yield for a bank-holding company.

Earnings of Provident Financial Services Inc. ( PFS ) will most probably dip this year on the back of higher provisioning for expected loan losses amid a heightened interest-rate environment. On the other hand, decent loan growth and slight margin expansion will likely support the bottom line. Overall, I'm expecting Provident Financial to report earnings of $2.04 per share for 2022, down 7% year-over-year. The year-end target price suggests a small upside from the current market price. Based on the total expected return, I'm maintaining a buy rating on Provident Financial Services.

Pipelines, Strong Job Markets Signal a Continuation of Loan Growth

The management mentioned in the first quarter's conference call that its pipelines remained healthy at around $1.4 billion at the end of the first quarter. Therefore, it's safe to assume that loan growth must've remained robust during the second quarter. To put the pipeline amount in perspective, $1.4 billion is 14% of the loans outstanding at the end of March.

The management was positive about maintaining strong loan growth throughout 2022, as mentioned in the conference call. Given the strong regional job markets, the management's target appears achievable. Provident Financial operates in New York, New Jersey, and Pennsylvania. All three states have worse job markets than the national average, but they're still doing extremely well from a historical perspective.

However, the anticipated interest rate trend is likely to drag down loan growth. The Federal Reserve projects interest rates to peak later this year or next year. As a result, customers whose borrowing requirements are not time sensitive may want to postpone their borrowing plans till late next year.

Overall, I'm expecting the loan portfolio to grow by 2.3% in the last nine months of 2022 leading to full-year loan growth of 3.2%. Meanwhile, other balance sheet items will likely grow more or less in line with loans for the last nine months of 2022. The following table shows my balance sheet estimates.

In my last report on Provident Financial, I estimated earnings of $1.91 per share for 2022. I have increased my earnings estimate because I've tweaked all income statement line items a little bit. The variance in the earnings estimates is not attributable to any main factor.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to inflation, and consequently the timing and magnitude of interest rate hikes. Further, the threat of a recession can increase the provisioning for expected loan losses beyond my expectation. The new Omicron subvariant also bears monitoring.

Maintaining a Buy Rating Due to Decent Total Expected Return

Provident Financial is offering a dividend yield of 4.1% at the current quarterly dividend rate of $0.24 per share. The earnings and dividend estimates suggest a payout ratio of 47% for 2022, which is below the five-year average of 56%. Despite the room for a dividend hike, I haven't incorporated any dividend change in my investment thesis to stay on the safe side.

I'm using the historical price-to-tangible book ("P/TB") and price-to-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.

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

Equally weighting the target prices from the two valuation methods gives a combined target price of $24.7 , which implies a 6.3% upside from the current market price. Adding the forward dividend yield gives a total expected return of 10.5%. Hence, I'm maintaining a buy rating on Provident Financial Services.

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