Prudential Bancorp, Inc. (FULT) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Fulton Financial Transactional Call. [Operator Instructions] Please be advised today's conference may be recorded. [Operator Instructions] I'd now like to hand the conference over to your host today, Matt Jozwiak, Director of Investor Relations. Please go ahead.

Good morning, and thanks for joining today's call to discuss Fulton's merger with Prudential Bancorp. Your host for today's conference call will be Phil Wenger, Chairman and Chief Executive Officer. Joining Phil are Curt Myers, President and Chief Operating Officer; and Mark McCollom, Chief Financial Officer. Our comments today will refer to the press release and related slide presentation included with our transaction announcement, which we released before the market opened this morning. The documents can be found on our website at fult.com by clicking on Investor Relations and then on News. The slides can also be found on the Presentations tab under Investor Relations. On this call, representatives of Fulton may make forward-looking statements with respect to Fulton's financial condition, results of operations and business. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, and actual results could differ materially. Please refer to the safe harbor statement on forward-looking statements in our press release and on Slides 2 and 3 of today's presentation for additional information regarding these risks, uncertainties and other factors. Fulton undertakes no obligation, other than as required by law, to update or revise any forward-looking statements. Now I'd like to turn the call over to your host, Phil Wenger.

Thanks, Matt. And let me offer my thanks to everyone for joining us on the call today. And I'll begin with some thoughts on the strategic rationale of today's announcement, and then turn it over to Curt Myers to review the business opportunities this merger creates, and then Mark McCollom will step through the financial details of the transaction. Before we go through a brief review of the transaction and transaction terms, I want to personally thank Dennis Pollack, Prudential's President and Chief Operating Officer, and other Prudential leaders for working with us. It's been a pleasure, and we look forward to partnering together on this important transaction. Fulton has identified Philadelphia as a strategically important market and has invested in building a presence there by opening 4 financial centers and a loan office in and around the city. We've also been fortunate to attract many talented employees in this market with significant financial services expertise to join our team in recent years. In addition to organic growth, Fulton recognized the need to identify acquisition opportunities that meet our strategic objectives. The acquisition of Prudential represents an opportunity to continue to grow our Philadelphia presence, expand on what we have already built and introduce a new customer base to our products and services. We're very excited about this opportunity and are looking forward to growing our Philadelphia market. As we've outlined on Page 4 of our materials, let me step through some transaction highlights. This acquisition enhances our presence in highly attractive and strategically important Philadelphia market. It is financially compelling and achieves all of our publicly stated financial metrics for M&A. It presents opportunities to optimize their balance sheet and leverage our product suite and delivery channels and further penetrate a market we view as a growth market. And it has lower integration risk due to its relative size and -- in an extensive due diligence that was performed. So now I'll turn the call over to Curt Myers to discuss the business opportunities we see with this transaction.

Well, thanks, Phil. And as you can see on Page 5, this fits into the heart of our franchise. It adds meaningfully to the existing balance sheet that we have in the Philadelphia market and accelerates our current Philly market initiative. Turning to Page 6. Prudential has a loan portfolio that fits well with ours, with an emphasis on commercial real estate, construction lending, small business lending, along with residential mortgage lending as well. Loan yields are strong and asset quality has been benign. The deposit portfolio, in total, has a higher cost than our existing deposit base and presents an opportunity to price deposits lower as CDs mature. When stripping out the wholesale component of Prudential's funding, there is a low-cost, long-tenured core deposit base that we really like. Turning to Page 7. As Phil noted earlier, this acquisition presents the ability to accelerate our growth in the Philadelphia market and expand our current market presence. Specifically, we've opened 4 financial centers since 2019 and have 1 new location planned for early '23. In addition to our financial centers, we have 21 team members, primarily focused on serving and growing our commercial customer base in that market. Before this transaction, we had $500 million in loans and $140 million in deposits in the Philadelphia market. So you can see that this transaction will double our lending presence and expand our deposit base fivefold in Philadelphia, a compelling acceleration of our current strategy in this key market of Philadelphia. Now I'll turn the call over to Mark to step through the financial metrics of the transaction.

Great. Thanks, Curt. So going to Page 8 and looking at the transaction terms and the financial impact. This is a $142 million transaction. It has an 80-20 stock-cash mix, with a fixed exchange ratio of 0.7974 shares and $3.65 of cash. We've assumed 45% cost savings, which we feel confident in achieving after an extensive due diligence of the company. The onetime costs are $16.5 million, and that includes normal items, one would expect, including contracts, professional fees and severance. It also includes a $2 million contribution to the Fulton Forward Foundation to advance economic empowerment in the Philadelphia market. Our credit mark is 1.86% and is based off of extensive loan level due diligence we performed. The other mark-to-market adjustments largely offset one another. And the net earnings impact of the accretable yield and the purchase accounting marks is less than $0.01 per share in 2023 and about 1 basis point to net interest margin. The deal produces earnings accretion of 3.5% in 2023. The initial tangible book value dilution is roughly one half of 1%, and the earn-back is 1.2 years using the cross-over method. The deal was neutral to capital ratios due to a low price to tangible book and also at Prudential's existing capital levels. We plan on filing our merger applications as soon as possible and would hope to receive all approvals for the transaction in the third quarter of 2022. Moving to Page 9. As this slide shows that when comparing this transaction to similar deals, we think all relevant metrics stack up attractively. At the bottom of the page, we compare the economics of this deal to a share repurchase for the cash portion of the deal, which is roughly $30 million. And again, we believe the economics are compelling. Page 10 highlights our due diligence process, which included over 40 professionals from Fulton, over 8 different work streams. This level of review provided the guidance for the assumptions that I just shared with you. Specific to credit, we reviewed 49% of the loans outstanding, all loans over $4 million, all watch list loans over $500,000, all special mention and substandard loans and all loans in the office space, hospitality and recreation industries. So with concluding our remarks, Page 11 shows that we believe this opportunity checks all the boxes we've outlined on our earnings calls previously and is aligned with the long-term strategic priorities we set for ourselves internally. So with that, I'd now like to ask the operator to open up the line for any questions you may have.

[Operator Instructions] Our first question comes from Daniel Tamayo with Raymond James.

Maybe we can first talk about the deposit base for Prudential, the assumptions that you're using in terms of any repricing or replacing of those deposits, and then the timing around how quickly that may happen.

Sure, Danny. It's Mark. So their time deposit book is about $235 million and that has a cost, just on that CD book, of about 2.6%. And that's a mix of both kind of core customers as well as some wholesale CD customers they have as well. About 70% of that is going to be repricing between now and when the deal closes. So then the assumptions that we have then for '23 for the first full calendar year combined operations, we think that, that will lower -- that the book will lower a little bit. We expect there to be about 80% retention. So on an average balance basis, it's going to drop from $235 million down to about $210 million, but the cost is going to drop from 2.6%, down to approximately 90 basis points. In that 90 basis points assumption, we do have assumed between '22 and '23 that there would be 4 rate increases, and then what we believe is a corresponding conservative deposit beta that we built into the repricing of that CD book. So we have factored in potential rising rates, but we think that there will be a good opportunity for that deposit book to lower.

Okay. All right. That's helpful. So just to make sure I'm understanding this. So about $25 million from the $235 million, down to $210 million, of CDs that you're going to let go, if I understood that correctly, but the rest of the deposit book, you're basically planning on keeping on and continuing to fund their loan portfolio?

That's right, yes. So the $235 million, down to $210 million, I mean, it's not really designed to keep. It's really -- there's assumption as to what kind of roll rates we will see from their existing customers as we reprice that portfolio lower.

Okay. All right. No, that's helpful. And then maybe on the other side of the balance sheet, if you could just talk about their loan portfolio and how that is expected to react to rising rates, assuming your 4 rate increases you just mentioned?

Yes. We have assumed -- when you strip out both -- when you have the CD book come down and reprice a little bit, but also the other thing, Danny, is that they have about $210 million of FHLB advances, which are at about a 2.50% rate. We've also assumed that we would pay off that FHLB portfolio and also then sell off about $100 million of their bond portfolio. The net of those 2 items would have an assumption of using cash. And again, we've assumed that by closing, that the cost of that cash would be about 50 basis points higher than it is today because we're assuming 2 rate increases here in '22. And so then, in terms of the loan portfolio, once you strip away the wholesale components of that balance sheet, this is a balance sheet that is a lot more neutral. So we would anticipate that their loan book would react favorably to a rise in interest rates, but not as much as our core balance sheet would, which is more asset-sensitive.

Okay. All right. So relatively neutral on the balance -- on the loan side. And thanks for all that detail on the payoffs. I'll step back.

Thank you.

Thank you.

Our next question comes from Frank Schiraldi with Piper Sandler.

Just on the projections you gave in the slide deck. You talked about the purchase price being, I think, about 16x 2022 expectations. Is there -- so I guess, on a stand-alone basis, you look at Prudential as being able to earn over $1.10, somewhere around the $1.10, $1.15 in EPS. Just wondering if there's any color you can give, any detail on assumptions there in terms of either, whatever, the expense base or NIM. Any color on that front?

Yes, sure, Frank. And knowing that your firm was the one analyst who actually covered this company, so I assume you'd have a vested interest in this. When you look at, whether it's their -- your estimate for '23 or where the company is currently tracking on fourth quarter annualized or 2021 full year, you get a number that's somewhere between $6.5 million and $7 million. Well, then, if you just focus on the 3 items I just mentioned, the sale of their bonds, which is going to take off after tax about $1.9 million, it deducts from that. But then paying off the FHLB advances, net of tax, adds back about $3.3 million. And then the repricing of their time deposits by '23, which I just explained, that adds about $2.8 million after tax. So we think that sort of the core earnings of the company, once you go through that balance sheet restructuring, goes from that $6.5 million to $7 million range to some number closer to $11 million to just a little bit north of $11 million.

Okay. So that includes the balance sheet restructuring. Okay. That's helpful.

It does, yes.

And then also on that -- in the slide deck, you talked about the price to tangible book, the adjusted price of tangible book of 1.2 adjusted for some anticipated litigation expense, I think, before close. Is that -- I know they had one large credit that had been nonperforming, had been in litigation for some time. Anything you can -- any color you can give there? Is that related to that credit? And should we assume that will get cleaned up then by close?

Yes, you can assume that. That was something that we were all over in our due diligence, certainly. And when we negotiated the transaction, we wanted to make sure that they would negotiate and come to a settlement, which was, actually, I think, today, filed by the company. You should be able to see that settlement out there in the public domain. So that was something that was very important to us, and that contingency was lifted. There was a cost to it, but we think it was important to clear the decks on that in order to make this transaction happen.

Great. And then that's baked into your tangible book dilution?

Exactly. That's -- yes. That additional settlement of $8.3 million is the difference between the 1.1x versus the 1.2x, a lower assumed adjustable tangible book adjusting for that settlement.

Our next question comes from Chris McGratty with KBW.

Great. Phil or team, the $1 billion deal is certainly at the low end of what you've been talking about, understandably, given it's your first deal in years. How do we think about subsequent capital priorities? It seems like the buyback would be on hold until you close. But once you get through it, it's a pretty plain vanilla deal. I'm just interested in kind of capital priorities in the back half of the year.

So we -- I still think we have capital that we would like to put to use. And buybacks certainly will be back on the table, depending on how attractive they are at the time. And we'll -- if strategic opportunities come along, we'll continue to look at them.

If I could just ask a follow-up. In terms of kind of the opportunity set that's available, I guess, Phil, how would you characterize what's available from an M&A perspective today?

Today, I would say that there are not a whole lot of deals that are out there, but stuff pops up when you least expect it. So...

Our next question comes from Russell Gunther with D.A. Davidson.

I wanted to focus on the commercial opportunity in Philadelphia and just get your sense for pro forma. Do you have the team you need to grow the way you want to grow? Or would you expect to continue to look to add talent going forward?

Yes. Russell, it's Curt. We certainly want to continue to add. We've built the team from scratch 4 or 5 years ago. We view this as just accelerating the revenue and the market presence that we have. We will continue to add talent. We're glad to welcome the Prudential team. But it gives us an opportunity to continue to add talent just from a hiring and attracting new commercial bankers, and wealth. We think wealth is a great opportunity in the market, and it creates a lot more customer base and a lot more financial footings and financial centers to grow from.

That's great. I appreciate the thought there. And then switching gears, guys, on the expense saves. Just any help in terms of how you expect that to break down? I know you mentioned the similar systems, but any other color in terms of the drivers of those cost savings?

Yes, it would be what you would expect. I think, Russell, for any deal of this size, there are going to be savings around certain duplicate positions. But I would also say that, as a company, we're running higher vacancy than what our historic long-term average has been. So there's -- we hope that for Prudential team members, who may have a role change, if there will be a role for them in the organization. Beyond that, looking at contracts, looking at professional fees, et cetera, gets you to that number.

Okay. Great. And then last one for me. In the deck, you called out that this transaction is not disruptive to internal initiatives. And so maybe that was the M&A conversation you just have. And if so, are you suggesting you could, if the opportunity arise, or would announce another transaction while this is pending? Or perhaps, any color on what type of internal initiatives you're referring to, if it's not M&A related?

Well, regarding M&A, I think we could. But again, there's certainly nothing on the table right now. And we have a number of technology initiatives that are in process that we do not think this will slow down or hinder those additions.

Our next question comes from Matthew Breese with Stephens.

Two-parter. So on the FHLB advances, what's the cost to pay that off? And is that included in the $16.5 million deal charge? And then secondly, as we think about restructuring the balance sheet, what is the pro forma net interest margin when all is said and done? How should we think about integrating the margins and, therefore, NII on day 1?

Yes. So the FHLB may call on that is about $5.5 million, and that is assumed in all of our deal analysis, Matt. And with respect to the margin, on a go-forward basis, their margin would come in much closer to being right on top of ours. So with the balance sheet that's only about 3% of ours, I would tell you that the kind of pro forma margin then really wouldn't be impacted by this. We just kind of sit right on top of whatever you model for us on a core basis.

Got it. Okay. I'm sorry if I missed this, is there a CECL day 2 provision? If so, how much?

Yes. So the accretable yield on this, the total CECL mark is 1.86%, which is about $11 million. You have -- it's a 81-19 split between non-PCD, PCD. So the double count portion of that provision is $8.9 million, which, that's what then creates, as I referenced in my prepared remarks, the difference that you see between earnings and margin next year. Margin is impacted by a basis point from that accretable yield, which is accreting that 8.9%, and then it's about $0.01 to EPS. Yes.

Perfect. Very helpful. Okay. And then just thinking about the loan portfolio, are there any aspects to what you're acquiring that you don't expect to grow or to be in runoff mode? And just wanted to get a sense for how much of that portfolio you intend to keep and grow.

Yes, Matt. I mean, we did extensive due diligence, so we think we understand the portfolio well. There probably are certain things that we will just let run off and not originate a few out-of-market things and things like that as an example. But it's really not material to the portfolio. And the overall portfolio, we were pretty pleased with and look to maintain that, and again, have that as a good base to grow in a consistent manner like we have.

Got it. Okay. And then just last one for me. Obviously, you guys are over the $10 billion threshold and have been for some time. But as you bring Prudential over $10 billion from a fee income standpoint, what's the lost interchange?

Yes. We have factored that into our model. It's a small number, a couple of hundred thousand dollars.

$150,000.

Yes, $150,000. Thanks, Matt.

[Operator Instructions] Our next question comes from Erik Zwick with Boenning and Scattergood.

My line dropped a little bit there earlier, so I apologize if I ask a duplicate question. One, just a follow-up to clarify. So you talked about the opportunity to improve Prudential's funding base. And just want to make sure that is included in that 3.5% EPS accretion to the '23 estimates. Is that correct?

That's correct.

Okay. Great. And then wondering if you could provide a little bit of detail into Prudential's construction lending portfolio, it's about 28% of their total book, just in terms of the mix of project types. And additionally, as you kind of take on prudential and go forward, would you expect to -- as those projects mature, kind of move those to permanent in your books? Or what your thought process for the strategy of managing that construction book going forward?

Yes, Erik, great question. In due diligence, we looked at all those projects. I wanted to be comfortable that they're in line and consistent with what we do, and we're pretty pleased at the consistency there. They're predominantly in market, and we were comfortable with it. We don't see any significant changes in that, what we do in our core business with what they have been doing.

That concludes today's question-and-answer session. I'd like to turn the call back to Phil Wenger for closing remarks.

Thank you, everyone, again, for joining us today, and we hope you'll be able to be with us when we discuss our first quarter results in April.

This concludes today's conference call. Thank you for participating. You may now disconnect.