OceanFirst Financial Corp (OCFC) 2011 Q2 法說會逐字稿

Good morning and welcome to the OceanFirst Financial Corp. earnings conference call and webcast. All participants will be in listen-only mode. (Operator Instructions). After today's presentation there will be an opportunity to ask questions. (Operator Instructions). Please note that this event is being recorded. I would now like to turn the conference over to Jill Hewitt, SVP and Investor Relations Officer. Miss Hewitt, please go ahead.

Good morning and thank you all for joining us. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer with OceanFirst Financial, and we will begin this morning's call with our forward-looking statement disclosure.

On this call representatives of OceanFirst may make forward-looking statements with respect to its financial condition, results of operations, business and prospects. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond OceanFirst's control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements.

OceanFirst undertakes no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. In our earnings release we have included our Safe Harbor statement disclaimer. We refer you to the statement in the earnings release and the statement is incorporated into this presentation.

For a more complete discussion of certain risks and uncertainties affecting OceanFirst, please see the sections entitled Risk Factors and Management Discussion and Analysis of Financial Condition and Results of Operations as set forth in the OceanFirst filings with the SEC.

Thank you. And now I will turn the call over to our hosts this morning, Chief Executive Officer, John Garbarino; President, Vito Nardelli; and Chief Financial Officer, Michael Fitzpatrick.

Thank you, Jill, and good morning to all who have been able to join us for our second-quarter 2011 earnings conference call today. We appreciate your interest in our performance and are pleased to be able to review these results, as well as the important factors behind them, with you this morning.

The second quarter has yielded decidedly mixed results for our Company. While we remain gratified by our ability to deliver solid earnings, continue our market expansion and strengthen our capital position, we plan to spend most of our time this morning analyzing the reported credit data and giving some comfort on the underlying strength of our credit portfolio and reserve position.

Diluted earnings per share for the quarter of course was 28%, unchanged from the linked-quarter despite the higher credit costs and $0.01 ahead of the EPS from the second quarter of 2010. The Company's 58th consecutive quarterly cash dividend was declared and maintained at $0.12 per share, representing a comfortable and sensible 43% payout ratio as well as an attractive 3.5% current yield on our shares.

Our income statement remains strong. Our margins and non-interest income are being sustained and, with continued lackluster demand on the commercial lending side in the struggling economy, asset growth has consequently been curtailed. Our deposit mix remains favorably weighted toward core deposits which are continuing to be priced conservatively. Our operating expenses are well-managed and our efficiency ratio remains in an attractive range.

All this has contributed to the further beneficial fortification of our capital position, growth in our book value and affords us the opportunity to prudently provide for our credit risk exposure. The issues we plan to address for you this morning, however, will concentrate on the important information and data behind this quarter's credit metrics. It will help you to better understand the quality of our loan portfolio and our ability to deal with the recent volatility we have seen.

While our credit metrics had appeared to be stabilizing, this quarter failed to confirm that. And we are prepared should this signal a new cycle. I'll now ask President Nardelli to give you a more detailed look at our credit situation before taking any questions you may have this morning. Vito.

Thank you, John. Before I speak about the specifics of our credit metrics, I want to update you on a change made this quarter in our residential loan origination group. You may recall that we maintained a loan production office in Kenilworth, New Jersey that originally was a shared facility with the Columbia Home Loans. In the second quarter of this year we decided to close that office as a means to reduce expense in the wake of the continuing weak loan origination volume.

The remaining loan officers continue on with OceanFirst reporting to the sales manager here in Toms River, increasing both efficiency and consistency. Now I will turn to some of the specifics, first of the unreported non-performing loans.

The rather significant increase quarter over quarter was 70 basis points of loans receivable. Of this increase $5.7 million is one long established commercial relationship secured by multiple commercial and residential properties along with business assets and a personal guarantee.

The real estate collateral alone for this relationship was appraised in May of 2011 at $8.1 million resulting in a loan to value ratio below 70%. The balance of the increase was in one to four family residential loans. This level of non-performing loans, while remaining below the most recent industry measures available, is higher than what we here at OceanFirst are accustomed to seeing. We know the composition of these non-performing residential loans and I will discuss that with you now.

One factor that is glaringly apparent is the significant impact on the level of the non-performing loans from the extreme slowdown in the foreclosure process. What would traditionally be a cycle of newly delinquent loans entering the non-performing category and replacing loans that would be foreclosed upon converted to REO and sold has become one of new loans entering the category as incremental additions.

The time to sheriff's sale has been extended significantly by modifications, mitigations and moratoriums. The court system throughout the entire state of New Jersey is being overwhelmed by the backlog with the volume of foreclosure cases currently averaging over 908 days.

The other characteristic is the origination source of these non-performers. Recall that we had origination channels for prime portfolio residential loans at the locations of Columbia Home Loans and in the loan production office in Kenilworth. As I mentioned earlier, both of these channels have been shuttered.

As a significant amount of non-performers were originated in these former areas prior to 2008, in fact while these channels account for less than one-third of the portfolio, they now account for more than three-quarters of the non-performers. This is attributable to a combination of factors, including the locale of the properties and the predominance of adjustable and interest only loans.

In fact, looking at the portion of the portfolio comprised of originations from Toms River location, our ongoing channel, the non-performing level is 1.11% versus 3.25% for the entire residential portfolio.

On an interesting note that may bode well for us in the future, loans 30 to 89 days delinquent were lower by $4 million from the peak of the prior quarter and are at $14.2 million. This decrease was evenly divided between commercial and residential loans.

For the fourth quarter we set the provision for loan losses at $2.2 million. When evaluating the provision consideration was given to the increase in non-performing and the historical loss levels of residential loans along with the current quarter's charge-offs and our overall assessment of the local real estate market.

Notwithstanding the generous quarterly provision, the coverage ratio has declined. However, based upon our rigorous quarterly analysis of the loan-loss reserve, we feel that our reserve level is strong.

During the quarter we realized net charge-offs of $1.2 million, up slightly from the linked-quarter and higher than the same quarter last year. However, charge-offs on residential loans were only $172,000, indicative of the historically low loss levels on the residential portfolio. This has a significant mitigating effect on our residential loan loss provision and consequential coverage ratio.

With that I'll turn the discussion back to CEO Garbarino for some concluding comments prior to engaging in a question-and-answer session this morning.

Thank you, Vito. We are again pleased to be able to report a strong bottom line in this unsettled environment. I hope the additional color we have provided this morning will help alleviate any increased concerns you may have relative to our asset quality.

We remain very comfortable with the quality of our commercial portfolio. What we think we are witnessing on the residential side, however, is a perfect storm comprised of a hangover of now seasoning slightly lower quality residential credits originated outside our primary market area compounded by the terrible foreclosure logjam created in this state.

It would appear that only time will allow the residential markets to overcome these circumstances. With that, misters Nardelli, Fitzpatrick and I would be pleased to take your questions this morning. Pete?

(Operator Instructions). Frank Schiraldi, Sandler O'Neill.

Good morning. Just a few questions if I could. First I wanted to ask just a little bit more on provisioning. Looking at the inflows in non-performers in the quarter, the commercial loan which has a pretty low LTV and the residential stuff which I would imagine has fairly low LTVs as well.

I was wondering, the provisioning -- just the increase in provisioning quarter over quarter seems to be maybe more geared towards the outlook for credit in general and I'm wondering how we should think about provisioning maybe over the next couple of quarters?

Well, Frank, in this market we don't want to be heroes and squeeze another penny or two out of our earnings capability to optically create a shortfall in the provisioning process. We're very concerned over the fact that our coverage ratio does not look as robust as some people might think it should be. And I think we're sensitive to that.

We think our experience has been good on the residential side with charge-offs, Vito addressed that and certainly that's been the case for several quarters. But we're still a little concerned about the unsettled nature of the real estate markets. And just owing to this foreclosure situation in the state again, that's clearly causing the markets to keep from being able to recover themselves; they've got to purge themselves at this point.

And with foreclosures averaging two and a half to three years on average, we've got foreclosures that are running approaching five years now, it's very difficult for the markets to purge themselves of the built up supply.

So we're not as sanguine as we might be about the future outlook and we certainly don't want to short the provision in today's environment, as I say, to squeeze another penny or two, that's not what this is about. I think that our provisioning has been very conservative from the standpoint that we're provisioning probably slightly more than what we think we might actually need. We don't want to be accused of shorting this in any way, shape or form.

So I don't know that our outlook is grim, but it's clearly still unsettled, and that's about the word I think I can use for it. I don't know if that's helpful to you.

You're the first guy that ever thought that we were provisioning very liberally here, I mean in terms of maybe being a little too cautious. Because certainly I know our regulators don't feel that. We've got our new regulator who's going to be in here shortly in a regulatory exam in the controller's office and I'm sure they're not going to tell us that our provisioning is too grim. So we think optically it's important for us to be able to set that money aside out of our current income.

And so, but I would think -- well, I don't want to put words in your mouth, but in terms of the NPA inflows in the quarter, expected loss content on those -- I mean what are your feelings there given the LTVs?

We think it would be small, and the commercial relationship, again, is really -- the increase in commercial is the result of this one relationship which we've had on the books for many years and has been frankly a classified asset but was always performing. It only became non-performing here during the second quarter and, as Vito alluded to, it's extremely well secured. And that's a very current appraisal in a very shaky market.

So we don't feel that the likelihood of significant loss on that is great at all. And on the residential side, again, as long as values hang in where they are we don't think that we see significant losses there either. But I think we're a little concerned about the unsettled nature of the markets.

And I don't know if you could -- if you have it with you there, but I was wondering if you could give maybe some metrics or color on the interest only residential portfolio, the size of it and maybe the LTV on that particular portfolio as well as delinquency rates?

I think we'd probably have to get back with you on that kind of detail. I don't think we have that handy. And you'd probably be more interested in the interest only portfolio that was originated out of those other two channels. Because again, out of the core bank here in Toms River, I don't think that was very great at all.

Frank, we can tell you the interest only at June 30 is $133.6 million, that's the total portfolio. I don't have it broken out by how that's LTV or FICO, it's different. But we do underwrite that based upon fully indexed amortizing payments. So even though it starts out as interest only, we underwrite it based upon the principal and interest payments.

Okay. And the geography there isn't really any different than the -- or I guess it is because it was done (multiple speakers)?

Yes, the geography would depend upon what channel originated it mostly because Kenilworth and CHL were really -- well, Kenilworth, of course, as you're familiar, is in the northern part of the state and Columbia was headquartered in Westchester County and originated in Northern Jersey, New York, Westchester County, Rockland and Long Island.

I'm looking at the breakdown that we do have here in front of us. And out of that $133 million, $50 million was out of Toms River and it's about -- $83 million was out of the other two channels. So the majority of it was in the two channels that have been shut down.

Right, okay. And finally, just wanted to ask a question on loan growth -- balance sheet versus margin here going forward. I mean it seems like maybe loan growth may be sort of flattish going forward, which will help you hold the margin at these levels. And maybe as you continue to improve the deposit mix, to the extent that's possible even, could we continue to see maybe a little bit of margin expansion?

Yes, I don't know how much more we can improve the deposit mix. I think we've pretty much run the limit on that. This past quarter we saw a changeover in some core deposits from a little higher price -- the government deposits back into more retail oriented core. But no major change.

On the lending side, as we've said several times, our pipeline on the commercial side is really rather robust. But the question is when and if these loans are successfully closed -- but we do at least see some encouraging signs that borrowers in our market are looking to increase their exposure to credits. We've issued term sheets on these and we rate by probability the likelihood that these pipeline loans will close, but it's always a question of timing as to when.

And what we've also seen early on in the year has been heavy pre-payments on the commercial side too. So we've closed a fairly significant number of loans, but there's also been relatively heavy pre-payments. So I mean the answer to your question on margin is simply I don't know how much more we can get out of the deposit side.

When we do close loans on the commercial side we're getting internal rates of return according to our pricing model that would prove to be very attractive. So as we're able to grow the commercial book I think you could possibly see some positive improvement in our margin.

And the muni -- higher-priced munis going over into regular core -- has that been played out, do you think, at this point or is there still maybe -- because I know that's been sort of a theme for the last couple of quarters.

Frank, we're looking at that, we look at it every time; we have an opportunity to look at it. I think the bigger factor here is the change in the mix. Although we might have adjusted our muni balances somewhat to the lower side, we've picked up on the retail and business side which is truly our core business and really where we want to grow.

We'll continue to look at muni costs and if we can seize upon an opportunity we will. But as John alluded to, we're getting to the point now where pricing is such that there's not too much underneath that you can drop to. So we're getting pretty skinny here.

Okay, maybe I could just ask the question another way and then if you have the available breakout of municipal deposits and how that breaks down even within munis in terms of whether they're sort of operational accounts or maybe some higher-priced deposits.

Well, they're all transactional accounts, Frank, and they're typically priced treasury plus a spread, treasury plus 10, 20 basis points, and they're floating rate. I mean some of them are more transactional than others, some just sit there, some have more transact -- but they're all treasury plus pricing and the total is a little over $400 million.

Okay, thank you.

Thanks, Frank.

Laurie Hunsicker, Stifel Nicolaus.

Yes, hi, good morning, gentlemen.

Good morning, Laurie, how are you doing?

Good. I just wanted to sort of piggyback on some of the questions that Frank asked at the beginning, going back to credit here. Do you all have a reserve to loans target?

No, but what we do have a target for, Laurie, is based upon our analysis what we'll characterize as unallocated loan-loss reserves. And that is that after -- we do the reserve analysis on a quarterly basis, we have an unallocated strategic target that we discuss with the Board. And that means that after we've allocated all conceivable reserves we still have a range of unallocated reserves that we look upon as a little bit of a cushion.

Okay, but I mean I guess if we were to sort of more generally to look at this at a time where people are sort of recapturing back or the provision is under their charge-off you guys are flipped around, which is great. But you're now at that 1.3%. Could we conceivably see that by year end approach 1.4%, approach 1.5%, or are we likely to see it hold at current levels? I mean, I realize it's a bit fuzzy, but any guidance you could give would be great.

There's no target on that and it's one factor that we look at when we go through the analysis. I mean, the first and foremost where we set the reserve is we do a detailed analysis on all the non-performing loans, we get current appraisals and we look at what our loss experience is and what our exhibit loss experience is going to be. And then we adjust those factors based upon trends in the economy, real estate environment, etc.

And we do that first and that sets a range. And then they go back and we set and we look at reserve coverage and all the ratios. And as John said, maybe if those ratios appear to be below or below peers we might try -- we might go to the higher end of our range, of our acceptable range to increase those ratios. But that's not -- that's at the back end, that's not how -- that doesn't drive the process.

Okay. I mean, I guess to the extent that we have seen an uptick in your non-performers to the extent that generally the economy appears to still be slowing, I mean is there any added color you can give us or you're just not comfortable?

No, I think as we told Frank, Laurie, I think the lack of comfort that we have with the unsettled nature of the markets is something that's causing us to approach this in a very conservative fashion right now. That and I think the regulatory changeover I think is also causing us to approach it in a very cautious fashion.

That makes sense.

Again, I mean we're changing over from OTS to OCC and we would like to get a better relationship and a better feel for how our new regulators are going to look at us when they visit us.

Okay, fair enough. And then you did allude to the fact that the regulators are coming in soon. When are they coming?

We'll actually have the regulatory exam scheduled for the third quarter here.

Third quarter.

We'll be one of the -- we have the honor of being one of the first thrifts in the country to be examined by the OCC.

That honor, I love it, fantastic. Okay, and then I guess just touching here continuing on charge-offs. Of your $1.2 million that you charged off this quarter, was any of it related to that $5.7 million commercial loan relationship?

No (multiple speakers).

Go ahead?

To give you some color, $970,000 -- we'll tell you $980,000 was related to one commercial loan that we took -- that went into REO, it was a construction, a partially built tennis facility and business center. And the charge-off was $980,000 for that one loan. So when you take that out it was only a couple hundred thousand dollars left for everything else.

Okay. And then your $5.7 million commercial loan relationship you mentioned has been I think on your watch list for some time or your cost side asset list for some time. Have you taken any charge-offs on that in recent quarters or did it start roughly at that level?

No, there are no charge-offs on that.

Okay, okay. And then just jumping over here to occupancy expense, that was a big jump up in the quarter, $1.3 million. Was there something that I missed there?

Well, it goes back to the first quarter. In the first-quarter results we took a $184,000 benefit from the settlement of leases at Columbia Home Loans where we had an evacuated the building and we had accrued for all remaining lease payments. And then we reached a settlement with the landlord to give him $0.80 or so on the dollar and we had a recovery from that.

So it was a onetime unusual item in the first quarter where we had a recovery of $184,000 of the amount we had set aside on those leases -- on those operating leases. So that's why this is a more normal level. The first quarter was unusually low.

Got it, okay. Great. And then just one last question and I guess this sort of goes to the new change in regulator. But if we were to assume that everything goes well with your third-quarter regulatory exam, could we expect that at some point you all will examine or I should say reexamine the use of share buybacks as a capital management tool?

Yes, you asked us that before, Laurie, and we answered it the same way. Yes, that's one of the factors that we're concerned about. We'd like to see how the OCC feels about us and we'll have to assess that as we develop an ongoing relationship with our new regulator.

But to the extent that they feel okay about you all, I mean, would that be higher on the priority list or would you be more apt to increase (multiple speakers)?

I mean, I think we've talked in the past about the fact that we think we have some excess capital at this point. Our tangible common is up now at $9.53 I believe this quarter, so that's a very robust level. And we haven't done any buybacks for quite some time, but we like the value in our shares certainly and that's a possibility that we review from time to time. The one fly in the ointment I think is the regulatory changeover here.

Sure.

And the little unsettled view that we have of the economy.

Yes, absolutely. So just one last question on that and then I'll leave it to somebody else. But if you were to look at just the buyback versus the dividend policy, because we haven't seen you increase your dividend either, and your stock were at these current levels would you favor a buyback over a dividend or would you favor a dividend increase over a buyback.

I think that would be a much better use of the excess capital at this point. The dividend payout that we've settled in at has been in the 40% range and we're very comfortable with where that is as a percentage of current earnings. And I think that if we looked at a capital management strategy, the buyback would be the favorite strategy over a dividend increase.

Okay, perfect. Thank you, gentlemen.

Bye, Laurie.

(Operator Instructions). Matthew Kelley, Sterne, Agee.

Hi, guys.

Good morning, Matt.

On the $5.7 million commercial relationship there, what's the back story, what's the industry and what kind of went wrong for that borrower?

Well, as we said, it's a number of different credits involved, but it's basically a local marine operator is the major portion of the credit and they've just been obviously in this economic environment in a troubled business situation for some time. But it's a credit that we've had a long relationship with, it's local, they've been in operation for an extended period of time so it's something that is in our backyard that we're comfortable with that has just recently gone into the non-performing category. So it's something that we don't think is terribly remarkable and we feel well secured on it.

Okay. And then with the foreclosure cycle taking so long, 900 days, how should we think about the carrying costs on non-interest expenses on that portfolio of non-accruals and assets you're working through the courts?

Yes, well, I mean obviously they're non-performing loans so it's -- there's no interest on them. So we're going to have to carry them, is that what you're talking about, the (multiple speakers)?

It was actually the non-interest income, just maintaining these things and legal fees and are those going to be up anywhere in the P&L on the expense side?

Incrementally I think. That's all part of not being able to purge it out of the system. So, yes, the fact that there's going to be more loans in foreclosure. But we still haven't seen anywhere near the numbers that we saw in the portfolio and a much smaller portfolio back in the late '80s and early '90s.

Matt, this is more -- it's a delay tactic, it's a delay strategy. So the ultimate cost of handling the situation from a legal matter doesn't really move much. Maybe some incremental because you've got to file delay papers and answer delay papers, but it's not huge.

Okay.

So I don't foresee any big jump in that expense line relative to how we would proceed with these foreclosures.

Okay, all right.

But you're absolutely right, Matt, in that every time a loan goes into foreclosure there's certain non-interest expenses that are going to be incurred with regard to it. So as there are -- you're obviously going to have a higher expense on 100 loans in foreclosure than you would if there's 50.

Right.

But I recall back in the early '90s we -- as I say in a smaller portfolio we had I believe over 270 loans in foreclosure.

Right.

And we're nowhere near that number today.

Sure, okay. What is the number right now?

I was afraid you were going to ask that. I can get it for you if you've got another question.

In this environment where it's tough to grow loans, would you consider taking the securities book up anymore, I mean above the 20% to 25% of -- 20% to 22% of assets it's been running at?

The securities up?

Yes.

Increase what we have, we didn't buy in the second quarter, but we did buy fourth quarter and first quarter (multiple speakers) a little bit. So I mean at this point there's not a lot of -- there's not a lot of opportunity for that kind of leverage. If you want to stay short, which we would do in light of possibly increasing rates, the yields are pretty modest.

Okay.

Matt, I've got that number for you. It's about 60 loans are in foreclosure right now.

all right. And then just last question, what should we be thinking about for your tax rate? It's been running 36% for two quarters now, is that a good run rate to (multiple speakers)?

Yes, that's been pretty steady, yes.

Okay, all right, thank you.

Thanks, Matt.

(Operator Instructions). All right, there's nothing more (inaudible) so I'd like to join the call back over to management for any closing remarks.

Thanks so much, Keith, we appreciate your help this morning and thanks, everyone, again for listening in on our second quarter call. We'll look forward to speaking with you again three months down the road, hopefully when it's a little cooler here in the great Northeast. Take care.

Thank you. That does conclude today's teleconference. You may now disconnect your phone lines. Thank you for participating.