OceanFirst Financial Corp (OCFC) 2012 Q2 法說會逐字稿

Good morning and welcome to the OceanFirst Financial Corporation earnings conference call. All participants will be in listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. Instructions will follow at that time. Please note that this event is being recorded.

I now would like to turn the conference over to Jill Hewitt. Ms. Hewitt, please go ahead.

Thank you, Keith. Good morning and thank you all for joining us. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer at OceanFirst Financial.

We will begin this morning's call with our forward-looking statements 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 this statement in the earnings release, and the statement is incorporated. 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 set forth in OceanFirst's 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 in on our second-quarter 2012 earnings conference call today. We appreciate your interest in our performance and are pleased to be able to review these results with you this morning.

You've all had the opportunity to review the earnings release from last evening and, following our usual practice, we will not be disrespectful of your time reciting a host of actual numbers from the release. Our introductory comments will merely help frame our opportunity to add some color to the results posted for the quarter before we take your questions.

Diluted EPS for the quarter, of course, was $0.30 a share, $0.03 ahead of the prior-year quarter and a $0.05 increase over the prior six months of 2011, largely the result of moderating credit costs over the past year. The current quarter was a penny off the linked quarter, however, as the persistent pressure on our margin took a toll.

The Company's 62nd consecutive quarterly cash dividend was declared and maintained at $0.12 per share, representing a comfortable and sensible 40% payout ratio of current earnings, as well as an attractive 3.4% current yield on our shares. We have posted another quarter of solid earnings, but decidedly mixed results overall owing to the lack of growth evident in our balance sheet and top-line revenue.

Nevertheless, we can point with pride to several positive factors helping build value for our shareholders in the near term. Significant earnings growth has been achieved over the prior year, and we have steadily increased our tangible book value to now over $12.00 per share.

Our tangible common equity ratio holds forth at 9.57% as of June 30, even as we pursue our current capital management program with additional share of repurchases and our attractive cash dividend payout of current income. Our return on equity for the first half of 2012 remains in double digits at 10.08%.

There was some nominal growth for the quarter in deposits and commercial loans, although meaningful growth in this environment continues to be difficult and arguably foolhardy to aggressively pursue and achieve. We continue to be disciplined in our pricing of both deposits and commercial credits in our market, given current conditions.

Residential mortgage finance remains a bright spot, with sustained refinance demand and attractive margins on loans sold into the secondary market helping to support the bottom line. We again express our concern this quarter, however, that our local residential market is not yet experiencing the sustained resurgence in purchase activity reported in other areas of the country.

We remain convinced that the oft-discussed three-year average backlog in New Jersey residential foreclosure resolution hampers the ability of the local market to self-correct, as it has in other areas. We definitely need to see more progress in freeing up this backlog before we can express confidence in the overall health of our market.

Operating expenses remain well controlled and, as discussed last quarter, although our efficiency ratio may have hit its low early in the year, it remained an attractive 55.7% over the past six months. In the absence of meaningful revenue growth, however, the contracting margin remains a heavy burden to overcome in maintaining our strong bottom line.

Moderating credit costs, increasing noninterest income contributions, and controlled operating expenses cannot be relied on to create sustained earnings growth. As market conditions prudently allow, we recognize the longer term need to generate growth in our top-line revenue stream.

As is our custom I will ask President Nardelli to provide some added background to our reported credit metrics and loss provisioning for the quarter.

Thank you, John. During the second quarter, nonperforming loans in the residential portfolio again showed improvement, leading to an overall decline in nonperforming loans of $291,000. On a year-over-year comparison, nonperforming loans have decreased $2.5 million, driven by the decrease in residential nonperformers, which are now down $3.3 million.

While on the topic of residential nonperforming loans, I would like to comment on the sale of our largest nonperforming residential note early in the third quarter at 103% of book value, which we mentioned in the press release. While we would have liked to have closed the sale in the second quarter, the purchaser required a third-quarter transaction. This disposition allows us to start the third quarter with an improvement in nonperforming residential loans of 9.2% and a 5.8% overall.

To expand a bit on what John mentioned regarding the ongoing foreclosure situation, I can report that the Bank did take back six properties in the quarter at sheriff's sale, more than in the past several quarters. Unfortunately, this level of activity is not indicative of a pace that will quickly eliminate the backlog but is more in line with the approximate three-year window we have discussed at length in prior calls. Coupled with the expected influx of filings from larger banks, we don't foresee any significant change in the foreclosure timeline in the near future.

It is likely that the continuing foreclosure backlog has delayed any substantial recovery in the local real estate market. While quarterly sales contract numbers are higher compared to both the prior year and linked quarters, our assessment is that there was some softening in purchase activity in June, leading us to call the market flat.

Of course on a continuing basis, our commercial portfolio and credit quality has fared extremely well, with nonperformers well controlled. We believe this is a tribute to our disciplined underwriting and overall credit administration.

In the final analysis looking at the market conditions, quality of our commercial portfolio, and considering the year-over-year improvements in nonperforming loans, we were comfortable with a provision equal to the prior quarter.

Finally I will comment on the mortgage loan repurchase activity, which continues throughout the industry, and the reserve we have established. During the quarter, we received six new repurchase requests. We also resolved five repurchase requests with no cost or need to take the loans back.

Understanding the apparent sustained desire on the part of loan purchasers from 2004 through 2007 to try to shift credit risk on nonperforming loans back to the originators, our analysis of the reserve for repurchased loans led us to conclude that an additional provision of $100,000 was appropriate.

At June 30, the reserve stands at $955,000. There are 10 outstanding purchase requests which we are negotiating or vigorously contesting.

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

Thank you, Vito. In summary, we are encouraged by the year-over-year improvement in our nonperforming loans and the relative stability of our commercial credit portfolio. Though far from a full recovery, our residential real estate market has exhibited some recent signs of life, with purchase activity increasing during the quarter. Solid quarterly earnings have again been posted.

Nonetheless, challenging times certainly lie ahead. Revenue and earnings growth, building sustainable value for our shareholders is what we will need to focus on as our markets continue to respond and economic conditions improve. With that Messrs. Nardelli, Fitzpatrick, and I would be pleased to take your questions this morning.

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

Good morning, guys. Just a few questions. Wonder first if you could maybe talk a little bit, John, about buybacks and your thoughts there on levels going forward? I think you bought back 100,000 in the first quarter, 400,000 in the second. That increase, does that signal a change in outlook and in the environment? Or what are your thoughts there going forward on repurchase levels?

No, well look, the modeling that we have done with the buyback, Frank, we are concerned obviously in buying back shares above book value and the dilutive effect on our book value. But given the fact that we are still able to grow our book value, we feel pretty comfortable. The modeling that we have done still indicates that it's the best use of some of that excess liquidity and excess capital that we have.

The fact that we got a little more aggressive in the second quarter I think was probably just in response to what the market gave us and not necessarily an affirmative indication that we wanted to be more aggressive in our repurchase activity. Our posture has always been to take what the market will give us in terms of a buyback strategy.

So, I think there was just probably some more shares available on the market; and that indicates why we did, as you say, approximately 4 times as much. I don't think that is a signal that we will be more aggressive going forward. But I do think that given current trading levels and the alternative uses of capital and liquidity, it still seems like the best use of the funds that are involved.

Great. Then on the loan side, it looked like you saw some decent commercial growth in the quarter. Could you maybe touch on that a little bit and your pipeline -- commercial pipeline outstanding currently?

Yes, I think for the last year or though we have said the pipeline has been pretty robust. I think we have indicated that in some cases it was just a question of getting things funded and closed and also curtailing some prepayments that we had. That businesses in our market essentially were still debt-averse, and we still see that is the case.

I think some of the nominal growth that we've had in the second quarter -- and I certainly don't think it's anything to pound our chests about -- was just a function of timing, that we closed some credits and perhaps prepayments decreased a little bit.

The pipeline is still reasonably robust, and we see the second half as maybe demand picking up ever so slightly. But we still see a debt-averse set of businesses in our current market and demand we would have to characterize as anything but still tepid on the commercial side.

So what we do see, as we have talked about on other calls also, is a relaxation in terms and covenants and underwriting criteria that is being applied in our market on an almost daily basis, as there are a lot of companies chasing very little demand. We are steadfastly trying to avoid competing on that basis and still maintaining our original return on investment objectives in terms of how we price these credits and look at the sound underwriting.

I think the performance of our portfolio, as Vito pointed out, is testament to that. And I expect that we will continue going forward. We're hopeful that the market will in fact come our way a little bit more as the year progresses.

Okay, then finally, just -- so I might have missed it in your comments, Vito. But the repurchase requests that are currently outstanding, there's 10 out there. So this is -- that represents the total amount of repurchase requests that are out there currently; and all those are currently being disputed. Is that right?

Yes, that's pretty accurate, Frank.

Okay. Then I'm just wondering about flow here. Because I think it the end of last quarter there were nine loan repurchase requests outstanding; now there's 10. Does that represent the same nine and then one more, or is there some outflow as well?

No, no. There was an outflow, as I mentioned, we resolved without paying a dime five of them. So we had some in and outs going on.

It is going in spits and kind of like an uneven tide the way they come in. There is no rhyme or reason to them. Periodically you might get a few more and then it drops off. It is as they are cleaning out their bottom drawer to see what they can throw over the side at an originator is the way I characterize this whole activity.

And we have to be mindful that the fact that we feel confident that we can defend, we still have to take defensive action in terms of making sure that our reserves are ample to cover any unforeseeable situation where we might be forced to repurchase. That is why we have been very, very successful, Frank, as you well know. (multiple speakers)

Okay, so sorry again for missing your comments which you made earlier. But then so those four -- or those five, those you had disputed and basically you won those disputes. You didn't have to repurchase them. Is that right?

That's correct.

Okay. That's all I had. Great. Thank you.

Travis Lan, Stifel Nicolaus.

Thanks. Good morning, gentlemen. I know last quarter there was a large commercial pre-payment that added about 5 basis points to the margin. Do you have a comparable number for prepayment income this quarter?

It is typically a low number, Travis. I mean the $219,000 we mentioned was an outlier. So we mentioned that it typically runs $50,000 a quarter; we don't mention it. So that's like the normal number, if you will.

Okay, all right. Then I guess could you talk a little bit about the dynamics on the deposit side in terms of pricing? I think there was a promotion that you guys were running, but maybe the impact of that. And then if you have any leverage going forward to bring down your deposit costs at all any more.

Well, deposit costs are managed with a high degree of discipline. And even though we periodically have these promotions we endeavor to time them in such a way that it has negative -- it doesn't have any severe impact relative to the deposit costs or liability side of the equation.

Indeed I think, Michael, we ticked down 2 ticks even after we did the promotion. So that doesn't have -- those promotions don't have a negative impact on our deposit costs, at least the way we time them.

And given the overall deposits that we have, and the ebb and flow in those deposits, we always have an eye on the cost of those deposits. So whatever we do, we do knowing full well that at the end of the day we have to keep those costs in check because of diminishing returns on the asset side of the equation.

Right. So thinking about the way the market looks now, do you think that you have any -- is there any opportunity to bring them down further? I mean understanding all the discipline that you price the deposits with, do you just feel like there is any room to bring it down to offset some of the yield pressure? Or do you feel like where you are now is as low as it can go on the deposit side?

Yes, there is not much, Travis. I mean we are -- at the end of the quarter, they were priced at 47 basis points. That is down from 49 basis points from the end of the prior quarter when you count the non-interest-earning assets.

The good thing is we had some growth in non-earning deposits for the quarter. So that was positive.

We still have a little bit of a CD book that is repricing down, so maybe we will pick up another 2 basis points the next quarter. But they are clearly not big numbers, and they are not going to offset the yield on the asset side.

It's pretty shallow water. There is not -- really not much -- there is really not much to move, it's so shallow.

Okay. On the noninterest deposit generation, which was obviously very strong in the quarter, was there anything seasonal or anything kind of abnormal in there? Or was that just core growth?

Yes, it was business deposits. I don't think it was anything seasonal. It was pretty well diversified. It was a lot of business deposits.

Okay, all right. Then just finally on the securities that you guys may be purchasing, could you give us an idea for what types of securities and the yield on that, and then the duration of the portfolio in aggregate at this point?

Yes, it was a mixture. In the second quarter we bought agency securities; we have been building a ladder with agency securities up to three or four years out. And there is a ladder, so there is always some rolling off every year. Those yields are 50, 60 basis points.

We were also buying MBS, CMOs with a medium-term horizon, 3-, 4-year average life. And those are 150 basis points.

Then we were also buying some municipal securities. Again 2-, 3-year life at 1, 1.5 point tax-equivalent basis.

Okay, perfect. Thank you very much.

Jason O'Donnell, [Marian] Research.

Good morning. Can you just give us some more color around mortgage banking activities this quarter, in terms of maybe volume and gain on sale margins? Maybe just characterize that.

Then also I am wondering how we should be thinking about the pipeline here heading into the third quarter versus what we saw in the second quarter.

Yes, the gain on sale margins, first of all, remained very strong. They were over 2%. That is historically high. Slightly over 2%, that is historically high levels for us.

So they remained strong. They were -- and then the actual volume for the quarter we reported in our press release, and that was -- our loans sold was $41 million. Actually it was about the same as the first quarter. It was $41 million each quarter in terms of loans sold.

Okay, great. Then in terms of just characterizing the pipeline heading in here to the third quarter versus the second quarter, should we expect revenues to hold up pretty well, or maybe accelerate a little bit given what you are seeing?

Yes, application volume has been pretty consistent over the past quarter. For three months now it has been running fairly strong, by earlier standards. So we still see and we have talked in the past about some of the cases -- this may be the second or third time we are seeing people refinance as rates have continued to move lower, obviously.

But our first-mortgage refinance -- our first-mortgage volume in general has been pretty strong. So the pipeline is pretty full. So we feel that this gain on sale, as long as the margins hold up, will be continuing for the foreseeable future.

Okay, great. Then just stepping back a little bit from this quarter's results, can you just provide some color around where you see the loan loss reserves settling out longer-term, just accounting for the shift in the earning asset mix here over the last few years? I guess I am just wondering where you see the Bank's normalized reserves-to-loans ratio in a range.

Yes, that's tough to obviously forecast, Jason. We are still running over our budget for the year, and that is still largely reflective of our concern in the residential market.

Again, our commercial quality has held up real well. The backlog in the residential market is still creating some issues for us and so it is still keeping us a little bit ahead of where we were budgeted for the year.

Whether or not that will continue in the third quarter is going to be reflective of how chargeoffs and how nonperforming run as we continue through the quarter. But we would be hopeful that we would get some relief in coming quarters. I don't know, Mike, did you have something?

Well, there is no long term -- I would just tell you that five years ago, our allowance as a percent of loans was 0.62; now it is about 1.12. So it's almost double that.

Obviously it's a different environment, but eventually the economy is going to improve. Housing and employment will improve, and those levels that we are showing now will go back.

They probably won't fall all the way back to 0.62, where they were five years ago, because the mix -- we have a little more commercial now and less residential, but on a long-term basis maybe we'll get back to 70 basis points or something. But that may take years to get there.

Great. That's helpful. Thanks, guys.

Brian Kleinhanzl, KBW.

Good morning, gentlemen. I just had a quick question here. You mentioned that there was tepid loan demand out in the market right now. What is the opportunity on the expense side to offset that?

Had negative operating leverage in the quarter. Is there a chance for expenses to go lower here?

No, I don't see that. In fact, we are constantly looking to build up our commercial staff because on a long-term basis we think that is the key to our ability to generate value, is with our commercial portfolio growth. So that is one of the keys that we are focusing on going forward.

So we are just the opposite. We are staffing up in our loan and our back-office credit department to make sure that as things turn around we're in a position to take full advantage of it.

I think -- and the residential side, of course, has been pretty strong also. So we are making good gains on sale there. We are not really interested in putting that 30-year product on the books at the levels that we are originating it.

So, I think on the lending side just the opposite. I don't think we see any opportunity to trim our operating expenses in terms of headcounts on there.

We have done about all we can, I think, as far as rightsizing the organization given the current volumes that we are experiencing. We have put a little bit of a hold on some de novo branches. Of course in New Jersey that is not too difficult, when you have probably got three-year lead times to get them open.

But other than that, we have controlled our operating expenses I think about as well as we can be expected to.

Okay. Then I just had a quick question or follow-up question on the repurchase requests. Is there a statute of limitations? You said it was from the '04 to '07 vintages. Isn't there like a five-year statute of limitations on when those can be put back to you?

Yes, forgive me for laughing, but we have a debate. There is in law a thing called equitable estoppel, which means notwithstanding the fact that you might have a legal right to pursue a claim in equity and justice and fair play, if you let that clock run out too long before you pursue your claim you might be estopped from asserting that legal claim.

I think we are getting close to that line, where -- it's been no secret that there has been problems with some of the originations that went on years and years ago. But when you take the profits of all the interest payments from '07 forward or beyond '07 forward and then, on some technical issue, try to put it back to the originator after you've enriched yourself and engorged yourself on those, on that principal and interest payment for 6, 7 years, that starts to raise the flag of equity. Is that right? Is that fair?

So that is the legal arguments that are posed. But the best line of defense -- and we have been very fortunate and our documentation has been very good -- that when they came come in on these technical items that we are able to beat them back, because we have the documentation to prove that their record-keeping was off. Because we have the documents they claim were missing in their file.

Okay, great. Thanks.

In some cases we are getting vintage 2004 repurchase requests. So that is an 8-year period. So further to Vito's explanation, it is hard to believe that it takes 8 years to find there's a defect in the delivery, isn't it?

Certainly is. Okay. Thanks for taking my questions.

(Operator Instructions) Matthew Breese, Sterne, Agee.

Good morning, guys. Just touching on the margins, so seeing where it is today and seeing where it has come from over the past year, I was hoping you guys could help me in looking forward the next 12 months and give me a range in how you think it will shape up, given a static rate environment.

Oh, static rate environment.

Well, there is clearly pressure on the margin. We talked about our deposit costs are at 47 basis points. Maybe there is a couple basis points per quarter that we might squeeze out of it. But clearly the largest moves are behind us in terms of funding costs.

We had some borrowings that reset down, but that is the same thing. It's a little bit -- the benefit is marginal.

On the asset side, all of our asset yields are under pressure because of prepayments and reinvesting cash flows in the -- and an excess liquidity.

You just heard me a few minutes ago talk about what we're investing in. They are very modest yields.

And the loan portfolio is generating a lot of cash flow; it's being reinvested at lower yields. So there is going to be continued pressure on the asset side.

So we see some margin contraction going forward. It's hard to say how much.

We hope to beat that back a little bit by trying to grow loans, especially commercial loans. So that would be one way to mitigate that. As John just mentioned, we are staffing up in our commercial area, and we are very much focused on increasing our commercial loan portfolio.

So if we are successful in doing that, that could mitigate the compression a little bit. So there's a few different factors that go into that, but we do anticipate that there will be some pressure.

Okay. You talked about beefing up the commercial lending staff. What kind of hires have you made over the last six months?

We are pretty opportunistic there, I think. Because we serve a relatively tight geographic market, we know who is in our market and who is valuable to us. And as they become disenchanted with maybe the operations of a mega-bank that might be headquartered in North Carolina or California, we very often find that they want to return to their community banking roots. So if we see that and we know the people are good, we use every opportunity to get them to join us.

So that is the kind of staffing up that we do. We are not out there with headhunters or with personnel agencies or with running help wanted ads in newspaper. But we're opportunistically looking for good people that are already serving our market as lenders.

And I think we are seeing some disenchantment, some dislocations that have come our way. And we are always pleased when that happens.

Okay. But just for reference, how many commercial lenders would you say you have currently and where was that (multiple speakers)?

We have got I guess about five lenders right now out on the street, and we can certainly add opportunistically to that. I don't think we are talking about trebling the number; but again we are talking about a relatively small geographic area. But we have certainly got people out making calls, dealing with the public, and in some cases bringing a book of business to us also.

Okay.

The other thing -- the other just comment. Even though we expect some margin compression, hopefully we will be able to offset that with the reduced credit costs. Our provisioned this year was less than last year, loan loss provision.

We see some moderation in our nonperforming loans. It has been kind of steady this year. It is down $2.5 million from last year.

We think it's going to be down this third quarter; we just reported that we sold one of our biggest nonper -- our biggest 1-4 family. So we're hopeful that there will be some moderation in credit costs going forward that might offset at least some of the margin compression.

And, Matt, one other thing that Mike alluded to. We continue to grow our business deposits and continue to grow our business customer base. Unfortunately, our business customers are hoarding cash right now, and a lot of our customers are legacy customers. They just know -- they know how to weather the storm.

They are not going to borrow up right now; they're going to wait till things settle out. There is just too much uncertainty out there for them to want to borrow up.

But the good news is, as this Company builds its customer base, when the incoming tide comes we are well positioned to take advantage of customers who know how to handle business, who now how to handle their money, and who know when to borrow and when not to borrow.

So I think it is a little bit of a patience game and to avoid the temptation to chase after a bad credit. John also alluded to there are too many banks chasing too few good customers, which creates this price war which we don't want to engage in, because that doesn't serve anybody anyway.

What are some of the rates you are seeing on standard commercial real estate loans?

There is always the next greatest horror story about how you lose a deal to somebody over rate. But more so than rate I think in some cases it is terms. We see a relaxation in the requirement for personnel guarantees. We see an extension of terms on the properties.

But I mean, we are pretty steadfast and disciplined in terms of looking at a pricing model, as I say, and looking at a return on investment on the relationship. And we are pretty true to that.

So we are not chasing a rate that comes our way unless it is maybe under extraordinary circumstances to preserve a relationship that we covet. I mean we have seen rates as low as you can possibly go. It is the next greatest story that might come along.

It all depends on how the individual credit is structured. But very often it is not just a question of rates; it is a question of covenants and guarantees, as I said.

Okay. Then my last question, getting back to the repurchase requests. How long did it take you to resolve the five that came off this quarter? And is that any indication of how long it might take to resolve the six that came in?

Yes, on average it takes about two quarters. You give yourself about six months, because there is a lot of back and forth with the paper. They make an initial claim; we reject the initial claim. They come back requesting specific documentation; we research it, send it back. They come back with another one; we go back to them. And then finally they give up.

So, it is a battle through. You have to be steadfast. You have to have resolve. And I think we have a lot of experience at this. Unfortunately, our experience came at an expense to this Company, but we have very good experience in handling this thing.

Thank you.

(Operator Instructions) There are no more questions at the present time, so I would like to turn the conference back over to John Garbarino for any closing remarks.

Thank you, Keith. I appreciate your help this morning, and as always we appreciate your interest for everyone that was on the call. We will look forward to speaking to you once again at the end of the third quarter in October. Thanks and enjoy the rest of your summer.

Thank you. That concludes today's conference. You may now disconnect your phone lines. Thank you for participating and have a nice day.