OceanFirst Financial Corp (OCFC) 2013 Q3 法說會逐字稿

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

Now I would like to turn the conference over to Jill Hewitt, Senior Vice President and Investor Relations Officer. Please go ahead.

Good morning and thank you all for joining us. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer, 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 conditions, 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 into this presentation. For a more complete discussion of certain risks and uncertainties affecting OceanFirst, please see the section 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. Now I will turn the call over to our host this morning, Chief Executive Officer John Garbarino, Chief Operating Officer Christopher Maher, and Chief Financial Officer Michael Fitzpatrick.

Thank you Jill, and good morning to all who have been able to join in on our third-quarter 2013 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 have 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. Following my brief comments, I will turn the call over to President and COO Chris Maher who will review the highlights in the quarter and discuss the additional strategic initiatives that we mentioned briefly in the release.

Of course, diluted earnings per share for the quarter were $0.29, unchanged from the linked quarter and $0.01 ahead of the prior-year quarter, reflective of the consistency of our core operating earnings power in the current environment. The Company's 67th consecutive quarterly cash dividend was declared and maintained at $0.12 per share, representing a comfortable and sensible 41% payout ratio of current earnings, consistent with our capital management planning.

As a further note on capital management, while we are gratified by the increased market recognition reflected in the trading of our stock over the past three months, the demand for our shares and consequential price movement has had a dampening effect on execution of our current share repurchase plan for the second consecutive quarter. Although we still consider the repurchase of our shares an attractive proposition to deploy our excess capital in the short run, at current trading multiples, the incremental book value dilution associated with the retirement of shares weighs heavily against the accretive effect on our earnings per share. This tempers our enthusiasm to aggressively execute open market repurchases in the absence of any market imbalance in the supply and demand for our stock. With just over 200,000 shares retired during the quarter, there remain a little over 300,000 shares available for repurchase under the current authorization.

One other quick comment I'll make is that while we are similarly pleased this quarter by continued core deposit growth, coupled with a long-sought solid increase in our commercial loan portfolio, we have chosen to not let our balance sheet expand in favor of using excess liquidity to reduce our Federal Home Loan Bank borrowings. This has facilitated plans to restructure our advanced book in the coming quarter. With this restructuring accomplished, we can now expect further increases in commercial loans outstanding to drive much desired growth in our balance sheet and revenue stream.

I'll now ask Chris to provide some additional background to our quarterly operating results and plans for the fourth quarter.

Thank you John. My comments today will note a few quarterly metrics worthy of discussion, and also address our progress as we continue to invest in organic growth initiatives and manage operating expenses accordingly.

Regarding quarterly performance, asset quality is trending positively, commercial lending growth is picking up, net interest margin has stabilized, and fee income growth from bankcard services and trust has partially offset declines in the net gain on sale of residential mortgages. Expenses have trended up due to the new Red Bank Financial Solutions Center and the impact of new hires in commercial lending. We are mindful that maintaining a competitive efficiency ratio is an important discipline, and we will be discussing expense management initiatives later in the call.

Asset quality trends continue to be positive as general economic conditions in our markets stabilize and the recovery from Superstorm Sandy continues. In addition to generally favorable credit trends, a $1.8 million provision against possible storm-related credit losses taken in the fourth quarter of 2012 has held up well with no charge-offs and $471,000 of specific impairments having been identified through September 30. We will be evaluating the remaining reserves against storm losses carefully over the next several quarters as the economic rebound and rebuilding brings more certainty to the situation. More broadly, 2013 year-to-date net charge-offs totaled $2.2 million, less than one half of 2012 year-to-date net charge-offs of $4.7 million.

Commercial lending growth was strong for the quarter with quarterly commercial originations growing to $49.5 million, producing commercial portfolio growth of $18.5 million. The commercial lending pipeline remains strong at $38.4 million at September 30. We continue to recruit quality commercial lenders that have become disenfranchised with large bank environments and have a demonstrated history of relationship lending in our footprint.

In addition to growth in commercial lending, residential lending in the form of owner-occupied construction loans has picked up, driven by demand related to Superstorm Sandy. While still modest, year-to-date residential construction closings total 50 loans for $21 million.

Additionally, year-to-date commercial construction credit facilities closed total an additional $11.1 million. Within our current pipeline, an additional $29.7 million of construction loans are pending. These storm-driven credit facilities are beginning to form a positive trend.

The combination of commercial lending growth, reduced refinance pressure on the residential portfolio, instability in the consumer lending portfolio have alleviated the study net interest margin compression experienced since peak margins in the second quarter of 2010. This is evidenced by reported net interest margins of 3.16%, 3.21% and 3.20% for the first three quarters of 2013 respectively. Improvements to net interest margin will require a continuation of our efforts to grow the balance sheet and replace low-yielding bonds with higher-yielding commercial loans.

Other income decreased as net gains on the sale of residential loans deteriorated as a direct consequence of rising mortgage rates which have substantially curtailed refinance volume. While our refinance volumes parallel industry trends, the growth of purchase mortgage applications and owner-occupied residential construction loans is providing some offsetting volume. The increasing popularity of adjustable-rate residential loans, particularly for owner-occupied construction to permanent loans, will result in more portfolio originations rather than originations for sale. These trends are expected to continue to depress gain-on-sale income.

Partially offsetting weakness in net gain on sale income are gains in bankcard services and trust. Revenue for these areas has increased from $3.3 million year-to-date 2012 to $4.3 million year-to-date 2013, a 28% or $930,000 improvement. We continue to invest in these businesses with card activation programs and the recent addition of a new full-time trust officer in Red Bank.

Note that we have revised our income statement presentation to report bankcard services revenue on a separate line to provide more detail regarding card revenue trends.

Expenses have increased in recent quarters as the Red Bank Financial Solutions Center is fully operational, and new revenue producing hires have been placed in commercial lending and trust.

As mentioned in previous calls, we are committed to maintaining expense discipline and have been looking for opportunities to fund our growth initiatives by reducing expenses, less strategic activities. As part of that review, we have identified two branches that have experienced significantly diminished traffic flow, coupled with a substantial overlap with their neighboring branches. These two branches will be closed in the fourth quarter and consolidated into nearby OceanFirst facilities which are larger, more modern, and more prominently positioned. While the closure of these branches provides additional capacity to invest in growth capabilities, the consolidation of the branches reflects more than an expense reduction opportunity.

Clearly, there's an ongoing transition of how customers choose to interact with their primary financial institutions. We have seen a steady decrease in branch traffic offset by a dramatic increase in the use of our electronic and mobile channels, along with increased use of our Visa check card and ATM machines.

We have been providing remote deposit capabilities to commercial customers for five years now, have begun deploying envelope-free ATMs, and will launch consumer remote deposit in the fourth quarter. The capabilities and evolving consumer traffic patterns will allow us to reduce the investment represented by branches in close proximity to each other without materially impacting customer convenience.

Finally, in an effort to bolster net interest income while improving our interest rate risk position, we have elected to restructure $159 million in Federal Home Loan Bank advances. The restructure will allow us to retire funding with a weighted average cost of 2.31% and a weighted average maturity of 16 months. This funding will be replaced with a combination of deposit growth and new Federal Home Loan Bank advances while the new advances will initially be laddered on a short-term basis and then rolled into long-term advances over the next four quarters, allowing for deposit growth to a portion of the long-term funding needs. The cost of this restructure will be $4.3 million pretax, $0.16 against our book value per share. The restructure has been executed in the fourth quarter and will be reflected in year-end financial statements.

In summary, commercial loan growth, bankcard services, and trust continue to be high priority areas as we focus on improving growth trends. Increased investment required to produce growth will be largely internally funded as we take the opportunity to reallocate expenses within the Company.

At this point, I'll turn it back over to John for the Q&A portion of the call.

Thank you Chris. With that, Chris, Mike, and I would be pleased to take any questions you have for us this morning. Emily?

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

Good morning. Just a few questions. I wanted to ask -- the $1.8 million in sort of the Hurricane Sandy provisioning Chris mentioned, it sounds to me like, if everything sort of goes according to plan or everything sort of remains as you see it today, this could be a tailwind, and you could see much of that recouped over the next year through the provisioning. Is that a fair reading of it, or am I reading too much into it?

It's Chris. Thanks for the question. You are always hopeful of that but you want to be cautious and guarded. We took a look at the experience after other natural disasters like Katrina, and we found that most institutions experience their losses within one to two years after the event. So we are hopeful. We have not seen anything that makes us uncomfortable today, and that's why we focused on that.

Okay. And then on the branch consolidation in the fourth quarter, it sounds to me like we shouldn't expect to see cost saves from that fall necessarily to the bottom line, because we're going to see offsets in the form of growth initiatives elsewhere. But I'm just wondering what that stream is in terms of expense saves off of that consolidation.

You're absolutely right, Frank. We tried to make that clear in the release. In fact, we've already spent some of that money, some of those cost saves. In terms of beefing up some of our commercial lending positions and some of our income producing positions, we've obviously increased our compensation line quarter-over-quarter, and you can see that in our operating expenses. So we expect to be using the branch rationalization and the consolidation we have and some other moves that we might be contemplating in the fourth quarter to actually allow us to make those types of investments without running that efficiency ratio amuck. Chris has been very clear about that in terms of his joining us. Chris, you want to comment on the efficiency ratio?

Frank, the efficiency ratio is important for us, and we think, by redirecting expenses, we can really invest in those growth areas. But you got the message exactly right. We don't expect to have net decreases in operating expense, but we do expect to blunt what would otherwise have been growth in the operating expense line.

Okay. Then just on the pipeline, I wonder if you could talk a little bit more about sort of the beginning of this Hurricane Sandy rebuilding phase that you are seeing starting to pop up. I'm looking at the construction pipeline that you gave, and the average yield just seen -- and I haven't seen a lot of new construction in other banks, so maybe I'm just thinking with sort of higher yield than the past, obviously. But average yield looked low to me at around 4%. I'm just wondering if you can give a little more color on what these construction projects look like. Are they generally one-off? Is it totally destroyed homes or would homes having to be raised fall into this category as well?

Sure. There's two components of the trend. One is the residential component. And just to differentiate what we are seeing, these are owner-occupied residential construction loans where either someone may be rebuilding their own home or taking advantage of a vacant lot that they may have purchased to go put a home in. There are approximately 50 of those, to give you kind of a color, and those are -- because they are construction to perm, the pricing on those tends to be closer to the residential market. You do get a premium above what you would get in the normal residential market, but it's not the premium you would expect in a speculative construction loan which carries a lot more risk.

On the commercial side, the projects that we are seeing are short-term in nature, so they tend to be priced pretty competitively, but they are also floating-rate instruments so you don't have a whole lot of interest rate risk. So when you look at those two things, I think that kind of tells the story.

Sure. Okay, great. Thank you.

Travis Lan, KBW.

Good morning guys. Chris, looking back at last quarter's release, just again on kind of the pipeline yields, it looks like the commercial yield in the pipeline last quarter was 4.46%, and this quarter it looks closer to like 3.97%. I just wondered what kind of accounted for that decline, if it's a mix shift or something else.

Sure. It is a little bit of a mix shift. We don't regularly report the duration of those loans, but comparing the duration from last quarter's pipeline to this quarter's pipeline, the duration dropped from an average duration of five years to an average duration of under four years. So it's a little bit more of that and a mix change than it is anything else.

And those -- our pipeline numbers will move around. We think it's important to share them with you. But you will see certain quarters where they may be bouncing up or down. As a trend, we are very comfortable with where the pipeline is. And although it was a little bit low for September 30 compared to June 30, it popped up right after the end of the quarter, which is timing of closings and timing of commitments. The pipelines we report are committed loans, are underwritten, approved, and committed. So we don't have too much in there that is speculative.

Got you, okay. And I know you've touched on this, a couple of points throughout the call, but just kind of the outlook for asset yields here. John's comment on balance sheet growth from this point maybe indicates there will be less securities to loan reinvestments. I'm just wondering are going to still see some of that and can you offset kind of absolute pressure, or do think asset yields kind of continue to come down with the market?

I think it's a complicated picture because we've got several things going on. We continue to be pleased with our deposit growth, which is helpful. And although we've restructured these Federal Loan Bank advances, our goal would be to soak up as much of that with deposit growth as we can, so there's a little bit of an unknown there, although our historical deposit performance has been pretty strong.

In terms of where the loan yields are going, obviously if you look at the yields that are in the pipeline, they maybe a little lower than the portfolio. But we expect more of the opportunity to be replacing bonds than replacing loan run-off with new loans. So I think, when you put it all together, we feel the margins are stable. Obviously, we do our best to grow them, but we see stability for now.

Got you. And then finally, obviously you've seen some good momentum on the fee side. But as you reinvest these branch savings, can you maybe quantify or give maybe a little bit more color around the capacity for additional growth on fee income?

Sure. There's really a couple things driving the fee income line. Let me talk about it. The two major items are cards and trust where we see the opportunity for potential growth. Cards is a cyclical movement. I think a number of institutions are seeing this. And so I think we are riding a little bit of the consumer wave on adopting cards for more and more payments, but we are also trying to execute better there. so we are reasonably comfortable that that's on a good growth trajectory.

In our trust business, while those increases have been, on a percentage basis, large, it is still a relatively modest business for us. So we are hopeful, but we've got to add the people, and that is a slower growing business than I think you'll see on the card side.

Great. Thanks guys.

(Operator Instructions). Matthew Breese, Sterne Agee.

Good morning guys. Just on the prepayment, how long do you expect it to take to transition from the short-term advances to deposits and supplement that with longer-term advances? Over what timeframe?

About a year. We're going to layer that into a three- to five-year Home Loan Bank ladder. We're going to try to build some five-year, some longer-term CDs, and we anticipate that that would take about a year, and then that would be in place.

Okay. And in the near term, I'm assuming they are under a year kind of classic FHLB advances.

Yes. Short-term 30 to 90 days. And then we would start laddering them out.

Okay. So I'm assuming that the fourth-quarter and the first-quarter margin are going to see a substantial benefit as a result.

Yes.

Could you put some numbers around that?

Sure. Okay, the NIM will be improved about -- well, probably start about 3 basis points for initially, and blend down over the course of the year. It's going to be 9 basis points over the course of the year is the improvement in the NIM. So it would probably be starting at 3 and then winding down to 1, etc., but it will be 9 over the next year.

Okay. That's great. And then as it relates to the provision and kind of your commentary around the Superstorm Sandy provision taken last year, the last couple of provisions have been lower than what we saw for all of last year. I'm just kind of getting -- want some commentary around your thoughts on credit quality. And is the provision now at a point where it's going to be under $1 million every quarter?

I think that remains to be seen. It's based upon our current loss experience, but certainly the trend has been very positive. Chris alluded specifically to our direct experience with regard to the Sandy losses. That's been positive, but so has been our experience with the losses in our portfolio. Most of those nonperforming loans that we have are on the residential side where loss ratios are very lean. You just don't see our charge-offs. Our charge-offs year-over-year have improved pretty dramatically, and our nonperforming loans are also a positive trajectory. So we see the credit profile as definitely improving. That's not to say that there can't be a shock in that in the fourth quarter of 2013. So we'll take that quarter-to-quarter as we go. But at the beginning of the year, we thought that we would see the credit profile improving, and I think we are starting to realize that, perhaps a quarter later than we thought it may have occurred at the beginning of the year.

Okay. Then as it relates to expenses, have there been any additional hires on the lending team front over the past 90 days or so?

We are following our practice of being fairly discriminating about adding commercial officers. We do have two new commercial officers joining in the fourth quarter from neighboring institutions, but we are very much taking the position that we need to find folks that are like-minded with where we want to go, which means, in our definition, we are looking for relationship-driven credits on the commercial side that are generally -- that have a book that's generally in our market area. And some may have slightly larger or smaller books, but we are looking for people to patch in. As we find them, we're going to add them.

Okay. And the cost of bringing on those two commercial lenders, do you expect that to fully offset the branch savings so we'll see a relatively flat quarterly expense run rate?

It would be our goal to manage the efficiency ratio. I want to be careful not to project operating expenses going forward, but I think you've got our goal down.

Okay. And what's a good tax rate, still around 35%?

Yes. It's been pretty consistent, about 35% or a little more. I would stay with that, yes. 35%, 35%. It's been right about 35% the last four quarters. I'm looking at it now. It's almost always 35%.

Okay. Thank you guys.

On the net interest margin, the average is 9 basis points for the whole year, so actually it will start out, in the first quarter, it will start out like 12 or 13 and then it will be 10, and then 8, and then 7. So that is how we progress, and the first quarter benefit might be about 12 basis points over the course of the year. Based on our model, it would be about 9 basis points.

Got it, okay. So essentially, all things being equal, 3.20% to below 3.30% next quarter.

That's absent other changes that are happening within the --

Yes, that's just the impact of that. Obviously, there's other items that will affect the margin. And some of that -- and of course we just executed the repurchase, so you'll see a lot of that in the fourth quarter this year. And then a lot of that starts in the fourth quarter this year, and then the first quarter next year, and then starting to slide down as we roll out the borrowings.

Understood, thank you.

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

Just one quick one on -- I think you already touched a little bit on it in terms of mortgage banking revenues. Just wondering if you can give the loan sale gain margins this quarter and last.

It was 1.65% this quarter. And I think it was about 2% or a little more last quarter. It's clearly declining. It's 1.65%. That's the lowest it's been in years in this quarter. Of course, as rates rise, we do hedge our portfolio. But it's not always hedged, it's not 100% hedged, so in a rising rate environment, you're always going to do a little worse than in a declining rate environment.

And is that sort of where you're seeing margins now, or have they come down over the quarter and then they're now lower than that 1.65%?

Yes, they'll probably be around that level. Now rates have kind of stabilized. Actually they've come -- the last couple moves have been down, so that may be a marginal benefit. But we're trying to get -- of course the refinance volume has lessened for everyone, so I think, in the competitive world, everybody is trying to get a little more competitive with rates, so that would put some pressure on the margin as well.

Okay. All right. Thank you.

Travis Lan, KBW.

One clarification on the margin. Your 12 to 13 basis point projection for the benefit from the prepay of the debt, does that include kind of refinancing that, or is that just your net or your gross benefit?

In the margin, well, 12 or 13 -- okay, so, right now, it is being rolled into short-term advances 30 to 90 days. So that benefit is about 12 basis -- an increase of about 12 to the NIM in the first quarter, and then as we roll those advances out into our three- to five-year ladder, the benefit will gradually decline every quarter.

That answered it. Thank you.

(Operator Instructions). There are currently no further questions, so that will conclude our question-and-answer session. I'd like to turn the conference back over to Mr. Garbarino for any closing remarks.

Thanks Emily. I'll be brief. Just again, let me just thank all of you for joining us this morning, and we look forward to the opportunity of speaking with you again in the new year. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.