OceanFirst Financial Corp (OCFC) 2014 Q3 法說會逐字稿

Good morning and welcome to the OceanFirst Financial Corp. earnings conference call.

(Operator Instructions)

Please note that this event is being recorded. I would now like to turn the conference over to Jill Hewitt. Please go ahead.

Thank you, Chad. 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 this 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 Conditions and Results of Operation set forth in OceanFirst filings with the SEC. Thank you.

And now I will turn the call over to our host, 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 2014 earnings conference call today. It is with mixed emotions that I greet you this morning, hosting my last quarterly call as CEO of OceanFirst Financial. As you know, President Christopher Maher will succeed me as CEO, effective with my year-end retirement, and be your host on future calls.

As always we appreciate your interest in our performance and are pleased to be able to review our operating results with you this morning. 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 from our opportunity to add some color to the results posted for the quarter before we take your questions.

I am pleased to conclude my participation in these calls with a successful quarter, announcement of a cash dividend increase and reporting the cleanup of a substantial portion of our residential nonperforming loan portfolio, which we all realize has been languishing due to the extended judicial foreclosure backlog in New Jersey.

In summary for the quarter, diluted earnings per share were $0.31 up a penny from the linked quarter and $0.02 ahead of the corresponding prior-year quarter. Factoring out all of the extraordinary items however, we view the quarter as reflecting a solid $0.30 of core operating earnings. The Board declared the Company's 71st consecutive quarterly cash dividend, increasing it a penny to $0.13 per share, representing a 42% payout of our earnings and underscoring our confidence in this sustainable ratio, well within the parameters of our capital management planning.

I will now ask Chris to provide additional details on our quarterly operating results and explain the steps we have taken to position us for a changing operating environment.

Thank you, John. OceanFirst has prospered under your leadership and I look forward to continuing your record of stewardship and development for what has become an admirable Community Bank franchise.

This quarter include the impact of the sale of the majority of our residential nonperforming loans, but before we address that transaction I'd like to comment on John's comments regarding the dividend and the progress being made in our core business. Commercial loan originations increased materially during the quarter to $66.7 million which compares against $46.9 million in the linked quarter and $49.5 million in the prior-year quarter. Net growth in commercial loans is a more muted $27.2 million due to payoff activity during the quarter. But the important point is that commercial loans have been growing at double-digit rates for the past five quarters.

Our objective has been and will continue to be consistent and methodical growth in the commercial business. This growth has stabilized net interest margins and when comparing 2013 year-to-date performance to 2014 year-to-date performance has supported a $2 million improvement in net interest income. The cumulative growth in commercial loans over the past five quarters totals $135 million and is now covering much of the incremental investment made to build a commercial business. The current pipeline indicates this trend should continue. Given the progress made in commercial, we see an opportunity to continue to expand this business in [2015] and beyond.

Noninterest income including investment gains in real estate operations totaled $4.7 million this quarter as compared to $4.6 million in the linked quarter and continues to grow. This quarter's growth was attributable to [strengthened banking] fees and continued despite sector-wide pressure of residential mortgage gain on sale income. To put the macro mortgage banking trends in perspective, the bank's [gain] on sale income ranged between $3.7 million and $3.9 million in 2010 and 2011 during the height of the refinance market. The annual run rate for 2014 is approximately $770,000.

The strategic effort to build the commercial banking business increased bank fee revenue and advanced both bank cards and wealth management has offset the decline in mortgage banking income and improved opposition of earnings for the long-term.

Operating expenses were flat for the quarter coming in at $14.5 million versus $14.8 million for the linked quarter, evidencing the most substantial investments have been made and operating leverage is under less pressure as the bank moves forward. Considering the continuing momentum in the commercial business, stable noninterest income, modest expense pressures and the material improvement in our credit and operating risk profile, we are pleased to be in a position to provide an enhanced dividend to our shareholders.

Regarding the sale of nonperforming residential mortgages announced on October 1, liquidating the majority of our residential nonperforming loan portfolio allows the bank to reduce our credit risk position while positively enhancing operations. The reduced financial and reputational risks associated with pursuing foreclosure actions will also allow us to reallocate resources in 2015 as we shift resources from collection and workout to the generation of additional revenue growth.

At this point I'll turn the call over to Joe Iantosca, Chief Administrative Officer. Joe will give you more color on the nonperforming loan sale and discuss the quarterly provision for credit losses.

Thank you, Chris. Let me first touch on the nonperforming loan sale. From time to time we've evaluated the market for nonperforming loans. This past quarter we determined that market conditions had approached the tipping point, whereby the difference between the upfront cost of the sale and the ongoing expense drain that would be incurred until each of these loans was fully resolved was reasonable, giving us the ability to focus resources on forward-looking activity rather than loan resolution.

We sold 106 loans totaling $23.1 million in nonperformers, taking a $5 million charge-off, including uncollected loan escrow receivables. As a result of the sale, we estimate direct expense reduction in 2015 of approximately $500,000, with a continuing benefit over the next few years. I would note that 93% of the loans in the pool for the sale which resolved over half of the current nonperforming loans were originated prior to January 1, 2008. Our internal analysis has shown that loans of this vintage have a much higher incidence of delinquency, take longer to resolve and result in larger losses than loans of a more recent vintage.

Turning to the activity in the allowance for loan losses for the quarter, I would like to take a moment to walk you through some of the items leading to the quarterly provision for $1 million and the charge-off of $5 million for the nonperforming sale. Each quarter the bank's asset classification committee reviews each and every loan on the commercial watch list for changes in performance, collateral value and ultimately impairment.

Positive developments within the commercial loan watch list resulted in a significant decrease in the required reserves for commercial loans. Specifically in the quarter, a single large commercial credit which has demonstrated substantial operating and collateral value improvement along with a long history of current payments was upgraded to special mention. The net effect of this classification and changes in the impairment positions of seven other credits drove the decrease.

The decrease in required reserves for commercial loans was unrelated to the residential nonperforming loan sale. However, the residential NPL sale which eliminated 57% of the bank's nonperforming loans as of June 30 did result in a 52% or $1.6 million decrease in unallocated reserves, which is appropriate considering the substantially improved risk profile of the loan portfolio. The combination of these developments resulted in the $1 million quarterly loan loss provision which exceeded routine quarterly charge-offs but was materially lower than the charge-offs related to the NPL sale.

I now will return the call to CEO Garbarino for his wrap-up and questions and answers.

Thank you, Joe. No wrap-up, but with that, Chris, Mike, Joe and I would be pleased to take any questions you have for us this morning.

We will now begin the question-and-answer session.

(Operator Instructions)

Our first question comes today from Travis Lan with KBW.

Thanks. Loan yields were flat in the quarter. I am wondering, was there a prepayment penalty in there, or are you seeing a bottoming in the loan yields in your opinion?

No prepayment penalty, Travis. So it was an unusual, so -- but they're leveling off, yes.

Okay. And, Mike, just given the temporary liquidity elevation in the quarter, would you expect the margin to rebound a bit in fourth quarter, or is there more pressure to come from current levels?

Yes, there's a few things. Number one, you had the excess liquidity, as you know, reduce the margins. We have a couple -- so that liquidity will run out in the fourth quarter, so that will push the margin back up. We also have the [non-] performing loan scale at $19 million was earning zero, so now it's invested in securities at a little over 2%. So, it's about -- that's a plus 2-basis-point increase in the margin, but in dollar terms it's an extra $100,000 a quarter.

The big increase you saw in home loan bank borrowings from last quarter to this quarter, most of that was done -- most of that extension was done in the second quarter and then flowed through into the averages for the third quarter. So that's been mostly behind us. You're not going to see a big increase in that in the fourth quarter. So -- and then we anticipate some loan growth again in the commercial loan book in the fourth quarter. So, I would say we'd be back into the low [330s] for the fourth quarter.

Okay, that's great, thanks. And on that borrowing extension that you [hooked up] from the second quarter that flowed through, do you have the terms on that in terms of the rate and duration on that extension?

Yes, we were building a three- to five-year ladder, so it was about four years on average -- a little over four years -- and that was within the [175] range.

Okay, great. And then, just on the NPL sale and the balance sheet derisking that, that brings, does that open up -- and I think, Joe, you were talking about this a little bit but I just want to circle back on it -- does that open up some existing reserve for you to absorb future loan growth, or do you expect to have to provide for the additional growth going forward?

We recaptured some, as we mentioned in my comments, and it does open up a little for future loan growth but as loan growth occurs we'll also provide appropriately.

And, Travis, as you know, things change from quarter to quarter so there's no guarantee that everything's going to move in this beautiful straight line that we create.

Right, right. Okay, and then just last one that Joe mentioned that there were $500,000 of expense savings related to the NPL sale. Is there an amount that you expect to be reinvested in other lines? I know, Chris, you mentioned reallocating, or do we expect that to be a net reduction in expenses going forward?

Yes, I think we're looking at that right now, Travis. It's a great time of the year because we're putting our budget together for next year. I would say that, given the maturity of the growth in the commercial business, we would feel comfortable looking at maybe a little bit more investment in that. Nothing along the lines of what we had to do 18 months ago, but we may take some of that and reinvest it back into -- in a couple commercial lenders. We're looking through that now, so I would generally expect that expenses would be around the level they are today (technical difficulty) a little low.

Thank you, guys, very much.

Our next question comes from Matthew Breese with Sterne Agee.

Good morning, everybody.

Hi, Matt.

I wanted to get a sense for -- you guys have had very strong commercial loan growth, Chris, you said over the last five quarters. I wanted to get a sense for the right mix of the portfolio in your view, and how close are we to that mix?

That's a tough question. I think it's easier to answer in broad strokes, and I know you're looking for more specifics, but as of the end of 2013 our residential portfolio -- one-to-four family mortgages -- was less than half of the loan book for the first time. We certainly see commercial continuing to grow and residential staying relatively stable. So we'd like to, over a series of years, get to the point where commercial is the largest component of our portfolio. But we don't have the specific quarterly target on that.

We're always very guarded not to drive to a number, because in each individual quarter you see a wide range of credit following, a wide range of pricing, and sometimes you take more opportunities than others. But I think, to your point, over time, we expect that commercial portfolio will be our largest portfolio at some point in the next several quarters.

Right. And then, with the mix shift in the portfolio, the overall size of the balance sheet has remained somewhat flat over the past year to date, at the very least. And I wanted to get a sense for, given where capital ratios are, your willingness to put on additional more -- a little bit more leverage, and grow the size of the balance sheet.

Well, that's a little easier to answer. I think when you look at our securities portfolio, it's a little bit outsized for what we would need for a liquidity portfolio. So we look at that as really just a source of liquidity is the primary function. So, if you were to normalize where our securities are in the balance sheet, we have a few more quarters of growth that we can do that are swapping securities for loans. But, within the next several quarters, we're going to get to the point where the dollars of loan growth are probably going to correlate pretty closely to dollars growth in the balance sheet as well.

Okay. That's all I had. Thank you very much.

Thanks, Matt.

(Operator Instructions)

Our next question comes from Rick Weiss of Boenning.

Good morning.

Good morning, Rick.

I was wondering if -- I guess the interest rate sensitivity looks to me about the same as you were in June. Maybe now you're more interest-rate neutral? Is that kind of like a -- accurate description?

I think, Rick, maybe one of the ways to look at it is that, in the fourth quarter of last year, our borrowings had a weighted average duration of about 19 months, and we've slowly pushed that back out to 42 months. And we've done that to get to what we consider to be a relatively neutral posture. Strategically, if you look at that as something that we should be as neutral as possible, too. We should not be positioned for either a rise or a decrease in rates. We're not the kind of company that should be trying to take advantage of that.

Based on the GAAP measure, Rick, we were at -- at June 30, we were at negative 5% and at the end of the year we were negative 10%. So, we had that program to extend our borrowings in the first six months of the year. We dropped the gap from negative 10% to negative 5% as of June 30, and probably maybe a little bit less than that now, but slightly negative in terms of the GAAP basis.

Okay, makes sense. And -- let's see, what else? It looks like you had great core deposit growth in the quarter, and just how are you able to do that when everybody's out fighting for these deposits?

I think one of the reasons you saw the excess liquidity there, Rick, is that some of those core deposit [flows] were seasonal, so we expect the tide kind of comes in and goes out. We did have good commercial deposit growth, but I would say the majority of the growth you saw will be here for a couple quarters and then it may just back out. So, we have a number of institutional clients who are pretty seasonal in their deposit flows.

Okay, got that. And then, just big picture, how is the local economy doing?

It depends on who you ask. You get all sorts of views. But I would say we're in an unusual market. We continue to see -- I think the economy is being driven more by Sandy activities and Sandy rebuild than maybe the more macro environment you may see statewide or nationwide. That being said, real estate values continue to be relatively flat. We have not experienced, in our market, a significant uptake in values as some other markets have. So, it's a relatively stable -- a little bit of growth, but nothing unusual.

Okay. And was this considered to be a good season for the shore, then, in your market? There's a lot of tourists and vacationers coming in. Was it better than in 2013?

Good leaves a lot of room for interpretation, Rick. We can certainly say it was better than last season. You know, the tourist business is all cry if they get one day of rain in the month of July. So, I mean, that was there. But really, in reality, we had a wonderful weather month for the summer. The activity was much improved over the first year following Sandy, but we still view that as a long road back. And I think before we get back to any sense of normalcy here at the shore, especially as far as the tourist season is concerned, you're talking about still a matter of years and not any quick return to normalcy.

Okay, got it. And I guess the last question would be with regards to any M&A. What's your impression of the M&A market in Jersey?

I think our impressions are probably pretty consistent with what you read in a lot of the industry journals, you know -- an awful lot of buyers, not so many sellers, and pricing can be a challenge at times. So, we have always said that we look at those things opportunistically. We're trying to drive our business by core organics [of the business], and if the right thing comes by that makes sense to us we'll take a look at it, but we're banking on the organic growth.

Okay, thank you very much.

Thanks, Rick.

Our next question comes from Frank Schiraldi of Sandler O'Neill.

Good morning. Just a couple of questions. First, I just want to make sure I understand the dynamics here of loan growth going forward. So, I know you had, obviously, the loan sale. And don't know if you had other elevated or bulky paydowns in the quarter. But, as we look out at 4Q, would we expect to see commercial loan growth in the fourth quarter flow through much more greatly into total loan growth linked quarter?

Yes, I think the big offset this quarter was the NPL sale because it took away some of the residential. But I think if you look back over the last four or five quarters, commercial loan growth has been between, say, $27 million, $30 million, $35 million a quarter. And we think that's a sustainable number, and we'd actually like to grow it slow and steady and methodically and make sure we're not overexposed to any one interest-rate period or credit issues. So, I think if you looked at commercial and you looked at the growth rate for the past three, four, five quarters, we're comfortable that that's a sustainable growth rate. And then, [absent a] residential loan sale, like the nonperforming sale, you should see relative stability in the residential book.

Got you. Okay. And then just to the -- back to credit. I understand the improved risk profile. I guess aesthetically, just the reserved loan ratio is below where I thought we'd see it, below 1%. So, you know, just -- it sounds like, if I'm hearing Joe's comments correctly, that we might not have seen a bottom there or, you know, can you give me some color there?

Well, obviously, we're very comfortable with where we are. I would kind of point you back and to talk more about total credit costs over the last several years. So, although the reserve was appropriately built during the crisis and during the aftermath, our actual credit charges were actually quite minimal. So, when you look at credit costs, excluding this bulk liquidation, not a whole lot of charge-offs for a portfolio of our size. And that's the most important driver of your reserve requirements. The unusual activity in the quarter is that, unrelated to the nonperforming loan sale, we had the twin effect of the nonperforming loan sale and we had the commercial book, which has nothing to do with the residential book, that has experienced substantial improvements.

If I think, though, about the increase in the commercial book here -- and I'm not sure exactly where we are on the accounting change or the proposed accounting change for looking more proactively at loan losses. You know, in terms of that, I think it's likely that companies, when that changes, if that changes, will be able to make a one-time adjustment, not through the PNL. Have you thought about what sort of increase, if there would be one, to the reserve's loan ratio under that scenario or change?

I mean, the proposal is that the losses would be -- either reserve the losses now over the life of the loan. So you make a loan today, it has an average life of five years, you identify what the expected losses are over the five-year period, and you put that in your loss reserve today. So, obviously, that takes that -- that's different than what we're doing now where we're basically looking forward for a year of losses. So that would increase the reserve, I think, for almost every bank. What that number is, is -- the proposal isn't even finalized yet, so, we need to take a look at it when that comes out. But it'd clearly be a higher number. But you're right -- it would be a one-time adjustment and then you might be back on some other lower track. But what that is, is -- that's a whole industry.

We look at that very much as kind of a capital question more than anything else, so that -- with our capital ratio, we aren't concerned about a bad surprise there.

Right, I guess that would be --

In the long run, Frank, it doesn't change your loss. Your loss -- you know, it may change within your reserve, but over the long-term the loss -- the losses get converted into flow-through dollar, you know, when you have the access. It doesn't change your actual losses, it just redistributes when you record them in expense.

Right. I guess I've just heard potential for -- or significant increases in the reserve. And does that -- you know, Chris, you mentioned it's just more capital question. Does that mean you keep more powder dry here? And where are you comfortable, I guess, on a TC ratio level ahead of any change there on the accounting front?

Well, I think, like you, we're waiting for the final rule so we can see it. But we're obviously comfortable with the capital level of the Company and nowhere near some of our peers who have lower capital ratios and be more thinly capitalized, and who might have a little bit more of a delta to make up. So, we think we've got adequate room and we'll wait to see how this -- how the guidance really comes out and how it works in practice. But capital for the quarter was 9% --

-- 9.5%, so it -- there's room in our current capital position to account for any temporary increase in the loan loss reserve.

Okay. All right. Well, that's all I had. Thank you very much, John, and enjoy retirement.

Thanks, Frank, looking forward to it.

(Operator Instructions)

This concludes our question-and-answer session. I would like to turn the conference back over to John Garbarino for any closing remarks.

Thanks, Chad. Once again, let me thank you for joining us this morning on my final call. Our team looks forward to the opportunity of speaking with you again in the new year. Thank you.

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