OceanFirst Financial Corp (OCFC) 2016 Q1 法說會逐字稿

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

(Operator Instructions)

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

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

Please remember that many of our remarks today contain forward-looking statements based on current expectations. Refer to our press release and another public filings, including the risk factors in our 10-K, where you will find the factors that could cause actual results to differ materially from these forward-looking statements. Thank you.

And now I will turn the call over to our host, Chief Executive Officer Christopher Maher.

Thank you, Jill, and good morning to all who have been able to join our first-quarter 2016 earnings conference call today. This morning I'm joined by our Chief Financial Officer, Michael Fitzpatrick, and Chief Administrative Officer, Joe Iantosca. As always, we appreciate your interest in our performance and are pleased to be able to discuss our operating results with you this morning. As has been our practice, we will highlight a few key items and add some color to the results posted for the quarter, and then we look forward to taking your questions.

For those of you who regularly read our earnings releases, you may have noticed this quarter's release includes some enhancements. The release has expanded disclosures to meet best practices in terms of providing five quarters of historical data, and more detailed information regarding both asset quality and other loan portfolio metrics. We hope that you find these additions meaningful.

In terms of financial results for the first quarter, diluted earnings per share were $0.25. Reported earnings were impacted by merger-related expenses of $0.07, or $1.2 million after tax, resulting in core earnings per share of $0.32. Merger-related expenses were accelerated, as the Cape Bancorp acquisition received the required regulatory approvals in March, which has afforded us the opportunity to accelerate our closing schedule. Pending the shareholder meetings scheduled for this coming Monday, we now expect the transaction to close as early as May 2, about two to three months earlier than originally anticipated.

Our core EPS is unchanged from the prior year period. Operating results reflect the addition of five new branches, three of which were acquired and two of which were opened as de novo locations over the past year. This additional infrastructure provides material capacity for organic deposit growth and, when combined with the Cape acquisition, will bolster the bank's ability to generate high-quality deposit growth in pace with loan growth. Later in the call, I'll ask Joe Iantosca to make a few comments regarding the integration of Cape Bank.

Regarding capital management for the quarter, the Board declared a cash dividend of $0.13, the Company's 77th consecutive quarterly cash dividend. No shares were repurchased during the first quarter, as the Company elected to build capital and tangible share value in advance of the Cape Bank acquisition. As a result, tangible book value per share increased to $13.75. As of March 31, the Company had 244,804 shares available for repurchase. The repurchase program remains active; however, the Company expects to continue to prioritize dividends and build tangible book value in advance of the Cape Bank transaction.

Operating results included organic loan production of $103.3 million for the quarter, which produced a modest gain of $26.3 million of portfolio. This level of production was somewhat lower than prior quarters, but the pipeline remains strong and we're confident that prudent organic loan growth remains achievable in the coming quarters. At this point, we believe economic conditions support additional loan growth, although competitive pressure is clearly impacting the number of well-structured credits available in the marketplace.

Deposits were a strong point for the quarter, as the focus on deposit gathering continues to pay dividends. Deposit growth was significant, at $54.7 million, 78% of which was in core deposits. $37.7 million of the deposit growth was organic, with the remainder representing the acquisition of a branch in Toms River, New Jersey. The cost of deposits was only 26 basis points, an important indicator of deposit quality. Finally, loan-to-deposit ratio decreased from 102.8% to 101.3%, evidencing our commitment to build both sides of the balance sheet in a high-quality manner.

Operating expenses of $16.7 million for the quarter were elevated as the result of $1.4 million of merger-related expenses driven by the Cape acquisition. Importantly, core operating expenses decreased versus the prior quarter. As compared to the prior-year period, operating expenses increased $1.6 million, which was driven by $779,000 of operating expenses to support the additional five branches added since the first quarter of 2015 and approximately $450,000 in expenses related to personnel additions in the commercial lending area.

Year over year, core operating expenses as a percent of total assets remained steady and are poised to decrease as both de novo branching will be restrained and the Cape acquisition will begin to improve operating leverage in the second quarter. The full benefits of the Cape acquisition will be effective following the data systems conversion, which is currently scheduled for October of 2016.

In terms of non-performing loans, the bank has historically favored optimizing total dollars recovered over faster resolution, which has sometimes resulted in an elevated level of non-performing loans. In the first quarter, we began to balance this approach in favor of accelerated recovery times when possible. Local real estate markets are demonstrating some improvement, which provides an opportunity to address non-performing loans more quickly and without materially impacting recovery amounts.

The focus on more timely resolutions is being managed by a newly dedicated asset recovery department which is focused on improving resolution time frames, a function that will become even more important as the bank grows and enters new markets. As a result, accelerated recovery efforts in the first quarter decreased non-performing loans by $2.1 million to bring the non-performing loan ratio down to just 80 basis points, the lowest level since 2008. Correspondingly, the coverage of allowance for loan and lease losses surpassed 100%, also for the first time since 2008.

Credit costs were a headwind for the quarter as the Renault golf course-hotel-winery property, which has been in OREO since November, contributed a $279,000 real estate loss, exacerbated by both seasonality and several one-time expenses related to the administrative efforts to ensure proper transfer of the liquor licenses. March results indicate that this OREO property is not expected to have a material impact on second-quarter results.

The buyer for the previously disclosed sales contract requested an extended closing time frame which, given the degree of interest in the property, the bank has declined. Negotiations are ongoing with several entities, with the intent to exit this property in the coming months at a resolution value that reflects the asset's current whole value on the balance sheet. In addition, the quarterly provision covered both net loan growth and the creation of some new specific reserves, while maintaining an unallocated reserve percentage of 3%, slightly higher than year end.

While credit card costs were a headwind, it's important to note that none of the non-performing loans at March 31 were commercial loans originated in the past five years. Consequently, current period credit costs are not being driven by recently originated bond [images]. Our strategic focus on expanding commercial lending over the past three years has been, in part, driven by the positive credit performance of our commercial loan portfolio.

With that, I'll turn the call over to Joe Iantosca, who will comment regarding our integration plans and timelines for Cape Bank.

Thank you, Chris. Our team is fully engaged on the integration of Cape Bank into the OceanFirst franchise. Since this is the third integration the bank has undertaken in a year, we thought it appropriate to take a moment to describe the capabilities and experience of the team assembled for these projects.

The same key core team members leading the integration effort for Cape completed the projects for both Colonial American Bank, in 2015 October, and the branch acquisition from Provident Bank during the first quarter. The performance of the team was assessed following each of these projects and was deemed successful by both objective and subjective measures. Our newly acquired customers experienced no unplanned outages or delays in account access, whether in person, by ATM, or debit transaction, or with their online or mobile devices. Measuring core deposit balance retention since conversion, the Colonial American branches are at 100% and the Provident branch is at 97%. There have been no significant customer concerns with the conversion or OceanFirst products following either project.

Looking at the composition of the team, I am the executive sponsor of our integration projects, and much of my background prior to OceanFirst was with National Bank technology service providers where I led projects teams responsible for over 100 conversion projects at banks ranging in size from several hundred million dollars to $25 billion. I am privileged to be able to work here at OceanFirst with several of my colleagues for many of those projects. One in particular is the project manager for all three of these integrations. He and I worked together at BISYS on several major acquisitions for New York Community Bank. He has led major project teams for significant integrations at Capital One bank, TD Bank, and Dime Bancorp.

What makes our team unique is that credentials such as these are not the exception, but the norm. Whether it be in the lending and credit functions, retail banking, or operations and technology, most of the 30-some members of the core conversion team have several similar projects in their backgrounds. This core team is supplemented with subject matter experts who also have years of experience in their particular business lines.

Back specifically to the status of Cape, with the acquisition tracking towards a closing on May 2, all areas of OceanFirst are prepared for the consolidation efforts commensurate with the legal closing. The full system conversion and branch integration is planned for mid-October, allowing for a full realization of the projected cost savings prior to year-end 2016. In addition to the systems conversion and integration, we have also been focused on operating within a new geography, while maintaining our focus as a community bank.

To achieve the most competitive position at the right operating cost structure, we will be consolidating functions such as credit policy, loan servicing and deposit operations, electronic banking, human resources, technology and cyber security, and an enhanced BSA security function at the corporate level. Importantly, we will maintain a local, empowered Management Team, positioned to address market needs in the responsive, flexible, and professional manner that has made OceanFirst so successful in Central Jersey.

The current Cape franchise will operate as a separate region, with all our client-facing personnel reporting to a newly recruited division president. We recognize that there's a lot more than 97 miles between the home of the Giants and the Jets, and the home of the Eagles. And a big difference between a hoagie and a hero. So we want to ensure that this region is led by an in-market team who understands the needs and requirements of our customer base.

So, based on the team we've assembled, our experience to date, and the organizational structure we've created, we have great confidence in our capability to fully integrate the Cape operation in a timely and effective manner and to quickly be recognized by customers, prospects, and centers of influence in the region as a highly competitive and responsive bank of choice.

With that I'll turn the call back to Chris.

Thanks, Joe. At this point, Mike, Joe, and I would be pleased to take your questions this morning.

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

(Operator Instructions)

Travis Lan, KBX.

Looking out for the margin, origination and pipeline line yields are 12 basis points or so lower than portfolio yields. Is it reasonable to expect a little bit more NIM compression going forward, excluding Cape, or are there opportunities to keep the NIM flat with earning asset adjustments?

I think that the -- my guess is that we're going stay about flat. There might be a little bit of compression, if so it's only going to be a couple of points. Because we will be -- continue to do a little mix shift. Obviously we will look at the balance sheets when we integrate Cape and we're currently looking at ways we can structure that to improve that interest margin. So you may see us do some work around the securities portfolio and the borrowing base as we do the integration.

When we do our financial report for the June 30 quarter, I think we will be able to walk you through the composition of the balance sheet going forward, which is a little fluid at this point. But to get your primary question, I think your margin is going to stay about where it is.

Okay. All right that's helpful. And then Chris, can you maybe give some additional color or maybe provide an example of the type of competitive pressures that you're seeing on the lending side?

Sure. The way I would characterize it is that we're seeing fundamentally good deals that have structural deficiencies in them. So we're seeing deals that have good borrowers, good cash flows, good LTVs. But once you start stressing these deals they hold up to maybe one point of stress. So for example, if you were to stress the interest rate, I mean debt service comes down little bit, but if you stress the interest rate should probably also stress the cap rate, so your LTV is going to go upside down.

And then the icing on that is that you're getting a deal that's fundamentally might be just a little bit weak, and then you put the flavor in of nonrecourse. Which then kind of pushes you over the edge, and you say look, I might live with a thin debt coverage, I'm not going to live with a thin debt coverage in what could be a thin LTV based on cap rates. And then the triple to that would be the nonrecourse. So those are credits we've been shying away from. They're not bad loans, they're just loans that are structured at the edge of acceptance and we don't want to play by that edge.

Got it. Is there any differential, and I know that the franchise as it stands today is fairly well concentrated along the shore, but is there any differential between the competitive environment in Mercer County and the shore or maybe even demand in Mercer County versus the shore that you can point to?

That's a great question. I would describe it this way, there is a difference. But interestingly I think the difference has less to do with geography and more to do with average loan amount. So I think in many places you find this phenomenon, as the loan amount goes up they tend to be more attractive loans. There are more bidders in the process and those spreads tend to be thinner.

In areas like, I'll compare two primary counties today, Ocean to Monmouth. We would see Monmouth County origination tend to be larger in size, which is nice because it's a little more efficient. But then more competitively priced. So I think you'd see the same phenomenon in Mercer County being more like Monmouth County, and then Ocean County being more like the counties where we move into Cape. But it's more related to the average size of the deal. $1 million to $5 million deals have price advantages over the $10 million and up deals.

And for us anyway, when we get, most of the time, when we get above $12 million or so, $10 million, $12 million, they become so competitive our likelihood of winning those goes down. So we have a few credits about the size but our sweet spot is probably between $5 million and $10 million, $5 million and $12 million.

Got it. Okay and then last one just housekeeping, the tax rate was a little higher this quarter than I expected. Is 34% to 35% still a reasonable expectation for the rest of the year?

Travis when you look at -- it's only high because of the merger-related expenses, a lot of that was not tax-deductible so if you look at it overall it appears high. But if you look at the last page of the press release we tell you that the merger-related expenses was $1.4 million, the tax benefit on that was only $171,000, so when you take those, when you redo -- when you take those out and redo it, you'll see that it's below 35%, it's actually favorable. So yes, 34% is probably, on a core basis is a right rate.

All right, thank you all very much.

Thanks, Travis.

Dave Bishop, FIG Partners

Maybe talk about, I think the narrative spoke about some payoffs that impacted total footings on the loan side, maybe going to that with the first quarter sort of seasonably aggressive from that perspective, did that have sort of a outsize impact?

You know you always have a little bit of a chance that in any given quarter you may get a payoff or two. And interestingly, I would tell you to the comment I made earlier about the quality of credits, we're seeing a couple of our customers we may have banked for a long time getting financing offers from competitors. That are just way outside what we would typically, we would typically look at.

So you're sad at that points, but which you don't want to do is get your customer in trouble by giving them too much leverage or putting them into a position where that might be an issue. So I guess the other comment I'd make is that it will be lumpy from time to time, it was a little lumpy in the first quarter but we're going to have payoffs from time to time.

Second thing is the portfolio is now $1 billion. And we really start pushing commercial growth three years ago it was about half that size. So with the bigger portfolio each quarter you're going to have to originate a little bit more to cover what is expected runoff because deals will go that way.

In terms of maybe looking at the crystal ball on the legacy basis, still think you can generate some of the double-digit commercial loan growth you have been turning lately?

We're comfortable with that, the first quarter was a little bit slower than we would have liked, but we are always going to favor -- you've got to do the deals that you feel like doing in that quarter based on your credit parameters and your pricing parameters, and we view our balance sheet as a precious commodity. We don't want to load it up with stuff that we would regret down the road.

The only caveat I give you is that, in our business, at least the way our pipelines work, we've got pretty good visibility into the next 90, 120 days. Beyond that it always becomes a little bit harder to see. If we continue to see a couple deals here and there with aggressive structuring, I don't think that gets in our way. But if that becomes a wider trend, yes, it may cause an issue.

And we're continuing -- I'm very conscious that even though the Cape acquisition is a significant move, we're continuing to build the organic engine here. And I point to the first quarter we had two senior commercial lenders join, one from Chase and one from TD, that are just really well-known folks in the market areas; I think they can help us push more growth.

So the short story is that it looks okay for now, for as far out as we can see. We're watching some of these structural issues and some of the deals we're not doing, and if that becomes more of a trend we'll update you. But pipelines are okay and I think we still have our sights set on double-digit growth in the commercial loan.

Got it. That's good color. And then one other follow-up and I'll jump back in the queue. Maybe some color on the net charge offs this quarter. Looks like obviously elevated from the recent norm, but clearly did not backfill on the nonperforming side, so just curious maybe some color on those two credits that were charged-off?

Sure. We're very conscious that we need make sure that all of our metrics are demonstrating what we believe is the core value franchise of the bank. So having the elevated nonperforming number from time to time, was a good tool if you're trying to optimize your net charge offs. So all of last year's net charge-offs were only 5 basis points. So really we looked at things, looked at the bank being larger and looked at wanting to have a systemic ability to move things through more quickly.

We said, you know what, we should try and make sure we clean up everything we can while real estate values are good and the sun is shining and there are really no big credit issues in our marketplace. So it's more of a slight shift in approach. The two commercial credits had been fully reserved in prior quarters so they really didn't impact much our look at the allowance.

And I thought importantly and I mentioned it in my comments earlier, the first question you ask yourself is, is this a trend that would be concerned about and we have no concerns in that regard. The loans that we're working through on that side are loans that were originated in more than five years ago for the most part. So these are things that we're trying to clean up, trying to make sure that the nonperforming ratio is in the right place versus the peer group, not recently originated [image].

Got it, great. I appreciate the color.

Thanks, David.

(Operator Instructions)

Matthew Breese, Piper Jaffray

Chris, I was hoping you could just touch on the margin a little bit further. I know that there were some lending fees that were down quarter over quarter that was embedded in net interest income and I wanted to know if that was included in your margin guidance of roughly flat?

Yes. So I think your point, Matt, in the fourth quarter, we had a little boost in margin, about 3 basis points from prepayment fees. Our portfolio is typically not structured to generate a lot of prepayment fees. So I know there are other portfolios that regularly generate prepayment fees, that's a little bit unusual for us. So I would take our first quarter margin, we think that margin is relatively stable.

And it's going to be a factor of the exact composition of the deals that close in a given quarter. Right now, we're cautious, we have not had much pressure on deposit funding costs. But that could change.

We're looking at what the Fed does, and I would characterize the Fed's first move of interest rates back in December. As having virtually no impact on us, I think that's probably pretty consistent with what I hear from my peers. But if they moved two more times this year I don't know what will happen. So I'm less concerned about yields on new loans coming on and probably more concerned to just have one eye in the funding side to make sure we don't get any pressure on that side.

Okay, so really another one or two Fed hikes would change your margin outlook, but absent that we can keep it flat?

Yes, and it may change our margin outlook. It really depends on what the competitive landscape is. So if the Fed moves, but it tends to be a move in a vacuum, and there's not a pricing change among our competitive institutions; have no impact. We don't have that much wholesale funding dependency. We're not increasing it over time, so our margin outlook is more closely tied to the deposit price market than wholesale funding markets. So it would be hard to say, but certainly it could cause pressure.

All right. And then on the noninterest income side, I know in the press release you mentioned that you're seeing customers more broadly not go through overdraft charges. Was there some seasonality this quarter? It seems like the drop-off was pretty steep. I can chalk some of it up to customer behavior, but should we see a little bit more of a pop up in the second quarter?

I think even within the quarter we saw a little bit of a recovery on the non-overdraft fees. So I think you'll see some stabilization there. I think the overdraft is really, it's a cyclical, not even cyclical, I'd say it's more of a social trend where people are choosing to be more careful about that. One of the downsides to having all this online information about your account is people are less likely to overdraw, they know exactly what their account balances are. So I don't think it's going to jump back up but I think it looked stronger for us in March than the prior two months. So we think it will recover a little bit.

Okay.

And the recovery is coming out of non-overdraft fees. Overdraft fees we think will continue their trend.

Got it. And then just thinking about the new asset recovery department, is it possible we could see, just for a period some higher levels of charge-offs, maybe some higher provisioning as that team takes a first cut at the nonperforming assets and works them off the book? Is that a more likely outcome as they get integrated and go through the portfolio?

I don't think you're going to see -- I don't expect you're going to see a material number there. That group has been hard at it for a full quarter now. And part of what you saw in the first quarter was some of that. I said, look if we're going to be focused on this let's go high and low, look at everything on the balance sheet, if things need to be moved into a classification, move them.

But part of it is, it's a cyclical opportunity to make sure we clean everything up. With real estate values a little better and all that. The second part is we're conscious that we're going to be a larger bank in hopefully in a couple weeks, and we're going to be operating in markets that have different credit dynamics. And while it's worked well in Monmouth County, to take your time on resolutions, it may not work well everywhere. So we need to make sure that the capabilities of the bank are growing to match the mission as we operate across a broader market.

Okay. And then in terms of the combined company. Have any of your profitability targets changed? As a result of the last 90 days?

That's another good question. No. We're on track, so we're pretty deep into this, the assumptions are holding where we expected them to be in aggregate. Obviously you'll always have one number with move a little more than another. But we will be very careful at the June 30 earnings release.

We'll be very clear on our purchase accounting marks, accretable yield, and all that. Because one thing we're very much aware of is that our investors deserve to understand how much of the business value is created out of organic and how much of it is created from the deal. But our original assumptions have held up just fine.

Got it. That's all I had. Thank you very much.

Thanks, Matt.

(Operator Instructions)

Dave Bishop, FIG Partners

Just a quick follow-up and just building on Travis's question regarding some of the pricing differential. As you sort of look at across Cape's franchise there, is there a meaningful or a material difference in terms of the pricing in and around some of that Philly, South Philly, Southern New Jersey area on the loan side that you've noticed?

I would say it's interesting that they are very distinct markets and there are several markets there. So when you really get to understand that geography, you have a little bit of a coastal market, you also have a kind of Western New Jersey/Philly suburb market and then you have Philly proper itself. And I would tell you that they're all priced a little differently.

So pricing in more of the traditional coastal markets, you know, Cape May all the way up through say Ocean City, is probably pretty similar to what we see in our Ocean County market. Reasonably well priced deals, but small. Your average deal is going to be smaller and not as much volume. When you get into the Philly side, the deals are a little more competitive, there are more players in that market, they tend to be larger. And you know, I think in blend it's not that different from the market we're operating in today, but it has those two distinct flavors.

I think in general you're going to see originations, we've been pretty stable with commercial originations having a low 4% yield and I think you'll see that blend continue. As we've looked that, obviously we're sharing a lot of information at this point with Cape. We've looked at the price structure of our deal and the price structure of the deals they've done historically. There's not a big delta.

Got. Thank you.

Thanks, Dave.

This concludes our question-and-answer session. I'd now like to turn the conference back over to Christopher Maher for any closing remarks, please go ahead.

Once again, thanks for joining us for the conference call this morning. We look forward to presenting additional updates as the year progresses. We'll talk to you soon. That's again.

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