OceanFirst Financial Corp (OCFC) 2017 Q2 法說會逐字稿

Good morning, and welcome to the OceanFirst Financial Corp. earnings conference call. (Operator Instructions) Please also note that today's event is being recorded.

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

Thank you, Andrea. 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 other public filings, including the Risk Factors in our 10-K where you will find 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, Chairman, President and Chief Executive Officer of OceanFirst Financial Corp., Christopher Maher.

Thank you, Jill, and good morning to all who've been able to join our second quarter 2017 earnings conference call today. This morning, I'm joined by our Chief Financial Officer, Michael Fitzpatrick; Chief Administrative Officer, Joe Iantosca; and Chief Banking Officer, Joe Lebel. As always, we appreciate your interest in our performance and are pleased to be able to discuss our operating results with you.

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.

In terms of financial results for the second quarter, diluted earnings per share were $0.23. Quarterly reported earnings were impacted by branch consolidation charges and merger-related expenses of $0.17 or $5.6 million after tax, resulting in core earnings per share of $0.40.

Regarding capital management for the quarter, the board declared a cash dividend of $0.15, the company's 82nd consecutive quarterly cash dividend. No share repurchases were made during the quarter, leaving 1.8 million shares available to repurchase.

Given our decision to acquire Sun Bancorp, share repurchases are likely in the coming months as our bias will be toward building capital levels to support potential balance sheet growth following the Sun acquisition.

Turning to organic growth and the overall operating environment, second quarter loan originations were strong at $215 million. Including $115 million of commercial loans with a weighted average yield of 4.52%. Net loan growth was modest as we maintained price discipline and continued to take advantage of opportunities to improve credit quality as the acquired loan portfolios mature. The total portfolio increase of $47 million occurred late in the quarter, producing a minimal increase in interest income but with a welcomed improvement from the $27 million of total growth in the first quarter of 2017.

Our strategy continues to favor steady and consistent loan growth as we invest our excess liquidity position over time.

The positive performance was stronger than the headline number indicates due to a seasonal rundown in our government banking business. The seasonal government deposit rundown matched healthy trends in retail and business deposits. On a year-to-date basis, retail core deposit growth was modestly positive at $4 million and nongovernment business core deposit growth was stronger, totaling $22 million. That performance is particularly notable given the consolidation of 15 retail branches over the last 90 days, which creates the risk of deposit runoff. The branch consolidation project began this time last year as we carefully evaluated locations, facilities and potential customer impacts. After making thoughtful decisions in the fourth quarter of last year, our staff commenced client communications in February of this year. They've done an outstanding job during every step of the process. I'm quite proud of the retail, marketing, operations and technology team that achieved the consolidations on time, on budget and with a bare minimum impact to customers. While still early, all indications are that the branch consolidations are exceeding our expectations as customer retention levels are high, and we are on track to achieve the efficiencies originally envisioned for this project.

Deposit cost remains stable, rising just 1 basis point. This modest increase was related to product mix shift rather than any increase in deposit rates across the portfolio.

The net interest margin was stable increasing 1 basis point this quarter. The improvements in asset yields were offset as purchase accounting benefits decreased by 3 basis points and prepayment income decreased by 1 basis point. The interest rate environment, including the slope of the yield curve, has been fluid and the impact of potential balance sheet reductions at the Federal Reserve can't be known with any precision. In this environmental, we'll maintain a balanced interest rate risk position and continue to dollar average our investments in both the loan and security portion of the balance sheet.

We have worked down the bank's cash position by just about $200 million since year end. We have over $100 million in cash currently available, and our loan-to-deposit ratio is a conservative 93%. With an expected seasonal increase in government deposits beginning in the third quarter, we anticipate having ample liquidity to support loan and securities growth in the coming quarters.

Operating expenses, excluding merger and branch consolidation expenses, decreased by $954,000 as compared to the prior quarter, driven by compensation expense reduction. This decrease represented a portion of the efficiencies we expected to achieve as part of the Ocean City Home Bank acquisition. Additional efficiencies will now be realized as the full integration of Ocean City Home was completed in May, with many of the separated staff working through June 30. As a result of the Ocean City Home systems integration and the branch consolidation project, third quarter expenses are expected to decrease by an additional $1.8 million on a pretax basis. As of the third quarter, the efficiencies anticipated as part of the Ocean City Home acquisition will be fully realized and compare favorably to our original projections. Of course, additional tuning of our operations will result in marginal improvements in efficiency, but those additional improvements won't be significant, and they will be offset by some expenses that will be required as we consolidate back-office facilities.

As previously mentioned, we currently have back-office staff operating out of 13 locations distributed throughout our market. We've been working diligently to determine the best solution to consolidate staff and continue the cultural integration. That issue has become even more important in light of this pending Sun acquisition, which brings another 6 sites into consideration as part of the back-office consolidation project. I would expect that the consolidation of back-office locations will be determined in the third quarter for implementation in 2018. Depending on the final solution, the bank will either purchase or lease a suitable location to accommodate current and future space needs.

In terms of asset quality, credit performance is strong as nonperforming loans decreased $5.4 million or 25%, now totaling just 42 basis points of total loans. The reduction in nonperforming loans was achieved through a combination of a small residential loan sale and 2 nonperforming commercial loan payoffs, totaling $1.7 million, which represented full recoveries. Excluding the residential loan sale, which resulted in a $925,000 charge-off, the remaining loan portfolio experienced a quarterly net recovery of $166,000. The provision of $1.2 million resulted in a $400,000 net increase to the allowance, primarily to cover quarterly loan growth.

Regarding the pending acquisition of Sun Bancorp, the timeline discussed in our recent acquisition conference call still remains on track. As this acquisition continues to advance the development of our commercial banking business, we have decided to make application to the Federal Reserve and to the Office of the Comptroller of the Currency to convert our holding company to a bank holding company and our bank to a national bank, concurrent with our acquisition of Sun. The additional step will likely add some time to the decision process but will serve us well in the future, and the requested charter structure more closely reflects our long-term strategy. We expect to file our regulatory applications at some point in August, using the June 30th co-report data for both institutions. Based on the required approvals and application timeline, we would target the Sun acquisition could close in early 2018. The acquisition of Sun should cement our competitive position in central and southern New Jersey, while providing a platform that will produce greater efficiencies and better operating scale.

In summary, this is an important quarter for the company. Performance for the second quarter was solid with a core return on assets of 1.02%, core return on tangible common equity of 12.42%, and a core efficiency ratio of 58.04%. These performance metrics are positioned to improve materially in the third quarter as expenses are trending down and there is currently no significant pressure on margins nor on credit costs. We were able to improve the rate of organic growth, deliver on the efficiencies promised from the Ocean City Home acquisition and demonstrate improving asset quality. With the Sun acquisition, we've set the stage for incremental progress in 2018 and beyond.

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

(Operator Instructions) And our first question comes from Dave Bishop of FIG Partners.

Question, circling back to the outlook for deposits and maybe some of the trends this quarter. Maybe just walk us through, I don't know if you can sort of bring sense to the dollar amount sort of tied to the seasonal run-off and maybe sort of expectations for how much sort of backfill there on the deposit front? And was that across the noninterest-bearing and some of the other core deposit segments?

Sure. So the -- so I'll talk a little bit about momentum, and then Mike may add some numbers to give you some perspective. But the government deposit business for us is very much about operating accounts. So we're handling cash management accounts for everything from municipalities to school districts. And there's a seasonality to when those tax payments are made. It typically picks up beginning in late July and gets quite heavy through August and September, probably peaking in the fourth quarter and then starting to come down again in the beginning of the year. So we certainly expect to see positive deposit flows as we have in the past. We have not lost any client, so these are just existing accounts that have drawn down their balances. The second thing is although the seasonal business is a giant for us, we do have a bit of a seasonal business being a shore-oriented bank. And typically, OceanFirst had a little bit of a positive flow of deposits going to the third quarter. And I think with the addition of Cape and Ocean shore, those were also seasonal to the same degree, so they would've seen deposit peaks, say, in the September, October timeframe as kind of the season finished and all the merchants and commercial entities had the most cash. So we expect deposit flows could actually be quite material in the third and fourth quarters. Mike, I don't know if you have any numbers you'd add to that.

No. But if you look at last year, there's the same trend where you see the second and third quarter, there was substantial growth. So as Chris says, attributed to the seasonality, the government and the shore economy.

Got it. So thus far from a, maybe from a municipal perspective, are you seeing much? We're hearing some of the banks across the Northeast talking about some of the local municipality and the school districts and public funds, so to speak, come back and really start to beat you all up for increases in deposit pricing. Are you seeing much of that phenomena as of yet? It doesn't look like it from your cost of funds but I didn't know if any of that was sort of underneath the surface at all?

So there's several different segments of that, of the government deposit business. And you have different kinds of entities like school boards and municipalities and utility authorities. And then within those entities, you have different -- very different investment instruments. So there will be what I'd call kind of high rate money market or CDs, those typically get bid around. And certainly on the big money, which tends to be kind of CDs and more money market, you're seeing more competition. That's not new. That's been going on for the last probably 2 to 3 years, where, look, if they've got a couple of million dollars they want to put away for 6 months or a year, those can be bid to a market rate. Most of our business has been the cash management operating accounts, payroll accounts. That's a different kind of a business. Those tend to be in accounts that are less sensitive to interest rates. So I wouldn't say 0 sensitivity, but as you can tell from our cost of funds, we've been able to retain the relationships without a lot of pressure on deposit growth. And those were very -- these are accounts that are not easy to move, right? You've got a ton of ACH activity, wire activity, you've got remittances in terms of municipal tax payments, you've got employees of the municipalities and the school board, you need a branch network to go in. It's not uncommon for some of these folks to have a requirement that if you don't have a branch within their municipality, you're not allowed to bid. So there's a couple of barriers around the operating accounts that are different from the investment accounts.

Got it. That's good color. And then circling back to expenses, I think I heard you right, did you say the third quarter, you're expecting run rate to be, was it $1.7 million, $1.8 million below second quarter on a core basis? Or is that, that $1.8 million annualized?

That's $1.8 million a quarter, pretax.

Our next question comes from Matthew Breese of Piper Jaffray.

I had a few questions. One, Chris, maybe you could just talk about the liquidity position of the bank, obviously, there's a little bit more in the securities portfolio, you're still holding on to quite a bit of cash? Could you talk about that in light of your commentary regarding the fluid yield curve? And then maybe tying that into the margin, if you're holding onto extra liquidity, how detrimental to the margin do you think it is?

Sure. So a couple of things. The -- while we're very pleased with the performance of the branch consolidation, the prudent thing to do is to model some attrition when you go into branch consolidations. And if you're modeling attrition, you're going to keep a little extra cash around to make sure that you're funding any attrition that may come out of your cash position than not having to cover that with borrowings or something. So I would say that we've been purposely managing to have little excess cash around for that purpose. Thus far, we're very pleased with that whole project. It doesn't look like we're going to have any measurable attrition. And I think the customer notifications began, first, last year when we made the acquisitions, then you're sending letters out in February. This is not something that just happened last week. These are processes we've been working through with consumers for quite some time, the conversion of the Ocean City Home folks in May. So in terms of liquidity, we kept a little bit extra cash around. I think we've got the option to use that. My comments earlier are we expect cash flow to be positive over the next couple of quarters. My comments about the Federal Reserve and the uncertain interest rate environment are just that we want to make sure that we maintain a balanced interest rate risk position and that this principle of dollar average again is very important for us. So we don't feel that an institution like ours should be taking interest rate bets. So we're not trying to dump all the money into an investment in any given quarter. So I think you're going to see us dollar average in. Implications for the margin are relatively benign. I think we have a general -- we have a positive impact on margins since coming out of the deployment of cash. On the negative side, we fully plan for the purchase accounting benefits to wind down over the next 8 quarters or so. They start to tail off after that. So every quarter -- last quarter, it was about 3 basis points of purchase accounting decrease, which we overcame with a little bit of growth and the right yield. So I think you're going to see the margin bounce around where it is, maybe up a couple of points here and there from quarter-to-quarter. But no significant pressure nor would I see it move significantly higher, with one caveat: We've seen the long end of the curve has been bouncing around this year with no real, I wouldn't say, kind of firm direction. If you got steepest to the yield curve and we maintain our cash position, we would then have the option at that point either to lock in some better margins. At that point, you might see the NIM expand a little bit more meaningfully.

Got it. Okay. And then on the loan growth side, what are your expectations for annualized loan growth for the remainder of the year?

Matthew, Joe Lebel. I think we expect the same type of growth that we're seeing, low to mid-single-digit loan growth for the rest of the year. We're very happy with the originations, and we temper that by doing what we've always done, which is look really closely at the credit metrics in the book and the acquired book, and make sure that those acquired loans meet the criteria that we set for ourselves.

Okay. Could you walk us through the implications of the charter change? Why you're doing it. Are there any implications for the P&L or the balance sheet? Anything we should be prepared for on our end as analysts, investors? Or is it more something you need to do as the balance sheet changes?

Sure, that's a great question. So the primary driver, and it's not an urgent matter, but it is a building matter, has been that our thrift charter comes with it a Qualified Thrift Lender test, which says that we've got a certain portion of our assets have to be thrift qualifying assets. A couple of things that benefited us from that thus far. The first is smaller dollar commercial loans count towards the residential test; and CRA qualifying loans, which we make a lot of, count double towards the test. So although the balance sheet has a good proportion of commercial loans on it now, we continue to qualify and do that QTL test. On a pro forma basis, as we put the company together with Sun, we will be getting close to that test. So now we could complete the Sun acquisition without doing a charter change, but then the runway thereafter, especially given our intent to be a much more commercial bank, could be restricted. And when you get to that point, banks start to make decisions over continuing to pass the QTL test by buying securities or manipulating your balance sheet in other ways, and that's not something we want to get ourselves into a trap around. And that's not something -- look, if we completed the Sun acquisition in early '18, it wouldn't happen right away, but probably within 4 or 8 quarters, you'd start to really feel the pressure over the QTL test. That's the primary reason that we're considering the change. And this is something that as long as you're filing regulatory application, you have the opportunity to do a simultaneous application of both of these things. In terms of implications for investors, I think it's relatively benign. We would have the same regulators at the end. We're OCC-supervised today. That reserve looks at the thrift holding company today, so it's the same regulators coming out the other end of the transaction. So it really doesn't change the cost structure. There's no statutory changes that would make much of a difference to us. There are some nuances to the differences in the charters, but they don't apply to the things we're doing as an operating business today. So there's certain businesses that thrift could engage in that a national bank couldn't. And then a national bank is allowed to carry a higher level of commercial asset. So I think from an investor's perspective, the only material thing is that we may be adding, it's hard to say whether it's 4, 6, 8 weeks to the regulatory process, because there's a parallel process going on as they consider things. So we thought the timing was right and we thought it reflects where we're going with the company. There are more academic discussions about whether one charter gets a better multiple than the other. But I've always believed that it's your balance sheet and your earnings stream that determine that, so.

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

Just wondered if you -- Chris, I heard you just talking about consolidating the back-office. I just wondered if you had thoughts on savings from there, or should we just think about that as part and parcel again into sort of pro forma 50% efficiency ratio over time?

Yes, I think it's all wrapped up in that 50% efficiency ratio over time. Certain line items might get more expensive, right? Because I mean, look, if you're going out to sign a lease or buy a property, you may incur certain expenses there. Some of the facilities that we exit, we will be able to take expenses out, right? Because they're back-office facilities, you can exit them, and you save money. Others are, we've got people in dual-purpose facilities where you may have a dozen people upstairs from a branch. That's not ideal from an operating efficiency standpoint, but you're not going to save that much money on that office if you consolidate it. So I don't think it has a big impact one way or the other, but there's certainly going to be some efficiencies and some new spends. I would just think about the guidance around the efficiency ratio is where we're targeting to get to.

All right. Okay. And then kind of higher level. I was just wondering if you could talk a little bit about the opportunities you see in the Philadelphia area. And are those -- is that sort of the next area to think about or consider M&A? And where do you see that maybe -- that piece possibly growing to over time as part of the overall franchise?

Sure. So we very much like the opportunity to diversify our geography a little bit. We've historically been -- our roots are is kind of a shore-concentrated bank, and we've diversified that a fair amount over the last few years, and we'd look to be able to further diversify in the coming years. What that means for us is we get a certain geography, right, to the south and the east of us are oceans, so we can't go there. So all we can do is consider going north or going west. And going north has its own challenges. There are formidable competitors in North Jersey, in the New York City Metro. There's a lot of unleveraged capital in those markets. So there's a heavy degree of competition. I think also as you look at deposit funding costs, certainly, the competition around deposit funding cost is brisker in North Jersey and metro New York than it is in our core market today. So it's a deep market, it's a great market. If we had the opportunity to do more in the North, we would. One of the things we loved about the opportunity to acquire Sun is they have a commercial lending team in Edison, they've got a commercial lending team in Manhattan. We intend to keep those capabilities and continue to build portfolio there. On the West side, as you get through kind of go from Monmouth County, where we're heavy today, through Middlesex, Mercer, Bucks County and down into Metropolitan Philadelphia, we see great opportunity there. We see an opportunity in a similarly strong kind of urban-centric environment. Admittedly, it's not as large as the New York City Metro. But one way, there are fewer competitors, there's less excess capital positions leveraged out there. And there's a nice set up of competitors where you've got a couple of very large competitors, which we typically try and compete against by service, price and flexibly. And then a number of smaller competitors, where we compete against them with capabilities in the commercial side that are difficult for a small bank to see. So it's really situational. On an organic basis, you'll see us growing a little bit in the New York Metro. You'll see us growing a little bit more in the Philadelphia Metro. That'll happen quarter after quarter after quarter. And in terms of M&A, we've always just kind of looked at the landscape and thought about what those opportunities are at any given time. Right now, we're focused on taking care of the Sun acquisition. We'll pick our heads up and think about that afterwards.

(Operator Instructions) Our next question comes from [Don Coach] of [Coach Investments].

I'm delighted that you made a decision to go from a mutual -- a savings-and-loan to a commercial bank. And looking at your footprint, have you ever thought about doing some kind of -- on a strategic sense, doing some kind of zip code analysis of where your client base migrates to? And have you ever thought about having some kind of function in Florida where you have several hundred thousand people that migrates sometime, they're sort of the snowbird population, and you give them sort of a national bank access. So if they go to Sarasota or St. Petersburg from the New Jersey shore in the winter time, they can still have that familiar banking with Ocean?

That's certainly a strategy that many banks have employed over the years and some of them quite well of it. It's a strategy the Valley has been focused on for a number of years now in terms of being able to provide kind of both ends to that seasonal migration. We don't rule things out and, certainly, Florida is a higher-growth stake and has certain attributes to it that are really favorable. Right now, I think we're focused on making sure that we're the best bank we can be in our geography. And I have -- I recall a mentor I worked for years ago who said, make sure you're doing all the business you can where you are before you get on a plane and fly somewhere else. So I think we're going to stick in this area for now, but over time, you never know what the opportunity...

That's a good answer. The second question, second part of that, is in the next 6 months, are you presenting anywhere at any seminar?

Yes. We regularly present at investor conferences. And if you want to contact us after the call, we'd be sure to get you on the words for that so you'd have the opportunity to meet up with us.

(Operator Instructions) There appear to be no further questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Christopher Maher for any closing remarks.

All right. Thank you. Once again, thanks, everyone, for joining us this morning for the call. We look forward to present the additional updates as the year progresses. Thank you.

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