OceanFirst Financial Corp. (OCFC) Q2 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the OceanFirst Financial Corp. Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jill Hewitt, Senior Vice President, Investor Relations Officer. Please go ahead.

Thank you, Andrew. Good morning, and thank you, all, for joining us. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer, and we'll 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 condition, results of operation, 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 the statement in the earnings release and a 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 & Analysis of Financial Condition and Results of Operations set forth in the OceanFirst's filings with the SEC. Thank you. And now I will turn the call over to our hosts this morning: Chief Executive Officer John Garbarino; Chief Operating Officer Christopher Maher; Chief Financial Officer Michael Fitzpatrick; and Chief Lending Officer Joseph Lebel.

Thank you, Jill. Good morning to all who have been able to join in on our second 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've all had the opportunity to review the earnings release from last evening. And following our usual practice, we will not be disrespectful of your time reciting a host of actual numbers from the release. Our introductory comments will merely help frame our opportunity to add some color to the results posted for the quarter before we take your questions. Following my brief comments, I'll turn the call over to President, COO, Chris Maher, who will review the highlights in the quarter and reflect on his first 4 months of the company. Chris' leadership has certainly manifested itself quickly, making a favorable impression on our management team. Finally, you'll get an insight from a new voice on our quarterly earnings call but a long-time valuable member of our management team and recently appointed Executive Vice President, Chief Lending Officer, Joe Lebel, who will assess the progress we are making in driving top line revenue growth through efforts to build our commercial loan pipeline and portfolio. There was certainly very positive development on this front during the quarter. Of course, diluted earnings per share for the quarter were $0.29, $0.03 ahead of the prior linked quarter, largely the result of improving credit metrics, a corresponding lower loan loss provision and a modest reversal of the retreat of our net interest margin. Current quarter was a $0.01 off the prior year quarter however, as the persistent pressure on our margin during the year could not be completely offset by our moderating credit costs. The company's 66th consecutive quarterly cash dividend was declared and maintained a $0.12 a share, representing a comfortable and sensible 41% payout ratio of current earnings. We continue to constructively manage our capital position in the absence of meaningful growth in our balance sheet through a combination of a healthy quarterly cash payout of current earnings and strategic acquisition of shares under our current repurchase plan. During the past quarter, we repurchased only a nominal number of our shares as our stock price generally responded favorably to overall equity market improvement and consistent favorable demand for our shares was present throughout the quarter. There remain an excess of 0.5 million shares eligible for repurchase under our existing authorization. I'll now ask President Maher to provide some additional background to the quarterly operating results.

Thank you, John. Good morning. My comments today will focus on operating results for the quarter. Before jumping into the quarterly assessment however, let me take a minute to reflect on my first full quarter at OceanFirst. As I work with the OceanFirst team, I'm confident that we have the franchise, infrastructure and leadership team required to drive operating results to the company. As we concentrate on growth initiatives and allocate additional resources towards business development activities, we expect to be able to capitalize on the bank's strong brand and reputation. I'm convinced we have the ability to deliver consistent and measured growth to further strengthen our franchise value. Net interest margin stabilized during the quarter as we took advantage of 3 opportunities: the investment of our surplus cash position into the securities portfolio; repricing our core deposits to decrease funding costs; and the maturity of Federal Home Loan Bank borrowings at above-market rates. These 3 factors impacted net interest margin as follows: 2 basis points driven by investment of the surplus cash position; 2 basis points driven by core deposit repricing; and 1 basis point driven by maturing Federal Home Loan Bank advances. Securities purchases totaled $62.9 million during the quarter with a weighted average yield of 1.19%. While these yields are relatively low, they reflect our continued vigilance regarding interest rate risk positions in the coming environment. Investments made this quarter had a weighted average life of 46 months. And our total securities portfolio has a weighted average reprice interval of 35 months. Given the company's strong core deposit position, we remain comfortable with our overall interest rate risk position. The recent rise in interest rates during the quarter resulted in a $4.9 million increase in accumulated other comprehensive loss. We consider it modest given the degree of interest rate movement and in available-for-sale portfolio, which totaled $619 million as of quarter end. Under the new capital rules, we will, of course, be reassessing this position through the second half of the year. Early in the quarter, we decreased core deposit rates, providing nearly a full quarter benefit from this pricing structure. The reduction in rates has not affected our ability to grow core deposits. Maturing Federal Home Loan Bank advances for the quarter totaled $46 million and carried a weighted average cost of 2.39%. Most of these advances were rolled into short-term borrowings while we review loan production estimates for the remainder of the year. While the actions taken to stabilized net interest margin for the quarter were successful, we expect the pressure to persist and to be further influenced by the direction and degree of interest rate movement. Our fully invested balance sheet and already low deposit costs provide little opportunity to offset additional net interest margin compression other than with significant loan growth. Asset volume trends for the quarter were positive. As nonperforming assets declined modestly, the net charge-offs declined materially, although the quarterly provision for loan losses decreased, the total allowance increased modestly, both in the amount and as a percentage of total loans receivable. Further signs of a favorable asset quality trend were likewise reflected in repurchased loan activity. The balance of the reserve from repurchased loans was unchanged for the quarter. During the quarter, only one repurchase request for a $100,000 loan was received and repurchase requests totaling $797,000 resolved with no loss. Higher operating costs over the linked quarter were driven by compensation expense increases related to the recruiting and hiring of additional lending staff, the opening of our Red Bank Financial Solutions Center, as well as higher marketing expenses, nonrecurring professional fees. Achieving our loan growth targets will require additional recruiting in a very competitive environment. They're likely to continue to place pressure on compensation expenses going forward. Last quarter, we discussed an increased focus on trust and asset management services and commercial lending. Trust and asset management revenue for the quarter, which is now reported separately on our income statement, totaled $528,000, up 43% from the prior year period. Year-to-date, trust and asset management revenue totaled $955,000, up 36% from the prior year. We continue to invest in this business as an opportunity to offset net interest margin mortgage banking pressures. At this point, I'd like to turn it over to Joe Lebel, Executive Vice President and Chief Lending Officer, to provide more color regarding our recent progress and continuing efforts to build the commercial loan pipeline and portfolio.

Thank you, Chris. Good morning, everyone. I would like to briefly discuss the company's focus on commercial lending, the results we've seen in this quarter and our outlook as we begin the second half of the year. Certainly, the successful conclusion of our search for a new President and COO and Chris' demonstrated leadership has allowed us to reposition resources in our commercial lending group to better attract talented commercial lending officers and drive consistent, measured growth in this competitive environment. You may recall our announcement of the hiring of 2 seasoned commercial lenders in late May, one of whom will be leading our team at Red Bank. We remain on the lookout for additional strategic recruiting opportunities as they may arise. During the second quarter of 2013, bank closed $29.3 million in new commercial loan business in comparison to $18.4 million in the prior quarter. Further, the commercial pipeline has grown significantly and does not yet include the full impact expected from our new lenders or the accelerated demand we continue to expect from this annual recovery. Commercial pipeline of $48.8 million at June 30 carries a weighted average coupon of 4.46% and weighted average term of 4.9 years. Pipeline pull-through results will always vary, making loan production figures a challenge to estimate. However, with our robust pipeline, we expect accelerating commercial loan growth through the remainder of 2013. Given the recent movement in residential mortgage rates, I thought it important to also comment on residential loan sales, volumes and margins. We have seen a recent dropoff in refinance activity, consistent with the Fed's Beige Book survey and driven by the sharp rise in fixed mortgage interest rates. Our mortgage pipeline is currently 65% weighted toward purchases for the first time in many quarters. We are definitely seeing more purchase money volume, which we believe can be attributed to the improving economic environment, firming real estate prices and Sandy recovery activity. We have been aggressive in pricing our hybrid short-term ARMs for our portfolio while continuing to sell all 30-year fixed-rate mortgages. These factors, coupled with the expected gain-on-sale margin compression as the Fed eventually winds down QE3, lead us to anticipate progressively lower gain-on-sale income in near term. Lastly, I'd like to comment further on the emergence of new loan business as a result of Superstorm Sandy. While it is too early to determine any significant trends, we have seen an increase in residential construction loans from borrowers on the barrier islands, indicating a concerted effort to rebuild. Conversely, although we have seen selected significant commercial loan demand, we're still not confident it is a trend. While loan demand directly attributable to Sandy recovery is not yet evident however, other economic indicators point to a meaningful improvement in economic conditions, which may result in a positive local operating environment over the next several quarters. With that, I'll return it to John Garbarino.

Thank you, gentlemen. Drew, I believe now Messrs. Maher, Fitzpatrick, Lebel and I would be pleased to take any questions our audience has this morning.

[Operator Instructions] The first question comes from Travis Lan of KBW.

Just digging in a little bit more on the margin. The portfolio loan yield was flat in the quarter. Was that more reflective of easing commercial loan competition or just a result of kind of mix shift from resi to commercial in the portfolio?

Yes. Mostly, the mix shift. I'd say we had some growth in commercial, so it's mostly mix shift.

Okay. And then I guess, Chris, based on your margin commentary, it sounds like you expect additional downward pressure to return. But it sounds like also the loan pipeline rate is in line with the current portfolio rate. So I'm just curious where kind of the additional or the incremental pressure comes from.

I think that it's just more of a matter of uncertainty, Travis, that the interest rates have been moving around a little bit. And we can't be all that certain about what the new loan rates will be over the coming 2, 3, 4 quarters. So it could be flat, it could go down, it could go up. It's a little bit hard to predict at this point. But as you point out, for the business that we're originating now, particularly on the commercial side, the margins are strong, so if we're able to continue to build that volume, it will help actually support stabilization or growth in the margin. We're just -- we don't want to get ahead of ourselves.

Got you. That's helpful. For the lenders that you added during the quarter, do you have a targeted loan portfolio size for each of them that they could eventually manage? And if you do, is there kind of a targeted timeline for them to achieve that?

I'll ask Joe to handle that.

I think the target portfolio for the lenders as they season themselves over a 3- or 4-year period would be about $100 million. We think that the lenders that we've hired have a good seasoned approach in our footprint, which we like. And that's a target that we should focus.

Great. And then just the last question. Obviously, you've been successful lowering the core deposit costs, particularly early this quarter. But how do you think about being positioned to react should competitors start to raise deposit rates if the short end of the curve ever moves up here?

I think experience has taught us that you have to be disciplined in that environment. We haven't been price-competitive for deposits, whether it be the short end of the curve or on the CD level for many, many years. And I don't see that changing if we have a maverick price war that breaks out here at the Jersey Shore. And I don't anticipate that happening, but you can never be sure because there's different levels of discipline present in every organization. But I think that experience has certainly shown us over the years that there's got to be a disciplined approach to rapidly increasing deposit costs, especially on the core deposit. And I think there's a demonstrated inelasticity inherent in those deposits that allows you to be that disciplined.

[Operator Instructions] The next question comes from Matthew Breese of Sterne Agee.

I just wanted to touch on the expense base a little bit. Last quarter, you mentioned that the strategy was more of a mix shift in expenses. And with the new hires, you've seen some increased comp costs. So I just wanted to kind of pick your brain on what's the offsetting factor to hold expenses flat.

Matt, it's Chris. I'll answer that. There were a couple of other items in the quarter, which we noted, the nonrecurring professional fees, as well as marketing expenses are a little bit elevated. So without those, I think they would have been a little bit more flat. So I think to answer your question, over time, we expect to be able to identify expense reduction opportunities in noncompensation lines to help us offset some of that compensation pressure.

And certainly, Red Bank came on board here in the quarter with full force. And we have talked on previous calls and certainly at investor meetings throughout this year about what the effect and what the payback would be on Red Bank. But we think that, that's a pretty significant presence, 7,000 square foot presence with a multidisciplined approach as we've discussed. And so that's a pretty significant expense line item that hit full force here in this quarter, which makes linked quarter and prior year quarter comparisons very difficult to look at. That and the professional fees that were elevated that we feel are nonrecurring, we think we're going to be not in unreasonable shape as the rest of the year unfolds.

What were those one-time costs, the professional fees and the Red Bank costs?

One-time special fees at Red Bank? Well, no...

Professional fees are nonrecurring. It was about $175,000 in nonrecurring professional fees. So those are not going to carry over to the third quarter. Red Bank was about -- just the Red Bank off of the retail branch is about $200,000 during the second quarter.

Okay. So the Red Bank -- and that's recurring you said or is that the one-time?

Well, the Red Bank is recurring, sure. I mean, the professional fees of $175,000 are not recurring. That has nothing to do with Red Bank.

Got it. Okay. And then maybe hopping back to the loan growth, you guys mentioned that there is maybe some targeted loan growth that you guys had out there. What were those figures that you kind of were expecting throughout the -- for the next year or so?

Well, Joe just answered the previous question in terms of what the new loan officers that came on would have in a mature portfolio. But we don't give guidance on what our budgeted numbers are through the rest of the year. But we suspect that those individuals will be bringing a book of business with them. And we've talked again on previous calls about that's the only way in the current environment to really grow your loan book is by stealing market share for someone else. So it's a -- we think the -- we've already seen some pickup in loan demand in the second quarter, some of it attributable to Sandy but certainly not as significant as we think we might see later on in the year. But we see a much bigger impact by the 2 new loan officers that we have coming onboard and the expected book of business and what they have already -- the difference they've already made to our pipeline. Obviously, it's going to take a while to convert that into portfolio growth. But I can see -- I think you can see evidence in the pipeline that the effect is there.

Right. I guess, what I meant by that was overall loan growth, have we reached an inflection point now, where we can foresee positive loan growth into the future?

Well, yes. It's been 12 quarters since we've reported any loan growth whatsoever. This is the first time in 3 years that we've reported any growth in the loan portfolio at all. And we think that since we have been emphasizing the commercial side of the business as opposed to the residential side of the business and selling most of our residential production, we think that this might, in fact, represent an inflection point. As I indicated in my earlier comments, I think the catalyst -- catalytic effect of Chris coming onboard and some of the changes that we made in the way we approach recruiting and some of the stability that, that has brought to our management team is making an immediate difference going forward, and as you point out, may in fact represent an inflection point going forward.

If in fact that's the case, we have reached an inflection point, what's the strategy with the securities portfolio? Do you plan to wind that down a little bit or continue to build there?

It has a very strong cash flow component, so it's ideally suited to just naturally wind it down as loan demand increases. So I think we can throttle that. The good news is, I guess, to rates coming up a little bit that futures securities purchases will probably be at a better yield than last quarter. So if the cash comes back in, our preference would be to redeploy it into loans. And I think we may have mentioned in the past, the securities portfolio is larger than we would typically keep in a bank our size, so there's plenty of room there.

I always looked upon that, Matt, historically as a liquidity vehicle. The securities portfolio was always a plug-in that took care of our either a lack of or extremely strong loan demand that serves as a liquidity vehicle entirely for us. It's not something that we managing aggressively for investment income.

My last question is regarding the new hires and potential new hires to come. It sounds like that's a big part of the new strategy. I guess, my question is with them coming on, what kind of profitability increases do you think we could see, maybe measured by return on assets, return on equity over the next year or so?

This is Chris. I'll handle that. The -- again, we don't provide future targets on return on assets or return on equity. But certainly, we're interested in growing it, so I think that's clear. For the individual lenders, I'm not sure if your question is about the deal metrics. But we do have a model that we use to determine pricing on each deal as it comes in. And I will tell you that we're not interested in doing deals that would provide returns on assets on a deal basis that would be less than 1%. That's kind of a threshold number for us. And we're looking for low-teens return on equities as a threshold as well but on a yield-by-yield basis. So that's what we're looking for them to produce in terms of price and duration and risk, if that's helpful.

Are there any other hires to come potentially in the pipeline?

Yes, I think we're -- this is Joe. We're very happy with additions we've made. We're going to be judicious as we move forward. We like our trade market. We're not going to chase transactional business. And we think, as John mentioned earlier, that the real focus in a market like this, which is still somewhat inorganic, is to grow by finding solid, seasoned, top-producing performers that can add value to the bank.

[Operator Instructions] The next question comes from Frank Schiraldi of Sandler O'Neill.

Just a few questions. First, on the commercial pipeline, you guys broke it out in the release and gave it on the call. I don't believe you broke out the pipeline, at least just the commercial pipeline a year ago. So I'm just wondering if you can give that, the growth in the commercial pipeline year-over-year.

The commercial pipeline a year ago was $27 million in June of '12. And I recall thinking at that time that, that -- we felt that, that was a robust pipeline. Of course, any time we deal with pipeline numbers, the numbers we're disclosing to you, Frank, are all raw numbers. Internally, we do a probability weighting of that pipeline in terms of what's likely to come onboard within the next -- within the near term and then perhaps the longer-term. But I recall in prior quarters that we thought that, that $27 million pipeline was fairly robust. So we feel particularly good about the fact that we're approaching $50 million. And we still don't think the new hires and Sandy recovery is fully reflected in that.

Okay. So the pipeline has gone from $27 million to close to -- I think it's like $45 million or close to $50 million. Has the probability -- can you give that? Has the probability of it increased as well?

No, I don't think it's markedly different. But I mean, what -- the only reason I bring that up -- and that's an internal management number that I don't think we'd want to release. But we don't -- we're not saying that we expect $48 million to be on our books in the next 3 months. That would be unreasonable. I don't think the probability today is markedly different than the probability in any other quarter. But you never know, you may have one large deal that may take a lot longer to close or may fund over longer period of time. And that's all factored into the probability weighting that we internalize.

Right. Okay. And just for clarification from my end, it sounded like, Joe, you talked about -- in talking about the commercial loan growth, you talked about the potential for it to accelerate through the rest of the year. And I think quarter-over-quarter, commercial loan growth was, all-in including residential construction, was like 2%. So I'm wondering if -- is that an easy way to look at it? Do you expect that 2% growth quarter-over-quarter to accelerate?

I think without giving any significant guidance, I think we'd expected to accelerate over the 2% quarter-over-quarter that we've seen so far, Frank, yes.

Yes. We don't think that's sufficient. We're certainly aiming a little higher than that.

Got it. Okay. Well, then I think this is probably an easy answer. But you talked about potential pressure on the margin going forward. But given the commercial loan growth you're looking at or expecting and the slowing of refi out of the mortgage book, I would guess your confidence level on producing NII expansion is high. Or how would you...

It's higher than it's been in recent quarters. I don't know that I would classify it as high. But I think, we're more confident in our ability to deliver a better value proposition the way we're currently structured as we finish the second quarter than we were 3 months or 6 months ago. But we've removed a lot of uncertainty in the last couple of quarters. We've reconstituted the management team, as I mentioned in my comments. We've restructured the commercial lending area. We've added some significant talent in that area. And so I think we feel a lot more confident today than we did. I think we have -- I don't think we're there yet, Frank. And I think we can continue to make some additional improvements. As we start to knock off some of these milestones that were set, I think that confidence level will grow.

[indiscernible] There's still probably a lag with respect to prepayments for loans. And of course, the higher loans are ones that -- higher coupon loans are ones that prepay. So I think we'll still see a little bit of a pressure from prepayments in the third quarter, where people have locked in, in the second quarter and closing in the third quarter. But then as time goes -- as we get farther and farther into the year, that prepayment pressure will ease a little bit.

Okay. So you're talking about on residential, the refi, the residential book, that could still be taking place for 3Q?

Yes. And our MBS portfolio as well. So yes.

Is there any -- I think you guys have highlighted it when we've seen it in the past, so -- and you kind of had a blow-by-blow in terms of the increase in the margin quarter-over-quarter. But there's no significant prepayment penalty income flowing through the margin in 2Q, is there?

No, not in the last quarter. There was very little.

Okay. And then Joe, I think it was you that mentioned a significantly -- expectations of significantly lower gain-on-sale revenue going forward. I'm just wondering, given potential growth in other areas of fee income, how close that could come to offsetting. And I'm thinking wealth management, which is still a pretty small piece of the total pie but has been growing. If you could just maybe talk a little bit about the potential for growth there to offset weakness in mortgage revenues going forward.

Actually, Frank, this is Chris. I'll take that because it kind of covers trust and some of our other fee items, like card services, et cetera. I think what you've seen in the last several quarters is a gradual movement in fee increases in other areas that have muted some of the sliding mortgage banking fee income. I'm not sure that I would use the word significant when I think about the pressure that's on mortgage banking at least on the next quarter or 2. But depending on how interest rates go, we consider that to be a vulnerable area or an area vulnerable to interest rates movements but not as necessarily one that is today under a lot of pressure in the next quarter or 2. So I think in short, there's a reasonable opportunity for us to offset some weakness in one line with strong growth in trust and in cards. Card is growing strongly as well.

Okay. And then just finally, I wanted to see if I could ask the expense question in a different way in terms of looking at investments in the company. Should we anticipate that we could see the efficiency ratio trend a bit higher in the short term? I think it's around 61% for the quarter. And then how do we think about efficiency ratios for 2014?

We're not pleased with the efficiency ratio where it is right now, Frank. We think that's a temporary phenomenon. I recall being on this call a year ago, and we said at the time that the efficiency ratio probably had no place to go but up. But I don't think we're pleased with as much as it's retreated over the last several quarters. I think we -- as with Red Bank, we've talked about the investment that's being made there. It's going to take time to yield some results. And so I think conversely at this point, we're probably talking about it being a high point for the year hopefully and for several quarters going forward.

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to John Garbarino, Chairman and Chief Executive Officer, for any closing remarks.

Thanks, Drew. I'll be brief. I just again wanted to thank everyone for their interest in our company this morning. And we'll look forward to hopefully speaking with you again come October. With that, enjoy the rest of your summer and stay cool.

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