OceanFirst Financial Corp. (OCFC) Q3 2013 Earnings Report, Transcript and Summary

Good morning. And welcome to the OceanFirst Financial Corp. Earnings Conference Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. Now I’d like to turn the conference over to Jill Hewitt, Senior Vice President and Investor Relations Officer. Please go ahead.

Good morning and thank you all for joining us. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer and we will begin this morning's call with our forward-looking statement disclosure. On this call, representatives of OceanFirst may make forward-looking statements with respect to its financial conditions, results of operations, business and prospects. These forward-looking statements are not guaranties 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 statement. 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 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 Condition and Results of Operations set forth in 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; and Chief Financial Officer, Michael Fitzpatrick.

Thank you, Jill. And good morning to all who have been able to join in on our Third Quarter 2013 Earnings Conference Call today. We appreciate your interest in our performance and are pleased to be able to review these results with you this morning. You’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 and COO, Chris Maher, who will review the highlights from the quarter and discuss the additional strategic initiatives that we mentioned briefly in the release. Of course, diluted earnings per share for the quarter were $0.29, unchanged from the linked quarter and $0.01 ahead of the prior year quarter, reflective of the consistency of our core operating earnings power in the current environment. The company 67th consecutive quarterly cash dividend was declared and maintained at $0.12 per share, representing a comfortable and sensible 41% payout ratio of current earnings, consistent with our capital management planning. As a further note on capital management, while we are gratified by the increased market recognition reflected in the trading of our stock over the past 3 months, the demand for our shares and consequential price movement has had a dampening effect on execution of our current share repurchase plan for the second consecutive quarter. Although we still consider the repurchase of our shares an attractive proposition to deploy our excess capital in the short run. At current trading multiples, the incremental book value dilution associated with the retirement of shares weighs heavily against the accretive affect on our earnings per share. This tempers our enthusiasm to aggressively execute open market repurchases in the absence of any market imbalance in the supply and demand for our stock. With just over 200,000 shares retired during the quarter, there remain a little over 300,000 shares available for repurchase under the current authorization. One other quick comment I’ll make is that while we are similarly pleased this quarter by continued core deposit growth, coupled with a long-sought solid increase in our commercial loan portfolio, we have chosen to not let our balance sheet expand in favor of using excess liquidity to reduce our federal home loan bank borrowings. This has facilitated plans to restructure our advance book in the coming quarter. With this restructuring accomplished, we can now expect further increases in commercial loans outstanding to drive much desired growth in our balance sheet and revenue stream. I’ll now ask Chris to provide some additional background to our quarterly operating results and plans for the fourth quarter.

Thank you, John. My comments today will note a few quarterly metrics worthy of discussion and also address our progress as we continue to invest in organic growth initiatives and manage operating expenses accordingly. Regarding quarterly performance, asset quality is trending positively, commercial lending growth is picking up, net interest margin has stabilized and fee income growth from Bankcard services and Trust is partially offset declines in the net gain on sale of residential mortgages. Expenses have trended up, due to the new Red Bank Financial Solutions Center and the impact of new hires in commercial lending. We are mindful that maintaining a competitive efficiency ratio is an important discipline and we will be discussing expense management initiative later in the call. Asset quality trends continue to be positive, as general economic conditions in our market stabilized and the recovery from superstorm Sandy continues. In addition to generally favorable credit trends, a $1.8 million provision against possible storm-related credit losses taken in the fourth quarter of 2012 has held up well, with no charge-offs and $471,000 of specific impairments having been identified through September 30th. We will be evaluating remaining reserve against storm losses carefully over the next several quarters as the economic rebound in rebuilding brings more certainty to the situation. More broadly 2013 year-to-date net charge-offs totaled $2.2 million less than 1/2 of 2012 year-to-date net charge-off of $4.7 million. Commercial lending growth was strong for the quarter with quarterly commercial originations growing to $49.5 million, producing commercial portfolio growth of $18.5 million. The commercial lending pipeline remains strong at $38.4 million at September 30th. We continue to recruit quality commercial lenders that have become disenfranchised with large bank environments and have demonstrated history of relationship lending in our footprint. In addition to growth in commercial lending, residential lending in the form of owner occupied construction loans has picked up, driven by demand related to superstorm Sandy while still modest year-to-date residential construction closings totaled 50 loans for $21 million. Additionally year-to-date commercial construction credit facilities closed total on additional $11.1 million. Within our current pipeline, an additional $29.7 million of construction loans are pending, the storm driven credit facilities are beginning to form a positive trend. The combination of commercial lending growth reduced refinance pressure on the residential portfolio and stability in the consumer lending portfolio have alleviated the study net interest margin compression, experienced since peak margins in the second quarter of 2010. This is evidenced by reported net interest margins of 3.16%, 3.21% and 3.20% for the first 3 quarters of 2013, respectively. Improvements to net interest margin will require a continuation of our efforts to grow the balance sheet and replace low yielding bonds with higher yielding commercial loans. Other income decreased as net gains from the sale of residential loans deteriorated as a direct consequence of rising mortgage rates, which have substantially curtailed refinance volume. While our refinance volumes parallel industry trends, the growth of purchase mortgage applications and owner-occupied residential construction loans is providing some offsetting volume. The increasing popularity of adjustable-rate residential loans, particularly for owner-occupied construction to permanent loans will result in more portfolio originations rather than originations for sale. These trends are expected to continue to depress gain on sale income. Partially offsetting weakness in net gain on sale income are gains in bankcard services and trust, revenue for these areas has increased from $3.3 million year-to-date 2012 to $4.3 million year-to-date 2013, a 28% or $930,000 improvement. We continue to invest in these businesses, the card activation programs and the recent addition of a new full-time trust officer in Red Bank. Note that we have revised our income statement presentation to report bankcard services revenue on a separate line to provide more detail regarding card revenue trends. Expenses have increased in recent quarters as the Red Bank Financial Solution Center is fully operational and new revenue producing hires have been placed in commercial lending and trust. As mentioned in previous calls, we are committed to maintaining expense discipline, have been looking for opportunities to fund our growth initiatives by reducing expenses in less strategic activities. As part of that review, we have identified 2 branches that have experienced significantly diminished traffic flow coupled with a substantial overlap with their neighboring branches. These 2 branches will be closed in the fourth quarter and consolidated into nearby OceanFirst facilities which are larger, more modern and more prominently positioned. While the closure of these branches provide additional capacity to invest in growth capabilities, the consolidation of the branches reflects more than an expense reduction opportunity. Clearly, there is an ongoing transition in how customers choose to interact with their primary financial institutions. We have seen a steady decrease in branch traffic offset by dramatic increase in the use of our electronic and mobile channels along with increased use of our Visa check card and ATM machines. We have been providing remote deposit capabilities to commercial customers for 5 years now, have begun deploying envelope free ATMs and will launch consumer remote deposit in the fourth quarter. The capabilities and evolving consumer traffic patterns will allow us to reduce the investment represented by branches in close proximity to each other without materially impacting customer convenience. Finally, in an effort to bolster net interest income while improving our interest rate risk position, we’ve elected to restructure $159 million in Federal Home Loan Bank Advances. The restructure will allow us to retire funding with a weighted average cost of 2.31% and a weighted average maturity of 16 months. This funding will be replaced with a combination of deposit growth in new Federal Home Loan Bank Advances. While new advances will initially be lighter on a short-term basis and then rolled into long-term advances over the next 4 quarters allowing for deposit growth to a portion of the long-term funding needs. The cost of this restructure will be $4.3 million pretax, $0.16 against our book value per share. The restructures have been executed in the fourth quarter and will be reflected in year-end financial statements. In summary, commercial loan growth, bankcard services and trust continue to be high priority areas as we focus on improving growth trends. The increased investment required to produce growth will be largely internally funded as we take the opportunity to reallocate expenses within the company. At this point, I’ll turn it back over to the John for the Q&A portion of the call.

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

[Operator Instructions] Our first question comes from Frank Schiraldi of Sandler O'Neill.

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

Hey, Frank. It’s Chris. We're always hopeful of that but you want to be cautious and guarded. We took a look at the experience after other natural disasters like Katrina and we found that most institutions experienced their losses within 1 to 2 years after the event. So we are hopeful, we have not seen anything that makes us uncomfortable today. And that's why we have focused on that.

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

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

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

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

sure. There is 2 components of the trend. One is the residential component and just to differentiate what we are seeing, these are owner-occupied residential construction loans where either someone maybe rebuilding their own home or taking advantage of a vacant lot that they may have purchased to go put a home in. There are approximately 50 of those to give you kind of a color. And those because they're construction to perm, the pricing on those tends to be closer to the residential markets. You do get a premium above what you would get in the normal residential market but it's not. In the premium, you would expect a speculative construction loan which carries a lot more risk. On the commercial side, the projects that we are seeing are short-term in nature, so they tend to be priced pretty competitively but they are also floating-rate instruments, so you don’t have a whole lot of interest rate risk. So when you look at those 2 things, I think that kind of tells the story.

The next question comes from Travis Lan of KBW. Please go ahead.

Chris, looking back at last quarter’s release, just again on kind of the pipeline yields, it looks like the commercial yields in the pipeline last quarter was 446 and this quarter it looks closer to like 397. Just wondered, what kind of accounted for that decline, if it’s a mix shift or something else?

Sure. It’s a little bit of a mix shift. We don't regularly report the duration of those loans, but comparing the duration from last quarter's pipeline to this quarter’s pipeline, the duration dropped from an average duration of 5 years to an average duration of under 4 years. So it’s a little bit more of that and a mix change than it is anything else. And those -- our pipeline numbers will move around. We think it's important to share them with you. But you'll see certain quarters where there maybe bouncing up or down. As a trend, we are very comfortable with where the pipeline is and although it was a little bit low for September 30th compared to June 30, it popped up right after the end of the quarter which is timing of closings and timing of commitments. The pipelines we report are committed loans, they're underwritten, approved and committed. So we don’t have too much in there that's speculative.

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

It’s a complicated picture because we’ve got several things going on. We continue to be pleased with our deposit growth which is helpful. And although we restructured these federal loan bank advances, our goal would be to soak up as much of that with deposit growth as we can, so there is a little bit of an unknown there. Although, our historical deposit performance has been pretty strong. In terms of where the loan yields are going, obviously, if you look at yields that are in the pipeline, they maybe a little lower than the portfolio. But we expect more of the opportunity to be replacing bonds than replacing loan run-off with new loans. So, I think, when you put it all together, we feel the margins are stable, obviously we do our best to grow them, but we see stability for now.

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

Sure. There is really couple of things driving the fee income line. Let me talk about, the 2 major items are cards and trust, where we see the opportunity for potential growth. Cards is a cyclical movement. I think a number of institutions are seeing this. And so, I think, we are riding a little bit of the consumer wave on adopting cards for more and more payments, but we are also trying to execute better there. So we are reasonably comfortable that that’s a good growth trajectory. And our Trust business while those increases have been on a percentage basis large, it is still relatively modest business for us so. We are hopeful, but we got to add the people. And that is a slower growing business than I think you’ll see on the cards side.

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

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

About a year, Matt, we are going to layer that in into a 3 to 5-year home loan bank ladder. We are going to try to build some 5-year, some longer term CDs and we anticipate that that would take about a year and then it would be in place.

Okay. And then in the near-term I’m assuming there under a year kind of classic FHLB advances?

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

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

Yes.

Can you put some numbers around that?

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

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

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

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

Yes. We are following our practice of being fairly discriminating about adding commercial officers. We do have 2 new commercial officers joining in the fourth quarter from neighboring institutions. But we are very much taking the position that we need to find folks that are like minded with where we want to go, which means in our definition we are looking for relationship-driven credits on the commercial side that are generally -- that have a book that’s generally in our market area and some may have slightly larger or smaller books. But we are looking for people to patch in. As we find them we are going to add them.

Okay. And the cost of bringing on those 2 commercial lenders, do you expect that to fully offset the branch savings, so we will see a relatively flat quarterly expense run rate?

It would be our goal to manage to the efficiency ratio. I want to be careful not to project operating expenses going forward. But I think you have got our goal now.

Okay. And what’s the good tax rate some around 35%?

Oh, yes. It’s been pretty consistent about 35%, so a -- or a little more, that’s a -- I would stay with that, yes, 35%, 35%, it has been right about 35% last 4 quarters, 6, yes, I am looking at it now, it's almost always 35%.

Okay. And Matt, on the net interest margins, the average is 9 basis points for the whole year. So actually it will start out in the first quarter, it will start out like 12 or 13 and then it will be 10 and then 8, and then 7. So, that’s probably the progressing, the first quarter benefit might be about 12 basis points, over the course of the year based on our model would be about 9 basis points.

Got it. Okay. So essentially all things being equal 320 to -- the low 330s next quarter.

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

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

Understood.

[Operator Instructions] And the next question is a follow-up from Frank Schiraldi of Sandler O'Neill.

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

It was 1.65% this quarter. And it was -- I thinks it was about 2 or a little more last quarter.

Okay.

It’s clearly declining. 1.65%, that’s the lowest it has been in years in this quarter. Of course, as rates rise, we do hedge our portfolio, but it’s not always hedged, it's not 100% hedged, so in a rising rate environment, you’re always going to do a little work than in a declining rate environment.

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

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

And the next question is a follow-up from Travis Lan of KBW. Please go ahead.

Hey Mike. Just one -- sorry, one clarification on the margin, your 12 to 13 basis point projection for the benefit from the prepay of the debt. Does that include, kind of refinancing that or is that just your net or your gross benefit?

In the margin, well 12 to 13 -- okay, so, right now it’s rolling -- it's being rolled into short-term advances 30 to 90 days. Okay. So that benefit is about 12 basis -- an increase of about 12 to the NIM in the first quarter. And then as we roll those 30 to 6 -- roll those advances out into our 3 to 5-year ladder, the benefit will gradually decline every quarter.

That answered it.

[Operator Instructions] At this time, we're showing no further questions. So it will conclude our question-and-answer session. I’d like to turn the conference back over to Mr. Gabarino for any closing remarks.

Thanks Emily. I’ll be brief and just again let me thank all of you for joining us this morning. And we look forward to the opportunity of speaking with you again in the New Year. Thank you.

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