OceanFirst Financial Corp. (OCFC) Q1 2014 Earnings Report, Transcript and Summary

Hello, and welcome to the OceanFirst Financial Corporation earnings conference call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Ms. Jill Hewitt. Please go ahead.

Thank you, Ed. Good morning, and thank you, all, for joining us. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer at OceanFirst Financial Corp. and we will begin this morning's call with our forward-looking statements disclosure. On this call, representatives of OceanFirst may make forward-looking statements with respect to its financial conditions, results of operations, business and prospects. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond OceanFirst's control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. OceanFirst undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In our earnings release, we have included our Safe Harbor statement disclaimer. We refer you to the statement in the earnings release and the 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 first quarter and 2014 earnings conference call today. This morning, we will discuss the components of the quarterly results we have posted following the operational restructuring we put in place at the end of last year. I obviously also intend to comment on the important next step we have taken to further advance our senior executive management succession plan. What we will not do is be disrespectful of your time reciting a host of actual numbers from the earnings release. Following my brief introductory comments, I'll turn the call over to the President and COO, Chris Maher, who will review the highlights and provide you with the promised background information on the quarter. Diluted EPS for the quarter, of course, was $0.28, that's $0.02 add of the prior year quarter and rebounding from the linked quarter, which, of course, included the previously referenced nonrecurring restructuring expenses. The company's 69th consecutive quarterly cash dividend was declared, maintained at $0.12 per share, representing a comfortable and sensible 43% payout ratio of our operating earnings, consistent with our capital management planning. We did execute a modest repurchase of 88,000 of our shares in the open market late in the quarter as we became aware of a relatively large walk of institutional shares. As previously discussed, we see ourselves as opportunistic purchases of our shares under the remaining repurchase authorization as market conditions dictate. Before moving on to Chris's comments, however, I need to share a few thoughts on Chris and review some information on the Management Succession Plan that we referenced in the release. Our announcement of Chris as my designated successor represents the latest step in the plan we began to formulate with our board some 10 years earlier. That plan unfortunately needed to be temporarily put on hold in 2008 as the financial world was staggered by the events of what we now commonly refer to as the great recession. Onboarding Chris to our management team early last year, however, afforded us the opportunity to advance these plans once again. As noted in yesterday's release, we could not be more pleased to have an executive of Chris's caliber in position to lead our company following my departure from the executive office. Chris brings a wealth of leadership talent and valuable experience to the company and has spent the past 14 months earning the trust and respect of our customers, employees and shareholders. Moreover, he and I have worked closely in crafting our strategic plans to further bolster our management team and ignite the growth engine of this company, taking advantage of the opportunities we recognize in the years ahead to further develop shareholder value. We expect to maintain this close transitional working relationship during my remaining term as CEO in 2014 and continue to work collaboratively with our fellow board members in enhancing the value proposition for OceanFirst shareholders. I have been privileged to spend the better part of my life leading this company, both before and after our 1996 demutualization and public offering, and I'm supremely confident in turning over the CEO range to Chris at the end of this year as he leads our company into the future. I'll now ask Chris to provide some additional background to our quarterly operating results.

Thank you, John, for your confidence and for your kind words. This morning, I will review selected aspect of the quarter's performance and discuss progress towards our strategic growth objectives. First quarter highlights included strong commercial loan growth and net interest margin stability, although noninterest income was weak and operating expenses were impacted by the investment in the bankcard business and adverse weather conditions. Credit quality remained stable, although charge-offs were elevated due to updated residential collateral valuations. Commercial lending growth is on target as our larger group of relationship lenders allowed us to increase market share while maintaining credit and price disciplines. Commercial loan growth initiatives implemented in 2013 have contributed net commercial loan growth of $27.5 million, $26.4 million and $18.5 million for the past 3 quarters, respectively. The commercial business remains focused on high-quality relationship credits. Specifically, commercial originations in the first quarter had an average yield of 4.29% against a repricing term of 4.7 years. While this growth includes commercial real estate lending, it is important to note that owner-occupied commercial real estate, which is priced and performs similarly to C&I loans, comprises 48% of the CRE portfolio. Further, our investor CRE represents just 145% of our risk-based capital, providing balance sheet capacity for substantial growth in both owner-occupied and investor real estate in future quarters. The commercial pipeline remained strong and is positioned to support continued commercial loan growth, similar to the past 3 quarters. The rotation of assets from investment securities into commercial loans is a pillar of our growth strategy and is demonstrating net interest margin stability at a healthy 3.36%. The year-over-year improvement in net interest margin lifted net interest income by 5%. Non-interest income was weak during the quarter, primarily as a result of pressure and residential lending. Gain-on-sale income was impacted much more than anticipated by the falloff in refinance volume experienced across the industry as well as by seasonally weak originations in January and February. Large residential lending volume recovered a bit, but the substantial reduction of refinance volume represents a longer term headwind for this business. Accordingly, the bank will be reducing expenses related to residential mortgage origination. The pressure on noninterest income related to gain on sale has now stabilized and can be expected to have a less significant impact in future quarters. In addition to the pressure from residential mortgage originations, bankcard revenue was seasonally soft and likely somewhat impacted by local weather conditions in January and February. During the quarter, the bank added 1,400 new debit cards, 850 of which were activated. Active cards grew at a 13% annualized rate and are a critical driver of transaction volume and revenue. We expect card revenue to return to prior-period growth trends in future quarters. Our third significant fee business, wealth management, improved over prior year but remained essentially flat as compared to the linked quarter. Senior management transition in this business was completed with the arrival of Craig Spengeman in January. As new wealth advisors are added to the team, we expect growth in both assets under administration and fee income to accelerate in future quarters. However, building this high-quality recurring revenue business will take some time. Given the value of this income stream, the investment being made into wealth management is expected to create long-term shareholder value. Core operating expenses declined modestly to $14.3 million in the first quarter as compared to $14.8 million in the linked quarter, primarily due to a decrease in professional services. Operating expenses did, however, include a significant increase in snow removal expenses. As discussed in our last earnings call, the majority of investment into growth initiatives has been completed. The operating expense run rate has been stabilized. To be appropriate, future investments and growth initiatives will likely be offset by corresponding expense reductions in nonstrategic areas. Credit metrics were largely favorable for the quarter, although quarterly charge-offs were elevated as compared to the linked quarter. The elevated charge-offs were driven by write-downs associated with updated appraisals on residential collateral securing previously reported nonperforming loans. In summary, we remain confident that the commercial loan business is capable of driving an important mix shift within the balance sheet. Noninterest income has the opportunity to add earnings in future periods. Operating expenses are now stable and credit disciplines are intact. Now I'll turn it back to John for the Q&A session.

Thanks, Chris. And I have no further comments at this point. I would ask Ed to open up the phone lines for questions.

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

Congratulations, Chris, and then, congratulations to you too, John. Well, I just had a couple of questions. I wondered if you could talk a little bit about seasonality. Is there any seasonality that affected the wealth management business in the first quarter? Does that explain any of the flatness? Is it just going to take some time to ramp up here? And then, I wondered if you had it, if you could share with us what the bottom line impact is on the business revenues minus expenses?

Okay, Frank, this is Chris. In terms of seasonality, the wealth business isn't really all that seasonal. However, if you were comparing linked quarter results from the fourth quarter to the first quarter, the fourth quarter did include a larger fee on the settlement of an estate, which is really the reason the revenue came down a little bit. I think more to your point, just over how we look at the business. Craig's here, he has hired 1 new wealth advisor this quarter. He's out looking for others, and it's still an area we expect to see growth from in future periods. In terms of the bottom line, it wasn't that much of an impact, because we're investing heavily in the business. So it's not a giant contributor to net earnings at the end of the day.

Got you, okay. And then, just secondly on -- you mentioned, Chris, reduction on expenses associated with mortgage banking. I'm just wondering if that has already partially taken place. Is that already partially reflected in 1Q numbers and what sort of expense saves are we talking there?

Well, in terms of what we're looking at there, it's a complicated situation for us because it's a community bank and we want to make sure that we retain the ability to serve the market. And we have the further complication that we do have some activity related to the Sandy rebuild, which is particularly strong in residential. We do think January and February were seasonally depressed with the weather conditions, especially as it relates to construction loans. But more to your point, the way we're looking at that unit, we've taken some opportunities to reduce expenses through attrition thus far, so there have already been some expenses we've reduced in the first quarter that will continue on. And we did implement an automated system to allow us to do paperless origination of residential mortgages. And if that system reaches maturity, we'll be looking at efficiencies beyond that. In total, I don't think the number is going to be that material, but we are looking at it closely, and over time, we'll be pulling those down.

Our next question comes from Travis Lan of KBW.

I want to echo Frank's congratulations to both John and Craig. I guess, Chris, if you could you just start talking a little bit about the NIM outlook. Pipeline yields are still a little bit below the portfolio yield on the loan side. I'm just wondering if you think there's enough mix shift to offset that and stabilize the NIM going forward.

Yes, I think we're pretty confident that the NIM is going to be essentially stable in future periods. I mean, it may bounce up by a couple of points here, there or down. But I think the 336 number, you're looking at 338 for last quarter, any pressure that we have on repricing we should be able to offset by mix shift. So I think you're looking at a pretty good number there. We're -- we don't see it going up in any material fashion nor do we see it really on the down side. And it was a tiny difference in the linked quarter but there were 2 additional days in the fourth quarter that were not in the first quarter. So ironically, if those 2 days have been in, it would've been exactly flat both for net interest income, as well as for the margin.

All right, that's helpful. And just on the construction side, I know it's a small piece of the pie overall, but it has been a pretty good contributor to loan growth. So I'm just wondering if you could talk a little bit about what you're seeing in that area, if there's any Sandy benefit on the construction side and just kind of generally your outlook for the construction portfolio.

Sure. Well, I think you hit the nail on the head. The entire activity level we're seeing is Sandy related. I would classify 90% or more being driven by Sandy, some of which may be people rebuilding their own homes and others which is people coming in and seeing opportunities to pick up lots or damaged homes and to rebuild from there. In terms of where we see it, the first quarter is actually a little bit slower than we thought it would be in construction. I do think the weather had an impact there. You got to get surveyors out and planners and all that before you see both originations and drawdowns on existing construction projects. So we think that'll strengthen probably a little bit in future quarters. From the beginning, we've felt that this is a multi-year rebuild opportunity. So we expect that line to continue to be kind of slow and steady quarter after quarter going forward.

Great. And then the last one for me is just -- your NPAs are still a little bit elevated versus peers, and I just wanted to hear a little bit about that dynamics there, and then, maybe your expectations for like a resolution timeline or when you could start seeing some improvement on the NPA side.

They're relatively stable and we expect them to continue to kind of be stable or favor downward over the future quarters. Early-stage delinquencies were off dramatically in the quarter, which is great, reduced significantly. So there's not a whole lot going into the bucket and we continue to deal with the residential foreclosure court situation here in New Jersey. Based on what we're looking at, I would think over the next several quarters, you should see a material reduction in that figure, but we can't be all that precise about which quarter that's going to hit. But certainly, over the next 4 to 8 quarters, I think you'll see that number normalize versus peers.

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

The last few quarters, loan growth has been much better, and a lot of that has to do with the new lenders in house. But I just wanted to get a sense for the sustainability of the loan growth to this magnitude for the rest of the year.

That's a great question. Certainly, the loan growth we see in the last 3 quarters has been materially impacted by some of the new officers who've come on board. However, our existing team of officers has also been productive, and I think in general, we're getting a little more name recognition, a little more market visibility to our efforts in commercial. And as that builds, the centers of influence in the market, whether they're attorneys or accountants, I think, are seeing us more. More comfortable getting us deals and we're building our reputation, not just to bring those customers over from, let's say, another bank, but also to win new deals that are organic in nature. I would simply say that we want this growth to be steady. We want to be careful if we don't bunch up too much growth in any one period or take an interest rate risk or credit risk position that gets us into trouble. So slow and steady is the word here, but I think we're going to see this pace continue. We have the pipeline, we have the team, and we're enjoying a little more success in the market and we expect that to continue.

And you'll see it also matters, Chris pointed out in his comments, the type of product that's being put on is not what you would consider to be the typical multifamily product that you're seeing in other areas of the state, but you're talking about reasonably attractive yields and repricing periods also. So as we always say, we're not in this to sacrifice quality in the sake of volume or to sacrifice underwriting standards and -- or price in the sake of volume. And I think that we have done a good job competing in the market that we deal in with the metrics that we have discussed.

Right. Now given that pace of growth and, Chris, I know you had said that you expect to fund some of that with the mix shift out of securities into loans, but also, I mean, you guys are somewhat over capitalized. So as we think about the total size of the balance sheet, should we be expecting it to remain flat or should we be expecting a little more leverage?

I think in the short term over the next few quarters, I don't think you're going to see a whole lot of total balance sheet growth. It's important as we grow the portfolio and grow this commercial customer base that we do it in disciplined manner. So we want to make sure that we've got everything working the way we want. As we get later in this year and look into '15, I would imagine we may actually ratchet up our expectations about growth. And at that point, I think balance sheet growth might come into play a little more firmly. We have a lot of securities we can chew up in the short term, I would like to do that first. But I think in the out-years, we've got plenty of capital. And if we continue to build our credibility in the market, we're going to use it to grow not just the loan book, but total assets over time.

And then, changing topics just a little bit. Last quarter, we discussed some of the new flood plan zones and potential for higher insurance premiums for a lot of impacted folks from Superstorm Sandy. And I just wanted to get your updated thoughts on the potential credit impacts from substantially higher insurance premiums, and at what point do you think that could become a factor?

Okay. That's a great question. One that we ask an awful lot around here. We do have -- just by the nature of our franchise, we have higher than average exposure into areas that have flood concerns. Similar to the discussion we had last quarter, the bank has done a thorough review of not just our flood properties, but in particular, looked at those that were susceptible to more significant flooding in Sandy and those that have had a history of insurance claims or where we've escrowed insurance money for flood claims. In summary, when we look at our allowance, we have -- we've taken into account the risk of a few additional defaults related to flood insurance premium escalations. It's a very complicated discussion, because at the end of the day, you may know that the Biggert-Waters Act was amended and certain provisions were stretched out for longer periods of time, others were accelerated, and in terms of whether you've got it, and owner-occupied first home or seasonal vacation home, as well as if your property has had a history of having flood damage in the past. So it's a pretty complicated soup to be on a conservative side and we've taken that into account in the calculation of our allowance. And then, I would look backwards and say, although it was a horrible expense going through Sandy for us, for our employees, for the market, it did give us at least some satisfaction that our underwriting standards and the policies and practices here left the bank in good stead after what was just a horrific incident. So having gotten through Sandy and keeping a close eye on things, I think we'll be okay, but we do have a specific reserve associated with this issue.

Our next question comes from Rick Weiss of Boenning.

Just a couple of questions. I guess, just on the loan growth is coming. Is this coming from just economic growth in New Jersey or is it taking market share from others?

I'd prefer if it were coming from economic growth, because I think that would be better, but it's mainly market share. That's I would say the -- there have been a couple of selected deals that I would say were probably economic activity from the Sandy rebuild, but the vast majority of it is taking share of existing credits from other lenders.

And in terms of your interest rate risk profile, has that changed significantly since December 31 or when you filed your K?

No, it hasn't, Rick. It hasn't moved that much. I mean, as Chris said, the commercial loans that we're adding had an average life, about 4.5 years -- or average terms of repricing about 4.5 years. So it's not like we're adding a lot of interest rate risk where we had those loans.

I guess, the only changes on profile is probably as a result of that home loan bank advance restructuring that we engaged in, in the fourth quarter. So we're gradually moving out of overnight advances into term advances and we're laddering them up over a period of time, but that would be the only change in the profile, Rick.

Okay, and when you're doing those advances, are they coming -- are you doing any with puts or calls or just a plain vanilla advances?

We're doing bullets. They're just plain vanilla. 3 to 5-year ladder.

And my last question would have to do with that M&A and what do you see, having the New Jersey M&A environment, not specifically for your company.

Well, I think a lot of people are asking that question. I think the single biggest impact is the additional capital that is coming into the competitive sector in New Jersey that has to be deployed. And I'm sure a lot of it will be deployed in organic means, which will make competition even tougher on the asset generation side. But some of it, given the extent of the capital being raised by certain folks over time, you would expect that would have to bleed down into some acquisition activity to efficiently deploy that capital back into the market. So I would think that there would be pressure on that, although, I have to say we operate in a rather concentrated market here at the Jersey Shore, not a lot of players. So there's not a lot of activity going on in one way or the other in our direct market.

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

Thanks, Ed, and I would just, again, like to thank everyone for the interest in our continued operations. We appreciate your questions and your interest as always and we look forward to speaking to you again in July.

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