OceanFirst Financial Corp. (OCFC) Q4 2014 Earnings Report, Transcript and Summary

Good morning, and welcome to the OceanFirst Financial Corp. Earnings Conference Call. All participants will be in listen-only mode. [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. Ms. Hewitt, please go ahead.

Thank you. 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 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 this statement in the earnings release and this 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 Conditions and Results of Operations set forth in OceanFirst filings with the SEC. Thank you. Now, I will turn the call over to our host, Chief Executive Officer, Christopher Maher.

Thank you, Jill. Good morning to all who have been able to join in on our fourth quarter 2014 earnings conference call today. This morning, I’m joined by our Chief Financial Officer, Michael Fitzpatrick; Chief Administrative Officer, Joe Iantosca; and Chief Lending Officer, Joe Lebel. As always, we appreciate your interest in our performance and our pleased to be able to discuss our operating results with you this morning. As has been our practice, we will highlight a few key items and add some color to the results posted for the quarter and then we will look forward to taking your questions. In terms of financial results for the quarter, diluted earnings per share for the fourth quarter was $0.30. Factoring out nonrecurring items, these results are relatively unchanged as compared to core earnings for both the fourth quarter of 2013 and the prior linked quarter both of which we also viewed as $0.30 in core earnings. Regarding capital management for the quarter, the Board declared the company’s 72nd consecutive quarterly cash dividend of $0.13 per share. In addition to the quarterly dividend, during the fourth quarter, the company repurchased 216,661 shares of common stock at an average cost of $16.69. For the year ended December 31, 2014, the company repurchased 551,291 shares of common stock at an average cost of $16.65. The Bank also announced the recruitment of our fourth commercial lending team, which will operate from the loan production office to be opened in Mercer County, thus expanding our reach into the broader central New Jersey market. In terms of what drove the numbers for the quarter, I would note that net charge-offs and correspondingly our provision for loan losses were both elevated as we completed the restructuring of our residential lending business. The residential lending repositioning effort, which Joe Iantosca will address more fully in a few moments included $532,000 of charge-offs related to loans restructured in previous years that were no longer considered collectable. Excluding these items, net charge-offs related to ordinary quarterly activity were a more modest $286,000. In addition to an elevated provision for the quarter, commercial loan growth while strong for the period provided little earnings impact during the quarter, as loan closings were heavily skewed towards the end of the quarter. As a result, the loan portfolio was $58 million higher at year end than the quarterly average balance, which will provide more benefit to future results. Growth prospects for our commercial lending business remain strong and the addition of another team of seasoned lenders in a contiguous market provide the potential for continued growth throughout 2015. Joe Lebel, our Chief Lending Officer is not presenting today but he is available to address any questions regarding our growing commercial business during the Q&A portion of the call. My final observation is that operating expenses, which had necessarily increased as we build out the commercial lending team, have leveled off in the past three quarters at approximately $14.4 million per quarter. While the expense line is always under some pressure, operating leverage is positioned to benefit from the growing loan portfolio and more stable operating expenses. At this point, I’ll turn the call over to Joe Iantosca, our Chief Administrative Officer. During the course of 2014, Joe played a critical role in revamping residential lending as we addressed origination operating efficiencies and liquidated the bulk of our residential nonperforming loan portfolio during the second and third quarters of 2014. These efforts culminated during the fourth quarter with the exit from the agency loan servicing business.

Thank you, Chris. Over the past three quarters, the Bank has undertaken actions to reposition the residential mortgage business line. You may recall that in the second quarter of 2014, steps were taken to improve the efficiency of the residential origination process. These actions included the introduction of enhanced automation including a paperless origination system. Additionally, underwriting and processing for both first mortgages and home equity products were aligned in one group resulting in staff reductions. Following these enhancements to the origination area, at the end of the third quarter, the Bank sold $23.1 million in nonperforming loans secured by one to four family residences, which represented 55.7% of the nonperforming loans at that time. Given the elongated and arduous foreclosure process on those loans, the vast majority of which were originated prior to 2008, the ongoing expense and resource strain was significantly diminished as a result of the transaction. In the fourth quarter, the Bank sold virtually all of the mortgage servicing rights in held on loans owned by the Federal agencies recognizing a net gain of $408,000. The unilateral authority of the agencies to modify the rules under which loans were serviced and the related ability to arbitrary sublimit that we’re not reflective of the current servicing timelines made this portion of the business unprofitable for all but the largest scale services. Coupled with the inclination of the agencies to push cost back to the servicer, the risk of continuing the servicing for these loans outweighed the reward. In the fourth quarter, there was lost revenue and elevated expenses associated with interim servicing of these loans, which are not included in the above gain. These totaled approximately $175,000 net. On an ongoing basis, beginning in the first quarter of 2015, the effect from the sale of the servicing rights will be an increase to net income on the scale of approximately $100,000 annually along with a substantially reduced risk of unanticipated charges being assessed by the agencies. These actions executed in 2014 in the residential loan origination and servicing processes will allow the Bank to invest in business line that are producing returns that exceed those possible in residential lending. Finally, looking at the net charge-offs for the quarter, of the $818,000 reported, $262,000 is attributable to residential loans, which continued to be owned by the bank and $24,000 is attributable to small business loans originated through our consumer underwriting area. The additional net charge-offs of $532,000 relate to troubled debt restructurings of residential mortgages conducted in prior periods but now being uncollectable. Importantly, no charge-offs were related to the commercial loan portfolio. With that, I’ll turn the call back to Chris.

Thank you, Joe. Mike, Joe and I will be pleased to take questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Frank Schiraldi with Sandler O’Neill.

Good morning.

Hi, Frank.

Just a few questions. First on, Chris, if you could just mention, give some color on the commercial growth coming late in the quarter. Was there anything you can point to that drove that? Was it because of when this production team came over?

Yes, I will say – I’ll ask Joe to comment as well. Much of it was transactions we thought might even close in the third quarter kind of drifted over and then made up against the year-end deadline that our customers wanted to hit more so than us. But Joe, anything to add?

Yes, that’s exactly it. Frank, it’s not uncommon to see these transactions sometimes more for one quarter to the other. And the bulk of these were from existing RMs that have pipelines. The 2015 year will be good for the new LPO.

I guess is there an another batch of closings that didn’t make it by year end that would boost the beginning of 2015?

Our pipeline is strong to start 2015, Frank.

Okay. How many commercial lending offices does this make now after this team is built out?

We have 12 on staff and we’ve built out two in the team so far with another to come in the first quarter.

Got you, okay, all right. And then, just trying to think about how this commercial loan growth that hit late in the quarter, how this will translate to say NII right off the bat in 2015? It looked to me just based on balances like the commercial loan growth was funded by FHLB advances. Can you just maybe talk a little bit about incremental spreads there in that new business put on late in the quarter?

Frank, it was funded mostly by home loan bank overnight advances at about 40 basis points. So it’s a pretty healthy spread there between that and what they came on at in the low 4%, probably about 3.75% in terms of a spread. Now, some of those overnight advances will be layered into longer term borrowings over the course of the next couple of quarters but the initial effect in January and February is going to be pretty healthy.

Got you, okay. And then just finally wondered if maybe you guys can talk a little bit about wealth management about expectations for growth in that revenue line year-over-year and maybe even more broadly expectations for fee income growth year-over-year?

Sure. I think the important thing about wealth management is that that’s been a small but growing business of ours. A relatively slow year in 2014 as we repositioned several staff members, we made some new hires and rotated in new production officers. So, we’re hopeful that 2015 will show a little more asset growth. We are maintaining consistent margins, so we’ve generally been somewhere in the range of 100 basis points in that business. We think we can hold that and grow a bit, but be a little cautious as we get all the new producers kind of settled and on line and hitting full stride.

Okay.

Our expectations are kind of muted about that in the short term. We think it’s more of a long-term play.

Okay. And then just more broadly fee income, I mean if I think about something like a fee in service charge line item, which obviously is a big piece of the fee income, should I just expect maybe that would trend along with deposit growth in 2015?

Yes, that’s a good assumption. The changes we had in 2014 were more structural as we reclassified and re-priced all of our transaction accounts with our consumer base. That went well and it did lift fee income somewhere in the range of about $1 million a year in pre-tax. We don’t expect anything of that magnitude in 2015. Having made that transition now to accounts that we think are properly structured, we think that the banking fees would be moving more along the lines of – in line with deposit balances. I will say though that on the deposit side, we have been growing our commercial deposits nicely along with the loan growth and Joe, you may want to comment on the commercial growth during the year in cash management.

We had almost 36 million in new commercial deposits along with 144 million in commercial growth.

Not that it’s a significant contribution from the new commercial customers are coming on, it’s a relationship business and a fair amount of that is cash management. So, again, I think your assumption is right. We should be looking at deposit fees moving kind of in lock step with deposits, but some of the deposit growth we’re seeing that’s kind of under the numbers is healthy commercial deposit growth.

Got you, okay. Thank you.

Thank you.

Thank you. The next question comes from Travis Lan with KBW.

Thanks. Mike, I think last quarter we had discussed that maybe the third quarter in NIM was a bit deflated and could kind of rebound during the fourth quarter. Was the reason that we saw the NIM being basically flat just the timing of loan growth or was there something else at play there?

That adds a lot of it. If you – we just talked about the commercial loan growth coming on very late in the quarter, our expectations were that it would have came on earlier in the quarter. But if you look at the – from quarter-to-quarter, there was no rotation of fourth quarter. There was no rotation out of securities and into loans as we saw in the previous quarters. It was virtually flat. The securities were down 3 million. Loans were up 3 million. So, we didn’t have that rotation that we’ve been seeing. We do anticipate that that rotation will now continue to occur in the first quarter especially when you see the average balance in the first quarter, you’ll see a significant increase in the average loan balance. And actually in the first quarter, you wouldn’t so much a change in the margin but you’ll see higher leverage. So our earning assets mix – our earning assets outstanding will be much higher in the first quarter than they are in the fourth quarter, so we’ll see the balance sheet increase a little bit with more leverage.

Got it, okay. And then could you just – what should we be thinking about in terms of the expense burden for the new lending team going forward?

The cost of loan production offices is going to be between 800,000 and 1 million, but I think that’s going to be somewhat muted by the fact that we had the cost cutting initiatives around the nonperforming loan sale and the sale of the mortgage servicing rights, so we’ll save some dollars there.

Got you. And then just one – go ahead --

I’m sorry. We did have our team manager for that business was on board in the fourth quarter, so some of that’s already baked in the fourth quarter expense. And as Joe said, we’ve been taking every opportunity as we’ve reduced expenses somewhere else in the bank to just continue to reinvest the commercial side. So the actual impact of the P&L next year will be much more muted.

Got you. What drew you specifically to Mercer County or was this just kind of the next – kind of the natural geographic progression?

It’s an interesting question. You look at Monmouth and Ocean County and then there’s a few ways we can go. We have the Atlantic ocean to our east, so we can’t go that way. As you go south, the opportunity for commercial lending becomes a lot weaker just by basis of the population and then the next market from us, which is still a distance off, is Atlantic City. So given all the turmoil there, we didn’t want to focus going in that direction. And we’re aware that going north provides a tremendous amount of competition in terms of all the new capital that’s predominately focused in north Jersey. So as we look at the prospects of – Mercer and Middlesex are both great counties. We expect to do some business in both of them. So while we will have the loan production team centered in Mercer County, they will be able to take advantages of opportunities at Mercer, Middlesex, western Monmouth and more broadly if you think about the route one quarter from say Trenton to New Brunswick, that’s an interesting market and that it’s dense in commercial opportunities but also it’s correlated a little differently than our core market in Monmouth and Ocean. So while it’s relatively close by, we expect that economic trends in Mercer and Middlesex maybe a little bit different than trends in Monmouth and Ocean over time. So some of it is a risk management play that as we grow, we don’t want to concentrate too much of our growth along the shore. The markets were favorable. And certainly going in that direction appears to be more favorable than going either north or south.

Got it, okay. And then just last one from me is the loan to deposit ratio moved up to 99% in the quarter and obviously you guys have mentioned the commercial deposit generation, but now you have this really strong loan engine. I just wondered how you think about kind of matching that up with the deposit side over time.

I think we’ve been very balanced in terms of the investment in our retail banking franchise over the last couple of years, even I would say biasing towards investing as much as we can in lending until we felt comfortable the lending engine was there. But I would say at this point, I think we’re looking at opportunities to potentially add to the branch network and I wouldn’t be surprised if you see some of that in 2015 because we want to continue to build that what we think is a core franchise value in our core deposits. So at this point now, now having the lending engine kind of catch up to the deposit position, I think we’re going to be investing more equally on both sides of the balance sheet.

Thank you very much.

Thank you. The next question comes from Matthew Breese with Sterne Agee.

Good morning, guys.

Good morning, Matt.

With the new lending team on board, I was just curious as to how that changes your commercial loan growth outlook for 2015?

It’s always depending upon market conditions and rates and all that. I think a reasonable way to think about it is that we had three teams in 2014 and we have a fourth team that will not be fully productive in 2015 because it’s a new team. But if you were to think about it as a 25% to a 30% increase in capacity that will be partially productive in the year, that’s not a bad way to think about it. Joe, do you think about any differently or?

I’m in total agreement. It’s going to take us a little bit of time to get up and running, get that third relationship management, but second half of the year should be strong.

Okay. And how should we be thinking about the residential loans segment with rates where they are and the potential for further balance declines in that bucket?

The major thing we’re seeing, which is probably an anomaly generated by our market is that our construction lending related to rebuilding Sandy damaged properties, and these are owner-occupied construction loans, has provided enough volume that our residential portfolio has been essentially flat. In any given period, it may be down or up a little bit, but it’s been holding primarily based on the amount of construction lending we’re doing in the post-Sandy world. We see that continuing in about the same pace. We said a few times before, we see that as a multiyear process where people are just going to be building as they can get permits and insurance settlements and FEMA maps and all that kind of stuff. So, I think we think about that as the construction loans providing the opportunity to maintain that portfolio. Absent those opportunities, we’re really not putting much in the portfolio. Almost everything else is being sold off. With the interest rate risk and the absolute level of rates today, which are lower than they were last year and maybe going down, we don’t want to put too much of that on the book.

Okay. And then hopping back to expenses, there’s a couple of moving pieces there. Is the 40.4 million going to shakeout as a good measure in 2015 or should we see some changes to that?

Well, we have in the first quarter we’ll have some relief from our loan servicing expenses were slightly elevated in the fourth quarter, so those would be trending down. There will be some additional costs in our loan production office, so they may offset in the first quarter. And then the trend after the first quarter will be a slight increase because the loan production office will be about $200,000 a quarter and increased expense from that.

You’re not going to see anything that’s a material change in expenses. It will be small bits around the edges.

Okay, that’s helpful. And then kind of bigger picture, you’ve always talked about the right level of profitability for the bank maybe being more closer to that 1% return on asset level. Given where interest rates are, is that still achievable in the near term?

We believe that our, what I would say our minimum profitability levels over the long term, which are the 1% ROA and the double-digit ROE are still achievable. Certainly the interest rate environment doesn’t help at all, doesn’t make it easier, but we think we can get there. The fourth quarter had both; our net interest margin was not – and an absolute level of loans was lower than we would have liked. That will be corrected in the first quarter. And our level of provisioning in the fourth quarter was larger than kind of what I would call the ordinary course charge-offs. So we have a little bit of an opportunity there. In the fee businesses, I think we’ll continue to kind of creep northward as well. So we see it achievable. And I think some of the operating leverage will get – on the ROA side that will end up being little self defeating as you add assets. But the incremental margin on the assets for adding is pretty healthy and the operating expenses as a percent of total assets will hopefully get a little help here as time goes on. So, I think we’re comfortable we can still get there.

That’s all I had. Thank you guys.

Thank you, Matt.

Thank you. [Operator Instructions]. We have a question from Rick Weiss with Boenning.

Hi. Good morning.

Good morning, Rick.

Hi. I was just wondering if you can give a little bit of color I guess behind the provision charge-offs and how you’re able to get credit, because I know you’re saying it’s elevated but it’s still only about like 20 basis points of the total average loans and reserve ratio is 95 bps? Going forward, how do you look at the reserve ratio?

It’s a difficult question. I guess the best thing I can say about that is to think about where we’re putting the balance sheet growth on and what our charge-off history has been over the long term. So, our commercial loan portfolio, and by the way although we’re adding growth to it now, the commercial loan portfolio and that business was launched in 1996 and many of the folks we have running it date back to when Joe Lebel joined the company in 2006. It’s a very mature capability. When we look at long-term charge-offs in that business, there are actually quite modest. I mean the last 10 years or so, I think we averaged about 14 basis points and those are the years including the crisis. So, the assets we’re putting on, we’re comfortable we’re going to have the right risk dynamic to them. I think it’s a little bit too early to think about what the long-term reserve to total loan book would be, but I would tell you the growth that we’re putting on is pretty high quality commercial loan growth. And in fact, the growth in 2014 the new loans put on had more favorable risk characteristics of lower risk ratings than the existing portfolio. So it’s actually getting even a little better. So I guess the best thing I can say to you is that we’re piling on the growth in areas where we have had a history of very modest credit costs.

Okay. And so then I guess for modeling purposes you could kind of figure like provisioning and charge-offs would be about the same and the reserve ratio, it is what it is [indiscernible] accounting for loan growth?

I think so. I think we always kind of look – we look at many variables before we come up with that answer, but we don’t want to see any sudden movements in any one direction or another; those are usually not called for. So, I think we look at what our charge-offs are for a period. We look at how much loan growth it was and what kind of loans we were putting on, what the net change and the risk position the balance sheet is, but I think you’ve got it.

Okay. And then I was just wondering if you could give a little bit of color behind the sale of the servicing rights on your residential mortgage loans? [indiscernible] to do that?

I think as Joe said in his conversation, the relationship between a servicer of our size and Fannie or Freddie Mac is very one-sided. And just in terms of scale, you’re talking the scale of Fannie or Freddie compared to the scale of the servicing operation that was your first, it’s very skewed. So when you have servicing requirements that change over time, particularly as it relates to loans that may have issues or require restructuring or the foreclosure process, the level of servicing demands have been increasing year-after-year and the level of servicing reimbursements have been decreasing year-after-year. So, when you looked at those two variables, we got to the point where we thought it was actually the detriment to operations. And then if it’s already a detriment, we didn’t see it getting better any time soon. And then as I’m sure everyone has read, you see servicers like Auckland [ph] having their problems, I’m not sure scale does it either. So, it’s just a business that had a return profile that we felt was subpar. We saw an opportunity to take that risk off the balance sheet. And then we have a small net save, it’s not a big thing financially, but that allows an incremental lender we can put on in Joe’s world that’s a business we feel in the long run is far healthier for the company. So, that’s how we think about it. I think it was mainly a scale-driven issue, a combination of scale and expectations of the national servicers, which we felt were not going to get better.

Okay. Then basically if the loan servicing income goes away, right, then they’ll be offset by something of the other expense line?

Yes, the primary expense in that business is staffing and we took staffing down at year end, so that going into 2015 the net of the reduction in income and the staffing expenses is actually favorable. So, we’ve added again and we have a little bit of a favorable position going into 2015. As Joe mentioned, we’re going to spend that on the commercial loans.

Okay, so I got it. So less income, much less expense and less risk, so all-in-all it makes a lot of sense.

Yes, you got it.

Okay, got it. Okay, thank you very much.

Thanks, Rick.

Thank you. [Operator Instructions]. Okay. There are no more questions at the present time. I would like to turn the call back over to management for any closing comments.

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

Thank you. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect. Have a nice day.