OceanFirst Financial Corp. (OCFC) Q2 2015 Earnings Report, Transcript and Summary

Good day and welcome to the OceanFirst Financial Corp. Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jill Hewitt, Senior Vice President. Please go ahead, ma’am.

Thank you, Dan. Good morning and thank you all for joining us. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer at OceanFirst 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 in Management Discussion and Analysis of Financial Conditions and Results of Operations set forth in OceanFirst filings with the SEC. Thank you. And now, I will turn the call over to our host, Chief Executive Officer, Christopher Maher.

Thank you, Jill and good morning to all, who have been able to join in on our second quarter 2015 earnings conference call today. This morning, I'm joined by our Chief Financial Officer, Michael Fitzpatrick, and Chief Administrative Officer, Joe Iantosca. As always, we appreciate your interest in our performance and are 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 then add some color to the results posted for the quarter and then look forward to taking your questions. In terms of financial results for the second quarter, diluted EPS was $0.31 per share. Reported earnings included merger related expenses of a penny, so core earnings were in line with the prior quarter’s $0.32 per share. EPS has grown nicely over 2014 as year-to-date EPS for 2015, excluding merger costs, was $0.64 representing a 10.3% increase over the $0.58 reported in the first half of 2014. Regarding capital management for the quarter, the Board declared the company's 74th consecutive quarterly cash dividend of $0.13 per share. In addition to the quarterly dividend, during the second quarter, the company repurchased 149,797 shares of common stock at an average cost of $17.16. As of June 30, the company had 358,458 shares available for repurchase. The Colonial American Bank acquisition is proceeding smoothly. The bank received OCC approval on June 17 and Colonial American Bank shareholder approval on July 9. Over 99% of the votes cast by Colonial shareholders were in favor of the transaction. Our effective execution through the approval process resulted in an expedited closing date of July 31. Systems conversion and other integration activities will be completed in the fourth quarter and we look forward to making Colonial American part of our franchise. Quarterly trends included strong loan growth, a seasonal recovery in the fee income line and expense discipline. While operating expenses increased slightly as compared to the prior quarter, year-to-date operating expenses decreased by $807,000 or 2.8% below the 2014 period. Net charge-offs were just $185,000 and the provision for credit losses was slightly higher than charge-offs as loan portfolio growth again required a modest addition to reserves. Loan growth continued to be given by the expansion of the bank’s commercial lending business. Total loans outstanding have grown by $137 million as compared to the prior year and second-quarter total interest income increased by $678,000 or 3.4% as compared to the prior year period. Margins have compressed, however, as the bank took action to reduce the sensitivity to an increase in interest rates. While interest-earning asset yields are still under pressure, year-to-date interest-bearing liability costs increased by 8 basis points as compared to 2014. This is a direct result of the bank’s decision to extend the duration of FHLB advances to provide additional protection from the risk of interest rate increase. Over the last six quarters, the average duration of FHLB term advances has been lengthened from 1.3 years to 3.3 years. The strategy has sacrificed some short-term earnings capacity in order to improve the bank’s long term risk position. Deposit funding has improved in both volume and cost as total deposits increased $56 million over the prior year, driven by a $57 million increase in non-interest bearing deposits. The shift in deposit composition helped drive a 2 basis point decrease in the cost of total deposits, which was only 22 basis points for the first half of 2014. This trend is critical as we consider the composition of our retail and commercial deposit portfolio a key strategic differentiator and potential driver of franchise value. Loan growth over the past two years has primarily been used to fund a mix shift from securities into loans. Since June 30, 2013 this has resulted in a $175 million decrease in the securities portfolio and a $274 million increase in total loans receivable. While this transition has stabilized margins and improved the earnings profile of the balance sheet, additional loan growth will now correspond more directly to total balance sheet growth. As a result, continued investment in deposit-gathering capabilities is becoming an important priority. These investments are required to maintain a healthy loan to deposit ratio that must be executed very carefully to ensure the bank maintains a highly efficient deposit gathering operation. I’ve asked Joe Iantosca, our chief administrative officer, to discuss developments in our retail banking business with a focus on emerging technologies and the role of the retail branch going forward.

Thanks, Chris. Over the past several years, the bank has been steadily acquiring the technology infrastructure and applications that support our ability to gather deposits in an environment where convenience remains a paramount measure of satisfaction. Specifically in 2007 we were among the very early adopters of remote deposit capture businesses. This year we expect nearly $0.75 million checks to be processed by our business customers from the convenience of their offices. In the years following that, the bank made incremental investments in consumer technology, such as account access by mobile phone and electronic statement delivery. Then in 2013 we introduced mobile deposit capture for consumers and small businesses. At that time we also evaluated the newest technology in ATMs and embarked on a $1 million upgrade of the entire ATM fleet to advance single deposit module machines in 2014. Currently we have several projects in implementation that are nearing completion, such as account access on your Apple Watch which supplements our recently implemented Touch ID on the iPhone. For our debit card holders we will soon be offering Apple Pay, EMV Chip Cards and card valet [ph], a mobile phone application that offers personal control of your card. These technologies offer a level of convenience to our customers that rivals any of our larger competitors. And while the demise of the branch is being heralded by many, we believe that a bank still needs local points of presence in order to gain and sustain scale and gathering the servicing deposits. Looking at Monmouth County, for example, we compete with banks operating five or six times more branch locations than we operate. We don't need and we won’t fill the 3200 square foot branches of the past. Instead we will utilize far more efficient sales and service locations in a variety of configurations. And we’ve been actively engaged in the changing branch design since 2013 when we opened our financial solutions center in Red Bank with the universal bankers and no teller line. Also in 2014 we implemented our first interactive telemachine or ITM which allows our customers to interact with a teller in a remote location in a manner almost identical to a drive-through, allowing us to service a sub-market that could not cost effectively support a full service branch. This is a significant start to the convergence of technology with personal service. Opening additional points of presence as scale and cost relative to the local market opportunity will be an imperative for the foreseeable future. Let me walk you through the near-term plan. In the second quarter, we had a fairly unique opportunity to enter the shore community of Long Brach in the mixed-use development known as Pier Village in a small existing facility. Giving seasonal traffic patterns, we fast-track the project and with minimal renovation opened in about 45 days. The capital outlay was while less than one quarter of our typical branch and the lease commitment is for five years with several renewal options, much different than the 20-year land lease that has been more common freestanding traditional branch configurations. Staffing at this location with universal bankers is 2.5 FTE, less than our typical branch. And in the third quarter, we will welcome the customers of the two Colonial American branches with total deposits of $132 million to the OceanFirst family. Recall that these branches were in the number one and three target towns for future OceanFirst locations. Additionally, in the quarter we will open our second branch in Jackson. This location, while in a more traditional footprint since the shell was already built, we utilized both universal banker model and ITMs allowing for staffing complement of two FTE less than the typical branch. Later in the year, we will put a point of presence in an active adult community in Lakewood with an ITM and regularly scheduled visits from a customer service professional. This will drive the positive growth by allowing potential customers to use an ITM while still maintaining a relationship with an existing nearby branch. Finally, over the next couple of years, in addition to new points of presence, we will transition several of our existing traditional branches to the universal banker model, providing better more efficient service to our customers who choose to visit us in a branch. I know that this discussion is likely driving one question – how much will all of this cost? The answer is not much at all. The heavy capital investments to acquire the technology are behind us and are already reflected in the current expense base. There will always be incremental expenses to technology but they will be just that incremental and primarily volume driven. And while not every location will be as capital light as Pier Village, many will be and everyone will carry less compensation and overhead than the traditional branches. Given the growth, offset by the efficiencies to be gained, we expect the retail expense line to remain relatively flat within a couple of percent of the current run rate either up or down. We view this process as a gradual reallocation of retail operating expenses from fully staffed traditional branches into technological improvements, remote service locations and more efficiently structured sales and service centers. This process will ensure our retail delivery channels position us to compete more effectively for incremental deposit customers while balancing the operating efficiency of our retail network. With that, I will turn the call back to Chris.

Thank you, Joe. With that, Mike, Joe and I would be pleased to take your questions this morning.

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

So I think you are on pace so far this year for about 10% organic loan growth. Do you think that's a pretty reasonable target for the full year?

Yes, I think we have said for a while that we like consistency more than pop in anyone quarter and I think if you look back over the last several quarters, that’s about the run rate we are at and we don’t see any market barrier or issue at this point that would prevent that.

Joe, your commentary answered a lot of questions, as it relates to expenses and kind of the buildout of the retail side. Just on expenses, maybe, Chris, you could say with the 4Q systems conversion, what do you think is a reasonable timeline to achieve the 35% cost save target for Colonial?

We expect that with that conversion being done in the fourth quarter, that in the first quarter of 2016 we will have achieved the cost saves that we anticipated in the deals. So there will be fully realized whole all of 2016 and there will be a partial realization in the fourth quarter. Although may not be that much, because it can be a partial quarter and there will be little bit of consulting expense et cetera as we complete the conversion. So I think it’s a clean 2016 is the way I’d like at it.

And then, if you put the two together, year to date, I think you are on pace to run around $56 million, $57 million for expenses. Colonial maybe adds a little bit more than $3 million, and Joe you had mentioned kind of a few percent potential movement. So does something in the neighborhood of $61 million expense level seem reasonable for a full year, with all your own initiatives and Colonial baked in?

Based on what you said, Travis, yes, that’s – your logic seems right but we are not looking at that far. I mean we are trying to – we are trying to execute on the cost saves and may hit 25% hopefully do a little better. Our goal is to do banner than the 35%.

And I think we said before, Travis, we expect kind of – excepting Colonial, we expect that our existing expense line is under kind of inflationary pressure, not structural pressure. So we don’t feel that that is pressure either from retail nor from the commercial side, we will make incremental investments but we don’t see it going much faster than an inflationary rate.

That makes sense. And just two more from me. The first is on the extension FHLB advances. How do you guys balance or quantify the amount that you want to extend? How does that interplay work for you? Just to protect yourself in the longer-term, but at the same time kind of minimize or reduce the impact of short-term profitability?

Yes, we have – well, first of all, we are funding – we are partially funding our commercial loan growth which is at the [ICC] at the stage to that has – we understand our press release has the 5 year light or we set 5 years to reset. So we are balancing it off against the asset that we are putting it on and we are generally doing about $5 million a month in extension, as we fund loans, we offset that with the home loan bank advance using that four, five year term.

I’d also say Travis that if just recall at the end of 2013 we had restructured our FHLB advance portfolio and took advantage of -- primarily in 2014 running that a little shorter term and getting little bit more earnings momentum out of it. When we did the restructure in 2013, we anticipated re-lengthening those maturities and we wanted to make sure that we had that process complete well in advance of what the market anticipated would be a Fed move. So while we have lengthened maturities over the past 6 quarters, we’re probably at a pretty stable point right now and I don't think we feel we need a lot more protection. So I think we are where we are. We’ve gotten back to where we like to be and we are comfortable and we are in a reasonable position, if and when the market rates begin to move.

That makes sense. And then the last one is just -- if you could talk a little bit about credit. I know it's not a big number, but NPAs have trended up a little bit, and obviously you guys have put on a lot of commercial growth, so it's understandable. But just what you're seeing in terms of the credit environment in your markets? Just any other comment that you would have on credit?

I guess credit went kind of two directions. We did have a small blip in NPAs that was largely related to a single commercial loan relationship that goes back a number of years, not something on a portfolio basis. So we had a little blip, I think $1 million in total, not large. On the other side, we saw near-term delinquencies in the consumer portfolio came down nicely. So I'd say across the portfolio in the market we don’t have concerns. I think it was just an isolated incident that kind of drove a little bit of a blip. And looking at the charge-off figures, we continue to have very modest charge-off figures so we don't expect – we’re not concerned with where we are in NPAs.

Our next question comes from Matthew Breese of Piper Jaffray.

Just a quick follow-up on the new branches. In the release, you also talk about the reason behind that, which is to expand funding sources. And with the loan to deposit ratio now north of 102% -- or it's at 102%, could you give us an idea where the high watermark is on that? And could we see that reverse or stabilize with the new branches coming online?

I think it’s a great question, you drove right to the commentary we had about establishing these branches and about the Colonial acquisition as well which brings into nice amount of deposits. Those deposits of Colonial are currently fully utilized or we lend out [ph]. We think that the most valuable franchises in our sector will be those that have the best long-term funding basis particularly if you're heading into an environment where there may be interest rate pressure. So I think the first thing to say is that our philosophy is to be as well-funded as we can. We think that's a lot of franchise value here and we think that differentiates ourselves. We’ve been able to drive some nice deposit growth with commercial relationships that’s helped to date. Monmouth County is a wonderful deposit market and we have a very small player in that market today. Our market share is less than 2%. So we see an opportunity there to take share away from some of the larger banks that may be a little more distracted are outside the area. The issue though is that if you look at our distribution franchise in Monmouth County, it had been relatively modest until we started making this investment. So having added Red Bank, now Pier Village, acquiring two Colonial branches, we felt we needed to get to a certain level of density to be – to provide an opportunity to really go into that county. In terms of your broader question, how we look at loan to deposit ratio, I would say that as we get north of a 100% like we have this time, you’re going to see us devote incremental resources to mitigate that. We don't see ourselves being primarily wholesale funded. There are a couple other folks that I think have done that well given their composition of the loan portfolio but we don't see ourselves as creeping up into 110%, 120%, 130% of loan to deposits. I think we ideally would like to be around the 100 or just below and we will make rational expenditures to try and manage within the fairly tight band around the 100.

And then related to deposit pricing, we've seen some of your peers, especially to the north, increasing rates with promotional CDs but also money market and in some cases savings accounts. Have you felt that pressure at all down by you?

It's funny. There certainly is market pressure. When you’ve got larger competitors – there are plenty of competitors that are offering say money market accounts that are at a north of 1% or 100 basis points, when you look at our total cost of deposits, the highest rack rate that we offer on deposits even in a tiered lay market account is only 10 basis points. So we've never been targeting that part of the market. So there's absolutely market impact. We haven't felt much in our deposit base because I think we are aiming for a different customer. I think the deposit growth we've had in the last year has been largely commercial and those are checking accounts and non-interest-bearing accounts, you’re really not as exposed there. I don't anticipate us going into that market for, I would call them kind of aggressively priced money market instruments. That's probably not going to be our strategy. On the other side though that leads you to say, well, then how are you going to gather deposits and I think part of that equation is these points of presence and service points that Joe was talking about. If you want to build on checking and you have that philosophy, you’re going to have to provide the convenience. So in a way we will be spending money on branches that we might have spent on rates but we think that, that’s probably a better outlay.

And then just another follow-up on the overall balance sheet. I think you'd mentioned that you'll start to see some net balance sheet growth. Is that to say that the securities portfolio here at $460 million is where it's going to stay for a while?

I think it’s going to be a pretty close range. I don't think you’re going to see it go up or down much from that. Historically it had been a liquidity portfolio, it got a little bit larger than was required for short-term liquidity because we didn't have attractive alternatives before we got put the additional resources into commercial lending. But I think it may not be dollars for dollar but I think you’re going to see almost dollar for dollar growth in the balance sheet to correspond with whatever loan growth we can produce. And that’s kind of the impetus for the investment in funding. As you do that now you’re going to have the required funding. We had the advantage of applying funding that was supporting bonds and just shifting that over to loans. Now we’re going to have to net grow funding as well.

And then that in a combination with lengthening of your liabilities, how is that going to affect the margin from here? Are we going to go much lower?

I don’t think we’d go too much lower. We were looking the other day, it’s kind of the loan pipeline. The yields in the loan pipeline for the second quarter are slightly better than the pipeline we had in the first quarter. So I don't think the market is being compressed. In fact, it may have gone a little bit the other way but the loans we’re originating are still slightly below the existing portfolio yields. So I think you might see a little bit of margin pressure on yields but I think at a pace where the overall growth in balance sheet is probably going to mitigate that. So we don’t see too much pressure on overall margin. And as I said before we've purposefully extended those FHLB advances at a cost we think we've gotten to the point where we’re at a comfortable balance between protection against future interest-rate increases and current period profitability. So we’re not going to have as much pressure on the funding side from the wholesale loan part of the balance sheet.

And then my last question. You had some nice growth in your fee and service charge line here. I think some of that was from bank card income. Is this a good run rate that in total $3 million quarter?

That’s a very good run rate. The first quarter, frankly is a little depressed. We've seen the last three years now the first quarter is just the seasonally weak quarter for some of that stuff, including the bank card. So I think we’re going to see that pattern in future period as well. End of Q&A

[Operator Instructions] Showing no further questions, I would like to turn the conference back over to Christopher Maherthe CEO and President of OceanFirst.

All right. Well once again I like to thank everyone for joining us on this morning’s call. We look forward to presenting additional updates as the year progresses. Thank you.

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