OceanFirst Financial Corp. (OCFC) Q3 2019 Earnings Report, Transcript and Summary

Good morning, and welcome to the OceanFirst Financial 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, Senior Vice President and Investor Relations. Please go ahead.

Thank you, Nick. Good morning and thank you all for joining us this morning. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer at OceanFirst Financial Corp. We will begin this morning's call with our forward-looking statements disclosure. Please remember that many of our remarks today contain forward-looking statements based on current expectations. Refer to our press release and other public filings included in the Risk Factors in our 10-K, where you will find factors that could cause actual results to differ materially from these forward-looking statements. Thank you. And now I will turn the call over to our host today, Chairman and Chief Executive Officer, Christopher Maher.

Thank you, Jill, and good morning to all who have been able to join our third quarter 2019 earnings conference call today. This morning, I'm joined by our Chief Operating Officer, Joe Lebel; and Chief Financial Officer, Mike Fitzpatrick. As always, we appreciate your interest in our performance and are pleased to be able to discuss our operating results with you. As has been our practice, we will highlight a few items and then add some color to the release to the results posted for the quarter. Then we look forward to taking your question. In terms of financial results for the third quarter, diluted earnings per share were $0.49. Quarterly reported earnings were impacted by merger-related expenses, branch consolidation charges and nonrecurring professional fees related to the renegotiation of our core systems contract. These items totaled $2.6 million net of tax benefit resulting in core earnings per share of $0.54, a 5.9% increase over core earnings in the second quarter of this year. Core operating expenses decreased to $40.1 million as compared to $42 million in the prior quarter as we realized efficiencies related to the Capital Bank acquisition. During the quarter, an additional four legacy were consolidated, which should help us manage expenses in the fourth quarter and into 2020. With these consolidations, our average deposits per branch now exceed $110 million. Joe will provide more color on the loan growth for the quarter, but we were pleased to see both Philadelphia and New York contributing strongly, which positions the company well for the future. The net interest margin contracted, but the impact was primarily due to purchase accounting and prepayment. Deposit cost appeared to have plateaued for this cycle and pressure on the net interest margin going forward should moderate. Regarding capital management for the quarter, the Board declared a quarterly cash dividend of $0.17, the company's 91st consecutive quarterly cash dividend. The $0.17 dividend represents a 31% payout of core earnings. Given the opportunity to repurchase shares at what we believe is an advantageous price, our capital deployment strategy will continue to favor share repurchases rather than dividend increases in the near term. On a year-to-date basis, the company has repurchased 786,000 shares at an average cost of $22.95. Since quarter end, we've been able to repurchase an additional 296,200 shares at a weighted average price of $23.43. Inclusive of those purchases after quarter end, we've repurchased a total of 1,082,767 shares this year. As long as we continue to be able to repurchase shares at these terms, share repurchases will serve as one of our preferred methods of capital deployment. During the remainder of the fourth quarter, however, repurchase volumes may be limited due to the rules related to the pending shareholder votes for the Country Bank and Two River Bank acquisitions. In addition, as part of our annual strategic planning effort, the Board will consider an expansion of the existing authority to repurchase shares and the existing plan may be exhausted by year-end. Our performance metrics remain highly competitive with a core return on assets of 1.35%, a core return on tangible common equity of 14.53% and a core efficiency ratio of 53.56%, all of which are slightly improved since the second quarter. The balance sheet remained strong with net credit recoveries and continuing low levels of delinquencies in nonperforming assets. In fact, at just 22 basis points, our nonperforming asset ratio is one of the lowest we have ever recorded. Tangible common equity to total assets remained strong at 9.73%, while tangible book value per share increased by $0.29 to $14.86. Regulatory applications related to the Two River and Country Bank acquisitions are in process, and we continue to plan that closing both acquisitions should occur in the first quarter of 2020. At this point, I'll turn the discussion over to Joe Lebel to provide more details regarding the development of our business.

Thanks, Chris. Record loan originations of $482 million drove loan growth of $138 million for the quarter. Commercial lending closing set an all-time quarterly high at $315 million with significant contributions from the Philadelphia and New York regions of $158 million and $100 million, respectively, as both geographies continue to gain momentum. We took the opportunity to add to our participation book after several quarters of planned runoff by partnering in $50 million of seasoned New York Metro co-op loans at average loan to values under 15%. As a result, the commercial portfolio grew $119 million for the quarter. Residential real estate continues to exceed expectations and delivered $156 million in closings for the quarter and $41 million in portfolio growth. The total pipeline remains robust despite the record closing quarter at $320 and while much of the pipe was residential at quarter end, we expect a solid fourth quarter in commercial activity. Our swap product, introduced earlier this year, had a solid quarter. And while fee income from swaps can be lumpy on a quarterly basis, booking floating rate loans with synthetic fixed rates for borrowers in this rate environment continues to diversify our loan book. While average yields and new originations were impacted by Fed cuts and competition in new and existing markets, net interest margin of 3.55% decreased 11 basis points largely due to decreased purchase accounting down 6 basis points to 15 basis points and lower prepayment fee income off from 4 basis points to just 1 basis point this quarter. Deposit costs are stable, and while competition is fierce, pressure on deposit pricing is abating. Our own cost of deposits was unchanged this quarter at 62 basis points after increasing 5 basis points in Q2 and 9 basis points in Q1. In the quarters ahead, pricing discipline remains paramount given the volatility in the yield curve. And our fundamental approach to credit remains steadfast in the face of rising uncertainty. Our use of interest rate swaps in 2019 has helped increase the amount and percentage of floating rate loans as an offset to our fixed-rate portfolios. While Fed cuts impact yields on these floating rate instruments in the short term, we manage interest-rate risk long term. We have built a strong stable lending teams and remain committed to strategic controlled growth in our markets. We are still finding good quality loans to strong borrowers as a result of our efforts. Moving to expenses. We are seeing the expected reduction as the Capital Bank cost saves take effect. Core expenses, exclusive of merger-related costs and noncore items, were reduced by $1.9 million in the quarter. Further improvements in the expense run rate due to the recently restructured core processor contract and the upcoming mobile and retail online vendor contracts will yield additional savings. We expect a portion of these savings will be reinvested in technology initiatives, and some of our 2020 branch rationalization savings will fund additional expansion in treasury services to support our growing customer base in New York, Philadelphia and New Jersey. One final note on the continued initial success of our hybrid robo advisory product, Net Egg. Since introducing the product in early 2019, we've seen organic growth measured by assets under management double each quarter, rising to nearly $24 million at the end of Q3. While this represents small dollars to date and has no impact on the financial performance in 2019 and likely 2020, acceptance from our customers has been notable, growth is ahead of plan and momentum is building. With that, I'll turn it back over to Chris for the Q&A part of the call.

Thanks, Joe.

[Operator Instructions] Our first question comes from Frank Schiraldi with Sandler O'Neill. Go ahead please.

Good morning.

Good morning, Frank.

Just a couple of questions. First on loan growth. Just given the strength in Philly and New York, first, maybe if you could talk a little bit about your expectation of trend in those two geographies. And then, just your thoughts, overall? I think, in the past, you've talked about $50 million to $100 million in net growth a quarter. And just sort of update us on your thinking there?

Frank, I think it's – I think the focus on $100 million quarterly growth is a fair number. And the expectations for Philadelphia and New York are on track where we expect them to go. I think New York will continue to build. Early returns are good. And I think Philadelphia has hit the stride because of their head start a little bit earlier. But I think both trends, assuming we can still in this marketplace find the kind of credits that we like to book, should continue to be positive.

Okay. And then just in terms of the margin outlook. I know the purchase accounting accretion kind of complicates things a little bit, but just thoughts on the NIM from these levels.

Frank, I would say that if you strip out the purchase accounting and even the prepayments, which are kind of transitory, and just look at the core NIM, we're pretty pleased that it just went down a couple of basis points in the quarter. And I think that, that's how we're seeing things going forward. Of course, if there are additional Fed cuts that place a little bit of a headwind, but I think if – even if we have a couple basis points of core NIM contraction from quarter to quarter, we can probably overcome that with new volume at this point and keep net interest income steady or rising. Mike, do you have any other comments on the margin?

Yes. So purchase accounting accretion actually for the fourth quarter will actually be slightly ahead of the third quarter. The third quarter was adversely affected because we had some true-ups to cash flow estimates, and we trued those up to actual, so there was this extra 3 basis points of downward pressure on that. So we had the benefit of slightly more accretion in the fourth quarter. Deposit cost seemed to have flattened and might even go down a little bit. And then there is a remix in the balance sheet from out of securities into loans and from – and even within loans into commercial book. So we think those are positives. The yield curve and maybe another Fed cut would be negative, but I don't see much of a change, maybe it's stable to slightly down in terms of the margin.

Okay. Thank you.

Thanks, Frank.

Our next question comes from the Russell Gunther, D.A. Davidson. Go ahead.

Thanks. Good morning, guys.

Good morning, Russell.

Mike, just a follow-up on the margin while we're on it. The stable to slightly down guidance there, is that for the fourth quarter? And does that assume an October rate cut?

No. Without a rate cut, stable to slightly down. Rate cut would obviously impact that a little bit, probably about – we think about 2 basis points in NIM, a 25 basis point rate cut, considering our mix of assets and funding sources that are tied to either Prime or LIBOR or Fed funds.

Got it. Okay, thanks for the clarification. And then on the expense side of things, obviously, a better result this quarter and appreciate the comments you guys gave about some incremental improvement in franchise reinvestment as well. But how would you expect that $40 million this quarter to run rate? Are there some pressures there? Can that be flat for the next couple of quarters? How – what are you thinking there?

Russell, it's Chris. It can probably stay around flat. There may be an opportunity to get maybe a little bit under $40 million. But what we're doing is really taking advantage of opportunities to reduce expenses in the branch network and even in our contracts on IT in order to fund the initiatives we have going on in terms of the digital build-out and all that. So I know we referenced, and it's in the numbers, the renegotiation of our core systems contract. We also referenced that in the fourth quarter we'll be renegotiating our digital vendor contracts. And we expected to give you a sense the cost per account will drop somewhere in the range of 50%. So we're trying to make sure we get on top of the unit economics in digital. As we move our customers from brick-and-mortar to digital, it's really important that we keep the unit economies in digital working. So I think you can you’re going to see us around that $40 million, some quarters might be a little better. We're not going to see a drop, but you also shouldn't see it under a lot of pressure either.

That’s very helpful, Chris. Thank you. And then just on the balance sheet side. So it sounds like organic growth and commercial lending growth is going to continue to be strong and then I hear you on remixing out of securities and into loans. So I'm curious as to when you expect sort of the $10 billion pressure to necessitate some sale out of single-family resi? And when we might see that show up in fees and, again, on sale perspective?

So I'll refresh everyone that when we announced the Country and Two River acquisitions, we discussed potentially staying at or below $10 billion throughout 2020 as a strategy to defend NIM and to be able to kind of increase our profitability before crossing over $10 billion maybe as soon as the first quarter of 2021. We look at a lot of things when we think through that. We look at economic conditions. We look at our organic loan growth numbers. And I would expect that you'll start to see us initiate some loan sales beginning in the fourth quarter. It won't be significant by dollar amount, but just to get us in that mode. But then throughout 2020, we're going to look at economic conditions, lending conditions and what we think we can do in organic growth rate. And it's possible we would consider accelerating the point at which we will cross $10 billion if we felt conditions were favorable enough. But we're going to have to see where the economy is, we're going to have to see what our organic loan growth is and weigh the – obviously, the headwinds on Durbin and things like that.

Got it. Okay, very helpful. Thank you guys.

Thank you.

The next question comes from Collyn Gilbert, KBW. Go ahead.

Good morning, guys.

Hi, Collyn.

Chris, just a follow-up on that comment, it's interesting. So a change from what, obviously, you guys had indicated after the July call. And is it – just what is it that you're seeing in the market? Is it just the 10 year coming back a little bit or – that might make you feel better about adding the growth in 2020 relative to where your position was in July?

I think you hit the nail on the head with the 10 year and the five year, even. The rebound makes us a little bit more bullish on loan growth. We're also feeling very comfortable with the New York and Philadelphia teams sourcing really good product at yields we think we can live with. So we're going through various modeling exercises to understand what the right time is to cross $10 billion. Our default is still the first quarter of 2021, and I don't think we'll really have the answer to that until we see, hopefully, in the next few months, maybe some resolution under trade agreements and things like that and where the core economy is going. So you don't want to push that organic lever too hard if you're thinking there may be a credit cycle. That said, good bankers always lend as though there's a credit cycle coming. So if you think you can kind of tailor your credit risk appetite in good times and bad, you're probably going to get caught. So we're pretty conservative to begin with. So we're looking at things, we're doing multiple projections. It is still our plan to defer the $10 billion across into the first quarter of 2021, but we're thinking about different options and how that might play out.

Okay. That’s helpful. And then, Joe, I just want to make sure I heard you correctly. When you were talking about the pipeline, did you say the majority of the pipeline is in resi at this point?

Yes. So at the end of the quarter, the – we had such a strong quarter in the third from commercial. At the end of the quarter point in time, September 30, the resi pipe was actually a little higher than the commercial pipe, but the commercial pipe has rebounded robustly since then. So – and we're still going to have a great fourth quarter resi as well.

Okay. That’s helpful. And then just going back to – trying to reconcile some of the NIM comments. So is the change that you're anticipating in the fourth quarter – so I guess I kind of look at the core NIM having fallen 4 – I'm sorry, 8 basis points if you exclude accretion, because it looked like the prepay impact was about the same in each of the quarters. So – and then it sounds like a better NIM outlook, I know, granted it doesn't assume a rate cut, but what – what's driving that? And again, it sounds like maybe you won't see a huge drop in deposits, which would then, perhaps, indicate that loan pricing is better. I don't know. Just trying to kind of piece that puzzle together as to why your NIM outlook will be better in the fourth quarter than what you guys saw the compression happen in the third quarter.

Yes. So for the third quarter, the compression was 11, but 8 – 9 basis points of that was purchase accounting accretion was down 6 and prepayment fees, which are not a big part of our net interest income, but they did go down from 4 basis points to 1 basis points. So 9 of the 11 was noncore items. So it was only 2 related to core. So – and then we're looking forward, as I said, we have – deposit costs have stabilized, the earning asset mix out of securities into loan is a benefit, within the loan book more weight on commercial loans is a benefit. Purchase accounting accretion in the fourth quarter will actually be $125,000 more than it was in the third quarter. So that's not a tailwind. That's a headwind as it usually is. So that's why we're thinking flat to slight contraction with that regards for a rate cut. And if there's a rate cut, like I said, that would be 2 basis points negative.

Also just add to, Collyn, that we're at about a 98% loan-to-deposit ratio, and we've always enjoyed being under 100% in that case. But in a declining rate environment like we're experiencing now, wholesale funding can have its advantages. So as we go into the fourth quarter, if we have the kind of loan growth we'd like to see, we don't feel pressure to have to fund all of that with deposits. So we have the alternative. We've got loads of availability on the wholesale side at pretty attractive prices. So we think we've got a couple of tools that will help us at this point in the cycle.

Okay. That's helpful. And then just as we think about kind of the efficiency, there's – reinvestments that are happening, as you guys have indicated, on some of the savings that you're going to see from the two acquisitions and then also what you did this quarter, can you just update us, perhaps, on maybe where you see kind of by the end of next year or where you have an efficiency target or goal to be?

So I think we've talked about this before, especially with the addition of Two River and Country, which will help us become – add to operating leverage when we do both of those. We think it's possible we could cross under 5%. We're just being a little bit cautious given the NIM outlook over the next four quarters and not knowing exactly how many times the Fed might cut that the revenue side may actually impact more – that more than the expense side. So we think we've got a good handle, we've got levers to prevent expenses from kind of creeping up, but it's going to depend a little more on the revenue side how low that goes.

Okay. That’s fair. I’ll leave it there. Thanks guys.

Thanks, Collyn.

[Operator Instructions] The next question comes from Sean Tobin of Janney. Go ahead.

Good morning, guys.

Good morning, Sean.

I guess to start out to touch on the buyback. You guys bought back a good amount of stock in the quarter and have a nice amount of approval remaining. I know there may be some restrictions between now and when you guys close the two transactions. But can you give us some color on your appetite for buyback activity and what we can expect to see in the near term even prior to the deals closing? Thanks.

Sure. I'd just point to a few things. First, just as a technical matter, when we issued the S4 and it's in the mail for the shareholder vote, we will not be repurchasing shares during the pendency of the vote. So that's just a matter of the rules we have to follow. But outside of that, our appetite for the shares, we think the earn back level at this price is pretty attractive. So we have a strong appetite. And then you really start to look at the capital equation, and where is capital today, where do we think it's going to be, where will it be post two important events, the acquisition of Country and Two River, but also the implementation of CECL. So we're maintaining a TCE ratio well in the 9s even after the acquisitions and likely after CECL, we think, will probably remain in the 9s. And as long as we're at that level, I think you can think about our – the earnings – the dividend ratio, the earnings payout ratio of 31% and then look to split what's left after that between organic growth, keeping capital for that, and then using the rest for buybacks if we can. So we could – depending on the circumstances next year, we could have a more active buyback program than we did this year.

Got it. That’s very helpful. Then switching gears to the nice growth you saw in noninterest-bearing deposits. Can you give us a little color on what drove that? Was that primarily from the C&I relationships from the new teams in Philadelphia and New York?

We’ve had a concerted effort on our treasury services line of businesses for several years now. And I think one of the things that's not commonly appreciated about our deposit base is that 40% of the total deposits at OceanFirst have at least one treasury product with the bank. And it's a really important line of business for us. It's one we've invested in, we've added staff to, we had a great leadership to that team a year ago, we're investing into technology underpinning that team, and we've recently hired folks to support treasury sales in the Philadelphia and New York markets. So it's a product that we think is probably incredibly important to us in the future. So we're not surprised to see a little uptick in noninterest-bearing deposits. They're not always going to come in that way, but we have a concerted effort against that.

That’s helpful. Good stuff. And then last one on the credit quality front. Is there anything you want to classify or criticize? Are those trends going to be similar to what we saw last quarter? And do they kind of directionally follow what we saw in the MPAs at quarter end?

So there – I mean the credit trends are very positive, very benign. We have not detected any trends in delinquencies, migration to classify that would be of any consequence. That said, you're not going to have quarters where you wind up with net recoveries every quarter, right? So – and given that this is one of the lowest quarters we've ever seen in nonperforming assets to total assets, I don't expect that we're going to be able to stay here forever. We did have a single credit included in the figures for the quarter end that moved to special mention. It was related to the bankruptcy of a tenant, a cluster of commercial real estate properties that we lend to. That has resolved favorably. So we had strong guarantors. They paid the loan during the period of the bankruptcy. Bankruptcy has been resolved. There was a buyer who has reaffirmed the leases through low LTV. So in fact, that will actually take a decrease from our special mention category. That was in the range of $16 million. But it was a well-structured credit. So when you have low LTVs, fast amortizations and good guarantors, even when you have a surprise, you should be able to work it out at a decent outcome. So all positive at this point.

That’s it. Good stuff. That’s it from me. Thanks for taking my questions, nice quarter.

Thanks, Sean.

[Operator Instructions] This concludes our question-and-answer session. I'd like to turn the conference back over to Christopher Maher for any closing remarks.

Thank you. With that, I'd like to thank everyone for their participation on the call this morning. We look forward to providing additional after year-end. So thank you.

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