Oceanfirst Financial Corp Q2 FY2022 Earnings Call

Good morning. Thank you for attending today's OceanFirst Financial Corp. Earnings Conference Call. My name is Bethany, and I'll be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions-and-answers at the end. I would now like to pass the conference over to our host, Jill Hewitt with OceanFirst Financial Corp. Please go ahead.

Thank you, Bethany. Good morning, and thank you all for joining us. 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 statement disclosure. Please remember that many of our remarks today contain forward-looking statements based on current expectations. We refer to our press release and other public filings including 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, Chairman and Chief Executive Officer, Christopher Maher.

Thank you, Jill, and good morning to all who have been able to join our second quarter 2022 earnings conference call. This morning, I'm joined by our President, Joe Lebel; and our Chief Financial Officer, Pat Barrett. You may recall Pat joined our team in April and resumed his role as Chief Financial Officer on June 2, upon the retirement of Mike Fitzpatrick. So this is Pat's first quarterly earnings season with us. As always, we appreciate your interest in our performance and are pleased to discuss our results with you. This morning, we'll provide brief remarks about the financial and operating performance for the quarter and then provide some color regarding the outlook for our business. As a reminder, in addition to the earnings release issued last night, an investor presentation is also available on our company's website. We may refer to those slides during the call. After our discussion, we look forward to taking your questions. Our financial results for the second quarter included GAAP diluted earnings per share of $0.47. Earnings reflect strong loan growth, expanding margins and benign credit conditions. Core earnings were $0.59 per share and reflect non-core items primarily related to unrealized equity mark-to-market valuation adjustments on preferred stock positions and to a lesser extent charges related to branch closures and mergers. Turning to capital management. Given the company's strong performance, the Board increased the quarterly cash dividend by $0.03 or 18% to $0.20 per common share. This is the company's 102nd consecutive quarterly cash dividend and represents 34% of core earnings. Tangible common equity per share increased modestly to $15.96, reflecting earnings momentum outpacing AOCI marks related to our investment portfolio, share repurchases and the acquisition of our interest in the Trident Title insurance business. The company's share repurchase activities continued during the second quarter with 272,779 shares repurchased at a weighted average cost of $19.25. Our appetite for share repurchases will be balanced against opportunities to deploy capital in growth initiatives and reflects trading rules that limit the number of shares the company is able to retire while awaiting the regulatory review for the Partners Bancorp acquisition. There are 2.9 million shares available under the current repurchase program. Regarding the Partners Bancorp acquisition announced in November 2021, the company has submitted all the necessary regulatory applications and continues to provide additional information as requested. At this time, we do not have a timeline from the regulators for when the process may be completed. Until all approvals and customary closing conditions are met, we cannot schedule the merger closing. Turning to net interest income and margin. Net loan growth of $316 million and our asset-sensitive balance sheet drove another quarter of margin improvement, which expanded by 11 basis points to 3.29%. We experienced elevated prepayment fees for this quarter of $2.6 million or 9 basis points and expect the level of prepayments to slow for the remainder of the year. Two factors should provide a tailwind for margins. First, the quarter-end loan portfolio of $9.4 billion was $176 million higher than the second quarter average of $9.2 billion. Second, the company held $2.3 billion of floating rate loans, repricing in the third quarter, which will provide the opportunity to strengthen margins as rates increase. And that should be the case in the third quarter and perhaps for the remainder of the year. The benefit from rate increases experiences a time lag. So in the coming quarters, NIM could be flat or expand, but trends should be positive overall. Core non-interest income and non-interest expenses included a full quarter of Trident Abstract Title Agency operations, which added $4.5 million of non-interest income, and $3.2 million of non-interest expenses for the quarter, resulting in $1.3 million of net income for the quarter. The purchase of our interest in Trident was completed on April 1. So these figures reflect a full quarter impact. Excluding the impact of Trident, our disciplined expense management resulted in core operating expenses related to banking operations improving modestly to $54.7 million, where $400,000 lower than the prior quarter. I'd also like to provide some additional color regarding expense trends. As noted in our earnings release, the Bank increased base salaries by 5% for over 80% of our employees and paid a one-time award to almost 20% of our employees to support our team members who would be most impacted by inflationary challenges. The annual impact not captured in this quarter's financial results is $2.3 million or almost $600,000 per quarter. I will add the compensation increases for this purpose are not typical at OceanFirst. Our company is a talent-led business and our employees provide our competitive advantage. This investment in our team reinforces our commitment to them. It demonstrates an understanding of the challenges they and their families are facing during the current economic cycle. No additional compensation actions are contemplated for the remainder of 2022. And it's simply too early to speculate on the level of labor expense pressure for 2023. Fortunately, our multi-year and comprehensive program of branch consolidations has improved our ability to manage the company's overall expense base. The second quarter run rate captures our expected core operating expense for the remainder of the year. At this point, I'll turn the call over to Joe to provide some color regarding our progress during the quarter.

Thanks, Chris. The loan portfolio had another strong growth quarter with $316 million in net growth fueled by commercial banking relationships. Total loan originations were $835 million, driven by commercial closings of $646 million. Our New York region crested $2 billion in its loan portfolio, while our Boston region has built a loan book of $250 million in one year from the opening of the office, a testament to our continued investment in commercial talent in our legacy and expansion markets. After nearly $1.6 billion in meaningful loan growth over the last 12 months, we are starting to see the impact of rising rates affecting the decision-making of certain segments of our customer base. Our pipeline of $385 million at the end of Q2 is typically our seasonal low for the bank, but also reflects our expectation of more measured loan growth for the rest of the year, as we maintain our traditional discipline and pricing, structure, and credit appetite. That said, I expect we can responsibly grow the loan book in the range of $250 million quarterly although growth could be choppy at times. I expect the residential originations to slow, where prepaid speeds will also moderate providing some offset. At the moment, we have less visibility in the pipelines looking much past Q3 given some of the noise and rates, supply chains, and economic uncertainty. Turning to deposits. Our loan-to-deposit ratio ticked upwards to 95.9% from 90.6% in the prior linked quarter due to the loan growth coupled with the traditional decline due to seasonality in certain deposit classes. You'll notice we took action to protect against near-term deposit cost pressure. During the quarter, we elected to replace a portfolio of market-sensitive floating rate deposits with term-based certificates. We accomplished the duration extension by issuing $689 million in brokered CDs with laddered duration maturities. The strategy also took advantage of some pricing anomalies in the brokered CD market and gained duration at lower rates than the equivalent duration of FHLB advances. The rotation is complete, and we expect to return to our traditional sources of funding for the remainder of the year. In keeping with normal seasonal trends, the Bank has experienced net deposit growth of $145 million since June 30. Credit trends remained benign with the company realizing just $9,000 of net charge-offs for the quarter and net recoveries of $83,000 year-to-date. Loan portfolio risk characteristics are very healthy with low delinquencies, positive risk rating trends, and non-performing assets, excluding PCD loans of just 14 basis points of total assets. For the first time in our history as a public company, we do not carry a single property of other real estate owned on our balance sheet. The loan loss provision for the quarter was driven primarily by net loan growth, with much of our reserve remaining in the form of qualitative factors that reflect the potential for economic uncertainty in future periods. As Chris mentioned, Trident was additive to non-interest income on a net basis by $1.3 million in its first quarter as a notion for a subsidiary. This partially offsets the loss in interchange revenue attributed to Durbin of roughly $1.5 million per quarter, which began on July 1st. With that, I'll turn it back to Chris.

All right. Thanks, Joe. We'll now begin our question-and-answer portion of the call.

Hey, guys. Good morning. Thanks for taking my questions.

Good morning, Mike.

I apologize. I did hop on a few minutes late, so I missed something quite a bit. But, Chris, what's the latest that you can share beyond the press release regarding the partnered transaction? And, yeah, I guess I'll just leave it there. I'm sure it's not much, but just I wanted to ask.

Yeah. I appreciate the question, Mike, and I know that's on everybody's minds, and it's on our minds as well. Unfortunately, the only thing I can share is that we continue to await regulatory approval, and that's just a process we're being respectful about and try to work through as best we can. And I don't have a timeline that I can give over when we might receive them.

Can you remind us though, in terms of the actual merger contract, like, what was the duration that it ran through or when would it be required to kind of negotiate the expansion?

Yeah. So the contract would call for us to consummate the transaction on or before November 4 of this year.

Okay. Got it. Helpful. And then, I heard the expense commentary, obviously, the environment is challenging, but I just want to make sure I heard it right. It sounds like obviously, ex-partners, do you guys think that second quarter run rate now kind of reflects the near-term higher level of salary benefits and should be a decent run rate for the back half of the year is at some of the other items, you guys are working on continue, or did I mishear that?

No. That's a good guide. As we think about, there is some kind of obviously in every quarter, there are going to be some puts and calls on things like that. But if you take the second quarter, we think that's roughly what we would experience in Q3 and Q4. It might be a little bit higher than that, but it's not going to be materially different than that.

Okay. And then just lastly for me, and then I’ll step up. Just on the capital front, you guys have been a little bit more insulated than some peers in terms of the AOCI impact. And I know there are regulatory cap ratios, but I guess the bottom line, as you guys are still sitting in a pretty strong position today despite the loan growth. So is it fair to assume that buybacks will continue to a certain extent near-term here or does the potential deal impact your ability to buy back stock in the back half of the year?

We continue to be open to buybacks, but that decision will depend on our current trading position, the potential earnings from a buyback, and the anticipated strength of loan growth. Joe pointed out that our pipeline is typically low at this time of year, which is normal. We are having positive discussions with clients and believe Q3 will perform well. However, I cannot provide much guidance on loan demand for Q4. Our priority is to grow the bank. If we can't utilize the capital effectively, we would prefer to return it to shareholders. While we remain interested in growth, we are closely monitoring how we consume capital organically. We will assess the situation and may decide to reduce buybacks in favor of funding growth.

All right. Sounds good. Thanks for taking my questions. Have a good weekend.

All right. Thanks, Mike.

Good morning, Chris. How are you?

Good morning, Dave. How are you?

I'm fine. In your comments, it seemed like there was a bit of caution regarding the near-term outlook for the net interest margin. Clearly, loan yields in the pipeline have increased by over 100 basis points year-over-year, but the inclusion of brokered deposits might affect asset sensitivity in the near term and could impact the tail end of the current cycle if we reach around $350 million by next year.

It may, a little bit in the short-term. I think what happens is, not unlike other places, the rate increases roll through our loan book over the course of sometime, there're some loans adjust immediately, some at the end of the month, some may have a quarterly repricing. So the asset sensitivity is there, whether it will show fully in Q3 is a question we're just kind of watching closely, which you might see as a little plateau and then it resumed expansion after that. And look, it may be an expansion in Q3, but we don't expect it to be a material expansion.

Got it. And then in terms of the new market initiatives here, just curious in terms of the pipeline there, what you're seeing relative to the rest of the book? And maybe potential for even further expansion but then maybe the Greater Boston Market? Thanks.

Good morning, Dave. We're very pleased with the progress in Boston and Baltimore. The $250 million this year for Boston is excellent; it's an impressive figure. They continue to maintain a strong pipeline in Baltimore. I now consider Philly and New York as legacy markets since we've been operating there for about four to five years, and both have exceeded $1 billion, with New York surpassing $2 billion. While some clients are hesitant about their future plans, we're confident that we can achieve that $250 million quarterly target, which is sort of our benchmark. There may be some fluctuations from quarter to quarter, but on an annual basis, we’re not overly worried. Our visibility extending beyond a quarter has become a bit clouded due to uncertainties around client decisions. However, I noted earlier today that just four years ago, we had 3% rates for 10-year bonds. People seem to forget that in December 2018, rates were 5.5%. Therefore, clients tend to adapt rather quickly.

Got it. Appreciate the color.

Good morning, guys.

Good morning, Matt.

Hey, Joe. Regarding the $250 million of growth per quarter, understanding that it could be inconsistent, how long should we expect that level of growth? I'm thinking it's still a strong pace; should we anticipate that through the end of 2023 or just according to your perspective?

I think it's difficult to forecast this accurately. I tend to analyze it on a quarterly basis. In the past, before the disruptions in supply chains and the economy, we had more visibility. The challenge with having engines in different regions is that if one region or market is performing poorly in commercial real estate, the commercial and industrial side may pick up, and vice versa. Overall, we feel positive about the situation. We stay in constant communication with our teams and have taken a careful approach to credit structure. This might have slightly affected the pipeline in the short term. We're committed to maintaining our discipline, and while there may be some fluctuations, I'm not overly worried about it as a near-term issue.

Understood. And then aside from capturing better yield, it sounds like perhaps you're just taking a second look at how you're underwriting things. In what ways have you become more conservative, are you asking for more skin in the game from the borrowers? Are you putting more stipulations in place? And if there is a portion of the portfolio that you've taken a second look at? I'd be curious which ones.

I think for us, we always prioritize equity. We are stressing portfolios at higher rates due to the rate increases. Property types are important, particularly in the commercial real estate space. Everyone is examining office spaces more closely because of uncertainty around lease expirations in the coming years. There is talk of consolidating space due to remote and hybrid work trends, and the same applies to retail. Retail is also under scrutiny. Industrial has become a very crowded sector as many have entered it over the past few years. In that area, I think it's essential to select opportunities carefully, considering both credit and pricing, as there’s no reason to engage in something unprofitable. However, I believe we are fairly confident.

Okay. And then maybe regarding the balance sheet that supports the $250 million in loan growth, how much of that can come from deposit growth? What types of deposits are involved? Additionally, I'm interested in the 96% loan-to-deposit ratio; how should we consider an upper limit on that?

Joe made some additional thoughts on kind of how we'll get those deposits, but I'll make some general comments. First, for the most part, we think that funding loan growth with deposits is the right thing to do. So that's generally what our position is. And we think we can grow deposits in the future quarters. Now, we may have to pay a little bit more for that or we may have to offer certain products or rates, but we're prepared to do that. In terms of loan-to-deposit ratio, I think the most valued banks are traditionally at that 100% or lower loan-to-deposit ratio. And that's where we generally like to be. That said, we have a very unusual rate cycle going on right now. And you could foresee that if the Fed may peak increases later in the year or early next year or something like that that it might be a good strategy to lean on some wholesale funds that would reprice faster. So we're just going to balance those two things off, but we're not going to turn into a company that's going to have a 120% loan-to-deposit ratio, it's not us. In fact, we're talking to our officers this morning and just emphasizing that we've always been good at deposit gathering and we're going to spend a lot more time and attention on that. So we can balance it out in a little while since we need that engine.

Got it.

First time in a long time, Matt, we're actually going to start looking actively for deposits. We've all been in the same boat the last couple of years with excess liquidity. But our books, I think are chomping at the bit to be able to go at it from both sides, right? We've been going at it hard on the lending side. And I think our folks, especially our retail folks are excited about going out positive.

The single biggest place we would see deposit growth is in our corporate treasury function. That is an engine that we have built over the last few years. We've got the right people in the right place. We've got the right technology. So we're going to push that pretty hard.

Okay. And then the last one along these lines. It's just expectations for the deposit beta now that what seems to have passed the halfway mark on the rate hiking cycle, and how you would compare and contrast expectations around the beta cycle versus last?

Every cycle is different, so I would be cautious about predicting how this will unfold. However, considering our deposit mix, with 85% being core, and the majority being checking accounts, both interest-bearing and non-interest-bearing, we anticipate that our performance will exceed that of the group, though it’s less certain how that group will fare. I don’t believe we will see positive outcomes in that context. Apart from the price-sensitive accounts that we addressed in the last call during the second quarter, we’ve observed very little pressure on deposit flows and rates so far. However, for the third quarter, we expect deposits to be significantly more expensive than in the second quarter. At this moment, loan yields are increasing more rapidly than that, so we aren’t worried about margin compression, but you will notice the cost of deposits increasing.

Got it. Okay. I'll leave it there. Thank you for taking my questions. I appreciate it.

Thanks, Matt.

Good morning. Thinking about the loan outlook, do you think that kind of the shortened view is being imposed on you by the greater market? Or are you seeing some things which a customer base that is informing that perhaps the fourth quarter could be a little different than higher expectations?

I'm sure that probably have the same view. I think when we think about what we're seeing in the market, there has not been a material decrease in economic activity or the demand for credit in our markets. However, here we talked about structures and pricing, we are going to stick to our structure and pricing requirements. It will take a little while to understand exactly how many of those deals we'll be able to pull out. So my caution is more about the market share deals we're going to get depending on rate and structure, not that the demand is falling off. Is it fair Joe? Is it kind of…

Yeah. That's fair.

I guess, following up on that. Are you seeing greater competition in terms of pricing and structure and is it different in different markets? So that's going to be my next question.

Sure. I mean I think the competition is similar. I think we purposefully had said, we've had significant growth in the last year. We know the kind of deals we put on. We also know the kinds of deals we're seeing today. And I think the market is a little bit more aggressive in pricing definitely a little over-aggressive in structure. So I think for us, we have the ability to select their work, they can choose. I'm not overly concerned in any one market, I think all markets are similar in scope. So I think what we're seeing is what we expected to see. We just hold to disciplines, our folks understand that. And remember that pipelines are a point in time. The pipeline you're seeing is a point in time it's improved since quarter-end, so.

Just one more point about the market. We are fortunate, and this was a deliberate choice given the market we are in. This Northeast market includes 50 million people, and we have a modest presence there. Joe can adjust his approach from quarter to quarter based on changing conditions in various regions and asset classes. We are operating in a significant regional economy, so I don't anticipate a decline in loan demand. Instead, it will depend on the decisions we make regarding risk selection.

Got it. I appreciate that. Kind of a tricky question for modeling. How quickly, if you get regulatory approvals, could your deal close?

Well, typically, if you secure final regulatory approval, you could close in two weeks, three weeks. There is a shareholder election thing we have to work through, should we get approvals, but it should be measured in weeks.

That's helpful. Thank you. That's it for today. Thank you.

Hi, Chris. Just a discussion on the funding and the deposit side. I guess, you mentioned the one-off of those interest-sensitive checking accounts. Just curious what's the genesis of those? Were those accounts acquired via acquisition sort of organic deposit growth? Just curious, where those were generated from?

Our corporate treasury group has a strong understanding of our customer base. We have nearly 40,000 customers with at least one cash management product. A very small number of those customers were sensitive to interest rates, and we were pleased to accommodate them when the Fed funds rate was just a quarter point. They sought to maximize their balances using different options. While we could have chosen to retain them, and interestingly, it would have been at a lower cost than the CDs we issued, we recognized that we would need to match rates closely. So we decided that we didn’t need those fully rate-sensitive deposits and opted to replace them with offerings that have a bit more duration. This was a defined portfolio, and the rotation has been completed, so we no longer have concerns about this issue.

Got it. This isn't a case of any outflows related to the branch network you have been aggressive in expanding. From what you mentioned, there are no issues with deposit attrition due to branch closures.

No. That's a really good point, Dave, thanks for mentioning it. In fact, we track deposit retention very carefully given our history. Even with the closures in December and January, attrition peaked probably by the end of March, and then those branches began to grow again. It was well within the range of what we expected, so this is not related to the branch consolidation efforts.

Currently, there are no questions waiting at this time. I would like to pass the conference back to Christopher Maher for any closing remarks.

Very, very thank you. We appreciate everyone's time and participation this morning. We look forward to speaking with you after our third quarter results are published in October. Thanks.

That concludes the OceanFirst Financial Corp. earnings conference call. I hope you all enjoy the rest of your day. You may now disconnect your lines.