Oceanfirst Financial Corp Q3 FY2022 Earnings Call

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

Good morning and thank you all for joining us today. 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 today, Chairman and Chief Executive Officer, Christopher Maher.

Thank you, Jill, and good morning to all who've been able to join our third quarter 2022 earnings conference call. This morning, I'm joined by our President, Joe Labelle, and our Chief Financial Officer, Pat Barrett. As always, we appreciate your interest in our performance, and we're pleased to discuss our results with you. This morning, we will provide brief remarks about the financial and operating performance for the quarter and 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 third quarter included GAAP diluted earnings per share of $0.64. Earnings reflected strong loan growth, expanding margins, and benign credit conditions. Core earnings were $0.60 per share and reflect non-core items primarily related to unrealized mark-to-market valuation adjustments on equity investment positions and, to a lesser extent, charges related to branch closures and mergers. I would also note that this quarter was the first quarter in which the company was subject to the Durbin amendment cap on interchange income, which reduced our interchange fees by $1.7 million for the quarter. This is the final material headwind we faced from crossing the $10 billion regulatory threshold. Turning to Capital Management, the Board approved the quarterly cash dividend of $0.20 per common share. This is the company's 103rd consecutive quarterly cash dividend and represents 34% of core earnings. Tangible common equity per share increased to $16.30 reflecting earnings momentum, outpacing AOCI marks related to our investment portfolio. The company did not repurchase any shares in the third quarter while we continue to await the regulatory review for the Partners Bancorp acquisition. Moving to the merger agreement with Partners Bancorp, November 4, 2022, will be the one-year anniversary of the announcement of the agreement to acquire Partners. We continue to collaborate with Partners and are working with our regulators as they review the application. As noted in the agreement, after one year, either party may but is not obligated to terminate the agreement without penalty. Of course, until all approvals and customary closing conditions are met, we cannot schedule the merger closing. We will publish appropriate filings when definitive information is available. Beyond our financial performance, I'm also pleased to note that earlier this month, we held a bank-wide afternoon volunteering, then closed our branches. Over 750 OceanFirst employees, whom we call our wave makers, could spend a collective 3000 plus hours at over 100 project sites to help our neighbors in five states. While the afternoon of October 6 is not the only volunteering that takes place at OceanFirst, it certainly was a significant opportunity for us to help the nonprofit organizations in our communities who do so much to help our neighbors every day. This commitment is a core part of how we serve our communities and build our business. 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 solid quarter with $294 million in net growth. Total loan originations were $544 million driven by commercial closings of $357 million. It's important to note that loan originations have slowed considerably, running 35% lower than Q2 and 47% lower than Q1. This is a natural consequence of our conservatism regarding credit risk and consumer demand falling as interest rates rise. However, net loan growth remains healthy and has grown at double-digit levels, as prepayments have decreased throughout the year. While originating less, the quality of our originations remains strong as our focus remains the diligent application of a consistent credit appetite for responsible loan growth in the face of certain economic environments. The economic uncertainty affords us less visibility into 2023, but we expect a modicum of continued responsible growth in certain segments. While we all expect continued declines in residential lending due to rising rates affecting affordability, coupled with ongoing supply constraints, multifamily demand is high as rental rates continue to outpace inflation, and a constant need for housing persists. We expect loan growth in the construction of multifamily and the conversion of existing projects to permanent amortizing loans in Q4 and into 2023. Turning to deposits, our loan to deposit ratio ticked up modestly to 97.6% from 95.9% in the prior linked quarter, due to loan growth coupled with a traditional decline in the seasonality of certain deposit classes. Organic deposit growth was $120 million for the quarter. Our total cost of deposits of 36 basis points rose 14 basis points as compared to the same prior year period but remains remarkably below the pace of Fed increases. We expect to aggressively look for new deposits to support prudent loan growth while still anticipating modest net interest income improvements. Moving on to fee income. As Chris mentioned, this quarter is the first time we've experienced revenue reduction as a result of reduced Durbin amendment fees. Accordingly, bank card fees related to Durbin fell by $1.7 million for the quarter. With that, I'll turn the call over to Pat to provide more details on the margin, expense trends, and tax rate expectations.

Thanks, Joe. Turning to net interest income and margin, net loan growth of $294 million and our asset-sensitive balance sheet drove another quarter of margin improvement, which expanded by 7 basis points to 336. While our strengthening margin was somewhat muted by higher funding costs, it's important to note that our deposit data so far are only about a quarter of what we saw in the last interest rate cycle. Two factors should provide further tailwinds for margins. First, the quarter-end loan portfolio of nearly $10 billion was $160 million higher than the third quarter average. And second, nearly a quarter of our earning assets are floating rate, providing further opportunity for margin expansion as rates increase in the remainder of the year and into 2023. Core non-interest expense ticked modestly upward by about $1 million to $59 million, primarily due to employee medical costs incurred in the third quarter. It's also worth noting that our effective tax rate for the quarter was just over 24%, and we expect that to remain in this range in future periods. Overall, we continue to remain very disciplined around expense management. This, combined with our steady growth this year puts us in a position to highlight that we've already outperformed the quarterly efficiency and profitability targets that we announced at last year's Investor Day. As a reminder, those target metrics were to earn $0.55 per share, meet or exceed a 1% ROA, and achieve an efficiency ratio of 55% or better. At this point, I'll turn the call back to Chris.

All right. Thanks, Pat. We'll begin the question-and-answer portion of the call. So give me a minute while we assemble everyone's questions.

Absolutely. The first comes from Michael Perito with KBW. Your line is open.

Thanks for taking my questions. I want to ask a couple of big picture questions and then I'll let others kind of drill in on the model. But I guess first for starters, pretty good balance sheet growth again this quarter and good name trends. As you think about some of your more expansion-type markets, where I imagine the core funding isn't as robust as in your legacy New Jersey, broader New York market, does it alter your appetite for expansion as those economics potentially change with deposit betas creeping up? Or how do you guys think about that dynamic as you continue to drive loan growth outside of your legacy New Jersey footprint?

That's a good question, Mike. So as we open these offices, I always kind of cringe when people refer to them as loan officers or loan production officers because we think of them more as commercial banking officers. It is the case, though, that deposits will grow a little slower than loans will. But we do expect to be raising deposits in each of these markets, and over probably a period of years achieve some level of self-funding in those markets. But even ask Joe to talk a little bit about our investments into treasury and cash management for our clients.

Just I'll echo Chris's points, Mike. And I will tell you, it's an interesting mindset for our folks because we spent, as you know, the last two years putting money to work, excess liquidity, trying to put money out on the street. And our folks justifiably focused on one side of the balance sheet, and now we're focusing on both sides of the balance sheet. So I'm not overly concerned; I spent two days in Boston last week talking to corporate clients that have excess liquidity that are excited to move dollars to us. And as Chris mentioned, we've spent a lot of effort and time investing in our treasury business for corporate clients. So I think we're well-positioned to gain market share in deposits in what I consider to be the non-legacy geographies that we operate in.

Last month, we released a significant upgrade to our treasury suite for our corporate clients called LFB Connect, which is a comprehensive mobile offering. This provides those corporate treasurers and CFOs on their mobile devices the kinds of things they've become accustomed to on the consumer side. So we've been investing heavily, and I think it'll take some time, but we do see deposit generation coming from all markets.

And I guess just at a really high level, it sounds like you guys still expect to be able to outpace any increasing funding costs with higher earning asset yields at this time.

We're pretty confident that at least over the next couple of quarters, the asset sensitivity position should persist. So funding costs will come up as we compete a little bit more for deposits, but we think margins will hold steady and expand even in the near term; it's harder to see the back half of next year.

Okay. And then just lastly, kind of a hypothetical here. And I realized this is somewhat challenging to talk about, but just the timing of the November 4th anniversary on the Partners deal. And this call being probably the last time you guys publicly speak before that. Just curious if hypothetically, for some reason that deal doesn't happen and close. Can you maybe just give us a sense of what the capital priorities will be prospectively going forward as you look at the end of this year, beginning of next year?

I think, as you can appreciate, Mike, we're going to be limited in what we can answer in a hypothetical case. We appreciate the frustration, but we share it, Partners share it about the timing and the process. Setting that aside for a minute, whether the transaction closes or not, we've been investing heavily in our organic growth opportunities. We expect to continue to do so. The most valuable thing we can do is to grow customer relationships, and that's where our focus will be. That's where our highest-level capital allocation will be. So I don't know if that helps exactly. But that has been a theme that's happened even while we've been doing acquisitions.

No, I understand and appreciate you guys taking my questions. Thank you.

Thank you. Our next question comes from David Bishop with The Hovde Group. Please proceed.

Thanks to Chris and Joe, obviously, investors theory continues to drive a lot of growth on the commercial side. Just curious your appetite for that product, maybe what segments are you seeing your best opportunities for growing that on a sort of risk-adjusted basis?

Joe talked to the segment, I will say though that we did see some nice growth in C&I in the last quarter on a percentage basis and continue to allocate resources to building those kinds of relationships out. In some cases, as we enter these new markets, your first transaction that you do to establish your brand is around real estate transactions—it's usually easier to build your brand that way. Then you transition more into what C&I. But Joe maybe you can talk to the segments and, to the extent we're doing CRE, which property types you're focusing on.

Hi, Dave. I will tell you that I mentioned earlier about the multifamily segment. And it is interesting because for a period of time, as you may recall, you followed us for a period of years, we were fairly conservative in the multi-space just by virtue of the competitiveness on pricing. We've seen a little bit of widening in pricing spreads, which is positive. That continues to be a very strong asset class. Last year, we created a vertical in construction, which has been very successful in the space, and we continue to gain market share. They're driven by Stan Correa, who runs that group for us and has the background and experience. So we do see opportunities to continue to grow multi, both in construction and in the permanent end of it. I think we're being a little thoughtful around other market segments, as you would expect. I mean, nobody is chasing urban office, with the exception of select opportunities. I would easily say the same about the retail and hospitality. I think everybody at varying levels likes industrial, as you would expect warehousing, but we're being thoughtful there as evidenced by more recent pronouncements around Amazon and others that are slowing down the growth of their supply chains. So I do think that there is CRE opportunity. I think we will demonstrate, we're very good at it. As Chris mentioned, we continue to put resources toward C&I, where you can drive some needed treasury and deposit growth as well.

I appreciate the color. And then maybe Chris, noticed in the slide deck, always appreciate the detail there. The tax spent up about another million dollars this quarter. Was that mostly related to maybe the cash and treasury management build-out you noted? Just curious maybe where you see those expenses trending and from a holistic basis, as you build up your digital mobile banking capabilities, do you view your competition as yourselves or the bigger banks like BofA, Wells Fargo, or community banks? Just curious where you see, where you're trying to compete most against there from that viewpoint?

Yes. I think I'd start with the strategy that we think that a branch-light delivery model makes sense in the state of technology today. Our customers really want to use digital. I think we've done a good job of focusing on our spend towards those kinds of capabilities. I mentioned, OFBCONNECT is one example. We recently launched full real-time payment capabilities. That's where the dollars are going, into those kinds of capabilities. If I think about where tech spend is going, I do think that we're achieving a level that should be plateauing for a bit for at least our size of business. We've made significant investments in the infrastructure and the platform. From here on out, it's going to be more efficiency gains. The last thing that is maybe less transparent is the investment in technology to serve our own people. So most of our investment has been focused on end customer experiences. The more recent spending is focused on enhancing efficiencies internally for the folks that serve our customers. We think there's an opportunity to get much better, but I don't think it's going to require the same levels of technology investment.

Got it. Then one final question. Any update to the targets from the Analyst Day last summer from an ROI or efficiency standpoint at this point?

Yes, we certainly need to update those because we think there's upside and opportunity. What we're going to do is work through, as you can imagine, the next few weeks, the outcome on the Partners transaction, and then I think that would give us the opportunity to come back to you and our other investors and share what we think the target should be going forward. So stay tuned; we will be back to update those numbers.

Thank you. The next question comes from an unidentified caller. Your line is open.

I wanted to ask about your thoughts about using wholesale debt to a greater extent over time? Or do you think it'll stay roughly where it is now?

Look, I think that there are opportunities in the funding market where you can do interesting things. Earlier this year, we saw an opportunity to exploit the brokered CD market. So we took advantage of that. Historically, our level of wholesale FHLB borrowings is much lower than we typically run, so we have that lever if we need it. That said, over the long run, we think the most valuable franchises have high-quality deposits. Therefore, we're not a company that's going to go over 100% loan-to-deposit ratio for long or to any great degree. We might drift over 100% if we think that's the right thing to do in the interest rate environment, and we had the capacity to do so. We still have a very modest wholesale borrowing position. We plan to be opportunistic and are watching like everybody else to see where we think kind of the terminal rate might come out.

Great. Thanks for that. During the last year, as you've been waiting for approval on the Partners transaction, have you had your regular kind of regulatory exam process? And has there been any observations from that process in the last year?

We've gone through the same kind of annual cycle that any bank would. There's nothing unusual in terms of our cycle. In terms of themes, I think each of the regulatory agencies has done a pretty good job of communicating publicly the things they're focused on. That's the same conversation we're having with our regulators as well.

Great, Chris. Thanks, again, for hosting us this morning.

Thank you. Next question comes from Matthew Breese with Stephens Inc. Please proceed.

I was hoping for a little bit more color on the NIM outlook, assuming we get another 150 basis points of Fed hikes. Where do you expect the NIM to peak out and post a peak, if you will, is there a fall off after that?

Hey, Matt, Pat Barrett here. I'll take a first run at that, then Chris or Joe can jump in. So look, I think what you saw from this quarter was kind of a mid-single digit expansion as a decent run rate that we should expect, as long as you see rates continuing to rise. It’s not going to be linear; some quarters it might be closer to flat, some quarters it might be closer to 10 basis points. It's not a bad proxy for the kind of rate increases we've seen, which we do expect to continue through this quarter and probably into the first quarter. I think we still remain asset sensitive with expansion upside, even when the Fed stops raising rates or when curves settle down simply by virtue of the mix of our portfolio. I'm really hesitant to put a peak or a timeframe on that because that's essentially overlaying what I think the Fed's going to do and what I think is going to happen with deposit competition and pricing, both of which could materially change. But I'm pretty comfortable you'll continue to see expansion and growth in NII until rates start to come down.

Got it. Very helpful.

I would just add to that. When we reach the terminal rate, the idea that maybe the Fed would decrease rates thereafter, the shape and speed of that decrease is going to matter a lot in terms of our margin. We saw during COVID that a rapid drop to zero impacted margins severely. If there's a slight pullback in rates but it's not a rapid drop, I don't think it would take a big toll on our margin. We should be okay in a more stable rate environment going forward.

Agreed. Yes. And then maybe one for Joe, I got the sense from your comments that perhaps the loan growth outlook might slow down a little bit, just being more selective in this environment that's worthy of a bit more cautiousness. Just curious as we think about the longer term $250 million net growth per quarter bogey, is it more likely that we come under that at least for the near term given some of the cautiousness you discussed?

It could be, Matt. But I think it ends up being just a little bit more choppy, right? I do think that we're still seeing quality loan requests. I think we're being a little bit more thoughtful around it. But we're still seeing activity. I do think there's an opportunity to outperform certain quarters and there will be other quarters that might be more muted, but I'm not uncomfortable. The capital position we have supports high single-digit growth. If we can find good growth, we'll look to do it.

Got it. Okay. And then just Trident revenues were a bit lower this quarter in the presentation. You noted that revenues will be around $3 million to $5 million per quarter. I'm curious, what factors should we consider when thinking about a really good quarter from Trident generating $5 million versus the $3 million? And then maybe just updated thoughts on overall fee income and expense levels from here?

Matt, Trident still gets a solid amount of bulk of revenues from the residential business. You'll know what's happened to the residential business. I do think that we'll have more opportunities to do commercial business as our corporate clients become more comfortable working with us. But I do think you're going to see the right level of where we're going to be for the time being. I don't see any significant increases in residential activity coming in the short-term.

The only addition to the outlook for fees is that when you think about swap fee income and total originations as Joe noted, with originations down, you have fewer transactions happening, so there's less opportunity for swap fees. You have the swap markets themselves and the pricing on that, and people thinking hard before they enter into a swap deal. We’ve seen a little weakness in this swap line item, which might continue for a bit. Deposit fees were also off. That's predominantly a story around overdraft, as we’ve been as conservative as we can, given the focus on those fees. In quarters with more transactions, you could have a benefit in both Trident and swap fees, but deposit fees will probably stay around where they are for a while.

Okay. And then two other ones. The first one is just, regardless of whether the Partners deal goes through or not, what's the message around future M&A? Has this process changed your view on the types of deals you'd like to pursue? If so, just maybe discuss your thoughts around that?

Sure. Look, you have to be aware of trends. When I think back about the opportunity we had to grow through tactical acquisitions over the last few years, I think it's a valuable thing for us. That said in the seven prior transactions we were involved in, the path between announcement and closing was a lot more straightforward. The risk level of getting a transaction done was low. At least for now, the risk level seems to be heightened as various regulatory agencies interpret how they want to evaluate M&A. So the net of that is that we really don't have any interest beyond Partners in pursuing any tactical M&A. We would focus on the organic side, because if you’ve got more risk, very few transactions are going to meet that hurdle. So risk is up, which means our tolerance to do additional tactical acquisitions is quite low.

Right. Okay. And then just the last one, I know that TCE Capital is healthy. Looking at kind of bank-level capital ratios, what stands out is the total risk-based capital below 12%. I just wanted your thoughts on that level and if there's capital Holdco you could downstream or any need for something like that.

I think we're evaluating all of our capital options, especially in light of whether or not we close Partners and calibrating to the growth rates that Joe talked about. That high single digits approaching 10% organic growth, we can handle that with the capital we have on hand today. If we think there's an opportunity to grow faster than that with good quality growth and the economy appears to have gotten through this period without a significant recession, we might look at opportunities to bolster capital through the first thing we would look at is sub-debt. That's probably the most efficient way to do that; we had redeemed $35 million of sub-debt at the end of Q1. We could conceivably replace that, add to it, but that's about the extent of our thought process for now. We're watching origination volumes, we're watching balance sheet growth, we'll get through the next few weeks of determination on the Partners transaction, and then we'll calibrate things. There’s also the opportunity for us to manage margins instead of growth, where we could slow down the growth rates a little bit but be more selective on pricing, which would allow us to boost profitability.

Great, that's all I had. Thanks for taking my questions.

Thank you. There appear to be no further questions in the queue. So there are no further questions at this time. I'll pass it back to Chris Maher for closing remarks.

All right. Thank you. For those who follow OceanFirst, you may have noticed slightly different timing for our earnings release and conference call this quarter. Going forward in 2023, we anticipate shifting the schedule for our quarterly earnings announcement and call to be in the third week in January, April, July, and October. As always, we appreciate your time and interest in OceanFirst, and we look forward to speaking with you after our fourth quarter results are published in January. For those of you celebrating holidays from now until the end of the year, we wish you and your families a safe and healthy holiday season. So thank you very much. Bye.

This concludes the OceanFirst Financial Corp. earnings conference call. Thank you for your participation. You may now disconnect your line.