Oceanfirst Financial Corp Q1 FY2023 Earnings Call

Hello everyone, and welcome to the OceanFirst Financial Corp Earnings Conference Call. My name is Bruno, and I'll be the operator for today. I will now hand over to your host, Jill Hewitt. Please go ahead.

Thank you, Bruno. Good morning, and thank you all for joining us today. I'm Jill Hewitt, Senior Vice President at OceanFirst. 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. 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. Good morning, and thank you to all who have been able to join our first quarter 2023 earnings conference call. This morning, I’m joined by our President, Joe Lebel, and our Chief Financial Officer, Pat Barrett. We appreciate your interest in our performance and this opportunity to discuss our results with you. Based on recent industry events, we will be adjusting our regular agenda to focus on the questions that are most relevant to the current environment. My comments will cover those areas and refer to slides filed in connection with the earnings release. The supplemental materials are also available on our company's website. After that, Joe, Pat, and I will jump straight into the Q&A portion of the call and take your questions. Turning to Slide 3, our financial results for the first quarter included GAAP-diluted earnings per share of $0.46. Our earnings reflect net interest income of $98.8 million, which, while down from the prior linked quarter, has increased by $14.6 million or 17% compared to the prior year period. Core earnings were $0.55 per share, an increase of 12% compared to the same period in 2022. Non-core items primarily relate to the sale of investments that were adversely impacted by recent industry events, resulting in a pretax securities loss of $5.3 million. The Board approved a quarterly cash dividend of $0.20 per common share. This is the company’s 105th consecutive quarterly cash dividend and represents 36% of core earnings. Tangible common equity per share increased to $17.42. The company did not repurchase any shares in the first quarter and we do not anticipate repurchasing shares until we can better assess the opportunity to deploy capital for prudent growth initiatives. Turning to recent events and the key questions being asked in the banking sector, I'll spend a few moments covering the company's strong liquidity position, prudently structured securities portfolio, well-diversified and conservatively underwritten loan portfolio, and our approach to dealing with the margin compression resulting from recent events. Regarding liquidity, funding, and deposits, our highly granular and well-diversified deposit portfolio performed well in the first quarter with deposits following our typical seasonality and ending the quarter at 99% of the December 31st balances, excluding the addition of some brokered CDs. Recall that OceanFirst has two seasonal deposit businesses: a government banking business that typically hits cyclical lows at quarter end in Q1 and Q2, as well as the segment of commercial clients along the New Jersey Shore that typically build inventories in advance of the upcoming summer season, drawing down account balances in the spring. Importantly, uninsured deposits make up less than 19% of total deposits, and our liquidity position of $3.6 billion at March 31st provides a 192% coverage of our uninsured deposits as shown on Slide 5. While discussing deposits, we provided enhanced disclosures that detail several important deposit metrics, including our cycle to date deposit beta of just 20% and several other data points regarding the granularity of our deposit portfolio. For some highlights, consider that 98% of deposit accounts at OceanFirst maintain balances of less than $250,000. Average deposit balances for consumer and business accounts are $20,000 and $123,000, respectively. Additionally, our deposit customers are clearly long-standing relationships, as evidenced by an average account age of 10 years and 68% of accounts banking with us for five years or more. To best understand why our clients bank with us, please turn to Slide 9, which demonstrates the primary deposit business at OceanFirst. Conducting financial transactions on behalf of our clients, as you can see in 2022, we facilitated over 43 million transactions totaling over $100 billion for our clients. To put that in perspective, transaction volumes at the bank equate to the total deposit base turning over about every five weeks. Detailed deposit metrics are included on Slides 7 through 9. Now for an overview of our investment portfolio. The company has $1.8 billion of investments in its portfolio, comprising high-quality investment-grade assets. Slide 6 provides important context on two key strategies employed over the past several years to avoid some issues that have been highlighted in recent weeks. First, we kept the size of the investment portfolio modest at just 13.3% of total assets. Secondly, we maintained a discipline around duration, favoring floating-rate securities when possible. As a result, the duration for the entire portfolio is just under four years. The unrealized loss position in the portfolio is modest, and even if the entire portfolio were to be marked to market using valuations as of March 31st, the impact would be limited to 50 basis points of capital. Given our quarter-end CET1 ratio of 10%, the current value of the securities portfolio does not present a material risk to the company. This discipline is further reflected in our ability to grow tangible book value per share, which is illustrated on Slide 12. Tangible book value per share has increased 9.3% over the past five quarters, placing us in a relatively high-performance band among our proxy peers. Next, I'd like to turn our attention to our loan portfolios starting on Slide 10. Conservative credit risk management has been a hallmark of the bank for decades, demonstrated by our history of better performance, thoughtful risk selection, diversification, and prudent portfolio management which focuses on rate risk management. Our history is clear: commercial real estate performance has been exemplary through several cycles. Over the past 16 years, aggregate CRE net charge-offs have totaled just $26.9 million, which includes all charge-offs related to the great financial crisis, our experience in Hurricane Sandy, and the COVID era. To put that into perspective, CRE net charge-offs averaged just 6 basis points per year, 92% lower than all commercial banks with assets between $10 billion and $50 billion. Peak annual charge-offs totaled just 47 basis points, compared to a peak of 455 basis points for the comparison group. That experience is heavily influenced by our portfolio, which is concentrated in commercial real estate, evidencing strong cash flows, low LTVs, and is diversified by both property type and geography. Slide 11 provides important details regarding our risk selection and notes that urban office loans represent just 2.5% of the portfolio and less than 1% of total assets. Further, even this portfolio is weighted toward credit tenants and medical and life science uses. The entire portfolio demonstrates a debt service coverage ratio of 1.7 times and a weighted-average LTV of 56%. Another hot topic in commercial real estate is the maturity wall, which represents the concern that even cash-flowing and low LTV loans may be subject to payment shock as rates roll over at maturity. Our portfolio has been carefully structured to avoid this risk. First, aggregate maturities facing rate resets in 2023 and 2024 total just $487 million, only 4.9% of total loans. Next, the weighted-average rates on these maturities are much higher than you might think. Loans subject to a rate reset in 2023 have a current weighted average rate of 5.99%. Those facing a rate reset in 2024 have a current weighted average rate of 5.41%. To best understand this risk, we conducted a rate-based stress test for all commercial real estate loans with balances in excess of $1 million. Over 90% of the tested loans are able to cover debt service at a 7% interest rate and within our amortization policies, all at the rental rates in effect at the time of underwriting. Current market rents for the majority of our portfolio are substantially higher than at origination. In many cases, that will result in stronger levels of NOI or net operating income, which will provide an additional cushion that was not considered in our analysis. We will continue to monitor this risk, but the relatively small portfolio subject to the risks and the strength of the stress test results evidence minimal to no rate rollover risk. One final comment regarding credit risk management. We actively manage our credit risk and move quickly to address concerns when they arise. In 2020, we were among the first banks to offer blanket forbearance programs but then also took two additional actions that raised some eyebrows then but will serve us well now. First, we de-risked the credit portfolio by selling all credits that demonstrated heightened risk attributes in the fall of 2020. Next, we implemented a practice that required all loans to return to their pre-COVID loan structures, including appropriate amortization. We did not offer long-term CARES Act deferrals or CARES Act credit restructures to our commercial clients. Our commercial credit portfolio does not contain any CARES Act modifications and has experienced zero net charge-offs in the five quarters since addressing that risk position. So our history of exemplary performance, conservatively underwritten and highly diversified portfolio, and the lack of a maturity wall issue bode well for the future performance of our portfolio. Before I turn it over to the question-and-answer session, I wanted to cover one last topic that’s more forward-looking in nature. Over the past six months, the company has been preparing for a difficult operating environment. We certainly did not anticipate the exact scenario that played out a few weeks back, but we did expect that protracted inflation would likely lead to conditions that would pressure margins and present risks to the economy. To prepare for this eventuality, we progressed the project that included dedicating resources and hiring external subject matter experts to evaluate all internal processes, performing a series of benchmark studies, and developing detailed design plans to improve performance. We've just completed the design phase of that project and are moving to the execution phase, which will run through the remainder of 2023 and into 2024. The focus of these initiatives will include expanding our commercial and residential businesses, improving the revenue contribution of our branch network, increasing automation of internal processes, and improving infrastructure support across all lines of business. While this program will expand certain business lines, such as corporate treasury management, C&I banking, and mortgage banking operations, our work to date has also identified opportunities to materially reduce the absolute level of operating expense. As a result, the efforts will not just be self-funding but will also allow for a measurable improvement in operating leverage. The improvement in operating leverage will be apparent later this year with expenses beginning to decrease no later than Q4 of this year and continuing into 2024. This transformation will be well underway during the second quarter of the year. I'll conclude my remarks with one final thought. The past few weeks, while challenging, have given us a tremendous opportunity to connect with the clients that are our business. These conversations have given us great assurance that we have a client base that values our relationship and has remained loyal to the bank. The quarterly margin weakness was disappointing, but it was driven by financial decisions to bolster liquidity and protect the balance sheet. It may take a couple of quarters to stabilize and then improve margins, but we have a rock-solid balance sheet, a terrific collection of bankers, and a wonderful set of client relationships. With those advantages, we will figure out how to capitalize on the new environment. At this point, we'll begin the question-and-answer portion of the call.

Our first question comes from Frank Schiraldi from Piper Sandler. Frank, your line is now open. Please go ahead.

Good morning.

Good morning, Frank.

If you guys could just walk through the NIM dynamics from here, could you provide a little bit of thoughts on 2Q in terms of modest or maybe more modest NIM compression? It's really helpful to see the spot deposit costs you guys provide in the period but, obviously, that still would imply meaningful pressure on deposit costs quarter-over-quarter on an average basis. Is it your expectation that that abates significantly? And kind of what are you thinking about, I guess, margin over the next couple of quarters?

Frank, it's Pat. So I'll take a shot at what will probably prove to be a not completely satisfying answer as to timeframe, but at least for the moment and into next quarter we aren't really seeing a huge amount of, or expecting a huge amount of flow or repricing actions with the exception of some actions that we know we’ve already taken. So we think that the aggregate kind of cost ramping up in Q1 and some higher repricings early in April that we've done will continue to put some pressure on our margin. When we say modest compression, we were thinking about it in terms of the 30 basis point compression we saw this quarter. I'll remind you that a third of those nine basis points were really kind of one-time benefits in our margin in the fourth quarter. They were absent due to early prepayments, prepayment penalties, and resolution of problem loans. So the core decline was more like 20 basis points and we think it's going to be less than that. If I had to guess, I would say probably in the 10 to 15 basis point range in the second quarter, but we don't see anything on the horizon that would cause that compression to continue beyond that because we really have stacked up deposits. We've termed out about half of our FHLB borrowings we did that in March, so $600 million we termed out at an average rate of kind of mid to three-quarters to four range, which will help and of course the retail CD promotion, brokered CDs we put on were fixed rates. That won't go up and that gives us the flexibility to roll off with the brokered CDs and FHLB funding as and if we see declines. And then I guess the last dynamic is just to remind you of, we've got $400 million of cash sitting in the balance sheet that actually earns a pretty healthy amount, just leaving it at the Fed right now. It's not a bad investment. It outperforms the securities portfolio by about 1.5 percentage points.

Frank, maybe just a little extra color to just on client conversations. It's a little hard for us to tell yet, but we have the sense that one of the impacts of calling all your largest customers to make them feel comfortable is that it introduces an opportunity for them to talk to you about the rates they are earning on their deposits. So I think we may have pulled forward some of those conversations that might have happened naturally over the course of the next month or two. So again, it's too early to tell, but the pace of conversations has changed in the past couple of weeks. I think we kind of got out ahead of it, but we may have paid the price by pulling forward some of that deposit repricing.

Got you, okay, that makes sense. And regarding the excess liquidity on the books, it's clear that it's less significant for the bottom line and net interest income. However, I assume you expect to have more cash and borrowings on the books in the second quarter compared to the first quarter. So first, is that accurate? And second, is that taken into account in your expectations for when you discuss the 15 basis points margin conversion?

I think you're right about that, Frank. That is the case, and it is reflected. So we expect that probably many of us will remain more liquid in the coming months.

Okay. Lastly, I recognize that being cautious about liquidity and capital is crucial in this environment, but you have provided solid detail and evidence regarding the health of your liquidity and capital levels. Turning to returns, regarding the operating leverage strategies planned through the end of this year and into 2024, how do you view profitability? Do you think it will help you return to a 1% return on assets? I expect the return on assets will dip below 1% due to ongoing margin compression, but do you believe it can get back to 1% or how do you generally view returns in this context?

I’d hesitate to give you a date on that, Frank, but we're obviously running the company to have returns better than a 1% ROA over time and we're working on a path to get there. It's a little uncertain with the rate environment, it's much more certain about kind of operating expenses and leverage. We feel very good about that. So we know what we can affect in terms of our levers, but we need a little bit of cooperation from the rate cycle at some point.

Okay. All right, great. Thank you guys.

Thanks, Frank.

Our next question comes from Daniel Tamayo from Raymond James. Daniel, your line is now open. Please go ahead.

Thank you. Good morning, everybody. Maybe we just follow up on that profitability question, but just focusing on the expenses. How should we think about the path of overall expenses and the savings that you're planning to make? I mean, is there any kind of a final point that you can help us put on how you're thinking about that?

Yeah, I'll take a shot at that. So the first quarter run rate is we think a good run-rate for the next couple of quarters. Hedging a little bit as to whether it's one or two, but because we may see some improvement in the third quarter, but let's call it a three-quarter run-rate through the third-quarter and then we think that we have a good opportunity to bring those down by at least 5% for the fourth quarter. Largely as we anticipate the completion of a lot of the external spend that has been in our run-rate going back to actually the fourth-quarter. We didn't talk about this a couple of quarters ago, but we've actually been working on laying out opportunities and efforts needed to improve processes and platforms and get better use out of our existing technology. And so at a minimum, we think that that will fall off, so professional fees are going to come down by probably $3 million bucks a quarter. Beyond that, we think there are opportunities for efficiency in a wide range of areas that we're trying to balance against the need for continued productivity and growth in non-CRE lending, treasury management, residential mortgage, and C&I lending which brings good deposits along with it. But we do think that there'll be some staffing efficiency as we exit and move into next year, and we'll continue. So I would say the total opportunity is more than 5%, but I'll just keep it to 5% by the fourth quarter of this year.

Okay. That's great insight, Pat. I believe you mentioned that you're anticipating additional savings in 2024 as well.

It's a bit early for us to finalize everything. I believe next quarter we'll continue refining our approach as we progress. At the same time, we have growth initiatives aimed at enhancing our capabilities in the originate and sell mortgage business, alongside growth in commercial and industrial lending and treasury management deposit gathering. All my comments would consider any necessary investments we need to make, so these are absolute statements.

Okay. All right, that's great. I appreciate it. And then secondly, just on the loan growth, I think you made a comment that you're expecting that to be low going-forward. If you could provide any more color or detail around what you're thinking when you made that comment that would be great.

Daniel, it's Joe Lebel. I think the easiest way to describe it is, you support your customer base. We're still seeing loan activity. You can see it evidenced by the pipeline. You're also seeing it at higher rates, you can see it in the pipeline. We're well into the sevens in the pipeline in terms of average rate. I think our approach has been consistent, which is pricing discipline, credit discipline, and that's going to cause some ups and downs intra-quarter around what you can do and what you can’t do. I think we support the existing clients, we look for new clients, and if good opportunities come up, we'll do them. And it also gives us a chance to look at our existing book and make determinations about what still fits and what doesn't fit. So, I do think you'll see some unevenness. There may be quarters where you have growth, and there may be some quarters where you see some flatness.

Okay, all right. That's helpful. I appreciate it. I'll step back.

Thank you.

Our next question comes from David Bishop from Hovde Group. David, your line is now open. Please go ahead.

Yeah, good morning, Chris.

Good morning, David.

Chris, I have a question for you regarding the macro environment. Clearly, the fallout from Signature Bank has had effects, particularly in your market, Silicon Valley. Can you discuss any potential impacts or if you've adapted by moving over any new relationships, such as deposits or loans, or changes with relationship managers? Are there any near-term effects from that?

I'd say a couple of things. I mean, there may be some customer movement. Certainly, the talent environment is going to be interesting over the next six to 12 months, but that goes on both sides of it when you're in a period of uncertainty, people think twice about moving from one organization to another. So we'll have to wait and see those things. There is a very significant consideration that will play out at least in the Northeast. And then, I think you can see credit spreads expand. There are far fewer people out lending today than they were a year-ago. I think that will translate into some opportunity for us to get paid for the work that we do. And I know Joe and his team will be really focused on making sure that as we grow the loan book from here, that we are paid to do so.

Got it. Joe, while there's a lot of focus on the office rebook, are there other segments within commercial real estate that might be raising warning signs? Are there issues you and your team are scrutinizing more closely that aren't getting as much media attention but could indicate potential concerns?

I believe everyone has made valid points, David. There's a lot of discussion about offices, and we've been careful in developing our credit portfolio over the past several years, focusing on remediation, geography, dispersion, and asset classes. We've definitely noticed a slowdown in the warehousing sector. We have moved beyond the impacts of the COVID environment concerning home shopping, and while that trend will continue, it may not grow at the rate that was initially expected. So far, we haven't seen softness in our portfolio, but we remain cautious. It's also worth noting that while everyone is concerned about the office segment, we possess $1.1 billion in office assets, which are quite diversified both in type and geography. Our office exposure is spread evenly across the Philadelphia, New York, and New Jersey areas. Additionally, half of our office investments are in credit tenants or medical office spaces, while the rest is mostly suburban. As we've indicated, less than 1% of our total assets are located in central business districts, and the average size of our office loans at the bank is under $2 million. Although we do have some larger and smaller offices, it's important to highlight that 155 loans are maturing this year, with 112 of those being under $1 million. I believe we've managed to safeguard our interests effectively. Returning to your earlier question, we still perceive multifamily as being quite strong. Since the onset of COVID, average rents in multifamily housing have risen by nearly 20%, which is remarkable given that many people are working from home. This underscores our national housing situation. At this point, we feel confident about our position, but we will continue to be vigilant about our future strategies.

And Joe mentioned in the introduction, when you conducted the stress test, you did not adjust the underlying cash flows or rents for the current environment, what was done in underwriting, correct?

Yeah, exactly right, David. We didn't adjust for current rent rolls or current dollars per tenancy, we looked at the original underwriting tenancies. We also looked and we obviously did that making sure that we still had those tenants and the properties which we do.

I think the theory on that Dave was, we didn't want to count on this inflation of rents, because I think you're going to get some of that back maybe over the next year or so, but we thought we had underwritten rents which were several years ago in multifamily. Most of that was kind of pre-COVID rents that would provide a good floor for us. So it's a pretty conservative way to look at it.

Got it. And one final question maybe on credit. We did see a little bit of a shift to special mention substandard. Just curious what drove the increase in substandard loans. Thanks, and I will hop off.

There was nothing significant. In fact, we remained lower than we were in the third quarter of last year. The main reason for the shift from special mention to substandard was well-secured loans.

Great. I appreciate the color.

Our next question comes from Michael Perito from KBW. Michael, your line is now open. Please go ahead.

Hey guys, thanks for taking my questions and for the extra supplemental information this quarter, it was helpful. You guys covered a lot of it, so I don't want to take too much time here, but just two quick questions. On the first one, I apologize if I missed it, but just on the noninterest income side, kind of a low watermark for you guys here on a core basis in the quarter. Just any near-term expectations for rebounds anywhere, whether it's kind of commercial swap income, trust, mortgage, is there anything we should be mindful of as we look at this kind of $9 million on a core quarterly run rate in the first quarter?

Thanks, Mike. You're right to point out that it's around a four-ish number as loan volumes have decreased and swaps have also decreased in this environment. We don't anticipate swaps to rebound anytime soon, although there may be a few larger swap deals in any given quarter. This is part of the reason we're putting more focus on our mortgage banking business, which may seem counterintuitive during a time of high-interest rates. However, we have the opportunity to attract some great talent. You may have seen the press release about Stephen Adamo joining our team. Joe and Steve are concentrating on the opportunities for our gain on sale business. Historically, this area has seen our income underrepresented. While we recognize that the multiples for a mortgage banking business typically aren't very high due to volatility, it is a counter-cyclical business. If rates decrease next year, we want to be positioned to benefit from that refinancing. This is probably the only line of business where I see potential. However, I’m talking about two to four quarters down the line, which would also require favorable interest rates. But I believe we can perform better there, and I trust that Joe and Steve will make it happen.

Got it, okay. Lastly, can you provide an update on your thoughts regarding the appropriate level of capital to maintain in the longer term? It seems reasonable to assume that you might prefer to hold more capital than usual for the foreseeable future until the impact of recent events becomes clearer. How are you approaching this?

I think you've probably guessed right, Mike. We're conservative folks. So we're going to carry a little extra liquidity or a little extra capital until we know what kind of the world thinks about acceptable liquidity and capital levels. Because, I think it's going to be a discussion in the industry that is going to go on for the next couple of quarters. We're all going to settle in. I will share with you, we've been talking internally. I remember all the discussions in 2009 and 2010 that capital is going to have to come up and banks were never going to earn their cost of capital and the sector was dead and uninvestable and some of which you hear today. There is a concern, right? Carrying the extra liquidity and capital will impact profitability, but I think just as we did after the great recession. The industry is going to figure it out and we'll get more efficient, we'll figure out how to get our margins back and whatever the capital ratios need to be, we'll adjust too and find a way to make money.

Great. Just one last one for Pat, just $13.5 billion in assets around 100% loan-to-deposit ratio, are these decent bogies for the near-term here that you think could be pretty stable?

Yeah, I think so. It's pretty typical for us to run at around this level of leverage. And again, to echo Chris' comments, notwithstanding the industry or other stakeholders in the industry deciding that's no longer acceptable, we're comfortable with that.

Our next question comes from Christopher Marinac from Janney Montgomery Scott. Christopher, your line is now open. Please go ahead.

Thank you. Good morning. Chris and Pat and team, I just wanted to ask about how often you're doing new commercial loans above 7%. I wanted to circle back to the stress-test, I'm curious if 7% is high enough in this environment.

So I think Chris, in relation to weighted average, one of the benefits we've seen with our balance sheet and our presence in the market has been the increase in focused construction lending in non-speculative areas where we have floating-rate opportunities and interest reserves. This can be observed in the weighted average in our pipeline as well as in the recent improvements in our weighted average returns. Additionally, as we assess our existing portfolios, we're doing so with a focus on risk and relationships, aiming to enhance returns wherever it makes sense and where cash flow can support it, which applies to most of our assets. We have a small number of maturities coming due at the moment, so the maturity wall is relatively minimal right now. In terms of our pipeline, it's around 7.25 to 7.26. While we may not always secure those deals at our desired rates, we're keenly aware of our cost of funds and its trajectory, and we recognize the importance of this.

I also think, Chris, that if you think about the credit characteristics of the loans that we have rolling that we apply this to, we're talking low LTV, high debt service coverage ratio. Many times, personal guarantees or other structures, for those loans in the market today, those would typically carry a high six handle there. They're not in sevens yet. And I don't see that coming soon. There may be other credits that go into the sevens that would have different risk characteristics, but 45% LTV, two times debt service. You're not seeing sevens on those, at least not in the Northeast, at least we have not seen.

And I think we're being more thoughtful for our existing clients versus those new opportunities, where we recognize what yields we need to get going forward.

Got it. That's very helpful. So the low LTVs, the non-spec that makes your 7% not the same as someone else's 7%. Got it, okay. And then my next question just goes back to the concentration of office. I know half is in the credit tenant and medical, as you described, do you want that just kind of slip back over time. Will it naturally fall back to another level? I'm just curious how you think about that now.

I think it's well diversified, but I think we're also smart enough and cognizant of what's going on in markets today. I've always taken the approach of you do good loans when good loans present themselves to you, you don't take undue risk. And we run our business for the long-term. So there are certain asset classes that maybe are out of favor today. But you look at things one-off, one-by-one, and you make the decision. That being said, I think we're enough to understand that if we don't get the return that we need, that we will purposely stay away from certain asset classes as they go forward.

We've seen a little bit of this, Chris. I don't know if this will turn into a trend, but given the negative commentary about office nationally. It's become like a pariah asset class. We've seen a couple of exceptional conservative deals, LTVs and debt service and tenancies that government agencies, things like that, that are priced just very differently than they would have been six months ago. So we don't intend to build this concentration. But if we have a client that has an exceptionally conservative property, we're going to work on the credit, we're not going to work on the popularity.

That's great. Thank you for that. And just one last question. I know we don't have all the details on reserve allocations by property type, but generally speaking, would it be fair to assume that you have a higher reserve allocation to office properties considering the property type and the level of criticism compared to the rest of the portfolio?

Interestingly, our offices performed quite well, so the historical losses do not require significant reserves. The distribution of past versus substandard is similar to our other office and real estate classes. There is nothing unusual about that allocation. I would like to point out that most of our reserve is qualitative. Over the past year, we have been ensuring we account for not only the current risk in the book but also potential risks that may arise due to economic conditions and other factors discussed this morning. If anything, we may see a reallocation of reserves in the future if there are changes within that reserve.

Got it. Thank you both. I really appreciate it.

Thanks.

Our next question is from Matthew Breese from Stephens. Matthew, your line is now open. Please go ahead.

Good morning. I would like to ask for more information on buybacks. It seems that the industry's concerns about capital are mainly centered on unrealized losses in securities portfolios. Given your situation and the minimal AOCI, you have managed this quite well. I understand the need to be cautious, but considering the current stock price, why not proceed with the buyback?

We have the ability to conduct buybacks, and we are prepared to do so. However, we want to ensure that we create some distance from market expectations regarding capital and liquidity, while keeping the option open for the future. We have the authorization and financial capability to proceed; we just want to gain a better understanding of the operating environment before making a decision.

Understood. Maybe a follow-up to that. You are understanding capital ratios, but also commercial real estate concentrations. Are the regulators paying any more attention to CRE concentrations in the wake of all this? If so, maybe you can give some sense for how and what they're looking at?

I guess they're focused on everything right now, and we don't fully understand why. Given the events of the last couple of months, we're receiving questions about various aspects of the business, including liquidity, concentration, and rollover risk. So, while they are paying attention to these issues, it's not more than their focus on liquidity, capital plans, stress tests, and other matters, so there’s no special emphasis. I should also mention that our commercial real estate position hasn’t changed significantly over the last couple of years; it has only increased slightly. We've been discussing the management of that asset class with our regulator for quite some time.

Okay. And then on page 11, the stress test, were 90% of the maturing book maintain a debt service coverage ratio greater than one. I feel like a huge point here is that, you stress it at the originally underwritten rents. Could you just give me some sense for maybe the asset classes where you’re seeing the most amount of rent increase and the asset classes where you’re seeing the least? And then what is the average kind of rent increase from 2018, 2019, to today?

We'd expect it kind of varies a little bit by geography and property type. But multifamily, as Joe said earlier, is consistently strong across the entirety of the market. That's why we're comfortable. And I should note we didn't call this out in the slides to any special degree. We've never really operated to any degree in the rent-stabilized multifamily. So this is market rent product that we're in. So multifamily is probably the strongest where you see flattish, and Joe mentioned this is industrial warehouse, some pullback and concern about do we need all this capacity. You've seen the headlines about Target and Walmart and Amazon pulling back their needs for warehouse space. Nothing of great concern there, but softer than it was, softer than it was a year ago. The central business district office is an open question, because I don't think anyone knows exactly what the real vacancy is. And I wouldn't even look at the rates that are out there today as indicative. I would tell you that the suburban office has done surprisingly strong and maybe Joe may comment a little bit on that, because it's unusual to us, and retail has held up better than we would have thought.

Yeah. I mean, if you think about it a year, year and a half ago, we were all worried about retail, given what has gone on. But Matt, we've taken the extra step; I mentioned, we're heavily suburban and then heavily granularity average loan under $2 million. And then, of course, geographically diversified. We've also taken the extra steps in addition to doing the math stress-test, we're sending folks out and we're actually doing site visits as you should and we are doing site visits a couple days a week. So you are not really just looking at it, you're looking at parking lots, obviously, where people actually back in offices, but they can walk in buildings as well and how they are maintaining. So we're doing all the prudent things you need to be doing in this environment, just because we don't want to be surprised, and so far the signs are good.

Just one more color comment on suburban office leases in our markets. It's been almost no creation of suburban office for maybe 15 years, because the class has been under pressure for a long time with all the migration into urban markets. So what we have here is not necessarily there is exceptional demand in the suburbs; there's just far less product, and there is some demand, and some of the demand is interesting. The stuff we did up in Boston is life sciences repurposing of kind of those office park situations. Those are rock-solid properties. And so, it's been a really interesting time. We were more concerned about suburban office probably a year, year and a half ago and we have been pleasantly surprised by the amount of absorption in many of our markets.

Great. Okay, last one from me. You show the amount of these loans that hold greater than 1.0 debt service coverage on a rate reset. I'm just curious, what is the average pre and post? I think you show weighted-average debt service coverage on page 11, again at 1.7. Under the stress test, where does kind of the portfolio average reset at?

I think 170 is a good number. I don't have an average for it. We'll get that information later.

Okay. All right, I'll leave it there. Thanks for taking my question.

Thank you, Matt.

Our next question is from Manuel Navas from D.A. Davidson. Manuel, your line is now open. Please go ahead.

Hey, good morning. It seems like you are successfully keeping like a core legacy deposit beta that 12% versus 20% for the whole book. And you're doing everything around the edges to kind of maintain that lower deposit beta on the legacy deposit base. Is that two-level data, how we should think about things going forward? How are you targeting them?

Yeah, exactly our strategy is not all that complicated. What we've done is tried to separate the price pressure on our existing base versus the price pressure of deposits we need to acquire, and not to let the contagion go from one to the other. Our existing customers that we are doing a tremendous amount of transactions for, they value being with us because we're moving their money around for them a lot every day and they're not looking for a giant rate. So we want to keep that where it is; we're providing good service. They're happy with it. But I do think it weighs on our incremental deposit growth; the marginal cost of that growth is higher. So we have to reflect on our loan rates and think about that carefully.

I think a lot of it is pretty well articulated on this slide where we talk about the transaction volume and the number of times our deposit base turns. When you have DDA and checking account concentrations like we do and people are using those to pay bills and to pay employees and to pay other things, they're not looking for yield and so our non-interest bearing has held up pretty well. It's still 20% of our base, and excluding brokered CDs and retail CDs, we're absolutely thrilled with a fairly low level of repricing that we needed to do. I'd say with the exception of maybe the government and municipal accounts which have tended to behave more as a group and are expecting kind of broad-based repricing, and we've had to do that.

As you kind of felt that rate increases you've done so far might kind of stabilize a little bit. Do you have a one number beta assumption for the whole book or do you kind of separate that into two levels?

I'm not sure we are having a broad core to give you that number. I would say, you're accurate that we think that the worst is behind us in that regard, and you can appreciate if we were to make decisions over the last 45 days over whether we should pay a price and hug a deposit or we've decided to do that, right? So we were on the side of being conservative. So as I said earlier, that, I think that pulled forward some of it; we're seeing a lot fewer of those conversations now. So I think that the tempo is going to slow down. What we did in the last two weeks, three weeks in March were things we probably would have done in April or May anyway; we just did them a month or two earlier.

On the loan growth in the pipeline, I want to clarify that some of the construction fundings we expected didn’t initially appear in the pipeline. Are they all accounted for now, and does the pipeline include all types of future construction?

Yes, that would be an undrawn commitment. That's where you would find that. We wouldn't put that in the pipeline. Of the existing infrastructure loans that are yet to draw.

Okay. And then in some of the revenue opportunities that you highlighted before, including mortgage banking. Is there any number you can place around it and also where you think big-picture, you thinking more of various local businesses, are you considering regional national businesses? Just kind of some of your thoughts there.

We have treasury products that have performed well, and we intend to invest further in that area, as it caters to a diverse range of customers. This includes small businesses and mid-sized businesses that are related, with amounts around $100,000 and managing up to $20 million. We have the necessary product suite and have demonstrated our competitiveness in this space. This represents both a deposit opportunity and a fee opportunity. As we've observed through this process, we've seen the transaction volume, and there may be certain segments that could compensate us more suitably for the services we provide. We're evaluating this, but it's too early to provide specific numbers. Regarding mortgages, given the current rates and volumes, there won't be significant changes in the third quarter. The mortgage market is known for its rapid fluctuations. Although we’ve been involved in mortgages since 1902, we've dedicated less time to them in the last decade. Joe, do you have any comments to add?

I think the only thing I'd add there is that we do expect to expand the geography, because we historically have been New Jersey-based, central southern New Jersey-based residential mortgage lender, and we have licensing in most of the states. I think 47 states and not that we're running national tomorrow, but we're in Boston, New York, Philadelphia, and Baltimore, and I do think there's an opportunity now when the market is quiet to put on some good talent and treat them fairly and prepare for the next not only refinance opportunity but also purchase opportunities as rates get more normalized.

One of the things we determined in our strategic review in the last six months is that we have an infrastructure that's appropriately tuned to do most of what you would need to do. We're just taking that out and trying to get more value out of it.

That's really helpful. As loan growth kind of downshifts and hopefully the environment clears up for capital deployment, is buyback kind of the preferred use of capital?

It all depends on kind of what we see in the market. If the credit spreads we're seeing now, we love the commercial banking business. I don't know if those are going to persist, but we'd have to get a little more comfortable about the environment, about the marginal cost of funding. But the first thing we'd like to do is to grow the Bank, but adds in a prudent opportunity to do that with capital. If we don't think we can do it and capital starts to build up to a point, then yes, buybacks are a nice tool.

Okay. Thank you very much for the comments.

Thank you.

We currently have no further questions. I would like to hand back to Christopher Maher for final remarks. Please go ahead.

All right, thank you very much. A few important additional comments before we finish the call. Today, we'll be commencing mailing the materials for our Annual Meeting of Stockholders, which will be held virtually on May 23rd at 8:00 AM Eastern Time. We encourage stockholders of record on April 4, 2023, to review the materials and vote your shares. Also, recently we transitioned the Investor Relations Officer role from Jill Hewitt to Alfred Goon. Alfred joined our finance team in March of 2020. I know many of you have already started reaching out to Alfred directly. If you've not, I encourage you to contact Alfred with any questions. Jill is still with OceanFirst, will continue to head our corporate communications function, and will now lead the company's marketing department. As a special thanks, Jill spent more than a decade with me working through these earnings calls and she did it much longer than that with my predecessor John Garbarino, so I know that many of you have spent time with her and we appreciate all the time and effort she's put forth to try and make it look as good as we can look. We appreciate your time today and your support of OceanFirst Financial Corp, and we look forward to speaking with you after our second quarter results are published in July or next month at the Virtual Annual Shareholders Meeting. Thank you.

Ladies and gentlemen, this concludes today’s call. You may now disconnect your lines. Thank you.