Oceanfirst Financial Corp Q3 FY2025 Earnings Call

Thank you for attending the OceanFirst Financial Corp. Third Quarter 202 Earnings Call. My name is Brika and I will be your moderator for today. I would now like to pass the conference over to your host, Alfred Goon, Investor Relations. Thank you. You may proceed, Alfred.

Thank you, Brika. Good morning and welcome to the OceanFirst Third Quarter 2025 Earnings Call. I am Alfred Goon, SVP of Corporate Development and Investor Relations. Before we kick off the call, we'd like to remind everyone that our quarterly earnings release and related earnings supplement can be found on the company website, oceanfirst.com. Our remarks today may contain forward-looking statements and may refer to non-GAAP financial measures. All participants should refer to our SEC filings, including those found on Forms 8-K, 10-Q, and 10-K for a complete discussion of forward-looking statements and any factors that could cause actual results to differ from those statements. Thank you. And now I will turn the call over to Christopher Maher, Chairman and CEO.

Thank you, Alfred. Good morning and thank you to all who have been able to join our third quarter 2025 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. This morning, we will provide brief remarks about the financial and operating performance for the quarter and some color regarding the outlook for our business. We may refer to the slides filed in connection with the earnings release throughout the call. After our discussion, we look forward to taking your questions. We reported our financial results for the third quarter, which included earnings per share of $0.30 on a fully diluted GAAP basis and $0.36 on a core basis. In terms of performance indicators, we are pleased to report a fourth consecutive quarter of growth of net interest income, which increased by $3 million as compared to the prior quarter and was fueled by an increase in average net loans of $242 million. Net interest margin of 2.91% remained stable compared to the second quarter. Total loans for the quarter increased to $373 million, representing a 14% annualized growth rate, driven by strong originations of $1 billion. Joe will have more to add regarding our growth strategy in a few minutes. Asset quality remained very strong as total loans classified as special mention and substandard decreased 15% to just $124 million or 1.2% of total loans. This places us among the top decile of our peer group. The quarterly provision was primarily driven by net loan growth and an increase in unfunded loan balances and commitments. Operating expenses for the quarter were $76 million, which includes $4 million of restructuring charges related to our strategic decision to outsource residential loan originations and underwriting functions. This initiative is expected to meaningfully improve operating leverage and earnings in 2026. Pat will provide a detailed update on our financial outlook in a moment. Lastly, capital levels remain robust with an estimated common equity Tier 1 capital ratio of 10.6% and tangible book value per share of $19.52. We did not repurchase any shares this quarter under the existing plan as our capital was deployed for loan growth. This week, our Board also approved the quarterly cash dividend of $0.20 per common share. This is the company's 115th consecutive quarterly cash dividend. At this point, I'll turn the call over to Joe for additional color on these businesses.

Thanks, Chris. I'll start with loan originations for the quarter, which totaled $1 billion and resulted in loan growth of $373 million. The value of our continued recruitment of talent, coupled with favorable conditions for many of our borrowers, has resulted in momentum in commercial and industrial, which increased 12% for the quarter. Despite the large origination and loan growth for the quarter, the commercial pipeline continues to be strong at over $700 million, only 10% below the high from the linked quarter. Turning to our residential business, during the quarter, we made the decision to outsource this business line. As we wind down the existing pipeline, we expect to see some modest growth in the fourth quarter before the portfolio begins to run off. Total deposits in the third quarter increased $203 million, although organic growth was higher at $321 million before decreases in brokered CDs, which declined by $118 million. Growth was primarily driven by government banking and Premier banking. Premier bankers contributed $128 million of new deposits for the quarter. The Premier banking teams, all of which we onboarded in April, remain on track to achieve our 2025 target of $500 million by the end of the year. Deposit balances as of September 30 totaled $242 million across more than 1,100 accounts, representing nearly 300 new customer relationships to date. Approximately 20% of those balances are in non-interest-bearing DDA, and the overall weighted average cost of those deposits was 2.6%. The percentage of DDA is increasing as these accounts become fully operational, which should continue to offset new customer acquisition costs. We remain pleased with their results thus far. Also of note is the Premier Bank's contribution to commercial lending. Premier clients represent $85 million of commercial originations this year and the Premier commercial pipeline totals $50 million. Lastly, non-interest income increased 5% to $12.3 million during the quarter, primarily driven by strong swap demand linked to our commercial growth. With the outsourcing of our residential and title platforms, we anticipate a reduction in fee and service income of approximately $2 million in the fourth quarter and a modest gain on sale of loans in the fourth quarter as we close out the remaining pipeline. With that, I'll turn the call over to Pat to review the remaining areas for the quarter.

Thanks, Joe. And we've got a lot of good stuff going on but a little noisy. So apologies in advance for taking a little bit longer with my prepared remarks. So as Chris noted, net interest income grew and margin remained stable this quarter. Furthermore, pretax pre-provision core earnings grew 15% or $4 million linked quarter with the addition of earning assets at the end of the second quarter and through the third quarter, improving earnings power. On the rate side, loan yields increased 8 basis points, while total deposit costs remained flat. While our core NIM remained flat, it was negatively impacted by lower loan fees and a full quarter of higher interest costs on our subordinated debt. Absent these two factors, our overall NIM would have improved to 2.95%. Borrowing costs increased 12 basis points, primarily due to the second quarter repricing of our subordinated debt. Average interest-earning assets increased during the quarter, reflecting increases in both the securities and loan portfolios. Chris and Joe have already spoken about the loan growth but I'll add that we took advantage of market conditions to essentially pre-fund next year's anticipated growth in the securities book with highly liquid, very low credit risk, and capital-efficient securities that will be accretive to our ROA, all without meaningfully affecting our neutral interest rate positioning. Looking ahead, we expect positive expansion in net interest income in line with or higher than loan growth, but modest short-term compression on margin in the fourth quarter due to seasonality and some residual repricing of a handful of large legacy deposit relationships. Asset quality remained strong with non-performing loans to total loans at 0.39% and NPAs to total assets at 0.34%. Delinquency levels continued to remain at the low end of historical levels, while criticized and classified loans declined noticeably. Risk ratings across our commercial portfolio were stable, while net charge-offs of $617,000 were benign and represented only 2 basis points of total loans, bringing our year-to-date net charge-off run rate to only 5 basis points. Overall, credit quality continued to perform in line with our company's strong historical experience and remains among one of the best in our peer group. Our provision for credit losses in the quarter was driven by both on and off-balance sheet loan growth, partly offset by overall improvements in asset quality levels. Core noninterest expenses increased from $71.5 million to $72.4 million, driven by increased compensation and occupancy expenses. This excludes the impact of noncore restructuring charges totaling $4.1 million in the third quarter. The increase in compensation expenses and occupancy expenses was driven by recent commercial banking hires, combined with modest increased variable spend during the quarter. Looking ahead, we expect our fourth quarter core operating expense run rate to move downward slightly to the $70 million to $71 million range. Turning to the noncore charges, we do anticipate a final $8 million in nonrecurring restructuring charges in the fourth quarter related to our outsourcing initiatives. Note that the reduction in headcount associated with the residential outsourcing will not be completed until late in the year, pushing the operating expense benefit from that initiative into the beginning of 2026. To be clear, we expect the pretax improvement in annual operating results to be approximately $10 million. Capital levels remain robust with our CET1 ratio moving down to 10.6%, driven by loan growth during the quarter. While the CET1 ratio remains strong, we continue to evaluate opportunities to further optimize our capital in the near term as we wait for the earnings from newly added earning assets to increase internal capital generation rates. We continue to focus capital priorities on supporting loan growth in the near term and do not expect to prioritize share repurchases. Finally, we've resumed our annual guidance, as you can see in our supplemental earnings materials. At this time, for the full year 2026, we expect 7% to 9% annualized loan growth for the year, predominantly driven by growth in C&I, which will be partly offset by runoff in our residential portfolio. We expect deposits to grow in line with loans as we continue to maintain a loan-to-deposit ratio of approximately 100%. The continued growth in earning assets should drive steady net interest income growth in line with or exceeding high single-digit growth rate, while our modeled three rate cuts of 25 basis points each throughout the year could drive a NIM trajectory well above 3% by mid-2026. Other income is expected to be $25 million to $35 million, reflecting reduced gain on sale and title revenues resulting from our outsourcing initiatives. 2026 operating expenses should range between $275 million to $285 million, reflecting the impact of our focus on expense discipline to offset any inflationary pressures. Capital should remain strong with our CET1 ratio at or above 10.5% for the year. These firm-wide targets should result in an annualized return on average assets of 90-plus basis points by the fourth quarter of 2026, with a glide path to achieving a 1% return on assets in early 2027, continuing to improve thereafter. At this point, we'll begin the question-and-answer portion of the call.

The first question we have comes from Daniel Tamayo with Raymond James.

Yes. Let's start with the net interest income guidance. To clarify, there are a few elements to consider. In the presentation, there was a mention of reaching a 3% rate by the end of 2026, or possibly indicating a terminal 3% rate. Pat, you also pointed out that we might reach this 3% by mid-2026. The guidance of around 8% growth for NII in 2026 suggests that the significant developments may occur towards the end of the year. This also indicates a potential reduction in the balance sheet by year-end. I apologize for combining multiple inquiries into one, but could you break down the NII guidance in relation to the balance sheet versus the margin outlook for next year? That would be helpful.

Sure. I'll do my best to clarify. The 3% terminal rate refers to our assumptions about Fed rate cuts, not our NIM margin. This assumes two more rate cuts this year and three next year. Just to clarify, we expect to approach or exceed a 3% NIM sometime in the first or second quarter of next year, which is very soon, and we anticipate a modest but steady expansion moving forward. We expect the balance sheet to continue growing in the high single-digit range, mainly due to loan growth. This should lead to steady revenue growth, at least in line with loan growth, which is in the high single digits. When I mention revenue, I mean net interest income, which we expect to grow at or above the rate of loan growth, also in the high single-digit range.

I appreciate your comments on the terminal rate. That was clearly my error. If the margin is at that level, it suggests that the balance sheet will decrease, not in the fourth quarter, but relatively speaking. There was significant growth in overall asset balances in the third quarter, and it seems you have prefunded some growth with securities for the upcoming year. Therefore, it appears that average earning assets will decline relative to the overall balance sheet size in the fourth quarter. Is that the correct way to view it?

Maybe. It's Chris. Maybe I'll just kind of try and draw a clear path. So to take the noise out of the third quarter, we did buy some securities and we don't anticipate doing that again. It was a pretty unique opportunity to pre-fund 2026. So the securities portfolio, you should consider being relatively stable as we go into '26 and throughout '26. On the loan side, though, we expect to continue to see growth. So very good quarter this quarter, $373 million. That was a particularly strong quarter. Maybe I would think closer to $250 million, plus or minus. Some quarters better, some quarters worse. But as Joe mentioned, his pipeline is very strong. We've got a lot of momentum. The new bankers are producing. So if you were to just use kind of back of the envelope and assume that over the course of '26, we're growing plus or minus $1 billion on the balance sheet, driven by loan growth, coupled with deposit growth. So that's the part of the balance sheet that would move. And then as we pointed out earlier, NIM crossing over that 3% in the first half of the year and you put those two things together and that's how you kind of get the glide path to the 90 basis points or better ROA by Q4.

That's helpful. Okay. But ultimately, the net interest income numbers you mentioned, just to confirm, does my calculation suggest that we should be looking at the range of the 380s for 2026 in terms of net interest income?

Or better, maybe a little bit higher.

Okay. So this 7% to 9% net interest income off of 2025 is essentially a minimum. Is that correct, or could it be higher?

Yes. Look, we haven't had annual guidance in a while, quite frankly, the uncertainty in the environment, the funding environment, and the growth environment being a big part of that. So this is our best estimate now and we're trying to probably err on the conservative side. And I know it's frustrating for us to give ranges of things. But we know we'll probably be wrong in our estimates but this is our best estimate today. And so we're trying to be a bit on the conservative side from a growth perspective, given that this is our first quarter of really meaningful growth in 2 to 3 years.

Your next question comes from Tim Switzer with KBW.

My first question is about the Premier Bank. I apologize if this has been covered already, but I noticed that you doubled your deposits this quarter. It seems like you'll need to double them again from a larger base in Q4. What is contributing to this growth? I'm sure you have a solid amount already lined up, but I'm curious about the factors driving this increase. Additionally, can you share any insights on this growth trend as you aim to reach $2 billion to $3 billion by the end of 2027?

So Tim, it's Joe. I'll address the first part of the question regarding what is fueling deposit growth. It is the teams we've brought on and how they have adapted to both the bank and the customers' acclimation to the bank. We mentioned that over 1,100 new accounts have been opened. Many of these operational accounts are in the process of being converted to funding. Initially, we have observed excess cash coming in, with a slightly higher rate being paid for those funds. As the actual operational balances start to flow in, we will begin to see more transactional opportunities at a lower cost. So, that's the short-term value. Looking at the long-term, clients typically come in segments; they don't arrive all at once. As these teams develop, they will create increasing activity from their previous client base, thereby enhancing the value of those deposits over the next few years, aiming for that $1.5 billion to $3 billion target.

I'm sorry, I was on mute. It was also great to see the $85 million of loan originations related to Premier Bank. That seems to be a bit above what you guys are expecting in terms of an LDR. But it's early and it can certainly vary. Can you provide an update on your expectations there?

Yes. Actually, we've been really pleased with the activity of the Premier bankers so far. And Tim, I expect that we'll see more of that. I think it's a little too early to try to forecast what the percentage of loans versus their deposits will be. Obviously, historically, it's been a pretty low number. But we have some seasoned folks that have been around a long period of time, and I think we're going to do pretty well in that space. And that sort of goes across some of the CRE space, some of the C&I space. So I think we'll be pleased with the outcomes as we go forward.

Okay. Great. And then I want to make sure I heard this correctly. I think you guys said the restructuring of the residential mortgage business will provide about a $10 million pretax benefit. So if that's a $14 million expense savings, that implies about a $4 million headwind to revenue. Are there other headwinds expected in noninterest income that gets you that $25 million to $35 million guide because that's obviously a bit below where you guys are trending for this year.

Yes. Tim, I'll mention a couple of things regarding residential, and then Pat will address the noninterest income. We've been in the residential business since 1902, so we are approaching the restructuring with great care. It's important to us to ensure we support all of our customers during this transition. We are committed to continuing to offer residential loans to those customers. Due to the scale of the workforce reduction, which is around 10% of our total headcount, we must comply with modification requirements at the state level. All of these factors contribute to a transition period. Consequently, you may have noticed some one-time expenses related to severance and contract terminations. We expect to conclude these by December, and the benefits will become evident starting in January. You are correct in noting the $4 million headwind in residential. Your figures align with that. Pat, could you discuss the noninterest income?

The missing element from what Chris mentioned, which concentrated on our operating residential origination and underwriting platform, involves the personnel costs, including severance. This is what leads to the $10 million net figure, stemming from a $14 million expense reduction and a current run rate gain on sale of $1 million per quarter, totaling $10 million for the year. An important aspect that might not fit smoothly into your models is our majority ownership in the title company we acquired around three years ago. While this hasn't significantly impacted the bottom line, it has contributed approximately $10 million in consolidated expenses and an equal amount in title fee revenues each year in our run rates. This aspect didn't come up much in discussions because it primarily served as a means to support origination rather than to generate profit. Therefore, this results in headwinds on the revenue side but also indicates a positive impact on expenses that will emerge from it.

Your next question comes from David Bishop with Hovde Group.

Chris, Joe, thank you for the insights on the NDFI exposure. It's been a topic in the news lately. Can you provide more details about the nature of that lending and how it aligns with regulatory guidelines? Also, do you have any updates on government contracting exposure in light of the shutdown and how that portfolio is performing from a credit standpoint?

Sure, Dave. Regarding the NDFI, I want to emphasize that it represents a very small portion of our operations, and we are not involved in NDFIs that lend to consumers. Instead, we focus on NDFIs that are engaged in commercial lending. For instance, our Auxilior Capital, which is an equipment finance business that we have an equity stake in and also provide credit facilities to, is aligned with this focus. We closely monitor this area, and I feel confident that our exposures are in good condition. After evaluating our situation this quarter, we ensured there were no concerns. Does that address your question?

Yes.

I'm sorry, the second that was.

On the government contracting exposure.

We currently have a relatively small exposure in government contracting, amounting to about $100 million, which is concentrated on mission-critical contractors. Over the past year, we have been careful in forming relationships with partners who are experienced in navigating government shutdowns and are financially stable. This gives us confidence. We continue to maintain close communication on this matter. Joe, do you have any updates from clients that you could share?

No, I think you summarized it well, Chris. I'd just add the comment that we've been pretty close to it. We didn't have historical exposure and presence there. So a lot of our stuff, as Chris mentioned, has been in the last 12 to 14 months. So that's been a benefit to us because we don't have any legacy risk.

Your next question comes from Tyler Cacciatori with Stephens Inc.

This is Tyler on for Matt Breese. The cost of deposits were stable again quarter-over-quarter despite strong deposit growth, including demand deposits. And I know you talked about competition a little bit but when do you think we start seeing some of the benefits from the team in terms of lower all-in costs there?

On the Premier side, we expect to see a gradual decline as non-interest accounts become activated and balances increase, leading to a slight shift in mix. However, this change should be quite gradual. Regarding our overall base, there is a delay in the adjustment of deposit rates due to some contractual agreements with commercial accounts. Reflecting on last year, when rates decreased toward the end of the year, we only began to see benefits in the first quarter of '25. There is usually about a 90-day lag, which factors into our guidance that net interest margin would be flat or possibly slightly lower in Q4. Additionally, we had some contractual repricings of accounts that were close to zero, which offset some of the positive movements in other areas. Therefore, we anticipate net interest margin will be flat or slightly down in Q4, but then return to growth in Q1 and continue to improve thereafter.

Yes, this is Pat, Tyler. This is a bit of the other side of the double-edged sword of growth, which we are pleased to manage. We need to raise deposit funding to support loan growth, and we are somewhat limited by the competition in today's markets. We are experiencing a similar delay in deposit cost declines as we did with increases during the upgrade cycle. Initially, it was slow to pick up, then gained momentum as the Fed continued to raise interest rates. We expect to see the same trend: a slow initial decrease, followed by a quicker pace as we transition into the rate decline cycle next year.

Also the CD book is pretty short duration. So it's under 6 months. So we'll see a lot of that repricing roll through the CD book in the coming months.

Great. And then my next question is about the ROA. When do you guys think you can hit a 1% ROA here?

So I think to kind of knit together our comments earlier, we think we're better than 0.9% by the end of next year, fourth quarter '26, crossing over above 1% in the first quarter of '27 and then for the full year, continuing to grow throughout that year. So it's going to be at or around fourth quarter next year, first quarter '27. And as Pat said, there's a lot of unknowns out there about Fed policy and rates and all that but that's our best guess today.

Great. And then just my last question here. I think you said it in the prepared remarks, sorry if I missed it, about the deposit composition of the deposits the Premier team is bringing on and if the expectations of that 30% DDA target has changed at all?

They're about 20% today and the expectations haven't changed.

Just a quick one on the allowance. If you were to see an increase in criticized loans still not big in the scheme of things, would that drive a change in the reserve? Or does that sort of have tolerance? I mean it's been low on criticized for several quarters. I'm just curious if that were to go back up a little bit, that would be anything material to how you provision?

You're correct, Chris. The model is affected by the levels of criticized and classified loans. A significant change in those figures would put some pressure on the allowance for credit losses. In fact, had we only considered the mechanics from this past quarter, the reduction in criticized and classified loans would have led to a reserve release. However, we felt that was not the appropriate decision considering the external environment and our transition to commercial and industrial lending. So while the model might suggest adjustments in either direction, we focus on our qualitative assessment and the economic signals we receive from sources like Moody's and others to guide our final decisions. There is some sensitivity involved, but we are being mindful in determining the provision for reserves based on our qualitative factors.

Perfect. That's great, Chris. I have a follow-up question. If we see more changes among some regional bank competitors in your area, would that affect your hiring? I'm thinking beyond the Premier initiative. Or would you prefer to pursue more business with the existing team?

It's always a balance. Whenever we find great talent, we don't want to pass it up because that's what drives our business. At the same time, we're very focused on achieving the return hurdles we've outlined today. So it's a trade-off. If we find very good people, we don't want to overlook them. However, we are mindful that we need to achieve our return on tangible common equity in the double digits. We expect to do that next year and want to stay on track. Therefore, we will balance the quality of opportunities to bring on new talent. We appreciate the bankers we've brought on and will likely continue to add bankers occasionally, but the number of bankers will depend on our ongoing improvements in profitability.

I can confirm that does conclude the question-and-answer session here. And I would like to hand it back to Chris Maher for some final closing comments.

Thank you. We appreciate your time today and your continued support of OceanFirst Financial Corp. We look forward to speaking with you in January. And as we kind of head off into the holiday season, we wish you and your families all the best. Thank you.

Thank you. That does conclude the OceanFirst Financial Corp.'s Third Quarter 2025 Earnings Call. Thank you all for your participation. You may now disconnect and please enjoy the rest of your day.