OceanFirst Financial Corp. (OCFC) Q1 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the OceanFirst Financial Corporation Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Ms. Jill Hewitt, Senior Vice President and Investor Relations officer. Ms. Hewitt, please go ahead.

Thank you, Laura. Good morning and thank you all for joining us. I will begin this morning's call with our forward-looking statement and disclosure. On this call, representatives of OceanFirst may make forward-looking statements with respect to its financial condition, results of operation, business and prospects. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond OceanFirst's control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. OceanFirst undertakes no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. In our earnings release, we have included our Safe Harbor statement disclaimer. We refer you to the statement in the earnings release, and the statement is incorporated into this presentation. For a more complete discussion of certain risks and uncertainties affecting OceanFirst, please see the section entitled Risk Factors and Management Discussion Analysis of Financial Condition and Results of Operations set forth in OceanFirst's filings with the SEC. Thank you. And now, I will turn the call over to our hosts of the morning, Chief Executive Officer, John Garbarino; President, Vito Nardelli; and Chief Financial Officer, Michael Fitzpatrick.

Thank you, Jill, and good morning to all who have been able to join in on our first quarter 2012 earnings conference call today. We appreciate your interest in our performance and are pleased to be able to review these results with you this morning. We have completed another strong, satisfying quarter with earnings per share increased over both the linked and prior year quarters, can point with pride to several additional positive factors helping us build value for our shareholders. Earnings growth has been achieved even in the current environment, which presents little or no opportunity for a loan portfolio growth or balance sheet expansion. Our tangible common equity ratio increased to 9.75% even as we pursue a more aggressive capital management posture this year with our stock repurchase program and attractive cash dividend payout of current income. Although loan demand remains relatively slack in our market, our credit metrics are stabilizing and beginning to show signs of improvement. We've all had the opportunity to review the earnings release from last evening and, following our usual practice, I will not be disrespectful of your time reciting a host of actual numbers from the release. My introductory comments will merely help frame our opportunity to add some color to the results posted for the quarter. Diluted earnings per share for the quarter were $0.31, that's $0.03 ahead of the prior-year quarter, and $0.01 increase over the linked quarter. The company's 61st consecutive quarterly cash dividend was declared and maintained at $0.12 a share, representing a comfortable and sensible 38% payout ratio of current earnings, as well as an attractive 3.4% current yield on our shares with limited realistic growth opportunities in our market, our balance sheet contracted during the quarter. This resulted primarily from lackluster loan demand except for residential mortgage refinance. Although the commercial lending pipeline remains relatively robust, commercial credit fundings are slow to develop and loan prepayments, along with line of credit paydowns, made portfolio growth difficult to achieve. Local businesses clearly remained debt-averse in this environment. It is certainly no time to become an overly aggressive pursuing commercial loan growth in the face of observed market softening of underwriting discipline and increasingly competitive loan pricing. With residential mortgage demand dominated by long-term fixed-rate refinance activity and the very attractive gain on sale margins, the residential portfolio contraction is accepted as a consequence of the sale of most of this loan production and the increase achieved in other income. We are mildly concerned this quarter that our local residential market is not yet experiencing the resurgence in purchase activity widely reported in other areas of the country. We wonder if the oft discussed 3-year average backlog in New Jersey residential foreclosure resolution is having a detrimental effect on the ability of the local real estate market to self-correct as they have already in other areas of the country. Our deposits reflected seasonal governmental unit outflows and the average core deposit mix again improved now comprising 84.9% of total average deposits. Net interest margin continues to benefit from disciplined control of our funding costs. Although the margin remained relatively flat in the linked quarter, it is noted that any pressure on the margin was muted by a 5 basis point benefit derived from a large commercial loan prepayment fee booked during the quarter. Operating expenses remain well controlled in the new year, and our efficiency ratio continues to improve, moving sharply downward to 55.3% at the end of the quarter, also benefiting from the reported increase in other income. As a practical matter, however, this could likely represent a low point for the efficiency ratio for this year. As is our custom, I'll now ask President Nardelli to provide some added background to our reported credit metrics and loan loss provisioning.

Thank you, John. During the first quarter, non-performing loans in the residential portfolio showed a small improvement and commercial and consumer portfolios each showed small increases, leading to a relatively flat overall performance with no significant deterioration in any individual category. Breaking down the residential portfolio, we continue to be very pleased with the performance of loans originated by the core bank, the only remaining origination channel, with a nonperforming rate of 1.4%. Loans originated by the now shuttered Columbia and Kenilworth channels carry 10.5% and 4.7% delinquency rates, respectively. Looking for a moment at the foreclosure backlog, while we did take 3 properties back at Sheriff's Sale in the quarter, these were loans that were in the process for about 3 years. Therefore, our view is that the overall foreclosure situation has not significantly improved nor do we expect to see any dramatic change in the overall timeframe in the near future. Other loss mitigation actions have been increasing and effective. Of note, delinquencies of less than 90 days show a significant improvement quarter-over-quarter, and as compared to last year's fourth quarter. After having completed our rigorous quarterly analysis of the loan loss reserve and recalling the change last year in our charge-off policy, whereby we now charge off the portion of a seriously delinquent real estate loan that is deemed to be uncollectible in the quarter there identified, we set the provision for loan losses at $1.7 million, basically flat to net charge-offs. Included in our analysis is our assessment of the local real estate market, which is still under pressure from excess inventory, as well as the commercial real estate market, which is improving slowly. Turning for a moment to the reserve for repurchased loans. You may recall that we entered the year with 4 repurchase requests pending. In the quarter, 5 requests were received for loans originated between 2005 and 2007 of the now shuttered mortgage banking subsidiary, Columbia Home Loans. These requests, we believe, are indicative of loan purchases looking to shift credit risk back to originators whenever there may be an adverse outcome on the loan. As appropriate, on a case-by-case basis, we are negotiating or vigorously contesting these claims. The increase in the motivation of investors to generate these repurchase requests, where they factor in our analysis, that concluded $150,000 provision in the quarter would be prudent, bringing the reserve to $855,000. With that, I'll return the discussion back to CEO Garbarino for some concluding comments prior to engaging in a question-and-answer session this morning.

Thank you, Vito. Recapping the quarter, we feel we've made a solid start to 2012 with a sense of cautious optimism towards the remainder of the year. Despite these strong results, we remain mindful that with inevitable pressure returning to our margins, to build long-term value for our shareholders' investment, we will need to restore some growth in our balance sheet and increase both our revenue and earnings. We accept that challenge in what we hope will become an improving economic environment, and see ourselves as well positioned to achieve just that. With that, Mrs. Nardelli, Fitzpatrick and I would be pleased to take your questions this morning.

[Operator Instructions] And our first question is from Frank Schiraldi of Sandler O'Neill.

Just a couple of questions, one on buybacks. So id the thinking changing it all, do you expect that given where loan growth has remained, do you think you might look to get more aggressive on that front at these stock prices?

Well, Frank, it's a good question, and it's one that we asked ourselves during the first quarter as prices kind of rebounded. If you recall, when we originally announced the buyback, we said we modeled it up to $14 a share, and we were content with the book value dilution that was occurring at that level. Once the stock began to trade above that level, of course, we took another look at it and we have taken another look at the modeling, and it's a question of how comfortable we'd becoming with the book value dilution versus the effect on the earnings per share. So I think we can say, yes, we're reasonably comfortable where it is today. But I don't want to prejudge that going forward. It's nice to see some market recognition in our shares, but when we announced the buyback, our shares had a lot more value in them than they do today. So it's something that gets evaluated on a continuing basis. As to your question whether or not we might be buying back additional shares, I think that's a little premature at this point.

Okay. And then secondly, I just wondered how -- it's always a tough question to answer, but how we can think about or should think about the reserve going forward? If we may be getting to the point, an inflection point, where provisioning could begin to trail charge-offs releasing some reserves? Or is that not a likely scenario on a short-term?

Well, again, we're still somewhat concerned, as I mentioned in my introductory comments, about the state of the real estate market. And we haven't seen this pickup in purchase activity that's being widely reported. Until we see that, I don't think that we can feel that we're really in a, what I would characterize as a healthy thriving market, that you can characterize as occurring in other areas of the country. So we're still very cautious about our provisioning. As you see this quarter, we just about matched our charge-offs. We see some encouraging signs about delinquencies. Our short-term delinquencies are certainly well down from levels that they have been in prior quarters. And we've seen some relative stability on the mortgage side, but the delay in the pickup of activity in the real estate market still gives us some pause. And so, I don't think we're ready to declare a victory yet.

[Operator Instructions] And our next question is from Matthew Kelley of Sterne Agee.

I was wondering if you can you just talk about the repurchase requests in the real change this quarter with 5 new ones coming in? I mean, how concerned are you on that?

Well, you know, if there's a silver lining, we -- most of that came in early in the quarter. We didn't get anything in the last month in the quarter. It appears to us to be a -- kind of a shifting of the credit risk, as I mentioned, on some of these very old and dated items. And I think a lot of scrubbing's going on at the various institutions, which are holding some of this paper. I think we're very well positioned to defend against some of these requests and have been in a good position defending these requests. We just don't pay out of hand. The indications, some of these things have been here a while because they still lack full documentation and information for us to properly adjudicate some of these requests. And it's kind of been kind of spotty. If you recall, for a couple of years that we practically had none. And then very recently, we started to get a few in. I really can't judge as to how much more is out there, only to say that this bucket of potential repurchase request is kind of diminishing. It's limited. And it has a life span, and that lifespan is aging every day.

How big is that bucket, how do you quantify the potential pool of loans that could be attempted to be put back to you?

It's not about a potential pool of loans. It's about a potential defect in something that was originated 7, 5, 10 years ago. And that defect is kind of subjective in this day and age by the presenter. It may be valid. It may be invalid. It's not -- I caution you. It's not a matter if we had x loans. And therefore, a percentage of those loans go sour. Some of these loans might be performing. It's just that they discover a defect and they want to put it back.

No. I think that we've seen that in some of the larger banks that have already reported. But my question will be, on the $150,000 reserve that you put aside for the 5 loans, if you look at the reserve you had at year end of $700,000 on the 4 requests outstanding, that's a pretty big dollar amount relative to what you put up this quarter for the 5 that you received. How do you explain or how do you kind of think of that relationship?

Why don't you talk about how that reserve is actually calculated and probably that is assigned to it? And so, well, that might give you some additional comfort on that.

Yes. Matt, we had, on the 4 loans at the end of the year, we do an analysis. We look at the loss. We look at our -- the loss that we might experience because they're all real estate collateralized. So we can go out, and then we can appraise the property. We can get an assessment of what the loss might be, number one. And then we assign a probability of loss because we've been very successful, as Vito just said, in disputing a lot of these. So we have -- so if the loan's $100,000, the actual loss based upon the real estate collateral might be $30,000, and your probability of loss might be 50%. So now you're down to $15,000 for a single loan. But included in the reserve is not just the specific reserve, a specific loan request, but most of it is related to -- it's like doing the same methodology for reserve for loan losses. We have specific losses that we anticipate, and then we have what we call general reserves based upon the pool of loans and the probability that something may come back to us, and then a loss experience on that. So the $700,000 loss at the end of the year, there was only $100,000 loss. I think that was specifically assigned to those 4 repurchase requests, and the other $600,000 was kind of general in nature. So now, we have 9 repurchase requests. You're right. The general -- the -- but our specific loss on that, I think, is about $200,000, $250,000, and the rest is still a general type related to unknown requests that we might receive down the road. And Matt recall we defease 93% of those Columbia Home Loans years ago through negotiated settlements and other actions taken by the bank in that timeframe. So the population is less than -- it's 7 and diminishing everyday as they mature out. So it's not a huge population, and it's not one where you would gauge based on a loan risk factor. It's more on the potential that there might have been some technical defect in some of the documentation related to that loan packaging when we sold the package 7 years ago.

Wasn't that the same servicer sending stuff back? Or...

Well, sometimes the servicers change. Okay? Sometimes, we've noticed there's a 1, 2, 3x change of hand. So that makes some of these things kind of like, makes you wonder why they're doing it, what their motivation is. That's why I characterize it as the investor motivation.

Okay. Switching gears on the securities portfolio, up 2% this quarter. Where should we expect that to go as a percentage of assets? I've kind of watched it grow over the last years. Loan growth has remained challenging, 25% of the portfolio now, 25% of assets. Where is that number going?

I don't think that's something we target, Matt, as a fallout from liquidity purchases. I mean, our goal, obviously, is to grow our loan portfolio. So -- and to the extent that the loan portfolio doesn't grow and might have a deposit liquidity or some -- of some sort. We'll invest it in investment. So we -- but we don't sit here and say, we want to get, we want to increase our investment portfolio. We -- our goal is to grow the loan portfolio.

Sure. I think, Matt, I think you're probably in a better position to know this. But I think on an industry basis, that percentage is probably right in line or maybe somewhat less than the entire industry is. So it's something we're experiencing in this environment. I mean, you can't force a loan. We certainly don't want to do that, because a year from now, we'll be having a totally different conversation about why you're writing them off.

Sure. And then just last question on the margins. So from kind of the 347 core margin extra prepayment activity, where do you see that heading if we just remain in a static rate environment? We don't change across the treasury curve, swap curves, libel prime, whatever. If nothing changes, where do you see that going?

Well, there's contraction just if we -- there's some contraction in that because our deposit costs, as we've said before, is starting to floor there, 47 basis points at the end of March. So those are flooring, and there's still a considerable cash flow on loans and mortgage-backed securities that are being reinvested at lower yields. So we think there's going to be some more contraction now. What we didn't have in the first quarter that we think we can offset that with is loan growth. So that sounds 6 basis points on a core nature in the first quarter, was without what we would anticipate to be our -- without very good loan growth. So if we can generate some loan growth, then that will mitigate some of that.

We have a question from Fred Cannon of KBW.

I just had a couple of follow-ups on the mortgage business. One on the put back loans. Are those all Fannie, Freddy loans?

No. Some were -- the 5 taken in first quarter this year are Fannie, and I believe the 4 last quarter, last year were Countrywide.

Okay. They were countrywide private label?

Countrywide private label.

They were Countrywide loans that they bought from us. We originated them.

Okay. Okay. And that weren't -- and weren't necessarily secured by Fannie, Freddie. Okay. And then, I know you're seeing some pretty good gain on sale spreads in the current market, can you tell us that's kind of HARP related loans? And if you see, near the end of the month, is that accelerating?

On HARP related.

Modification-wise? No. These are mostly refinances on performing loans that we routinely originate. It's no special program.

It's our base case product that we sell.

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

Thank you, Laura. Once again, let me thank you for joining us this morning. We hope you may be able to join us also for our annual shareholder meeting in Point Pleasant, New Jersey on May 10. But if not, we look forward to speaking with you again in July.

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.