OceanFirst Financial Corp. (OCFC) Q1 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the OceanFirst Financial Corp. 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, SVP and Investor Relations Officer. Please go ahead.

Thank you. Good morning, and thank you all for joining us. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer at OceanFirst Financial Corp. We will begin this morning's call with our forward-looking statement disclosure. On this call, representatives from OceanFirst may make forward-looking statements with respect to its financial condition, results of operations, 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 and 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 and Analysis of Financial Condition and Results of Operations set forth in the OceanFirst's filings with the SEC. Thank you. And now I will turn the call over to our host this morning, Chief Executive Officer John Garbarino; Chief Operations Officer, Christopher Maher; Chief Financial Officer, Michael Fitzpatrick; and Chief Administrative Officer, Joseph Iantosca.

Thank you, Jill, and good morning to all who have been able to join in on our first quarter 2013 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. Before we get started, however, with all that has transpired this week following the terrorist attack on our nation on Monday, and continues to unfold in the Boston area as we conduct our call this morning, I'd like to let our investors and managers in the area know that our hearts, thoughts and prayers are with them as our law enforcement authorities hopefully bring the responsible parties to justice. Returning to the business at hand, as you've just learned from Jill's introduction, this morning's call will include the participation of Christopher Maher, who joined our company only 4 weeks ago as President and Chief Operating Officer. Chris's wealth of experience and hard work during this period have shown him to be a quick study and well prepared to lead our management team in their daily activities at OceanFirst, furthering our mission to develop incremental value for our shareholders' investment. We will also hear from Chief Administrative Officer Joe Iantosca. As has been our recent custom on these calls, we'll update our ongoing work on our Sandy loan portfolio assessment and recovery, as well as the resolution of the residential loan repurchase requests from mortgage-backed security issuers that continue to lay off any possible credit losses from their bonds. You have all had the opportunity to review the earnings release from last evening. And following our usual practice, we will not be disrespectful of your time reciting a host of actual numbers from the release. Our 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, of course, were $0.26, a $0.05 off the prior year quarter, and 4% -- $0.04 below the core operating earnings reported in the linked quarter after adjusting that quarter for the year-end Sandy provision. Adjusting further for the noise associated with this quarter, core operating earnings remained relatively stable. The company's 65th consecutive quarterly cash dividend was declared and maintained at $0.12 a share. The first quarter has obviously been less than satisfying on 2 fronts. The resolution activity regarding residential loan sales and repurchase requests has resulted in additional charges during the quarter, but the real issue for OceanFirst and the industry is the continuing challenge to combat the relentless pressure on the margin. This marks the second consecutive quarterly period, however, where the growth in our core earnings has been unable to overcome the impact of not only mother nature, as in the case of Superstorm Sandy, but also the current operating environment where growth prospects are slow to develop and the entire industry scrambles to cut expenses and find new sources of revenue. While we recognize that this operating environment requires patience, as we continue to move through this period, we remain confident in our ability to deliver on the value proposition set forth to our shareholders. The resilience of our central Jersey Shore market and the promise of an economic rebound from Sandy that we see developing, albeit slowly, continues to present an effective scenario under which we can achieve our growth goals. With that, I'll ask Chief Administrative Officer Iantosca to provide some details on our Sandy recovery, overall credit quality and loan repurchase activity.

Thank you, John. My comments this morning will discuss asset quality and credit costs. In addition, I will update you on the status of the portfolio related to the aftereffects of Superstorm Sandy and also add some color to the activity in the loan repurchase reserve we've established. First, recapping the effects of Sandy, there is no change in information previously reported on the commercial portfolio. There remain 3 borrowers with property severely damaged, but who continue to perform under their loan agreements, and 6 borrowers who are performing under the short-term relief they were granted. Looking at the combined residential and home equity portfolio. I would refer you to the release with the details regarding the performance of the status of the 124 borrowers with loans totaling $30 million who had requested and received temporary relief as presented. Looking a bit closer at the $4.5 million that is in the nonperforming category. These are almost all residential investment properties who have suffered the loss of tenants, as well as varying levels of property damage. We are evaluating each of these loans to determine the best course of possible loss mitigation. We also continue to work with all of our Sandy-affected borrowers in their rebuilding efforts. And to date, we've processed well over 1,000 insurance claim checks. On an overall basis, we continue to be encouraged by the performance of this affected pool of loans, but we remain cognizant of possible future developments, especially related to the proposed FEMA flood zone maps and the impact their final adoption may have on the cost of rebuilding and on existing real estate values. We remain comfortable with the adequacy of the $1.8 million special provision, which we took at the end of 2012. Turning to asset quality overall. The increase we report on non-performing loans is solely attributable to the Sandy loans I just discussed, which had been anticipated. The increase in 30 to 89 days past due is $3.3 million, including $1.7 million in Sandy-affected residential loans that are being evaluated for longer-term hardship measures. Moreover, $3 million in these 30- to 89-day commercial loans have already cured or are very likely to cure within the month. Net charge-offs in the entire portfolio for the quarter was $1.1 million, an increase of $235,000 in the linked quarter or a decrease of $573,000 in the same quarter last year. Considering these facts, along with the $24.5 million reduction in total loans receivable net, set the quarterly loan loss provision at $1.1 million, resulting in a stable allowance balance quarter-over-quarter. Turning now to the reserve for repurchase loans and loss-sharing obligations on the Federal Home Loan Bank MPF program, let me walk you through the activity driving the additional provision of $975,000 for the quarter and address the most significant items. First, there were 2 recoveries into the reserve totaling $205,000, which resulted from successful settlements with insurance companies on previously repurchased loans. Next, there was a charge to the reserve for $450,000, which funded a comprehensive settlement with one of the largest non-GSE investors who had purchased loans from both Columbia, the bank's former mortgage banking subsidiary, and OceanFirst. This settlement extinguished 6 existing repurchase requests with a total loan value of $2.2 million and provided for full release from any future repurchase claims from this investors. Total sales from this investor were in excess of $440 million, with approximately $230 million of that still outstanding. With this settlement in place, we have now successfully defeased future repurchase requests from a total of 10 investors on sales totaling over $1 billion. There remains 6 open repurchase requests that we are contesting, 3 from the GSEs and 3 from a single private investor. The final component in the discussion of the reserve for repurchase loans and loss-sharing obligations is related to claims made and the reserving methodology regarding loans sold to the Federal Home Loan Bank under the MPF program. The bank has participated in the MPF containing a credit loss-sharing component for well over 10 years. Under the MPF, loans are sold individually into a pool over the course of a defined timeframe. Each pool stands separate and distinct as related to credit loss performance. OceanFirst has 5 pools in the MPF program, one of which has a very high concentration of Columbia loans, one of which has a small concentration of Columbia loans and 3 of which have little to no Columbia production in them at all. The bank accepts a varying degree of credit risk over the first 1% of each. The second tier threshold for each pool is set individually at the inception of that pool and varies between 1.5% and 4%. The bank is responsible to reimburse the MPF in full for credit losses in this second tier. Any losses beyond the second tier are borne by the Federal Home Loan Bank. In the first quarter, for the first time since participating in this program, the pool with a very high concentration of Columbia loans broke into the second tier, triggering the bank's responsibility to honor credit loss claims in the amount of $245,000. In addition to honoring these loss claims, the bank evaluated all the pools with potential losses and concluded any likely losses are primarily limited to this single pool. The provision which was taken is sufficient to absorb the maximum remaining loss exposure in this pool, as well as limited losses in the other 4 pools. Total exposure in the remaining pools, which are performing well at this time, is $1.8 million. At quarter end, total balance in the reserve for repurchase loans and loss-sharing obligations is $1.7 million, which we believe adequately provides for all likely losses. It's now my pleasure to turn the call over to President and COO, Chris Maher, who will discuss plans to address continuing challenges of the current operating environment.

Thank you, Joe. It's a pleasure to be here at OceanFirst. I'll make a few brief comments before we enter the Q&A portion of the call. The earlier portion of this call was focused on financial performance and asset quality metrics for the first quarter. My comments will focus on our thoughts regarding the persistent low interest rate environment, which continues to apply pressure to net interest margins. We recognize that industry-wide pressure on net interest margins in the industry reality of more conservative capital requirements must be overcome as we deliver on our commitment to provide shareholder value. Credit quality requirements and interest rate risk management have resulted in a very disciplined approach to loan production. Those core values will remain our most important considerations. While those principles won't change, we're dedicating more resources to support quality loan growth in commercial, residential and home equity loans. In each of these primarily lending areas, we have the seasoned underwriting professionals, portfolio managers and the systems and controls to compete effectively. Our communities are rebuilding from the impact of Superstorm Sandy. We are implementing new marketing initiatives and recruiting additional loan officers to support the communities' rebuilding efforts and to ensure we are positioned to attract opportunities and satisfy the resulting loan demand. We are focusing on loan portfolio growth to address net interest margin compression. Additionally, we continue to make progress in building our trust business. As with our lending areas, the trust business has been built carefully and conservatively for several years and is well positioned to contribute earnings growth. Trust revenue is not subject to the restraints or constraints of the rate environment, nor is it governed by material capital requirements. These lending and trust initiatives are bank-wide efforts, but the positioning of our Red Bank Financial Solutions Center illustrates our dedication towards providing a more diversified portfolio of products. Red Bank will be our first branch location with full-time commercial loan officers, residential loan officers and on-site trust services. We feel this model positions us well to compete in a new market. Communicating the status of these efforts in a transparent manner is a high priority. As these efforts develop, our quarterly financial results will be expanded to provide additional metrics regarding loan production and trust performance. I look forward to using these metrics to demonstrate our progress in future conference calls. We remain focused on restoring growth in revenue and earnings and on building additional value for our shareholders' investment. With that, we're pleased to take questions.

Yusef, you want to queue up any questions?

[Operator Instructions] Our first question comes from Frank Schiraldi with Sandler O'Neill.

Just a few questions. I wondered if you could talk about the potential -- as you look out over the next 12 months and you think about loan growth, how would you gauge the likelihood that refis out of the resi portfolio will continue to overwhelm any commercial growth, creating flat to negative total loan growth?

Well, actually, Frank, it's an interesting question because we've sat here probably for 3 or 4 years and the industry has talked about the refi blitzes and so forth. We definitely see the refis abating as we enter the new year. And in fact, just recently from a very positive standpoint, the last 2 or 3 weeks, we've seen the purchase money activity really pick up on the residential side. So I think, although we've said probably 3 or 4 times over the last several years, that we may have seen the end of the refi blitz, I think it really may be in sight. I think rates have been so low for so long that we're probably nearing the end of that. And our refis are now less than 50% of our total residential activity and dropping, certainly as we enter the spring season. So I think the runoff that we've seen in the portfolio, you're absolutely right, has been very much related to refis and prepayments on the residential side. And I think we might see that beginning to soften up a little bit as we get farther into 2013.

Great, okay. And then a question on buybacks. Do you think we can see the activity pick up here given where buybacks or transacts did in the first quarter and given where the stock stands today? Or could a pickup be significant? Or do you see sort of business as usual in terms of those sort of levels?

Well, we were at 250,000 shares for the first quarter, Frank, so we view that as fairly healthy levels. That's a $1 million for the year. So that would be completing our -- our stock buyback was 5% 900,000 shares, so that would be on pace to complete the whole program within a year. So we view that as a fairly good pace. I mean, it could pick up or, of course, out of the market for the first 3.5 weeks of the quarter, before we issue our press release and then we have a few days afterward. So we're really in the market only for the second 2 months of the quarter. And it depends on volume -- availability of shares, volume and whatnot. But I think that the 250,000 -- it could be a little more, it could be a little bit less, but that's a pretty good pace, I think.

Okay, great. And then just finally, I know it's not the long-term strategy, but we saw expense reductions sequentially offset most of the core revenue pressures. And so just wondering how you think that plays out maybe in the shorter term here over the next couple of quarters. Is there additional room to cut costs to offset margin pressures?

Well, of course, we just talked about the Red Bank opening in the press release, about that opening in -- grand opening on May 11. So those costs are going -- there's going to be additional costs related to that branch opening. So it's unlikely that we would -- very unlikely that we'd see reductions in expense. We have to account for some of the Red Bank costs. We're always looking for opportunities on a bank-wide basis to reduce cost and be more efficient. We've done a fairly good job with that over time. But we're never satisfied. We're always looking to do things better and more efficiently. So hopefully, we can continue to do that.

And can you just remind us, Mike, I'm sorry if I missed it, but what the expected expenses initially are for the Red Bank opening?

It's a couple hundred thousand a quarter.

Our next question comes from Travis Lan with KBW.

Mike, I wondered if you can just talk about the larger purchase reserve in the quarter. I know you gave some good detail on it during your prepared remarks. But does the high level of the provision just reflect re-upping, making up for the settlement charges that came out of the reserve in the quarter? Or is there something else to be taken from that in terms of the way that single pool has performed?

Yes. When we were looking at the -- well, the single pool was under the MPF program with the Home Loan Bank and we saw a significant deterioration in that pool. So a lot of the 975,000 re-up would be related to the Home Loan Bank MPF program.

But 450 was for the settlement, yes.

450 is for the settlement, the settlement that took care of...

You're absolutely right. Almost half of that, Travis, was for the settlement that we negotiated that had been underway for some time here with that major single investor.

Right, okay. And then exclusive of the provision and reclassifying the fees for reverse mortgages, what -- can you give us a sense for just how mortgage banking volumes and gain on sales trended in the quarter?

Yes. We reported in the press release the sales volume for the quarter was $37 million. It was $40 million this quarter a year ago. For the fourth quarter, we were a little bit more than that as well. We were -- one second, for the fourth quarter we were at $39 million. So a little bit more. So volumes were off a little bit from the trailing quarter. Gain on sale margins came in quite a bit. We were running well over 2% for most of last year. It was especially high in the fourth quarter. We're now down slightly below 2% the last month in March. So we've seen the gain on sale contract a little bit, the margin contract. And part of that is a function because there was some increase, there were some rate movements, some rate movements up during the first quarter.

Got you, okay. And then on the loan yields, I mean, obviously, it remained under pressure but accelerated, the compression accelerated this quarter. Is there anything specific that you can point to? Or is it just general loan yields or what your portfolio continues to come in so much below your portfolio yields?

Well, there's a lot of cash flow that's being reinvested at relatively low yields. Prepayment speeds are still relatively high. As John said, we expect those to trail off. I mean, prepayment activity should trail off as refinance volume moderates. But there's a lot of cash flow during the quarter and it came out of loans, high-yielding MBS and high-yielding loans, and that cash flow -- and we had some deposit growth as well. And that was reinvested into the investment portfolio at relatively modest yield. So the incremental spread going into investments is very modest.

Got you. And then just finally, Chris, just wondered if you could elaborate a little bit on some of the changes that you think need to be made in terms of becoming more competitive in the lending market while also maintaining the discipline that we've seen at OceanFirst in the past. I mean, just any commentary you would have on that.

Sure. I think it's been a tough market for most institutions when you think about kind of core loan demand and trying to write or at least to support and advance on the net interest margin pressures. So I think it's an industry-wide issue. What we're looking to do, I think, when we talked about the expense guidance, is that there will always be opportunities to reduce expenses, and I think the company has got a good track record of having done that fairly aggressively over the years. What we're looking to do now is to reposition expenses that we have today and use them to drive, particularly loan growth, and then also the trust activity. So not so much about spending on new money but redirecting spend so that our marketing dollars are as tight as they can be around loan products. And we have connected with Red Bank, but also in addition to Red Bank, we will make a few more hires on the loan production side. We have 15 mortgage -- residential mortgage producers today. That's up 3 since the first quarter started, so since year end. And we'll look for opportunities to do some adds there. We will be adding a dedicated commercial officer in Red Bank. But we also have 2 more spots in the budget for the year that would help us compete in those markets as well. So I think we're talking about an incremental focus around the revenue generation piece. And we've got capacity here. So it's really not going to drag much expense in the back office.

[Operator Instructions] Our next question comes from Matthew Breese with Sterne Agee.

Given all the pressure on investment yields these days, and the margin is reflecting that, is there any opportunity that we can see the margin dip below 3% in the back half of this year?

Stop trying to cheer us up, Matt. God, I don't know. I mean, you're talking about the residential market? You're talking about the commercial market?

The overall margin. I mean, it seems like loan yields are still under pressure compared to where you average loan yield is today. So I mean, clearly there's going to be more pressure on the margin. It's just to what extent, really?

Matt, it's Chris. Let me just point one thing out. In the first quarter, we invested about $86.5 million in securities, and the weighted average rate we were able to get on that is just under 1.4%, so 1.39%. And that was for durations of just under 4 years. So to put that in perspective, what we're hoping to do as the year continues is certainly to pull back and not have to invest nearly as much in the securities book at those yields. So while absolute loan rates are pretty low, you see that everywhere in the market, we have opportunities with reasonable durations to pick up 150, 200 basis points in improvements over those securities purchases by growing the loan book. So our task is really to make sure that to the extent we can, the cash flows get back into the loan book and not into the securities portfolio. So I think more of the drag on NIM has been related to that than movement within the loan book. So it's a mix of loans versus securities that we're focused on.

Matt, if you're concerned, too, about the NIM compression this quarter, recall that we did have some unusual items in the fourth quarter of last year. So on a linked basis, the compression wasn't probably as heavy as what the numbers would have indicated also. So I realized the run rate does not bode a lot of confidence here, but I think we got to try and combat that, as I said in my comments, too. I mean, it's not something that we've been extremely successful at in, as Chris says, eliminating the investment portfolio and making better use of the loan portfolio. That's something we have to do a much better job to prevent that from happening later this year.

Is there a point of stabilization?

Well, yes, there obviously will be. And whether it's -- the point of stabilization is reached by our internal actions or by external market forces remains to be seen. I think over the longer term, we're obviously going to see a turnaround in the market at some point. If you believe the Fed's current forecast, that's still not going to occur for some time. So it's incumbent upon us to do everything we can to bring that point of stabilization closer to today's date.

My last question, earlier in the month, we saw 2 New York franchises get together, merger of equals, realizing cost savings. I mean, both were under a lot of the pressures you guys are feeling as well. Would you guys ever consider a maneuver like that, given the economic outlook we're in?

Of course, Matt, we would never comment on any considerations that were underway. So we -- but we would never put anything off the table. We recognize our fiduciary responsibility to shareholders, and we recognize that the value proposition that we present to the shareholders has got to be greater than the value proposition that someone else might be able to present to them. So we understand our fiduciary responsibility, but we would never comment on whether or not anything was ever under consideration. The Provident, Sterling deal that you refer to is certainly an interesting exercise, and it's interesting to take a look at, and I wish them a lot of success.

[Operator Instructions] I'm showing no further questions at this time. I would like to turn the conference over to John Garbarino for any closing remarks.

Thank you, Yusef. Once again, let me thank you for joining us this morning. We hope you may be able to join us for our Annual Shareholder Meeting in Point Pleasant, New Jersey on May 8. But if not, we'll look forward to speaking with you again in July after the second quarter. Thank you.

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