OceanFirst Financial Corp. (NASDAQ:OCFC) Q1 2023 Earnings Call Transcript

OceanFirst Financial Corp. (NASDAQ:OCFC) Q1 2023 Earnings Call Transcript April 21, 2023

OceanFirst Financial Corp. misses on earnings expectations. Reported EPS is $0.55 EPS, expectations were $0.64.

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

Jill Hewitt: 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.

Christopher Maher: Thank you, Jill, good morning and thank you to all 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 net interest income has increased $14.6 million or 17% as compared to the prior year period. Core earnings were $0.55 per share, increasing 12% as 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 access 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, which resulted 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 commercial clients along the New Jersey Shore that typically built 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. And 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 equates to the total deposit base turning over about every five weeks. Detailed deposit metrics are included on Slide 7 through 9. Now for an overview on our investment portfolio. The company has $1.8 billion of investments in its portfolio. The investment portfolio comprises of high quality investment grade assets. Slide 6 provides important context on two key strategies implied over the past several years to avoid some of the issues that have been highlighted in recent weeks.

First, we kept the size of the investment portfolio modest at just 13.3% total assets. Then, we maintained a discipline around duration, favoring floating-rate securities when possible. As a result, 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 mark-to-market using valuations as of March 31st, the impact will 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.

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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. Credit demonstrated by our history of better performance, our thoughtful risk selection and diversification and our prudent portfolio management which focused 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. That 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 six 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 as 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 by 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 towards 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 rollover a maturity.

Our portfolio has been carefully structured to avoid this risk. First, aggregate maturities to face the rate reset in 2023 and 2024 totaled 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%. And 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 evidenced a 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 are 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 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 have progressed the project that included dedicating resources and hiring external subject matter experts to evaluate all internal processes, performed 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 has 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, some 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.

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Q&A Session

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

Frank Schiraldi: Good morning.

Pat Barrett: Good morning Frank.

Frank Schiraldi: If you guys could just walk through the NIM dynamics from here, 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 do you think at that point — is it the expectation that that abate significantly? And kind of what are you thinking about, I guess, margin over the next couple of quarters.

Pat Barrett: 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. And that’s when we say modest compression, we were thinking about it in terms of the 30 basis-points compression we saw this quarter. I’ll remind you that a third of that 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 and 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 — in the 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 is that, we’ve got $400 million of cash sitting in the balance sheet that actually earned 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.

Christopher Maher: 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 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.