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OceanFirst Financial Corp (NASDAQ:OCFC)
Q3 2019 Earnings Call
Oct 25, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day and welcome to OceanFirst Financial Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Ms. Jill Hewitt, Senior Vice President and Investor Relations. Please go ahead.

Jill Apito Hewitt -- Senior Vice President and Investor Relations

Thank you Nick. Good morning and thank you all for joining us this morning. 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. 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 today, Chairman and Chief Executive Officer Christopher Maher.

Christopher D. Maher -- President and Chief Executive Officer

Thank you Jill and good morning to all who have been able to join our third quarter 2019 earnings conference call today. This morning I'm joined by our Chief Operating Officer Joe Lebel; and Chief Financial Officer Mike Fitzpatrick. As always we appreciate your interest in our performance and are pleased to be able to discuss our operating results with you. As has been our practice we will highlight a few items and then add some color to the release to the results posted for the quarter. Then we look forward to taking your question. In terms of financial results for the third quarter diluted earnings per share were $0.49. Quarterly reported earnings were impacted by merger-related expenses branch consolidation charges and nonrecurring professional fees related to the renegotiation of our core systems contract. These items totaled $2.6 million net of tax benefit, resulting in core earnings, per share of $0.54 a 5.9% increase over core earnings, in the second quarter of this year.

Core operating expenses decrease to $40.1 million as compared to $42 million in the prior quarter, as we realized efficiencies related to the capital bank acquisition during the quarter, and additional for legacy branches were consolidated, which would help us manage expenses in the fourth quarter and into 2020. So these consolidations are average deposits per branch now exceed 110 million dollars. Joe will provide more color and the loan growth for the quarter. But we're pleased to see full Philadelphia, New York contributing strongly which positions the company well for the future. The net interest margin contracted so the impact was primarily due to purchase accounting and prepayment deposit costs appear to have plateaued for this cycle, and pressure on the net interest margin going forward should moderate. Regarding Capital Management for the quarter, the board declared a quarterly cash dividend of 17 cents, the company's 91st consecutive quarterly cash dividend. The 17% dividend represents a 31% payout of core earnings. given the opportunity to repurchase shares of what we believe is an advantageous price. Our capital deployment strategy will continue to favor share repurchases, rather than dividend increases in the near term.

On a year-to-date basis the company has repurchased 786567 shares at an average cost of $22.95. Since quarter end we have been able to repurchase an additional 296200 shares at a weighted average price of $23.43. Inclusive of those purchases after quarter end we have repurchased a total of 1082767 shares this year. As long as we continue to be able to repurchase shares at these terms share repurchases will serve as one of our preferred methods of capital deployment. During the remainder of the fourth quarter however repurchase volumes may be limited due to the rules related to the pending shareholder votes for the Country Bank and Two River Bank acquisitions. In addition as part of our annual strategic planning effort the Board will consider an expansion of the existing authority to repurchase shares and the existing plan may be exhausted by year-end.

Our performance metrics remain highly competitive with a core return on assets of 1.35% a core return on tangible common equity of 14.53% and a core efficiency ratio of 53.56% all of which are slightly improved since the second quarter. The balance sheet remained strong with net credit recoveries and continuing low levels of delinquencies in nonperforming assets. In fact at just 22 basis points our nonperforming asset ratio is one of the lowest we have ever recorded. Tangible common equity to total assets remained strong at 9.73% while tangible book value per share increased by $0.29 to $14.86. Regulatory applications related to the Two River and Country Bank acquisitions are in process and we continue to plan that closing both acquisitions should occur in the first quarter of 2020.

At this point I'll turn the discussion over to Joe Lebel to provide more details regarding the development of our business.

Joseph J. Lebel III -- Executive Vice President and Chief Operating Officer

Thanks Chris. Record loan originations of $482 million drove loan growth of $138 million for the quarter. Commercial lending closing set an all-time quarterly high at $315 million with significant contributions from the Philadelphia and New York regions of $158 million and $100 million respectively as both geographies continue to gain momentum. We took the opportunity to add to our participation book after several quarters of planned runoff by partnering in $50 million of seasoned New York Metro co-op loans at average loan to values under 15%. As a result the commercial portfolio grew $119 million for the quarter. Residential real estate continues to exceed expectations and delivered $156 million in closings for the quarter and $41 million in portfolio growth. The total pipeline remains robust despite the record closing quarter at $320 million. And while much of the pipe was residential at quarter end we expect a solid fourth quarter in commercial activity.

Our swap product introduced earlier this year had a solid quarter. And while fee income from swaps can be lumpy on a quarterly basis booking floating rate loans with synthetic fixed rates for borrowers in this rate environment continues to diversify our loan book. While Fed cuts impact yields on these floating rate instruments in the short term we manage interest rate risk long term. We have built a strong stable lending teams and remain committed to strategic controlled growth in our markets. We are still finding good quality loans to strong borrowers as a result of our efforts. Moving to expenses. We are seeing the expected reduction as the Capital Bank cost saves take effect. Core expenses exclusive of merger-related costs and noncore items were reduced by $1.9 million in the quarter. Further improvements in the expense run rate due to the recently restructured core processor contract and the upcoming mobile and retail online vendor contracts will yield additional savings. We expect a portion of these savings will be reinvested in technology initiatives and some of our 2020 branch rationalization savings will fund additional expansion in treasury services to support our growing customer base in New York Philadelphia and New Jersey.

One final note on the continued initial success of our hybrid robo advisory product Net Egg. Since introducing the product in early 2019 we have seen organic growth measured by assets under management double each quarter rising to nearly $24 million at the end of Q3. While this represents small dollars to date and has no impact on the financial performance in 2019 and likely 2020 acceptance from our customers has been notable growth is ahead of plan and momentum is building.

With that I'll turn it back over to Chris for the Q&A part of the call.

Christopher D. Maher -- President and Chief Executive Officer

Thanks Joe. At this point we would be happy to take your questions.

Questions and Answers:

Operator

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

Frank Schiraldi -- Sandler O'Neill -- Analyst

Good morning.

Joseph J. Lebel III -- Executive Vice President and Chief Operating Officer

Good morning, Frank.

Frank Schiraldi -- Sandler O'Neill -- Analyst

Just a couple of questions. First on loan growth. Just given the strength in Philly and New York first maybe if you could talk a little bit about your expectation of trend in those 2 geographies. And then just your thoughts overall? I think in the past you've talked about $50 million to $100 million in net growth a quarter. And just sort of update us on your thinking there.

Joseph J. Lebel III -- Executive Vice President and Chief Operating Officer

Frank I think it's I think the focus on $100 million quarterly growth is a fair number. And the expectations for Philadelphia and New York are on track where we expect them to go. I think New York will continue to build. Early returns are good. And I think Philadelphia has hit the stride because of their head start a little bit earlier. But I think both trends assuming we can still in this marketplace find the kind of credits that we like to book should continue to be positive.

Frank Schiraldi -- Sandler O'Neill -- Analyst

Okay. And then just in terms of the margin outlook. I know the purchase accounting accretion kind of complicates things a little bit but just thoughts on the NIM from these levels.

Christopher D. Maher -- President and Chief Executive Officer

Frank I would say that if you strip out the purchase accounting and even the prepayments which are kind of transitory and just look at the core NIM we are pretty pleased that it just went down a couple of basis points in the quarter. And I think that that's how we are seeing things going forward. Of course if there are additional Fed cuts that place a little bit of a headwind but I think even if we have a couple basis points of core NIM contraction from quarter to quarter we can probably overcome that with new volume at this point and keep net interest income steady or rising. Mike do you have any other comments on the margin?

Michael J. Fitzpatrick -- Executive Vice President and Chief Financial Officer

Yes. So purchase accounting accretion actually for the fourth quarter will actually be slightly ahead of the third quarter. The third quarter was adversely affected because we had some true-ups to cash flow estimates and we trued those up to actual so there was this extra 3 basis points of downward pressure on that. So we had the benefit of slightly more accretion in the fourth quarter. Deposit cost seemed to have flattened and might even go down a little bit. And then there is a remix in the balance sheet from out of securities into loans and from, and even within loans into commercial book. So we think those are positives. The yield curve and maybe another Fed cut would be negative but I don't see much of a change maybe it's stable to slightly down in terms of the margin.

Frank Schiraldi -- Sandler O'Neill -- Analyst

Okay. Thank you.

Michael J. Fitzpatrick -- Executive Vice President and Chief Financial Officer

Thanks Frank.

Operator

Thank you. Our next question comes from the Russell Elliott Gunther D.A. Davidson. Go ahead.

Russell Elliott Gunther -- D.A. Davidson -- Analyst

Thanks. Good morning, guys.

Christopher D. Maher -- President and Chief Executive Officer

Good morning, Russell.

Russell Elliott Gunther -- D.A. Davidson -- Analyst

Mike just a follow-up on the margin while we are on it. The stable to slightly down guidance there is that for the fourth quarter? And does that assume an October rate cut?

Michael J. Fitzpatrick -- Executive Vice President and Chief Financial Officer

No. Without a rate cut stable to slightly down. Rate cut would obviously impact that a little bit probably about, we think about 2 basis points in NIM a 25 basis point rate cut considering our mix of assets and funding sources that are tied to either Prime or LIBOR or Fed funds.

Russell Elliott Gunther -- D.A. Davidson -- Analyst

Got it. Okay. And then on the expense side of things obviously a better result this quarter and appreciate the comments you guys gave about some incremental improvement in franchise reinvestment as well. But how would you expect that $40 million this quarter to run rate? Are there some pressures there? Can that be flat for the next couple of quarters? How, what are you thinking there?

Christopher D. Maher -- President and Chief Executive Officer

Russell, it's Chris. It can probably stay around flat. There may be an opportunity to get maybe a little bit under $40 million. But what we are doing is really taking advantage of opportunities to reduce expenses in the branch network and even in our contracts on IT in order to fund the initiatives we have going on in terms of the digital build-out and all that. So I know we referenced and it's in the numbers the renegotiation of our core systems contract. We also referenced that in the fourth quarter we will be renegotiating our digital vendor contracts. And we expected to give you a sense the cost per account will drop somewhere in the range of 50%. So we are trying to make sure we get on top of the unit economics in digital. As we move our customers from brick-and-mortar to digital it's really important that we keep the unit economies in digital working. So I think you're going to see us around that $40 million some quarters might be a little better. We are not going to see a drop but you also shouldn't see it under a lot of pressure either.

Russell Elliott Gunther -- D.A. Davidson -- Analyst

Okay. No that's very helpful Chris. And then just on the balance sheet side. So it sounds like organic growth and commercial lending growth is going to continue to be strong and then I hear you on remixing out of securities and into loans. So I'm curious as to when you expect sort of the $10 billion pressure to necessitate some sale out of single-family resi? And when we might see that show up in fees and again on sale perspective?

Christopher D. Maher -- President and Chief Executive Officer

So I'll refresh everyone that when we announced the Country and Two River acquisitions we discussed potentially staying at or below $10 billion throughout 2020 as a strategy to defend NIM and to be able to kind of increase our profitability before crossing over $10 billion maybe as soon as the first quarter of 2021. We look at a lot of things when we think through that. We look at economic conditions. We look at our organic loan growth numbers. And I would expect that you'll start to see us initiate some loan sales beginning in the fourth quarter. It won't be significant by dollar amount but just to get us in that mode. But then throughout 2020 we are going to look at economic conditions lending conditions and what we think we can do in organic growth rate. And it's possible we would consider accelerating the point at which we will cross $10 billion if we felt conditions were favorable enough. But we are going to have to see where the economy is we are going to have to see what our organic loan growth is and weigh the, obviously the headwinds on Durbin and things like that.

Russell Elliott Gunther -- D.A. Davidson -- Analyst

Got it. Okay, very helpful. Thank you guys.

Christopher D. Maher -- President and Chief Executive Officer

Thank you.

Operator

The next question comes from Collyn Gilbert KBW. Go ahead.

Collyn Gilbert -- KBW -- Analyst

Good morning guys. Chris just a follow-up on that comment it's interesting. So a change from what obviously you guys had indicated after the July call. And is it, just what is it that you're seeing in the market? Is it just the 10-year coming back a little bit or, that might make you feel better about adding the growth in 2020 relative to where your position was in July?

Christopher D. Maher -- President and Chief Executive Officer

Yes. I think you hit the nail on the head with the 10-year and the 5-year even. The rebound makes us a little bit more bullish on loan growth. We are also feeling very comfortable with the New York and Philadelphia teams sourcing really good product at yields we think we can live with. So we are going through various modeling exercises to understand what the right time is to cross $10 billion. Our default is still the first quarter of 2021 and I don't think we will really have the answer to that until we see hopefully in the next few months maybe some resolution under trade agreements and things like that and where the core economy is going. So you don't want to push that organic lever too hard if you're thinking there may be a credit cycle. That said good bankers always lend as though there's a credit cycle coming. So if you think you can kind of tailor your credit risk appetite in good times and bad you're probably going to get caught. So we are pretty conservative to begin with. So we are looking at things we are doing multiple projections. It is still our plan to defer the $10 billion across into the first quarter of 2021 but we are thinking about different options and how that might play out.

Collyn Gilbert -- KBW -- Analyst

Okay. That's helpful. And then Joe I just want to make sure I heard you correctly. When you were talking about the pipeline did you say the majority of the pipeline is in resi at this point?

Joseph J. Lebel III -- Executive Vice President and Chief Operating Officer

Yes. So at the end of the quarter the, we had such a strong quarter in the third from commercial. At the end of the quarter point in time September 30 the resi pipe was actually a little higher than the commercial pipe but the commercial pipe has rebounded robustly since then. So, and we are still going to have a great fourth quarter resi as well.

Collyn Gilbert -- KBW -- Analyst

Okay. That's helpful. And then just going back to, trying to reconcile some of the NIM comments. So is the change that you're anticipating in the fourth quarter, so I guess I kind of look at the core NIM having fallen 4, I'm sorry 8 basis points if you exclude accretion because it looked like the prepay impact was about the same in each of the quarters. So, and then it sounds like a better NIM outlook I know granted it doesn't assume a rate cut but what's driving that? And again it sounds like maybe you won't see a huge drop in deposits which would then perhaps indicate that loan pricing is better. I don't know. Just trying to kind of piece that puzzle together as to why your NIM outlook will be better in the fourth quarter than what you guys saw the compression happen in the third quarter.

Michael J. Fitzpatrick -- Executive Vice President and Chief Financial Officer

Yes. So for the third quarter the compression was 11 but 8, 9 basis points of that was purchase accounting accretion was down 6 and prepayment fees which are not a big part of our net interest income but they did go down from 4 basis points to 1. So 9 of the 11 were noncore items. So it was only 2 related to core. So, and then we are looking forward as I said we have, deposit costs have stabilized the earning asset mix out of securities into loan is a benefit within the loan book more weight on commercial loans is a benefit. Purchase accounting accretion in the fourth quarter will actually be $125000 more than it was in the third quarter. So that's not a tailwind. That's a headwind as it usually is. So that's why we are thinking flat to slight contraction with that regards for a rate cut. And if there's a rate cut like I said that would be 2 basis points negative.

Christopher D. Maher -- President and Chief Executive Officer

Also just add to Collyn that we are at about a 98% loan-to-deposit ratio and we have always enjoyed being under 100% in that case. But in a declining rate environment like we are experiencing now wholesale funding can have its advantages. So as we go into the fourth quarter if we have the kind of loan growth we would like to see we don't feel pressure to have to fund all of that with deposits. So we have the alternative. We have got loads of availability on the wholesale side at pretty attractive prices. So we think we have got a couple of tools that will help us at this point in the cycle.

Collyn Gilbert -- KBW -- Analyst

Okay. That's helpful. And then just as we think about kind of the efficiency there's, reinvestments that are happening as you guys have indicated on some of the savings that you're going to see from the 2 acquisitions and then also what you did this quarter can you just update us perhaps on maybe where you see kind of by the end of next year or where you have an efficiency target or goal to be?

Christopher D. Maher -- President and Chief Executive Officer

So I think we have talked about this before especially with the addition of Two River and Country which will help us become, add to operating leverage when we do both of those. We think it's possible we could cross under 50%. We are just being a little bit cautious given the NIM outlook over the next 4 quarters and not knowing exactly how many times the Fed might cut that the revenue side may actually impact more, that more than the expense side. So we think we have got a good handle we have got levers to prevent expenses from kind of creeping up but it's going to depend a little more on the revenue side how low that goes.

Collyn Gilbert -- KBW -- Analyst

Okay, OK, that's great. I'll leave it there. Thanks, guys.

Christopher D. Maher -- President and Chief Executive Officer

Thanks Collyn.

Operator

[Operator Instructions] The next question comes from Sean Tobin of Janney. Go ahead.

Sean Tobin -- Janney -- Analyst

Good morning, guys.

Christopher D. Maher -- President and Chief Executive Officer

Morning sean.

Sean Tobin -- Janney -- Analyst

I guess to start out to touch on the buyback. You guys bought back a good amount of stock in the quarter and have a nice amount of approval remaining. I know there may be some restrictions between now and when you guys close the 2 transactions. But can you give us some color on your appetite for buyback activity and what we can expect to see in the near term even prior to the deals closing?

Christopher D. Maher -- President and Chief Executive Officer

Sure. I'd just point to a few things. First just as a technical matter when we issued the S4 and it's in the mail for the shareholder vote we will not be repurchasing shares during the pendency of the vote. So that's just a matter of the rules we have to follow. But outside of that our appetite for the shares we think the earn back level at this price is pretty attractive. So we have a strong appetite. And then you really start to look at the capital equation and where is capital today where do we think it's going to be where will it be post 2 important events the acquisition of Country and Two River but also the implementation of CECL. So we are maintaining a TCE ratio well in the 9s even after the acquisitions and likely after CECL we think will probably remain in the 9s. And as long as we are at that level I think you can think about our, the earnings, the dividend ratio the earnings payout ratio of 31% and then look to split what's left after that between organic growth keeping capital for that and then using the rest for buybacks if we can. So we could, depending on the circumstances next year we could have a more active buyback program than we did this year.

Sean Tobin -- Janney -- Analyst

Got you. That's very helpful. Then switching gears to the nice growth you saw in noninterest-bearing deposits. Can you give us a little color on what drove that? Was that primarily from the C&I relationships from the new teams in Philadelphia and New York?

Christopher D. Maher -- President and Chief Executive Officer

We have had a concerted effort on our treasury services line of businesses for several years now. And I think one of the things that's not commonly appreciated about our deposit base is that 40% of the total deposits at OceanFirst have at least one treasury product with the bank. And it's a really important line of business for us. It's one we have invested in we have added staff to we had a great leadership to that team a year ago we are investing into technology underpinning that team and we have recently hired folks to support treasury sales in the Philadelphia and New York markets. So it's a product that we think is probably incredibly important to us in the future. So we are not surprised to see a little uptick in noninterest-bearing deposits. They're not always going to come in that way but we have a concerted effort against that.

Sean Tobin -- Janney -- Analyst

That's helpful. Good stuff. And then last one on the credit quality front. Is there anything you want to classify or criticize? Are those trends going to be similar to what we saw last quarter? And do they kind of directionally follow what we saw in the MPAs at quarter end?

Christopher D. Maher -- President and Chief Executive Officer

So there, I mean the credit trends are very positive very benign. We have not detected any trends in delinquencies migration to classify that would be of any consequence. That said you're not going to have quarters where you wind up with net recoveries every quarter right? So, and given that this is one of the lowest quarters we have ever seen in nonperforming assets to total assets I don't expect that we are going to be able to stay here forever. We did have a single credit included in the figures for the quarter end that moved to special mention. It was related to the bankruptcy of a tenant a cluster of commercial real estate properties that we lend to. That has resolved favorably. So we had strong guarantors. They paid the loan during the period of the bankruptcy. Bankruptcy has been resolved. There was a buyer who has reaffirmed the leases through low LTV. So in fact that will actually take a decrease from our special mention category. That was in the range of $16 million. But it was a well-structured credit. So when you have low LTVs fast amortizations and good guarantors even when you have a surprise you should be able to work it out at a decent outcome. So all positive at this point.

Sean Tobin -- Janney -- Analyst

Got you. Good stuff. That's it for me, thanks for taking my question.

Christopher D. Maher -- President and Chief Executive Officer

Thanks sean.

Operator

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

Christopher D. Maher -- President and Chief Executive Officer

Thank you. With that I'd like to thank everyone for their participation on the call this morning. We look forward to providing additional updates after year-end. So thank you.

Operator

[Operator Closing Remarks]

Duration: 29 minutes

Call participants:

Jill Apito Hewitt -- Senior Vice President and Investor Relations

Christopher D. Maher -- President and Chief Executive Officer

Joseph J. Lebel III -- Executive Vice President and Chief Operating Officer

Michael J. Fitzpatrick -- Executive Vice President and Chief Financial Officer

Frank Schiraldi -- Sandler O'Neill -- Analyst

Russell Elliott Gunther -- D.A. Davidson -- Analyst

Collyn Gilbert -- KBW -- Analyst

Sean Tobin -- Janney -- Analyst

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