OceanFirst Financial Corp. (NASDAQ:OCFC) Q3 2023 Earnings Call Transcript

OceanFirst Financial Corp. (NASDAQ:OCFC) Q3 2023 Earnings Call Transcript October 20, 2023

Operator: Hello, all and welcome to OceanFirst Financial Corp’s Third Quarter 2023 Earnings Call. My name is Lidya and I’ll be your operator today. [Operator Instructions] I’ll now hand you over to your host, Alfred Goon, SVP of Corporate Development and Investor Relations to begin.

Alfred Goon: Thank you, Lydia. Good morning, and welcome to the OceanFirst third quarter 2023 earnings call. I’m 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 Chief Executive Officer.

Christopher Maher: Thank you, Alfred. Good morning, and thank you to all, who’ve been able to join our third 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 in this opportunity to discuss our results with you. This morning, we’ll 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. Our financial results for the third quarter included GAAP diluted earnings per share of $0.33.

Our earnings reflect net interest income of $91 million, representing a modest decline compared to the prior linked quarter of $92 million. Our third quarter results were impacted by modest margin pressure linked to our efforts to improve the bank’s liquidity position and the quality of our deposit funding. These efforts resulted in meaningful deposit growth, a substantial decrease in brokered CDs, and a measurable reduction in the loan-to-deposit ratio. The resulting mix shift in our deposits play some pressure on net interest margins, but that pressure is decreased significantly as compared to the past two quarters and appears to be reaching a point of equilibrium. Our deposit betas increased to 35% from 29% in the prior linked quarter. Advancing a more competitive pricing strategy through various channels has protected our deposit base, which increased 4% to $10.5 billion, while reducing brokered time deposits by $426 million and bringing our loan-to-deposit ratio to 96%.

Capital remains strong as we ended the period with a tangible book value per share of $17.93 and a CET1 ratio of 10.36%, both measures improving modestly since last quarter. Turning to Capital Management. The Board approved the quarterly cash dividend of $0.20 per common share. This is the company’s 107th consecutive quarterly cash dividend and represents 61% of GAAP earnings. The company did not repurchase any shares in the third quarter. While we continue to see the frequency and magnitude of external economic, geopolitical, and natural forces increase. I am reassured that over the past year, our quarterly net interest income is only declined in the range of 5% and we are highly confident that our quarterly expense run rates as we finish 2023 are reverting to mid-2022 levels.

Whether or not this becomes a new normal for the industry remains to be seen, but I’m convinced that we will remain very competitive in whatever environment may evolve. At this point, I’ll turn the call over to Joe to provide some more details regarding our progress during the quarter.

A – Joe Lebel: Thanks, Chris. Net deposit growth for the quarter of $375 million was concentrated in core growth of $343 million. For the month of September, a decrease of $305 million in non-core, primarily brokered CDs, resulted in a meaningful change in deposit composition for the first time this year. Year-to-date deposit growth of $859 million is a reflection of our thoughtful and concerted effort to win meaningful deposit relationships in today’s competitive and higher cost deposit environment. Continuing on the deposit front, I wanted to mention our addition of a new branch opening in December in the town of New Brunswick, located in Middlesex County, New Jersey. On the loan origination side, we continue to see tempered growth as a result of reduced demand from customers and our pricing expectations given the cost of funding.

Asset quality metrics remained strong with non-performing loans in criticized and classified assets, representing 1.3% and 0.2% of total loans, respectively. The quarter included an $8.4 million charge-off on a single commercial real estate relationship as previously announced, which so far continues to be an outlier in our portfolio. Additionally, this relationship was included in our non-performing loans at September 30. Absent this, non-performing loans would have decreased $1.4 million. Net charge-offs for the year are $8.3 million, representing only 11 basis points of total average loans on an annualized basis. With that, I’ll turn the call over to Pat to review margin and expense outlook.

Patrick Barrett: Thanks, Joe, and good morning. Net interest income and margin were $91 million and 2.91% respectively, reflecting higher funding costs associated with deposit growth. As Chris noted, funding costs reflect cycle-to-date deposit betas of 35% and we clearly saw margin compression begin to stabilize throughout the quarter. While we believe our fourth quarter margin may see further modest compression, we’re hopeful that such compression will be ending as we finish the fourth quarter of 2023. We continued to maintain excess cash during the quarter, reflecting the stress liquidity environment and combined with continuing uncertainties around monetary policy and the risk of a government shutdown. As those risks ease and the banking sector continues to stabilize, we expect to normalize cash levels which will have a modest, but positive impact on net interest margins and capital ratios.

Non-interest expense increased $1.5 million to $64.5 million compared to the prior quarter. The increase in expenses includes $2.4 million of one-time charges related to severance and other compensation linked to the company-wide strategic initiatives and investments we introduced earlier this year. As a reminder, we’ve been investing improving processes and longer-term strategic growth throughout this year focusing on expanding our C&I, deposit gathering, and residential businesses, as well as improving the revenue contribution of our branch network, increasing automation of internal processes, and improving infrastructure support across all lines of business. Progress on this project remains on track, and we’ve made meaningful strides to improve both internal processes and the customer experience.

As a result of the work performed on this project, we believe quarterly operating expenses will decline to the $58 million to $59 million range next quarter, representing an annualized reduction of between $20 million and $25 million going forward, compared to the current expense run rate that we’re tremendously pleased. We continue exploring additional opportunities to further improve our operating leverage in 2024. Our effective tax rate for the quarter, 24% remains in line with prior periods and guidance, and we expect to remain in this range going forward. Turning to the balance sheet, which we don’t usually talk about on an earnings call, we just wanted to highlight one thing, the company completed its annual goodwill impairment test as of August 31 and we concluded that our goodwill is not impaired.

However, given the depressed stock prices that many banks are experiencing combined with the volatility of those stock prices that we’ve seen over the last few months. We’ll likely be reevaluating this conclusion at year end. Finally, we expect capital to remain strong through the remainder of the year with a CET ratio of about 10%. At this point, we’ll begin the Q&A portion of the call.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question today comes from Daniel Tamayo of Raymond James. Your line is open.

Daniel Tamayo: Thank you. Good morning, everyone. Maybe we can start just on — good morning, on the margin and you talked a little bit about, Pat and Chris, the forecast for the fourth quarter being similar compression to the third and then stable, and the deposit mix shift that’s happening. I’m just curious, if you can go in a little bit more detail about kind of what’s driving the remainder of the compression in the fourth quarter and why you think that you can get stable margin in 2024?

Christopher Maher: I think we would start by just kind of gauging the pressure we’ve had on deposit costs throughout the course of the year, and we’ve seen it steadily decline kind of step by step since April of this year, and it really appears to be flattening out. So as we kind of look through our models, which are always imperfect, and we kind of think about the outside rate environment which is outside our control, it’s challenging to come up with a forecast, but it does appear that NIM could trough in the fourth quarter, that’s our best guess as of this point. And then in terms of what happens in 2024, it’s really dependent upon the outside rate environment. There is the possibility for a tailwind and we’re certainly working to improve the chances of that on our side, but we are going to be beholden to the market to a certain degree.

Daniel Tamayo: Okay. But in terms of, I guess, the mix shift that you’re anticipating, is it fair to say that you’re going to see or you expect the remainder of the broker deposit balances to come off in the fourth quarter or the FHLB? I’m just curious kind of how you expect the entire kind of funding side to work over the next few quarters.

Joe Lebel: Yeah. I think we had — historically we’ve had a very low level of brokered CDs, so we took the opportunity when things got a little bit tight in the spring to build up excess liquidity and we used brokered as a quick way to do that effectively. I think over time, lower brokerage is always better, but we’re going to be — I think we’re in a good place now. So we will take the opportunity depending on kind of how rates market — rate markets work in the fourth quarter to maybe move that around a little bit. But I don’t think you’re going to see big changes. We’ve also seen that our non-interest bearing accounts seem to be behaving very steadily. So when we think about non-interest deposits compared to earlier this year, you’re just not seeing customers behaving in the way they were back in April.

So if deposits which may continue to increase in cost hold a little bit slower at the rate of increase, we do have a lot of loans repricing, we have new loans we make every day and then we have the opportunity to work on that side of the margin. So I think some additional deposit pressure, not a big mix shift. We think the mix is going to be largely similar to where you see it as of September 30 and we do have some opportunity on the loan side.

Patrick Barrett: If I could add just one thing that, that isn’t in the material, this is Pat, that might be helpful. We have repaid all of our short-term liabilities that we can. So everything we have left on the balance sheet is term. Our FHLB funding about $600 million matures $100 million every year starting next year or $200 million starting next year. And then our brokered CDs and our own house-issued promotional retail CDs have average remaining lives of about six months right now. So we’d have to actually break and penalize ourselves if we were going to reduce things further. So that’s kind of what’s driving the near-term compression. And then everything that Chris said kind of means next year is going to be — probably bouncing along plus-minus range at fairly stable, unless there’s higher levels of loan growth, which we should hopefully coincide with expansion.

Daniel Tamayo: Okay. All right. I appreciate all that color. And just lastly, maybe a little on the asset side. If you could provide any kind of color on what cash flows may look like in the next few quarters and on the cash side to the excess cash, just your thoughts on the pace of the reinvestment of that.

Christopher Maher: In 2024, we have a little bit more cash flow in terms of maturing loans than we had in 2023. Maybe, Joe, if you could just talk to the market for that and then, we can kind of swing back to give you a sense of the magnitude.

Joe Lebel: So, Dan, I think I’d start by saying that, I think we have opportunity to improve margin from the renewal of loan transactions. We’re looking at this. As you know, we’ve done a variety of things on the asset quality side, stress testing, all the kind of things you need to do. But we’re hearing from — we’re hearing from clients that as loans renew, their expectations are very similar to ours. They understand the market that we’re in, their relationship clients, they understand that they’re going to be repriced at certain levels. Those that are in the C&I bucket are already at floating rate levels, so they’ve repriced the market for the most part. And we don’t have a significant amount of maturities in ’24. You guys are aware from the 8-K supplement, but the stuff that we do will price and provide us with a little bit of extra NIM as we go forward.

Christopher Maher: Yeah. And maybe I just add on to that. On the asset side, we’ve got about $1.4 billion repricing maturing coming in next year. The loans are the bulk of that. So our securities cash flows remain relatively stable at about $40 million a quarter. Then we’ve got the liabilities that are repricing, and I just kind of outlined those. Those are actually a little bit more volatile with the remaining $0.5 billion, call it, of record CDs maturing fairly evenly over the next three quarters and our retail CDs have buckets and some volatility, Q1, Q2 being the bigger quarters of maturity. So that’s kind of the general range of cash flows.

Daniel Tamayo: Terrific. I appreciate all the color. That’s all for me.

Christopher Maher: All right. Thank you.

Operator: Thank you. Our next question today comes from Justin Crowley of Piper Sandler. Your line is open.

Justin Crowley: Hey. Good morning, guys.

Christopher Maher: Good morning, Justin.

Justin Crowley: Just want to hit on some of the expense measures. Good morning. That have taken place. You saw that run through the base this quarter, and I know you’re maybe not necessarily in a position to get real specific about ’24. But just wondering if you can comment on perhaps any smaller initiatives that could be additive to some of the efficiency gains that are already in the run rate?

Patrick Barrett: Sure. So this is Pat. I would first caveat anything we see — say about opportunities in 2024, still facing the headwinds of persistent inflation. So the bias for every cost is to go up, including people costs. And so, it’s not an easy market without reducing vendors or reducing employees to do that, but we continue to have some opportunities. So we think — we actually think our run rate of, call it, $58 million, $59 million that we’re expecting in the fourth quarter is a pretty good run rate quarterly for the following year, it will be a little tough because we’re going to have to manage through inflation and normal merit increases and all that, but we feel like we’ve got a decent shot at that. We still have initiatives that are in the early stages that are geared around some of our larger processes.