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OceanFirst Financial Corp. (NASDAQ:OCFC)

Q3 2008 Earnings Call

October 24, 2008 11:00 am ET

Executives

Jill Hewitt – Senior Vice President and Investor Relations Officer

John Garbarino – President and Chief Executive Officer

Vito Nardelli – Chief Operating Officer

Michael Fitzpatrick – Chief Financial Officer

Analysts

Frank Schiraldi – Sandler O’Neill

Ross Haberman – Haberman Funds

Operator

Greetings and welcome to the OceanFirst financial quarterly earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Ms. Jill Hewitt, Senior Vice President for OceanFirst. You may begin.

Jill Hewitt

Thanks. Thank you all for joining us. I am Jill Hewitt, Senior Vice President and Investor Relations Officer. We will begin this morning's call with our forwardlooking statements disclosure.

This call, as well as our recent news release, may contain certain forwardlooking statements, which are based on certain assumptions and describe future plans, strategies, and expectations of the company. These forwardlooking statements are generally identified by use of the words "believe," "expect," "intend," "anticipate," “estimate,” "project" or similar expressions. The company's ability to predict results or the actual impact of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the company and its subsidiaries include, but are not limited to, changes in interest rates, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan product, deposit flows, competition, demand for financial services in the company's profit area, and accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forwardlooking statements, and undue reliance should not be placed on such statements. The company does not undertake and specifically disclaims any obligations to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Thank you.

Now I will turn the call over the our host this morning, President and Chief Executive Officer John Garbarino, Chief Financial Officer Michael Fitzpatrick, and Chief Operating Officer Vito Nardelli.

John Garbarino

Good morning to all who have been able to join in on our third quarter 2008 earnings conference call today. This morning, we are indeed pleased to be able to report on the continued improvement in our operations for the quarter just passed. We appreciate your interest in our performance and are eager to review our latest operating results with you this morning.

You have all had the opportunity to review our release; and, following my 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 earnings posted for the quarter as we continue to wrestle with the challenges in our current operating environment. It is abundantly clear that the unprecedented events of the past six weeks are having a dramatic effect on all financial institutions.

Most importantly, at OceanFirst, as a community bank, we have delivered strong financial performance and maintained the confidence of our depositors and local market as we emerge from the events of 2006 and 2007. In the coming days, as a healthy well-capitalized institution, we will certainly be further evaluating the options available to us under the Treasury's Troubled Asset Relief Program as additional details become available. For the quarter, diluted earnings per share were $0.32 representing a 6.7% increase from the link quarter and an 18.5% increase above the corresponding prior year period.

The company's 47th quarterly cash dividend was $0.20 per share, unchanged for the 23rd consecutive quarter, as our board remains committed to maintain the dividend in the near term consistent with our strengthening financial performance. The quarter’s earnings have again benefited from an expanding net interest margin, which increased 14 basis points from the previous quarter, partly offset by a decline in average interest-earning assets.

Earnings also benefited from the sale of a previously impaired, available for sale investment security, which was in fact sold during the quarter with an accounting recovery book. Partially offsetting this was the opening of our 23rd branch office, and the continuation of heavy professional fees and other administrative charges lingering from the shutdown of Columbia also resulted in higherthananticipated operating expenses. Our efforts to sublet office space previously occupied by Columbia in this market continue to fall short of our expectations. We have continued to temper these expectations and have increased our provisions for this vacant space through the first quarter of 2009.

Core deposits grew $41.4 million for the quarter, but were partially offset again by a $24.9 million decline in CD balances as we continue to exercise restraint in our CD pricing. Core deposits now exceed 71% of our total deposit base, a very satisfying transformation in the composition of our liabilities. We continue to bolster our tangible and core capital ratios which grew to 7.94% during the quarter. As noted earlier, with the strengthening of our earnings stream, our cash dividend is secure for now as our capital levels help improve our capacity to generate liquidity in the holding company.

At this point, however, irrespective of our revolving TARP strategies, with continuing plans to reserve capital, we do not anticipate any change in our moratorium on share repurchase activity for the foreseeable future.

I will ask Vito Nardelli, our Chief Operating Officer, to again bring you up to date on the Columbia loan repurchase reserve performance as well as comment on our core bank credit quality and loan loss provisions.

Vito Nardelli

Clearly in the current environment, concerns over credit quality command the attention of our management team and also remain a significant interest to our shareholders. I am pleased to report that total non-performing loans declined $2 million for the quarter to $12.5 million or 75 basis points of total loans receivable. Looking at the core bank portfolio, excluding the $5.2 million of residual Columbia loans which have already been aggressively written down to market, non-performing loans totaled $7.3 million.

Last quarter, I spoke of three non-performing commercial relationships totaling $4.3 million. This represented the area of improvement, as only $2.3 million consisting of two relationships remained outstanding at quarterend. The first relationship is a $9.1 million credit, which is well secured by commercial real estate in the process of a foreclosure. The second is the remaining balance of a loan to now notorious investor Solomon Dwek, which received a significant pay-down in the quarter, as one of two properties securing the credit was sold at a bankruptcy, leaving a $480,000 outstanding balance. The second Dwek property remains under a contract for sale for $950,000 under the control of the bankruptcy trustee.

Despite the quarter-to-quarter improvement of 12 basis points in non-performing loans and the fact that our portfolio delinquency metrics remain remarkably stable, easily outperforming peer indices, we remain diligent in our monitoring of emerging trends that might foretell future weakness. Reflective of this as well as the modest increase in our commercial loan production and the net chargeoffs of $101,000 in the quarter, we maintain the level of our third quarter loan loss provision at $400,000.

I would now turn our attention to the reserve for repurchase loans established as a result of the lingering potential from the subprime issues at Columbia. I am pleased to state once again, that performance has been in line with our expectations. While we received two repurchase requests in the quarter, they were resolved or repurchased. As with three of the four repurchase requests, which were outstanding at June 30, there is currently one remaining request and we are vigorously contesting this claim. In the light of the repurchase activity and resolution, our analysis indicates that the current reserve for repurchases was above what is deemed necessary, prompting a modest recapture of $50,000 of that reserve during the quarter. This reserve is $1.2 million at September 30. With that, I will return the discussion back to CEO Garbarino for the some concluding comments prior to engaging in a questionandanswer session this morning.

John Garbarino

Thank you. In closing, I would like to reflect on the extraordinary events of the past six weeks and perhaps, more importantly, the speed with which it has all transpired. Throughout this turbulent period, we have been continually challenged by the markets and unprecedented governmental interventions to address the problems.

In the past, I have often referenced the potential for and caution over major financial systemic shocks, which have now obviously come to pass. As I referenced earlier, we are carefully and cautiously following the remaining details of the comprehensive Treasury TARP as they are released. Pending the continued emergence of those details, our board will be assessing the merits of participation in TARP and remains cognizant of it fiduciary duty to shareholders with regard to exploring all available options.

In the interim, we plan to continue to exercise discipline in the pricing of our deposits and loans, particularly CDs, to both preserve our margins and protect profitable relationships wherever we can.

As I said earlier, the solid relationship we have nurtured with our community is perhaps our most cherished asset in this environment. It remains the principal point of differentiation for OceanFirst in this market. With that, Messrs. Nardelli, Fitzpatrick, and I we will be pleased to take your questions this morning.

QuestionandAnswer Session

Operator

(Operator Instructions) Your first question is from Frank Schiraldi Sandler O'Neill.

Frank Schiraldi Sandler O'Neill

Just a few questions. First, I wonder if John could give us a little more detail on the increased occupancy costs. I know you talked about a couple of subleases through Columbia. If you could just talk about the size of those offices, how long the leases run, and plus say they do stay vacant for an extended period of time, what sort of losses or sort of increase on a quarterly basis?

John Garbarino

As I said, we had developed expectations about how long it might take us and at what rate we might be able to sublet most of this space. Needless to say, commercial real estate markets haven't moved in our favor as far as that's concerned. The largest office that we have, I believe, is about 10,000 square feet up in Westchester County in Valhalla. That's the one with the longest lease to run, too, I believe it still runs three or four years, 2012 it expires.

We're looking at that on a quarter-by-quarter basis. There are some other smaller parcels out on Long Island and other areas around. We have tempered, as I said, our expectations with regard to that and tried to lower the goals that we would have for subletting it. Clearly, we are looking at it on a quarter-by-quarter basis, trying to stay six months ahead of it. The provisions that were made in this quarter cover us through the end of March 2009. If we are still unable to get any activity after that date, then we will have to extend it again. And we will take a look at that a little closer at the end of the year.

The other local occupancy expenses we had, maybe more importantly compensation expenses, were related to, and I said in my opening comments the 23rd branch office, but in essence it was the 22nd and 23rd. The 22nd office was opened right at the end of the second quarter, and so there wasn't a full quarter of expenses associated with it. We’ve been gearing up for these for some time, and the people have been brought on board. So it’s really two offices that were opened in essence over the last four months or so.

Other than that, the operating expenses, just we have some very heavy professional fees, attorneys and still some accounting fees associated with the unwinding of Columbia. As much as we'd like to see it go away, it's still lingering on much longer than we thought originally. We would love to see a real clean quarter here; and I know in terms of your modeling it, you’d love to be able to get your arms around it a little better, too. Believe me, the attorneys’ fees are substantial.

Frank Schiraldi Sandler O'Neill

Is there any disclosure you can give, the one you mentioned about 10,000 square feet up in Westchester, how much are you paying for that and what are your loss expectations?

John Garbarino

You want us to open the kimono and tell you what we'd like to get for it? Is that the deal? I don't know that I have all that information handy. It's my recollection that we have remaining exposure there of almost $600,000 through 2012. That's if there's no sublet available. If you can look at it say over the next four years, there’s about $600,000, about $150,000 a year, of total exposure.

I don't know if that helps you. That's the most exposure. The other properties have shorterterm leases and significantly less exposure. The one in Valhalla is largest.

Frank Schiraldi Sandler O'Neill

Do you have any thoughts on margins expectations? I would think the Fed cuts would help you guys pretty quickly. Is that fair to say?

John Garbarino

I think we're probably at the point where the Fed cuts have very little effect because, and we've talked about this numerous times, there's only so low that you can take your deposit rates. I think we're probably there. The last 50-basis point rate cut and any subsequent cuts that may be coming along are likely to have much less effect on our margin than they've had to date. There would still be some benefit in any borrowings that were being rolled, presumably that's going to be passed along in terms of our home loan bank advance rates; but our ability to exercise any additional discipline with regard to pricing our retail deposit products, our principal source of funding, is pretty much all used up at these levels. We see much less margin effect in the quarters going forward that might come from the Fed. We're still anxious obviously in pricing CDs, as I said, with a strong degree of discipline and earning our way with our core deposits as much as we possibly can. We have seen significant improvement in that over the first three quarters of this year. As I say, they’re over 71% now total deposits. That's a significant milestone for us.

Frank Schiraldi Sandler O'Neill

Finally, just wonder if you can touch on the balance sheet as far as the loan size, flattish growth there and what. Is it the fact that what you're seeing coming in the door is basically just not creditworthy? Is it that funding costs are just making it not worth it on the margin side?

John Garbarino

I think it's been a question of funding. I think that if you look at this quarter, you will see that we had some pretty significant commercial loan growth and that's always our primary focus here in terms of portfolio growth. The funding has been somewhat limited. We haven’t been in an expansive stage with regard to our balance sheet as a whole, and so any commercial loan growth that we're able to generate, it's generally generated at the expense of our residential mortgage portfolio. So what we're trying to do in times like these, I mentioned this, is to conserve our capital, manage those capital ratios and close as we can, not pursue an exceptional amount of growth, but where we can pursue growth in the commercial portfolio, we take it.

We have seen over this last quarter, several instances where formerly very difficult and formidable competitors in the commercial loan market, principally Wachovia, B of A, TD Banknorth, have declined to even issue term sheets on credits that we had been competing for. That's amazing. I think with Wachovia, we understand that. I think they are subject to pressures now, having seen what's occurred with them over the last three months. We also see that with B of A. The money sent there in super-regional banks, I think have been more and more absent from our market. We see more and more opportunity.

Having said that, we have certain funding restrictions ourselves and we're not at breakneck speed to try and grow this portfolio. We still exercise an extreme amount of discipline and attention to credit quality, and there's no way that we're going to be the repository here for everyone else's bad credit.

We had some nice portfolio growth on the commercial side this past quarter. I believe the increase was something of the order just under $20 million for the quarter, which is pretty strong for us. Takes our commercial portfolio up. I think if we can see that continue certainly for the subsequent quarters, we will be pleased.

Operator

Your next question comes from Ross Haberman Haberman Funds.

Ross Haberman Haberman Funds

Did you summarize how much in terms of the other expenses, legal, and so forth, putting aside the leases for the moment. Do you think it will be less recurring or not recurring after this quarter or two?

John Garbarino

I’d love to cut the attorneys off, Ross.

Ross Haberman Haberman Funds

I would, too.

John Garbarino

They’re still pretty significant.

Ross Haberman Haberman Funds

You see this lasting for how many more quarters?

John Garbarino

As I said in the past, I think they're beginning to wind down. There's a lot of actions that are being pursued right now that are still costing us substantial legal fees. That, and then the other big item is the compensation and benefits associated with the new offices. Those are the two biggest items really, the occupancy compensation and benefits and legal fees.

Ross Haberman Haberman Funds

How much were the extraordinary legal fees?

John Garbarino

This quarter, just under $200,000. It's significant. Not a number to be sneezed at. I’m not talking about some token fees here. With what's going on with TARP and so forth, it's not just the Columbia. Maybe I am unfairly characterizing as related to the unwinding of Columbia. Every time we have to evaluate another Treasury proposal and take a look at TARP or any other program that comes down the pike, obviously, the attorneys are involved and that clock is running.

Ross Haberman Haberman Funds

Unfortunately, right. I have two balance sheet questions. The $215 million of what you deemed consumer loans, are those all home equity and how much of that do you have the first mortgages on?

John Garbarino

They're principally home equity loans and lines. There's a very, very minor amount of direct auto loans. We don't do any indirect auto lending. And there’s some overdraft line of credit loans. The vast majority is home equity loans and lines. I don't know that we have the exact ratios as to how much represents first lien, but I think it would be fairly significant the way lending went over the last couple of years.

The amazing thing, the delinquency metrics with regard to that portfolio is holding up so well. And completely uncharacteristic compared to what we see in other areas of the country. I think that's true of what we see around the state also. I don't think it's singular to OceanFirst. I think in the state of New Jersey the home equity lending delinquency metrics are very, very strong.

We're even monitoring and we monitor closely 30-day delinquencies here. There's no uptick in even 30-day billing. Looking for a dark cloud, our collection people tell us that people who used to pay on the 17th might be paying on the 25th but that's about as dark a cloud as they can find on the horizon.

Ross Haberman Haberman Funds

Finally, with the advent of Sovereign going away, how do you see that? Do you see that affecting business much?

John Garbarino

I'm not sure that's going to be a big effect. We didn’t see Sovereign very much, even over the last four or five years quite frankly. I wouldn’t classify them in the top three or so of our retail competition. My understanding is that Santander generally does not rebrand when they do this. They didn't do that certainly with First Union and some other occurrences. I think Sovereign with continue to exist there, whether or not they're going to be a more formidable competitor as a result of Santander acquisition, I think, remains to be seen. I don't think we ever considered them to be a significant force in our market. They had a reasonably large market share, but that was all acquired over the year with acquisitions that they had done. On a continuing basis, their market share has been decreasing.

Ross Haberman Haberman Funds

Could you describe, I got on a little late, could you give us some color on the local residential and commercial market today?

John Garbarino

Vito spoke to that in terms of our credit metrics. Without going into specifics, just that the credit metrics are holding up real well.

Ross Haberman Haberman Funds

I guess what I am getting at is commercial is holding up [inaudible] residential. Is that down?

John Garbarino

You mean lending or delinquency?

Ross Haberman Haberman Funds

Pricing.

John Garbarino

Pricing has been pretty stable. The pricing on the residential side has been whipsawed obviously with what's gone on in the credit markets. When I saw whipsawed, I'm talking about one-eighth to three-eighths up or down in any given monthly period. It's holding in there pretty tight. On the commercial side, we haven't seen any opportunity to get more aggressive with pricing, but we always had a fairly high pricing threshold. We never dropped our prices as low as some other institutions did. Quite frankly, as I mentioned a little bit earlier, we haven't seen Wachovia on any deal that we have issued term sheets on in the last month, and we’ve seen B of A less and less. They were two very formidable forces in the market, and their exit from the commercial lending market has been, I think, to our benefit.

Operator

There are no further questions in the queue at this time.

John Garbarino

We do want to correct one piece where Vito misspoke. We attacked him as he did this. He transposed a number and that was related to, Vito?

Vito Nardelli

When I characterized the first relationship talking about the $2.3 million consisting of two relationships. I think I mentioned the first relationship was $9.1 million; it's $1.9 million.

John Garbarino

That was in the commercial real estate in the process of foreclosure. We didn't want to leave the impression that there was a $9 million relationship in the process of foreclosure. It was a simple transposition of 1.9.

Vito Nardelli

I am being sent to the eye doctor this afternoon, so that will never happen again.

John Garbarino

Vito, thank you for your honesty. We thank you all for your attention this morning. We look forward to talking to you toward the end after the year.

Operator

This concludes today's teleconference.

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Source: OceanFirst Financial Corp. Q3 2008 Earnings Call Transcript

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