OceanFirst Financial Corp. 2017 First-Quarter Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited interim results. OceanFirst Financial Corp. is the holding company for OceanFirst Bank, a community bank serving central and southern New Jersey. Results include the Cape Bancorp acquisition completed May 2, 2016, and the Ocean Shore acquisition completed November 30, 2016; the March 2016 comparison does not include those acquired operations.
Key Financial Metrics
| Metric | Q1 2017 | Comparable period or date |
|---|---|---|
| Net income | $12.0 million | $4.2 million in Q1 2016 |
| Diluted earnings per share | $0.36 | $0.25 in Q1 2016 |
| Net interest income | $41.5 million | $20.6 million in Q1 2016 |
| Provision for loan losses | $0.7 million | $0.6 million in Q1 2016 |
| Other income | $6.0 million | $3.4 million in Q1 2016 |
| Operating expenses | $31.0 million | $16.7 million in Q1 2016 |
| Total assets | $5.196 billion | $5.167 billion at December 31, 2016 |
| Net loans | $3.826 billion | $3.803 billion at December 31, 2016 |
| Deposits | $4.199 billion | $4.188 billion at December 31, 2016 |
| Stockholders’ equity | $582.7 million | $572.0 million at December 31, 2016 |
| Net interest margin | 3.56% | 3.34% in Q1 2016 |
| Return on average assets | 0.94% | 0.65% in Q1 2016 |
| Return on average equity | 8.42% | 7.01% in Q1 2016 |
| Efficiency ratio | 65.21% | 69.84% in Q1 2016 |
Revenue, Profitability, Cash Flow, Debt and Liquidity
- Total interest income was $46.0 million, compared with $23.1 million in Q1 2016. Average interest-earning assets increased by $2.254 billion, and their average yield rose to 3.95% from 3.75%.
- Interest expense increased to $4.5 million from $2.5 million, while the average cost of interest-bearing liabilities declined to 0.48% from 0.50%.
- The net interest rate spread was 3.47%, compared with 3.23% in the financial summary for Q1 2016.
- Net cash provided by operating activities was $12.0 million. Investing activities used $153.4 million, principally for loan growth and purchases of investment and mortgage-backed securities. Financing activities provided $15.3 million. Cash and due from banks declined by $126.1 million to $175.3 million.
- Debt and borrowings included $250.0 million of FHLB advances, $77.2 million of repurchase agreements and $56.6 million of other borrowings. Total contractual debt obligations were $383.8 million.
- The loan-to-deposit ratio was 91.11%. Time deposits scheduled to mature within one year totaled $367.1 million.
- Management stated that the Company maintained significant liquidity under stress scenarios and expected sufficient funds to meet normal commitments. The holding company held $25.6 million in cash at March 31, 2017.
- The Bank and Company exceeded applicable regulatory capital requirements. The Bank’s total risk-based capital ratio was 13.15%, and its common equity Tier 1 ratio was 12.68%. Tangible common equity to tangible assets was 8.43%.
Material Changes Versus Prior Periods
- Net income increased 186% from Q1 2016, primarily because the Cape and Ocean Shore acquisitions more than doubled the Company’s asset, loan and deposit base. Average diluted shares outstanding increased to 33.1 million from 17.1 million.
- Net interest income approximately doubled, reflecting acquired interest-earning assets, a higher margin and $1.8 million of additional purchase-accounting accretion.
- Other income increased by $2.6 million, including $2.1 million contributed by the acquired operations.
- Operating expenses increased by $14.2 million. Cape and Ocean Shore contributed approximately $11.2 million of the increase, and Q1 2017 included $1.4 million of merger-related expenses.
- The effective tax rate declined to 24.0% from 36.8%. Adoption of ASU 2016-09 reduced income tax expense by $1.4 million, primarily because of tax benefits associated with exercised acquisition-related stock options and the increase in the Company’s share price. Excluding that benefit, the effective tax rate would have been 32.7%.
- Compared with December 31, 2016, securities increased by $132.1 million as cash and short-term investments were deployed into higher-yielding securities. Loans increased by $22.2 million and deposits increased by $10.9 million.
Asset Quality, Outlook, Risks and Unusual Items
- Non-performing loans increased to $21.7 million from $13.6 million at December 31, 2016, primarily because of a $4.2 million commercial real estate relationship and a $3.9 million increase in non-performing residential mortgage loans.
- Non-performing assets increased to $30.5 million, or 0.59% of total assets, from $23.4 million, or 0.45%. The allowance for loan losses was $16.2 million, or 0.42% of total loans, compared with $15.2 million, or 0.40%.
- The Company recorded net loan recoveries of $268,000 in Q1 2017, compared with net charge-offs of $1.1 million in Q1 2016.
- The Company continues to hold a hotel, golf and banquet facility in OREO. The property generated a $733,000 loss in other real estate operations during Q1 2017, and the Bank was conducting a sales process with qualified buyers.
- Merger-related expenses and an accelerated stock-award expense associated with a director retirement reduced Q1 2017 earnings by $1.1 million after tax, or approximately $0.04 per diluted share. The comparable Q1 2016 reduction was $1.2 million after tax, or approximately $0.07 per share.
- Management described interest rates as beginning a gradual upward movement but cited uncertainty surrounding monetary policy, economic growth, competition and market conditions. The Company’s one-year interest-rate gap was negative 5.25%, within Board-approved policy limits, indicating exposure to changing interest rates.
- Key disclosed risks include interest-rate changes, economic and real estate conditions in New Jersey, credit quality, deposit flows, competition, regulatory changes, loan and securities prepayments, and successful integration of acquired operations.
- At March 31, 2017, the Company had $506.5 million of undrawn lines of credit and $139.3 million of commitments to originate loans. Management indicated that some commitments may expire undrawn and that normal liquidity was sufficient.
- The Board subsequently authorized repurchases of up to an additional 1.6 million shares, or approximately 5% of outstanding common stock. No shares were repurchased during Q1 2017. The quarterly dividend was $0.15 per share.
- The Company expects ASU 2016-13, the current expected credit loss standard, to increase the allowance for loan losses, particularly for longer-duration portfolios, but the amount was not determinable at filing. No material legal proceedings or material changes to previously disclosed risk factors were reported.
Important Facts for Investors to Verify
- Whether the increase in non-performing loans persists and whether the allowance remains adequate, particularly for commercial real estate and residential mortgage exposures.
- The sustainability of earnings after removing acquisition-related purchase-accounting accretion, merger costs, director-retirement costs and the $1.4 million discrete tax benefit.
- The pace and cost of deposit growth, loan growth and funding as interest rates rise, including the negative one-year interest-rate gap.
- The effectiveness and cost savings of integrating Cape and Ocean Shore, including the effect of elevated operating expenses and acquired goodwill and intangibles.
- The outcome and carrying value of the OREO hotel, golf and banquet facility sale process.
- The eventual capital and earnings impact of adoption of the CECL credit-loss model.
- The ability of OceanFirst Bank to distribute dividends to the holding company, which supports holding-company liquidity, debt service and shareholder dividends. The Federal Reserve had not objected to up to $32.0 million of Bank dividends over the year, subject to revocation for safety and soundness concerns.