Business Context and Reporting Period
OceanFirst Financial Corp. is the holding company for OceanFirst Bank N.A., a regional bank serving New Jersey and the metropolitan Philadelphia and New York City markets. This unaudited Form 10-Q covers the three and nine months ended September 30, 2020. Results include the January 1, 2020 acquisitions of Two River Bancorp and Country Bank Holding Company, which materially affect comparability with 2019.
Financial Performance and Position
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Interest income | $93.0 million | $76.9 million | $287.0 million | $231.7 million |
| Net interest income | $76.8 million | $63.4 million | $235.1 million | $192.6 million |
| Other income | $8.2 million | $11.5 million | $33.3 million | $30.9 million |
| Credit loss expense | $35.7 million | $0.3 million | $55.3 million | $1.3 million |
| Operating expenses | $56.8 million | $43.4 million | $175.5 million | $141.5 million |
| Net income | $(4.9) million | $25.0 million | $30.2 million | $65.1 million |
| Net income available to common stockholders | $(6.0) million | $25.0 million | $29.2 million | $65.1 million |
| Diluted EPS | $(0.10) | $0.49 | $0.49 | $1.28 |
- Net interest margin declined to 2.97% in Q3 and 3.23% for the first nine months, versus 3.55% and 3.66%, respectively, in the comparable 2019 periods. The decline reflected lower rates, low-yielding PPP loans, and excess liquidity.
- Operating expenses included $4.0 million of merger-related and branch-consolidation costs in Q3 and $19.0 million year to date. Q3 also included $1.7 million of COVID-19-related operating costs.
- Other income included a $3.6 million net unrealized loss on equity investments in Q3 and a $3.3 million loss year to date.
- Excluding identified merger, branch-consolidation, investment-loss, and applicable CECL-related items, management reported adjusted Q3 net loss of approximately $0.3 million and adjusted nine-month net income of $48.3 million.
Balance Sheet, Cash Flow, Debt and Capital
- Total assets were $11.65 billion at September 30, 2020, up from $8.25 billion at December 31, 2019, primarily from the Two River and Country Bank acquisitions.
- Net loans were $7.94 billion, including $388.8 million of loans held for sale. Deposits were $9.28 billion versus $6.33 billion at year-end 2019. The loan-to-deposit ratio declined to 86.2% from 98.2%.
- Cash and due from banks increased to $980.9 million from $120.5 million. Net cash provided by operating activities was $127.5 million; investing activities used $536.5 million; financing activities provided $1.31 billion.
- FHLB advances were $343.5 million, down from $519.3 million at December 31, 2019. Other borrowings were $246.9 million, including the May 2020 issuance of $125.0 million of subordinated notes with an initial 5.25% rate and May 2030 maturity.
- The Company issued approximately $55.9 million of 7.0% fixed-to-floating, non-cumulative perpetual preferred stock. Total stockholders’ equity was $1.46 billion; tangible stockholders’ equity was $935.7 million, or 8.41% of tangible assets.
- The Bank remained well-capitalized. At September 30, 2020, the Bank’s total risk-based capital ratio was 12.37%, common equity Tier 1 ratio was 11.62%, and Tier 1 leverage ratio was 8.36%.
- The Board declared a $0.17 common-stock dividend and a $0.4375 dividend per Series A preferred depositary share. Common-stock repurchases remained suspended, with 2,019,145 shares available under the authorization.
Material Changes Versus Prior Comparable Period
- Q3 net income available to common stockholders declined from $25.0 million to a $6.0 million loss, while diluted EPS declined from $0.49 to $(0.10).
- Net interest income increased 21.1% in Q3 and 22.1% year to date because of the larger balance sheet and acquired operations, but margin compression limited profitability.
- Credit loss expense increased sharply to $35.7 million in Q3 and $55.3 million year to date, compared with $0.3 million and $1.3 million, respectively, in 2019.
- Non-performing assets increased to $97.5 million, or 0.84% of assets, from $18.1 million, or 0.22%, at December 31, 2019. Non-performing loans held for investment were $29.9 million versus $17.8 million.
- The allowance for credit losses increased to $56.4 million, or 0.70% of loans, from $16.9 million, or 0.27%, following CECL adoption, pandemic-related provisioning, and credit-risk actions.
- Special mention and substandard loans increased to $141.5 million and $176.0 million, respectively, from $34.5 million and $73.2 million at year-end 2019.
Guidance, Outlook, Risks and Unusual Items
- Management did not provide specific earnings or revenue guidance. It stated that the full impact of COVID-19 remains unknown and rapidly evolving.
- The Company strategically transferred $45.5 million of forbearance loans to held for sale and sold higher-risk commercial loans to accelerate resolution of credit losses. Excluding loans held for sale, full-forbearance loans declined to $209.6 million, or 2.6% of loans, at October 23, 2020, from a peak of nearly 20%.
- The Company disbursed $504 million of PPP loans and recorded $17.7 million of deferred processing fees. It sold $298.1 million of PPP loans on October 29, 2020 and recognized a $5.1 million gain in the fourth quarter. A separate October 16 sale of $25.4 million of commercial loans resulted in a $92,000 fourth-quarter loss.
- COVID-19-related risks include additional borrower defaults, collateral-value declines, delayed foreclosures and loan resolutions, reduced fee income, elevated credit provisions, and increased operating costs. Government regulations and foreclosure moratoriums could delay collateral liquidation.
- Additional risks include interest-rate changes, deposit flows, competition, real estate values, integration of acquisitions, regulatory capital constraints, and the effectiveness of CECL estimates. Goodwill testing through September 30, 2020 identified no impairment.
- Outstanding undrawn credit lines totaled approximately $1.03 billion and commitments to originate loans totaled $377.1 million. Management stated that liquidity was sufficient under stress scenarios, but future dividends depend substantially on permitted capital distributions from the Bank.
Investor Verification Checklist
- Verify the sustainability of credit costs, allowance coverage, non-performing assets, and pandemic-related loan deferrals after the PPP and higher-risk loan sales.
- Assess whether deposit growth and excess liquidity can be redeployed without further net interest margin compression.
- Review the integration costs, credit marks, goodwill, and core deposit intangibles associated with the Two River and Country Bank acquisitions.
- Confirm fourth-quarter accounting and cash proceeds from the $298.1 million PPP loan sale and the $25.4 million commercial loan sale.
- Evaluate dividend capacity and any potential resumption of share repurchases against regulatory capital requirements and Bank dividend restrictions.
- Monitor commercial real estate exposure, forbearance performance, collateral values, foreclosure timelines, and future CECL assumptions.