OceanFirst Financial Corp. 10-Q Summary
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 Philadelphia and New York City metropolitan areas. This unaudited filing covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods. The January 31, 2019 acquisition of Capital Bank of New Jersey contributed $494.7 million of assets, $307.8 million of loans and $449.0 million of deposits; its results are included from February 1, 2019.
Financial Performance and Condition
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net interest income | $63.4 million | $61.5 million | $192.6 million | $178.7 million |
| Provision for loan losses | $0.3 million | $0.9 million | $1.3 million | $3.0 million |
| Other income | $11.5 million | $8.3 million | $30.9 million | $26.1 million |
| Operating expenses | $43.4 million | $39.5 million | $141.5 million | $147.3 million |
| Net income | $25.0 million | $24.1 million | $65.1 million | $45.2 million |
| Diluted EPS | $0.49 | $0.50 | $1.28 | $0.95 |
- Total assets were $8.135 billion at September 30, 2019, up from $7.516 billion at December 31, 2018. Net loans increased to $6.082 billion from $5.579 billion, and deposits increased to $6.221 billion from $5.815 billion.
- Q3 net interest margin was 3.55%, down from 3.67% a year earlier; the nine-month margin was 3.66%, down from 3.71%. The net interest rate spread was 3.32% in Q3, versus 3.52% in the prior-year quarter.
- Deposit costs increased to 0.62% in Q3 and 0.60% for the first nine months, compared with 0.39% and 0.36%, respectively, in the prior-year periods.
- The Q3 efficiency ratio improved to 57.9% from 68.1% in the linked quarter, reflecting initial Capital Bank integration savings. The reported Q3 ratio includes $3.2 million of merger-related, branch-consolidation and non-recurring professional expenses.
- Return on average assets was 1.23% and return on average equity was 8.66% in Q3, compared with 1.26% and 9.36%, respectively, in Q3 2018. These ratios include unusual expenses.
- Net cash provided by operating activities for the first nine months was $82.0 million, versus $62.2 million in the prior-year period. Investing activities used $28.3 million and financing activities used $20.3 million. Cash and due from banks plus restricted cash ended at $155.7 million.
- FHLB advances totaled $512.1 million at September 30, 2019, including $278.0 million of overnight borrowings. Total debt obligations were $673.9 million, with $452.5 million due within one year.
- Stockholders’ equity was $1.145 billion, or 14.07% of assets. Tangible common equity was $753.4 million, representing 9.73% of tangible assets. The Bank exceeded applicable regulatory capital requirements and remained well-capitalized under prompt corrective action standards.
- The quarterly cash dividend was $0.17 per share. The Company repurchased 477,400 shares in Q3 and 786,567 shares during the first nine months; 508,986 shares remained available under the repurchase authorization.
Material Changes Versus Prior Comparable Period
- Q3 net income rose 4% year over year, while diluted EPS declined to $0.49 from $0.50 because of a larger share count following the Capital Bank acquisition.
- Nine-month net income increased 44% to $65.1 million, primarily reflecting the Capital Bank acquisition and lower merger-related expenses.
- Excluding identified unusual items, management stated that net income increased in both comparison periods, primarily due to Capital Bank.
- Interest income increased with higher average interest-earning assets and loans, but higher funding costs compressed the net interest margin.
- Other income increased primarily because of lower real estate-operation losses, higher derivative fee income and the Capital Bank contribution.
- Q3 operating expenses increased because of $3.2 million of merger-related, branch-consolidation and professional expenses. Nine-month operating expenses declined despite $17.5 million of merger-related, branch-consolidation, professional and executive-retirement costs, compared with $28.8 million of comparable merger and branch-consolidation costs in the 2018 period.
- Asset quality remained generally stable: non-performing loans were $17.5 million, or 0.29% of loans, and non-performing assets were $17.7 million, or 0.22% of assets. The allowance was $16.6 million, or 0.27% of loans.
Guidance, Outlook, Risks and Unusual Items
- The filing provides no formal earnings or revenue guidance. Management expects sufficient liquidity to meet normal commitments and reports significant liquidity under its stress scenarios.
- Management is integrating Capital Bank and consolidated four branches during Q3, bringing total branch consolidations over three years to 40. The filing states that cost savings are beginning to be realized.
- Pending merger agreements with Country Bank Holding Company and Two River Bancorp were disclosed; the transactions were expected to close during the first quarter of 2020. The preliminary CECL reserve estimate does not include their anticipated impact.
- CECL adoption was scheduled for periods beginning after December 15, 2019. Based on September 30 portfolio balances and forecast conditions, management preliminarily estimated a 20% to 40% increase in current reserves, which were $25.1 million including non-accretable credit marks. The estimate remained subject to model refinement and future economic conditions.
- Material weaknesses in internal control over financial reporting previously disclosed in the 2018 Form 10-K remained unremediated at quarter-end. Management expected remediation to be completed during 2019, but disclosure controls were still deemed ineffective as of September 30.
- Key risks include interest-rate and funding-cost pressure, credit and commercial real estate exposure, deposit competition, economic and real estate conditions, regulatory changes, integration execution, and the transition away from LIBOR. The Company also had $809.9 million of undrawn lines of credit and $319.7 million of commitments to originate loans.
- The Company held debt securities with $5.1 million of total unrealized losses at quarter-end, including $4.9 million in held-to-maturity securities. Management considered the impairments temporary and stated it did not intend or expect to be required to sell the securities before recovery.
Investor Verification Checklist
- Verify the remediation status and testing results for the previously reported material weaknesses and ineffective disclosure controls.
- Assess the effect of higher deposit costs, a 97.8% loan-to-deposit ratio and increased FHLB borrowing on future margins and liquidity.
- Monitor Capital Bank integration savings, branch consolidation costs and the timing and execution risks of the pending Country Bank and Two River transactions.
- Reconcile the eventual CECL adoption adjustment with the preliminary 20% to 40% reserve-increase estimate.
- Review commercial real estate concentrations, special-mention loans of $61.1 million, substandard loans of $56.8 million and acquired PCI loans of $13.3 million.
- Evaluate the sustainability of the $0.17 dividend and share repurchases in light of holding-company cash of $5.8 million and dependence on Bank capital distributions.