OceanFirst Financial Corp. 2018 Form 10-K Summary
Business context and reporting period
OceanFirst Financial Corp. is the holding company for OceanFirst Bank N.A., a community bank focused on central and southern New Jersey, with commercial and residential lending, deposits, bankcard, wealth management and related financial services. This Form 10-K covers the fiscal year ended December 31, 2018. The Bank converted to a national bank charter and the Company became a bank holding company on January 31, 2018.
The January 31, 2018 acquisition of Sun Bancorp materially expanded the Company. Sun contributed approximately $2.0 billion of assets, $1.5 billion of loans and $1.6 billion of deposits; its operating results are included from February 1, 2018. The subsequent Capital Bank of New Jersey acquisition closed January 31, 2019 and is not included in 2018 operating results.
Key financial metrics
| Metric | 2018 | 2017 | Change or commentary |
|---|---|---|---|
| Total assets | $7.516 billion | $5.416 billion | Increased primarily from Sun |
| Loans receivable, net | $5.579 billion | $3.966 billion | Increased $1.613 billion |
| Deposits | $5.815 billion | $4.343 billion | Increased $1.472 billion |
| Net interest income | $240.5 million | $169.2 million | Increased 42.1% |
| Other income | $34.8 million | $27.1 million | Included $8.0 million from Sun |
| Provision for loan losses | $3.5 million | $4.4 million | Net charge-offs were $2.6 million versus $3.9 million |
| Total operating expenses | $186.3 million | $126.5 million | Included $26.9 million of merger expenses and $3.2 million of branch consolidation expenses |
| Net income | $71.9 million | $42.5 million | Increased 69.4% |
| Diluted EPS | $1.51 | $1.28 | Increased 18.0% |
| Net interest margin | 3.68% | 3.50% | Benefited by $10.7 million of Sun purchase-accounting accretion |
| Return on average assets | 0.98% | 0.80% | Improved |
| Return on average equity | 7.31% | 7.20% | Improved modestly |
| Efficiency ratio | 67.68% | 64.46% | Worsened due partly to integration and consolidation costs |
Commercial real estate, multi-family and land loans represented 49.5% of total loans, while commercial loans overall represented 54.9%. The allowance for loan losses was $16.6 million, or 0.30% of total loans, excluding acquired-loan credit marks. Non-performing loans were $17.4 million, or 0.31% of loans, and non-performing assets were $18.8 million, or 0.25% of assets.
Cash provided by operating activities was $92.6 million. Investing activities provided $48.6 million, primarily reflecting loan-related cash flows and securities maturities, while financing activities used $128.4 million, including dividends, share repurchases and debt and deposit activity. Cash and due from banks, including restricted cash, increased $12.7 million during the year to $122.3 million.
Borrowings totaled $610.7 million at year-end, consisting primarily of $449.4 million of Federal Home Loan Bank advances, $61.8 million of repurchase agreements and $99.5 million of other borrowings. The loan-to-deposit ratio was 96.0%. Management stated that liquidity remained sufficient under its stress scenarios. Outstanding loan commitments were $186.2 million and unused credit lines totaled $733.9 million.
The Company and Bank exceeded applicable regulatory capital requirements. The Bank reported a 10.01% Tier 1 leverage ratio, a 13.39% common equity Tier 1 ratio and a 13.72% total capital ratio, and qualified as well-capitalized. The Company’s tangible common equity to tangible assets ratio was 9.55%.
Fourth-quarter 2018 results
For the quarter ended December 31, 2018, net income was $26.7 million, or $0.55 diluted EPS. Net interest income was $61.8 million, the provision for loan losses was $0.5 million, other income was $8.7 million and operating expenses excluding merger and branch consolidation expenses were $37.8 million. Merger-related and branch consolidation expenses were $1.3 million.
Material changes versus the prior comparable period
- The Sun acquisition drove most of the balance-sheet expansion, including increases in assets, loans, deposits, goodwill and equity.
- Net interest income increased primarily from higher average earning assets, increased loan balances, purchase-accounting accretion and higher asset yields.
- Funding costs increased: the cost of average interest-bearing liabilities rose to 0.70% from 0.50%, and total deposit cost rose to 0.39% from 0.29%.
- Credit metrics improved overall: non-performing loans declined from $20.9 million to $17.4 million, and net charge-offs declined from $3.9 million to $2.6 million.
- Operating expenses rose substantially because of the Sun acquisition, $26.9 million of merger expenses, $3.2 million of branch consolidation expenses and higher compensation, occupancy and data-processing costs.
- The effective tax rate declined to 15.9% from 35.0%, reflecting the Tax Cuts and Jobs Act and a $1.9 million deferred-tax-asset revaluation benefit. Excluding that revaluation, the 2018 effective tax rate was 18.0%.
- The Company paid $0.62 per share in cash dividends, compared with $0.60 in 2017, repurchased 459,251 shares for $10.8 million and retained authorization to repurchase approximately 1.3 million additional shares.
Guidance, outlook, commentary, risks and unusual items
Management did not provide formal quantitative earnings guidance. Its stated strategy is prudent growth in commercial lending and core deposits, expansion of fee-based services, operational investment, branch rationalization and opportunistic acquisitions. The Company expected at least seven branch consolidations in 2019 and planned additional commercial loan production capacity in Philadelphia and New York City.
On January 31, 2019, the Company completed the $76.8 million Capital Bank acquisition, issuing approximately 3.185 million shares. The transaction added approximately $498 million of assets, $311 million of loans and $449 million of deposits. Management also noted that the Company was approaching the $10 billion asset threshold that would trigger additional regulatory and operating requirements.
Important risks include concentration in New Jersey real estate and commercial lending, interest-rate and deposit-cost pressure, acquisition integration, prolonged New Jersey foreclosure timelines, natural disasters and coastal exposure, competition from banks and technology providers, cybersecurity and third-party systems, regulatory and tax changes, and potential goodwill impairment. The Company expects the current expected credit loss standard to increase the allowance for loan losses, particularly for longer-duration loans, but had not yet determined the amount.
The filing contains a significant control issue: management concluded that internal control over financial reporting was not effective at December 31, 2018 because of material weaknesses in information-technology general controls over user access and in monitoring controls for the core banking system. KPMG issued an adverse opinion on internal control over financial reporting, although it issued an unqualified opinion on the consolidated financial statements. Management planned remediation during 2019; the weaknesses were not considered remediated until controls operate effectively for a sufficient period and are tested.
Facts investors should verify
- Whether the 2019 remediation fully resolved the material weaknesses in IT access and monitoring controls.
- The sustainability of earnings after removing Sun purchase-accounting accretion, tax benefits and merger-related items.
- Deposit pricing, deposit retention and liquidity as the loan-to-deposit ratio remains near 96% and interest rates change.
- Credit performance of the expanded commercial real estate and acquired-loan portfolios, including the $31.6 million acquired-loan credit mark.
- The ultimate allowance impact from CECL adoption and whether credit losses rise in a weaker economic or real-estate environment.
- Integration costs, branch consolidation savings and operating results following the Capital Bank acquisition.
- Potential effects of approaching the $10 billion asset threshold and related regulatory, compliance and interchange-fee costs.
- Future dividend and repurchase capacity, including dependence on dividends from the regulated Bank subsidiary.