Business Context and Reporting Period
OceanFirst Financial Corp. is the holding company for OceanFirst Bank, a community-oriented savings bank serving Ocean, Monmouth and Middlesex Counties in New Jersey. The Bank primarily gathers deposits and invests in residential mortgages, commercial real estate, consumer and commercial loans, and securities. This Form 10-K covers the fiscal year ended December 31, 2012, with comparative information for 2011 and 2010. The filing was signed March 7, 2013, and audited by KPMG LLP with unqualified opinions on the consolidated financial statements and internal controls.
Key Financial Metrics
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Total assets | $2.269 billion | $2.302 billion | Down $32.9 million |
| Loans receivable, net | $1.523 billion | $1.563 billion | Down 2.5% |
| Deposits | $1.720 billion | $1.706 billion | Up 0.8% |
| Stockholders’ equity | $219.8 million | $216.8 million | Up $2.9 million |
| Net interest income | $73.5 million | $77.3 million | Down 4.9% |
| Net income | $20.0 million | $20.7 million | Down 3.5% |
| Diluted earnings per share | $1.12 | $1.14 | Down $0.02 |
| Net interest margin | 3.37% | 3.59% | Down 22 basis points |
| Return on average assets | 0.87% | 0.91% | Down 4 basis points |
| Return on average equity | 9.15% | 9.88% | Down 73 basis points |
| Operating expenses | $52.9 million | $52.7 million | Up $0.2 million |
| Net cash provided by operating activities | $30.9 million | $17.6 million | Up $13.3 million |
Interest income declined to $87.6 million from $95.4 million as asset yields fell, particularly on loans and mortgage-backed securities. Interest expense declined more substantially, to $14.1 million from $18.1 million, reflecting lower deposit and borrowing costs. Other income increased to $18.2 million from $15.3 million, mainly from higher loan-sale gains, fees and service charges, and lower losses from other real estate operations.
Net charge-offs were $5.6 million, compared with $9.2 million in 2011. The allowance for loan losses increased to $20.5 million, or 1.32% of total loans, from $18.2 million, or 1.15%. Non-performing loans were $43.4 million, or 2.80% of loans, versus $44.0 million, or 2.77%, in 2011. Total non-performing assets were $46.6 million, or 2.05% of assets.
The Bank had $225.0 million of Federal Home Loan Bank advances, $60.8 million of securities sold under repurchase agreements and $27.5 million of other borrowings at year-end. Total borrowed funds were approximately $313.3 million, compared with $359.6 million in 2011. Cash and due from banks totaled $62.5 million. Management reported sufficient liquidity under its contingency funding and stress-testing scenarios.
Regulatory capital remained strong. At December 31, 2012, the Bank’s tangible and core capital ratios were 9.49%, Tier 1 risk-based capital was 14.86% and total risk-based capital was 16.11%. The Bank was classified as well-capitalized. The Company’s tangible common equity-to-assets ratio was 9.69%.
Material Changes Versus the Prior Comparable Period
- Loans receivable declined $39.8 million, primarily from loan prepayments, weak commercial demand and sales of newly originated 30-year fixed-rate residential mortgages.
- Investment and mortgage-backed securities increased collectively by $17.2 million to $547.4 million, partly replacing lower loan balances with lower-yielding assets.
- Core deposits increased $56.3 million, while time deposits declined $42.7 million. Core deposits represented 86.8% of total deposits at year-end.
- FHLB advances declined $41.0 million because of excess liquidity and loan cash flows.
- The Company repurchased 843,370 shares for $11.9 million and paid $8.6 million in common dividends. The annual dividend remained $0.48 per share, and the Board declared a $0.12 quarterly dividend in January 2013.
- Net interest income and the net interest margin declined because of low market rates, refinancing-related prepayments and a shift toward lower-yielding securities.
- Other income increased $2.9 million. Net gains on loan sales rose to $4.0 million, although results included a $750,000 increase in the reserve for loan repurchases.
- Operating expenses were broadly stable. A $687,000 net severance and related expense associated with the departure of the former Bank President and Chief Operating Officer affected 2012 results.
- The 2012 provision for loan losses included an additional $1.8 million related solely to the expected impact of Superstorm Sandy. Excluding that item, the provision declined from 2011.
- Compared with 2011, classified substandard assets increased to $90.0 million from $88.1 million, while special mention assets declined to $6.2 million from $11.5 million.
Guidance, Outlook, Risks and Unusual Items
Management expected the low-interest-rate environment to continue beyond 2012, with further pressure on net interest margin and net interest income. The Federal Reserve’s stated policy thresholds at the time suggested that short-term rates could remain low through at least mid-2015. Management planned continued growth in commercial lending, core deposits and fee-based services, including new banking locations in Red Bank and Jackson, New Jersey during 2013.
Superstorm Sandy materially affected the Bank’s primary market area. The Bank provided payment deferrals to affected borrowers and recorded the $1.8 million additional loan-loss provision. At February 28, 2013, 124 residential borrowers had requested deferrals on loans totaling $30.3 million; the Bank reported that most had either paid, become current or entered repayment arrangements. The ultimate level of storm-related losses remained uncertain.
Key risks include concentration of lending and collateral in Ocean and Monmouth Counties, further declines in local real estate values, elevated unemployment, extended New Jersey foreclosure timelines, commercial real estate and commercial lending exposure, interest-rate and prepayment risk, and the adequacy of the allowance for loan losses. Approximately 96.2% of the loan portfolio was secured by real estate, and local residential values had declined approximately 21% from their 2006 peak.
The Company had $1.2 million reserved for potential losses on repurchased loans. Twelve outstanding repurchase requests involved loans with a principal balance of $3.6 million, compared with four requests involving $1.2 million in 2011. Management believed the reserve was adequate, but future repurchase activity could reduce earnings.
The securities portfolio was entirely classified as available for sale. Corporate debt securities had an amortized cost of $55.0 million and estimated fair value of $43.5 million, representing a $11.5 million unrealized loss. Management concluded the losses were temporary because issuers remained current and the Company did not intend, and was not expected, to sell the securities before recovery. A change in issuer credit quality, market liquidity or the Company’s intent or ability to hold the securities could result in an impairment charge.
Outstanding commitments included $56.8 million of commitments to originate loans, $261.3 million of unused lines of credit and $28.7 million of commitments to sell loans. Contractual debt obligations totaled $313.3 million. The Company stated that routine legal proceedings were immaterial to its financial condition, results of operations and liquidity.
Most Important Facts for Investors to Verify
- Whether the decline in net interest margin continues as low rates, loan refinancing and portfolio mix pressure asset yields.
- Whether Superstorm Sandy produces additional delinquencies, restructurings, charge-offs or allowance provisions beyond the $1.8 million recorded in 2012.
- The trend in non-performing loans, troubled debt restructurings, classified commercial real estate assets and local real estate collateral values.
- Whether the $20.5 million allowance for loan losses remains adequate relative to the $43.4 million of non-performing loans and concentrated real estate exposure.
- Future mortgage-loan repurchase requests and the adequacy of the $1.2 million repurchase reserve.
- The valuation and credit performance of the $55.0 million corporate debt securities portfolio with a $11.5 million unrealized loss.
- The pace and profitability of commercial lending and the planned 2013 branch and Financial Solutions Center openings.
- The Company’s ability to sustain the $0.12 quarterly dividend and planned share repurchases, given reliance on regulatory approval and dividend distributions from the Bank.
- The effect of Dodd-Frank, CFPB mortgage rules and Basel III-related capital requirements on compliance costs, product offerings, lending and capital distributions.