OCEANFIRST FINANCIAL CORP quarterly report, Q2 FY2017

OceanFirst Financial Corp. — Q2 2017 Form 10-Q Summary

Business context and reporting period

OceanFirst Financial Corp. is the holding company for OceanFirst Bank, a community bank serving central and southern New Jersey. This unaudited Form 10-Q covers the three and six months ended June 30, 2017. Results include the acquired Cape Bancorp and Ocean Shore operations, which make comparisons with 2016 less comparable.

Key financial metrics

Metric	Q2 2017	Q2 2016	Six months 2017	Six months 2016
Net interest income	$42.2 million	$30.0 million	$83.7 million	$50.6 million
Provision for loan losses	$1.2 million	$0.7 million	$1.9 million	$1.2 million
Other income	$7.0 million	$4.9 million	$13.0 million	$8.3 million
Operating expenses	$37.1 million	$28.6 million	$68.1 million	$45.4 million
Net income	$7.7 million	$3.7 million	$19.7 million	$7.9 million
Diluted EPS	$0.23	$0.16	$0.59	$0.39

Total assets were $5.202 billion at June 30, 2017, compared with $5.167 billion at December 31, 2016.
Net loans were $3.869 billion, up $65.4 million from year-end; deposits were $4.177 billion, down $10.8 million.
Stockholders’ equity was $587.3 million, and tangible equity to tangible assets was 8.51%.
Net interest margin was 3.57% for the quarter and 3.56% for the six-month period. The loan-to-deposit ratio was 92.6%.
Cash flow from operating activities was $30.2 million, while investing activities used $239.0 million, primarily for loan and securities purchases. Financing activities provided $15.1 million, and cash and due from banks declined by $193.7 million to $107.7 million.
Total FHLB borrowings were $277.5 million, including $23.0 million of overnight borrowings. Total debt obligations were $409.2 million.
The Bank and Company exceeded applicable regulatory capital requirements. The Bank’s total capital ratio was 13.44% and its common equity Tier 1 ratio was 12.95%.

Material changes versus comparable periods

Quarterly net income increased 110%, primarily because the Cape and Ocean Shore acquisitions increased the asset base and related interest and fee income. Six-month net income increased 150%.
Average interest-earning assets increased by $1.357 billion in the quarter and $1.805 billion in the six-month period. Net interest margin was stable year over year in Q2, while the six-month margin improved from 3.47% to 3.56%.
Other income increased $2.1 million in Q2 and $4.7 million for the six months, with the acquisitions contributing $1.7 million and $3.8 million, respectively.
Operating expenses increased substantially, including $8.6 million of merger-related and branch-consolidation expenses in Q2 and $10.1 million for the six months. Excluding these items, acquired operations were the primary driver of expense growth.
Reported Q2 and six-month net income was reduced by after-tax merger and branch-consolidation costs of $5.6 million and $6.7 million, respectively. The six-month period also included accelerated stock-award expense related to a director retirement.
The effective tax rate declined to 29.2% for Q2 and 26.1% for the six months, partly because adoption of ASU 2016-09 reduced tax expense by $172,000 and $1.5 million, respectively.
The Company completed consolidation of 15 branches, with expected annualized cost savings of $6.1 million.

Asset quality, liquidity, outlook, and risks

Non-performing loans were $16.3 million, or 0.42% of loans, at June 30, compared with $13.6 million, or 0.35%, at December 31, 2016. The increase was primarily associated with one $4.2 million commercial real estate relationship.
Non-performing assets were $25.2 million, or 0.48% of assets. The allowance for loan losses was $16.6 million, or 0.42% of loans, excluding acquired-loan credit marks.
Management stated that liquidity was sufficient under its stress scenarios. Outstanding undrawn credit lines were $514.1 million and loan-origination commitments were $137.0 million. Time deposits maturing within one year totaled $338.6 million.
The Company declared a quarterly dividend of $0.15 per share, payable August 18, 2017. No shares were repurchased during the first six months; 1.75 million shares remained available under repurchase programs.
On June 30, 2017, OceanFirst announced an agreement to acquire Sun Bancorp for approximately $487 million. The transaction was expected to close in the first quarter of 2018, subject to shareholder, regulatory, and other closing conditions.
The Company also agreed to acquire Monmouth County, New Jersey real estate for $42.5 million for a back-office consolidation initiative, expected to close in Q4 2017.
Risks include interest-rate and deposit-cost pressure, credit deterioration, real estate values, integration execution, regulatory approvals, potential litigation, transaction costs, dilution, and failure to achieve expected merger synergies. Three purported Sun shareholder class actions were filed in July 2017; management considers the claims meritless and intends to defend them.
The Company expects ASU 2016-13’s current expected credit loss model to increase the allowance for loan losses, particularly for longer-duration loans, but the amount was not yet determinable.

Important facts for investors to verify

Reconcile reported earnings with and without the $5.6 million after-tax Q2 merger and branch-consolidation impact.
Assess the sustainability of loan growth, deposit trends, the 92.6% loan-to-deposit ratio, and rising funding costs.
Monitor commercial real estate credit quality, the new non-performing relationship, impaired loans, and allowance adequacy.
Verify the timing, regulatory approvals, consideration structure, dilution, termination-fee exposure, litigation, and integration costs associated with the Sun transaction.
Evaluate whether the projected $6.1 million annualized branch-consolidation savings are realized and whether the $42.5 million back-office real estate investment affects liquidity or expenses.
Review the eventual impact of CECL adoption on reserves, retained earnings, regulatory capital, and reported credit costs.