OCFC OceanFirst Financial Corporation

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

________________________________________________ 

FORM 10-Q

 ________________________________________________  

For the quarterly period ended June 30, 2020

For the transition period from                      to                     

Commission file number 001-11713

________________________________________________  

Registrant’s telephone number, including area code: (732) 240-4500

________________________________________________  

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   ☒    No   ☐.

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer		☒	Accelerated Filer		☐
Non-accelerated Filer		☐	Smaller Reporting Company		☐
			Emerging Growth Company		☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ☐    NO  ☒.

As of August 3, 2020 there were 60,359,511 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.

OceanFirst Financial Corp.

INDEX TO FORM 10-Q

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Summary

OceanFirst Financial Corp. is the holding company for OceanFirst Bank N.A. (the “Bank”), a regional bank serving business and retail customers throughout New Jersey and the metropolitan areas of Philadelphia and New York City. The term “Company” refers to OceanFirst Financial Corp., the Bank and all of their subsidiaries on a consolidated basis. The Company’s results of operations are primarily dependent on net interest income, which is the difference between the interest income earned on interest-earning assets, such as loans and investments, and the interest expense on interest-bearing liabilities, such as deposits and borrowings. The Company also generates non-interest income such as income from bankcard services, trust and asset management, deposit accounts, the sale of investment products, loan originations, loan sales, derivative fee income, and other fees. The Company’s operating expenses primarily consist of compensation and employee benefits, occupancy and equipment, marketing, Federal deposit insurance and regulatory assessments, data processing and general and administrative expenses. The Company’s results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and the actions of regulatory agencies.

Over the past two years the Company has grown significantly through the acquisitions of Capital Bank of New Jersey (“Capital Bank”), Two River Bancorp (“Two River”) and Country Bank Holding Company, Inc. (“Country Bank”). These acquisitions added $2.6 billion in assets, $1.9 billion in loans and $2.0 billion in deposits.

Highlights of the Company’s financial results and corporate activities for the three months ended June 30, 2020 were as follows:

Loans and Deposits: Drove record loan and deposit growth, including quarterly originations of $975 million, which included $504 million of Paycheck Protection Program (“PPP”) loans and total loan growth of $450 million after loan sales of $110 million. Deposits increased by $1.076 billion, driven by deposits from PPP borrowers of $504 million, ordinary course growth of $291 million, and short-term brokered deposits of $281 million.

Capital: Bolstered a strong balance sheet with the addition of $181 million of subordinated notes and non-cumulative perpetual preferred stock. The increased capital further strengthened resources available to the Bank while credit metrics, including delinquencies, forbearances, and net charge-offs all evidenced significant positive trends.

Operating Expenses: Improved operating leverage with the consolidation of thirteen branch locations, eight of which were driven by the completed integration of the Two River acquisition bringing the total number of branches consolidated over the past four years to 53. These consolidations increased the average branch size to $145 million and will help reduce operating expenses beginning in the third quarter.

COVID-19: The Company’s second quarter results were adversely impacted by the COVID-19 pandemic, including an elevated credit loss provision of $9.6 million and an additional $1.1 million in operating expense.

Net income for the three months ended June 30, 2020, was $18.6 million, or $0.31 per diluted share, as compared to $19.0 million, or $0.37 per diluted share, for the corresponding prior year period. Net income for the six months ended June 30, 2020 was $35.2 million, or $0.58 per diluted share, as compared to $40.2 million, or $0.79 per diluted share, for the corresponding prior year period. Net income for the three months ended June 30, 2020 included merger related and branch consolidation expenses, which decreased net income, net of tax benefit, by $3.0 million. Net income for the six months ended June 30, 2020 included merger related expenses, branch consolidation expenses, and the Two River and Country Bank opening credit loss expense under the CECL model, which decreased net income, net of tax benefit, by $13.4 million. Net income for the three and six months ended June 30, 2019 included merger related expenses, branch consolidation expenses, and compensation expense due to the retirement of an executive officer, which decreased net income, net of tax benefit, by $7.0 million and $11.4 million, respectively. Excluding these items, net income for the three and six months ended June 30, 2020 was $21.6 million and $48.6 million, respectively, a decrease from $26.0 million and $51.6 million for the same prior year periods, respectively, primarily due to the adverse impact of the COVID-19 outbreak.

The Company remains well-capitalized with a tangible equity to tangible assets ratio of 8.77% at June 30, 2020.

The Company declared a quarterly cash dividend of $0.17 per share. The dividend, related to the quarter ended June 30, 2020, of $0.17 per share will be paid on August 14, 2020 to common stockholders of record on August 3, 2020. The Company also declared a quarterly cash dividend of $0.4764 per share for every depository share, representing 1/40th interest in the Series A Preferred Stock, payable on August 17, 2020 to preferred stockholders of record on July 31, 2020.

Impact of COVID-19

On March 16, 2020 the Company announced a series of actions intended to mitigate the impact of the COVID-19 virus outbreak on customers, employees and communities. The Company offers its Borrower Relief Program to addresses both commercial and consumer needs to customers who were current as of either year end or the date of the modification. In addition, in keeping with regulatory guidance under the Coronavirus Aid, Relief and Economic Security (“CARES”) Act, these loans are not considered troubled debt restructured (“TDR”) loans at June 30, 2020 and will not be reported as past due during the deferral period.

The Commercial Borrower Relief Program includes: 1) public accommodation businesses, such as restaurants/caterers, and certain retail establishments, that are forced to close are eligible for full deferral of loan payments (principal and interest) for 90 days and immediate working capital facilities up to $200,000; 2) public accommodation businesses that are reducing services in response to the pandemic (such as reducing capacity, transitioning to take-out only, etc.) are eligible to make interest-only payments and defer principal payments for 90 days, and immediate working capital facilities up to $100,000; and 3) additional relief programs may be available to the Bank’s commercial borrowers on an individualized basis, depending on the borrower’s circumstances.

The Consumer Borrower Relief Program includes automatic deferral of residential mortgage or consumer loan payments (principal and interest) for 90 days upon request. Borrowers who request a second 90-day deferral are required to provide reason(s) for financial hardship as a result of COVID-19.

As a result of the COVID-19 outbreak, loans under forbearance totaled $1.5 billion at June 30, 2020. The forbearance pool is expected to decrease substantially as customers return to regular payments. As of July 15, 2020, borrowers with balances totaling $650 million have indicated to the Bank that they will return to regular payments in the third quarter. In accordance with the CARES Act, none of these loans are considered TDR loans and will not be reported as past due during the deferral period.

The Company also accepted and processed applications for loans under the Paycheck Protection Program beginning April 3, 2020. Through July 15, 2020, the Company disbursed $504 million and recorded deferred processing fees of $17.7 million, which will be recognized over the life of the loans.

In addition, COVID-19 could cause a goodwill impairment test where a triggering event has occurred, and under certain circumstances, result in an impairment charge recorded in that period. Such a charge would not impact the Company’s tangible equity to tangible assets ratio of 8.77% or regulatory capital. At June 30, 2020, the Company’s goodwill balance was $501.5 million and the Company concluded that no triggering event occurred and therefore no impairment existed.

The full impact of COVID-19 is unknown and rapidly evolving. It is impacting the Company’s operations and financial results, as well as those of the Bank’s customers. For the quarter ended June 30, 2020, the Company recognized an elevated credit loss expense of $9.6 million and an increase in operating expense of $1.1 million.

For further discussion, see Risk Factors - The ongoing COVID-19 pandemic and measures intended to prevent its spread could adversely affect business activities, financial condition, and results of operations and such effects will depend on future developments, which are highly uncertain and difficult to predict.

Analysis of Net Interest Income

Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them.

The following tables set forth certain information relating to the Company for the three and six months ended June 30, 2020 and June 30, 2019. The yields and costs are derived by dividing the income or expense by the average balance of the related assets or liabilities, respectively, for the periods shown except where noted otherwise. Average balances are derived from average daily balances. The yields and costs include certain fees which are considered adjustments to yields.

Comparison of Financial Condition at June 30, 2020 and December 31, 2019

Total assets increased by $3.099 billion, to $11.345 billion at June 30, 2020, from $8.246 billion at December 31, 2019, primarily as a result of the acquisitions of Two River and Country Bank, which added $2.031 billion to total assets. Cash and due from banks increased by $600.5 million, to $721.0 million at June 30, 2020, from $120.5 million at December 31, 2019, due to the Company’s decision to build liquidity during the economic downturn and the cash received from the issuance of subordinated notes and non-cumulative perpetual preferred stock as described below. Loans receivable, net of allowance for credit losses, increased by $2.128 billion, to $8.335 billion at June 30, 2020, from $6.208 billion at December 31, 2019, due to acquired loans from Two River and Country Bank of $1.558 billion coupled with strong organic loan growth. As part of the acquisitions of Two River and Country Bank, the Company’s goodwill balance increased to $501.5 million at June 30, 2020, from $374.6 million at December 31, 2019 and the core deposit intangible increased to $26.7 million, from $15.6 million. Other assets increased by $57.1 million to $226.6 million at June 30, 2020, from $169.5 million at December 31, 2019, primarily due to the increase in swap positions.

Deposits increased by $2.639 billion, to $8.968 billion at June 30, 2020, from $6.329 billion at December 31, 2019, primarily due to acquired deposits from Two River and Country Bank of $1.594 billion. The loan-to-deposit ratio at June 30, 2020 was 93.4%, as compared to 98.2% at December 31, 2019. The deposit growth funded a decrease in FHLB advances of $175.9 million to $343.4 million at June 30, 2020, from $519.3 million at December 31, 2019. The increase in other borrowings of $150.0 million to $246.8 million at June 30, 2020, from $96.8 million at December 31, 2019, primarily resulted from the May 2020 issuance of $125.0 million in subordinated notes at an initial rate of 5.25% and a stated maturity of May 15, 2030. Other liabilities increased by $76.0 million to $138.5 million at June 30, 2020, from $62.6 million at December 31, 2019, primarily due to the increase in swap positions.

Stockholders’ equity increased to $1.476 billion at June 30, 2020, as compared to $1.153 billion at December 31, 2019. The acquisitions of Two River and Country Bank added $261.4 million to stockholders’ equity. During the three months ended June 30, 2020, the Company raised $55.7 million from the issuance of 7.0% fixed-to-floating rate non-cumulative perpetual preferred stock, with a par value of $0.01 and a liquidation price of $1,000 per share. Under the Company’s stock repurchase program, there were 2,019,145 shares available for repurchase at June 30, 2020. The Company suspended its repurchase activity on February 28, 2020. For the six months ended June 30, 2020, the Company repurchased 648,851 shares under the repurchase program at a weighted average cost of $22.83.

Comparison of Operating Results for the Three and Six Months Ended June 30, 2020 and June 30, 2019

General

On January 31, 2019, the Company completed its acquisition of Capital Bank and its results of operations are included in the consolidated results for the three and six months ended June 30, 2020, but are excluded from the results of operations for the period from January 1, 2019 to January 31, 2019.

On January 1, 2020, the Company completed its acquisitions of Two River and Country Bank and their respective results of operations from January 1, 2020 through June 30, 2020 are included in the consolidated results for the three and six months ended June 30, 2020, but are not included in the results of operations for the corresponding prior year periods.

Net income for the three months ended June 30, 2020 was $18.6 million, or $0.31 per diluted share, as compared to $19.0 million, or $0.37 per diluted share, for the corresponding prior year period. Net income for the six months ended June 30, 2020 was $35.2 million, or $0.58 per diluted share, as compared to $40.2 million, or $0.79 per diluted share, for the corresponding prior year period. Net income for the three months ended June 30, 2020 included merger related and branch consolidation expenses, which decreased net income, net of tax benefit, by $3.0 million. Net income for the six months ended June 30, 2020 included merger related expenses, branch consolidation expenses, and the Two River and Country Bank opening credit loss expense under the CECL model, which decreased net income, net of tax benefit, by $13.4 million. Net income for the three and six months ended June 30, 2019 included merger related expenses, branch consolidation expenses, and compensation expense due to the retirement of an executive officer, which decreased net income, net of tax benefit, by $7.0 million and $11.4 million, respectively. Excluding these items, net income for the three and six months ended June 30, 2020 was $21.6 million and $48.6 million, respectively, a decrease from $26.0 million and $51.6 million for the same prior year periods, respectively, primarily due to the adverse impact of the COVID-19 outbreak.

Interest Income

Interest income for the three and six months ended June 30, 2020 increased to $95.9 million and $194.1 million, respectively, as compared to $78.4 million and $154.8 million, respectively, in the corresponding prior year periods. Average interest-earning assets increased by $2.684 billion and $2.435 billion for the three and six months ended June 30, 2020, respectively, as compared

to the same prior year periods. The averages for the three and six months ended June 30, 2020 were favorably impacted by $1.815 billion and $1.793 billion, respectively, of interest-earning assets acquired from Two River and Country Bank and $373.7 million and $186.8 million, respectively, of PPP loans. Average loans receivable, net, increased by $2.347 billion and $2.215 billion for the three and six months ended June 30, 2020, respectively, as compared to the same prior year periods. The increases attributable to the acquisitions of Two River and Country Bank for the three and six months ended June 30, 2020 were $1.606 billion and $1.581 billion, respectively. For the three and six months ended June 30, 2020, the yield on average interest-earning assets decreased to 3.94% and 4.13%, respectively, from 4.43% and 4.46%, respectively, in the corresponding prior year periods.

Interest Expense

Interest expense for the three and six months ended June 30, 2020 was $17.2 million and $35.8 million, respectively, as compared to $13.6 million and $25.6 million, respectively, in the corresponding prior year periods. Average interest-bearing liabilities increased $1.965 billion and $1.804 billion for the three and six months ended June 30, 2020, respectively, as compared to the same prior year periods. For the three months ended June 30, 2020, the cost of average interest-bearing liabilities decreased to 0.92% from 0.98% in the corresponding prior year period. For the six months ended June 30, 2020, the cost of average interest-bearing liabilities increased to 0.98% from 0.94%, in the corresponding prior year period. The total cost of deposits (including non-interest bearing deposits) was 0.57% and 0.63% for the three and six months ended June 30, 2020, respectively, as compared to 0.62% and 0.60%, respectively, in the same prior year periods.

Net Interest Income

Net interest income for the three and six months ended June 30, 2020 increased to $78.7 million, and $158.3 million, as compared to $64.8 million and $129.2 million for the same prior year periods, reflecting an increase in interest-earning assets, partly offset by a reduction in net interest margin. The net interest margin for the three and six months ended June 30, 2020 decreased to 3.24% and 3.37%, respectively, from 3.66% and 3.72%, respectively, for the same prior year periods. The compression in net interest margin is primarily due to the lower interest rate environment, the origination of low-yielding PPP loans, and the excess balance sheet liquidity which the Company strategically accumulated entering the economic downturn.

Credit Loss Expense

For the three and six months ended June 30, 2020, the credit loss expense was $9.6 million and $19.6 million, respectively, as compared to $356,000 and $976,000, respectively, for the corresponding prior year periods. Net loan recoveries were $232,000 for the quarter and net loan charge-offs were $922,000 for the six months ended June 30, 2020, as compared to net loan charge-offs of $926,000 and $1.4 million in the corresponding prior year periods. Non-performing loans totaled $21.0 million at June 30, 2020, as compared to $17.8 million at June 30, 2019. Credit expense for the three and six months ended June 30, 2020 was significantly influenced by economic conditions related to the COVID-19 outbreak and estimates of how those conditions may impact the Company’s customers.

Other Income

For the three and six months ended June 30, 2020, other income increased to $11.4 million and $25.1 million, respectively, as compared to $9.9 million and $19.4 million, respectively, for the corresponding prior year periods. Excluding the Two River and Country Bank acquisitions, which added $692,000, the increase in other income for the three months ended June 30, 2020 was due to an increase in commercial loan swap income of $1.9 million, and an increase in the net gain on sales of loans of $619,000, partially offset by lower fees and service charges of $1.7 million, as compared to the corresponding prior year period. For the six months ended June 30, 2020, excluding the Two River and Country Bank acquisitions which added $1.4 million, the increase in other income was due to the increase in commercial swap income of $5.5 million, and an increase in the net gain on sales of loans of $733,000, partially offset by decreases in fees and service charges of $1.8 million. The waiver of certain fees during the COVID-19 pandemic may continue to suppress deposit fee income for the remainder of the public health crisis.

Operating Expenses

Operating expenses increased to $55.9 million and $118.7 million for the three and six months ended June 30, 2020, respectively, as compared to $50.9 million and $98.2 million, respectively, in the same prior year periods. Operating expenses for the three and six months ended June 30, 2020 included $3.9 million and $15.1 million, respectively, of merger related and branch consolidation expenses, as compared to $8.9 million and $14.3 million, respectively, of merger related expenses, branch consolidation expenses, and compensation expense due to the retirement of an executive officer, respectively, in the same prior year periods. Excluding the impact of merger related expenses, branch consolidation expenses, and compensation expense due to the retirement of an executive officer, the change in operating expenses over the prior year was due to the Two River and Country Bank acquisitions, which added $7.6 million and $16.1 million, respectively, for the three and six months ended June 30, 2020. The remaining increase

in operating expenses for the three months ended June 30, 2020 was primarily due to a Federal Home Loan Bank (“FHLB”) prepayment penalty fee of $924,000 and expenses related to COVID-19 of $1.1 million. The increase in operating expenses for the six months ended June 30, 2020 was primarily due to a FHLB prepayment penalty fee of $924,000 and expenses related to COVID-19 of $2.1 million.

Provision for Income Taxes

The provision for income taxes was $5.9 million and $9.9 million for the three and six months ended June 30, 2020, respectively, as compared to $4.5 million and $9.3 million, respectively, for the same prior year periods. The effective tax rate was 24.0% and 22.0% for the three and six months ended June 30, 2020, respectively, as compared to 19.0% and 18.8%, respectively, for the same prior year periods. The higher effective tax rate in the current year period is primarily due to the impact of a New Jersey tax code change and a higher allocation of taxable income to New York due to the acquisition of Country Bank.

Liquidity and Capital Resources

The Company’s primary sources of funds are deposits, principal and interest payments on loans and mortgage-backed securities, Federal Home Loan Bank (“FHLB”) advances, access to the Federal Reserve Discount Window, other borrowings, which includes subordinated debt, and to a lesser extent, investment maturities and proceeds from the sale of loans. While scheduled amortization of loans is a predictable source of funds, deposit flows and loan prepayments are influenced by interest rates, economic conditions and competition. The Company has other sources of liquidity if a need for additional funds arises, including various lines of credit at multiple banks.

At June 30, 2020, the Company had no outstanding overnight borrowings from the FHLB, as compared to $270.0 million at December 31, 2019. The Bank utilizes overnight borrowings from time-to-time to fund short-term liquidity needs. FHLB advances, including overnight borrowings, totaled $343.4 million and $519.3 million, at June 30, 2020 and December 31, 2019, respectively.

The Company’s cash needs for the six months ended June 30, 2020 were primarily satisfied by the increase in deposits, net proceeds from the issuance of subordinated notes and preferred stock, proceeds from sale of loans, principal payments on mortgage-backed securities, proceeds from maturities and calls of debt investment securities, and acquired cash from acquisitions. The cash was principally utilized for loan originations, and the repayment of short-term borrowings. The Company’s cash needs for the six months ended June 30, 2019 were primarily satisfied by principal payments on loans and mortgage-backed securities, and acquired cash from Capital Bank. The cash was principally utilized for loan originations, the purchase of loans receivable and securities, and the repayment of borrowings.

In the normal course of business, the Company routinely enters into various off-balance-sheet commitments. At June 30, 2020, outstanding undrawn lines of credit totaled $1.031 billion and outstanding commitments to originate loans totaled $359.2 million. The Company expects to have sufficient funds available to meet current commitments arising in the normal course of business.

Time deposits scheduled to mature in one year or less totaled $1.038 billion at June 30, 2020. Management strategically manages these maturities and is opportunistic about renewing these time deposits, as needed.

The Company has a detailed contingency funding plan and comprehensive reporting of funding trends on a monthly and quarterly basis which are reviewed by management. Management also monitors cash on a daily basis to determine the liquidity needs of the Bank. Additionally, management performs multiple liquidity stress test scenarios on a quarterly basis. The Bank continues to maintain significant liquidity under all stress scenarios. In response to COVID-19, management identified additional sources of contingent liquidity, including expanded borrowing capacity with the FHLB, the Federal Reserve and existing correspondent bank relationships. In addition, in May 2020, the Company issued $125.0 million of subordinated notes at an initial rate of 5.25% and a stated maturity of May 15, 2030. The Company also issued $55.9 million of 7.0% fixed-to-floating rate non-cumulative perpetual preferred stock, with a par value of $0.01 and a liquidation price of $1,000 per share. The proceeds were retained to strengthen balance sheet liquidity entering the economic downturn.

Under the Company’s common stock repurchase program, shares of OceanFirst Financial Corp. common stock may be purchased in the open market and through privately-negotiated transactions, from time-to-time, depending on market conditions. The repurchased shares are held in treasury for general corporate purposes. On February 28, 2020, the Company suspended its repurchase activity in light of the COVID-19 pandemic. As such, for the quarter ended June 30, 2020, the Company did not repurchase any shares of common stock. At June 30, 2020, there were 2,019,145 shares available to be repurchased under the stock repurchase program authorized in December of 2019.

Cash dividends on common stock declared and paid during the first six months of 2020 were $20.5 million, as compared to $17.3 million in the same prior year period. The increase in dividends was a result of the additional shares issued in the acquisitions of Two River and Country Bank. On July 23, 2020, the Company’s Board of Directors declared a quarterly cash dividend of seventeen cents ($0.17) per common share. The dividend is payable on August 14, 2020 to common stockholders of record at the close of business on August 3, 2020. The Company also declared a quarterly cash dividend of $0.4764 per share for every depository share, representing 1/40th interest in the Series A Preferred Stock, payable on August 17, 2020 to preferred stockholders of record on July 31, 2020.

The primary sources of liquidity specifically available to OceanFirst Financial Corp., are capital distributions from the bank subsidiary and the issuance of preferred and common stock and debt. For the six months ended June 30, 2020, the Company received a dividend payment of $36.0 million from the Bank. The Company’s ability to continue to pay dividends will be largely dependent upon capital distributions from the Bank, which may be adversely affected by capital constraints imposed by the applicable regulations. The Company cannot predict whether the Bank will be permitted under applicable regulations to pay a dividend to the Company. If applicable regulations or regulatory bodies prevent the Bank from paying a dividend to the Company, the Company may not have the liquidity necessary to pay a dividend in the future or pay a dividend at the same rate as historically paid or be able to meet current debt obligations. Additionally, regulations of the Federal Reserve, under certain circumstances, may prevent the Company from either paying or increasing the cash dividend to common shareholders. At June 30, 2020, OceanFirst Financial Corp. held $198.4 million in cash.

As of June 30, 2020 and December 31, 2019, the Company and the Bank exceed all regulatory capital requirements currently applicable as follows (dollars in thousands):