Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FINANCIAL SUMMARY (1)
At or for the Quarters Ended
(dollars in thousands, except per share amounts) September 30, 2023 June 30, 2023 September 30, 2022
SELECTED FINANCIAL CONDITION DATA:
Total assets $ 13,498,183 $ 13,538,903 $ 12,683,453
Loans receivable, net of allowance for loan credit losses 10,068,156 10,030,106 9,672,488
Deposits 10,533,929 10,158,337 9,959,469
Total stockholders’ equity 1,637,604 1,626,283 1,540,216
SELECTED OPERATING DATA:
Net interest income 90,996 92,109 95,965
Provision for credit losses 10,283 1,229 1,016
Other income 10,762 8,928 15,150
Operating expenses 64,484 62,930 58,997
Net income 20,532 27,882 38,804
Net income attributable to OceanFirst Financial Corp. 20,667 27,797 38,611
Net income available to common stockholders 19,663 26,793 37,607
Diluted earnings per share 0.33 0.45 0.64
SELECTED FINANCIAL RATIOS:
Book value per common share at end of period 27.56 27.37 26.04
Cash dividend per share 0.20 0.20 0.20
Dividend payout ratio per common share 60.61 % 44.44 % 31.25 %
Stockholders’ equity to total assets 12.13 12.01 12.14
Return on average assets (2) (3) (4)
0.57 0.80 1.19
Return on average stockholders’ equity (2) (3) (4)
4.75 6.61 9.68
Net interest rate spread (5)
2.37 2.52 3.19
Net interest margin (2) (6)
2.91 3.02 3.36
Operating expenses to average assets (2) (4)
1.88 1.87 1.87
Efficiency ratio (4) (7)
63.37 62.28 53.10
Loan-to-deposit ratio (8)
96.10 99.30 97.60
ASSET QUALITY (9) :
Non-performing loans (10)
$ 30,098 $ 22,758 $ 21,498
Allowance for loan credit losses as a percent of total loans receivable (8) (11)
0.63 % 0.61 % 0.55 %
Allowance for loan credit losses as a percent of total non-performing loans (10) (11)
212.23 271.51 248.96
Non-performing loans as a percent of total loans receivable (8) (10)
0.30 0.23 0.22
Non-performing assets as a percent of total assets (10)
0.22 0.17 0.17
(1) With the exception of end of quarter ratios, all ratios are based on average daily balances.
(2) Ratios are annualized.
(3) Ratios for each period are based on net income available to common stockholders.
(4) Performance ratios for the three months ended September 30, 2023 included a net gain on equity investments of $1.5 million, or $1.1 million, net of tax expense. Performance ratios for the three months ended June 30, 2023 included a net loss on equity investments of $559,000, or $397,000, net of tax benefit. Performance ratio s for the three months ended September 30, 2022 included a net benefit related to merger related expenses, net branch consolidation (benefit) expense, and gain on equity investments of $3.4 million, or $2.6 million, net of tax expense.
(5) Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.
(6) Net interest margin represents net interest income as a percentage of average interest-earning assets.
(7) Efficiency ratio represents the ratio of operating expenses to the aggregate of other income and net interest income.
(8) Total loans receivable excludes loans held-for-sale.
(9) At September 30, 2023, non-performing loans included the remaining exposure of $8.8 million on a single commercial real estate relationship that was partially charged-off of $8.4 million during the three months ended September 30, 2023.
(10) Non-performing loans and assets generally consist of all loans 90 days or more past due and other loans in the process of foreclosure. It is the Company’s policy to cease accruing interest on all such loans and to reverse previously accrued interest.
(11) Loans acquired from prior bank acquisitions were recorded at fair value. The net unamortized credit and purchased with credit deterioration (“PCD”) marks on these loans, not reflected in the allowance for loan credit losses, was $8.8 million, $9.8 million, and $13.6 million at September 30, 2023, June 30, 2023 and September 30, 2022, respectively.
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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 major metropolitan areas of Philadelphia, New York, Baltimore, and Boston. 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 its 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 products and services, deposit account services, bank owned life insurance, commercial loan swap income, gain on sale of loans, securities and equity investments, title-related fees and service charges 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, check card processing, professional fees and other general and administrative expenses. The Company’s results of operations are also significantly affected by competition, general economic conditions, including levels of unemployment and real estate values, as well as changes in market interest rates, inflation, government policies and actions of regulatory agencies.
Key developments relating to the Company’s financial results and corporate activities for the three months ended September 30, 2023 were as follows:
• Deposit Growth: Total deposits increased $375.6 million, or 4%, as compared to the prior linked quarter. The current quarter includes a reduction in brokered time deposits of $425.7 million and a loan-to-deposit ratio of 96.10% at September 30, 2023. The Company’s non-interest-bearing deposits declined modestly and represented 17% of the total deposits.
• Asset Quality: Asset quality metrics remain strong, despite the impact of a charge-off related to a single credit relationship. Criticized and classified loans, and non-performing loans both as a percent of total loans, were 1.30% and 0.20%, respectively, at September 30, 2023.
• Strong Capital: The Company’s common equity tier 1 capital ratio remained above “well-capitalized” levels, at 10.36% at September 30, 2023.
The current quarter results were impacted by the following matters. Net interest income and margin were adversely impacted by a continued mix-shift and repricing to higher cost deposits that outpaced the repricing and increase in yields on interest-earning assets. Deposit betas, which is the change in rates paid to customers relative to the change in federal funds target rate, increased modestly to 35%, from 29%. Additionally, the current quarter results were impacted by an increase in non-performing loans due to a single commercial real estate credit relationship totaling $17 million, which was written down to an estimated realizable value of $8.8 million. The credit was originated in June 2019 and is secured by an office building in Midtown Manhattan, New York City. The credit was also included in total delinquent loans 30 to 89 days at September 30, 2023. Lastly, the Company recognized one-time compensation and benefits expenses of $2.4 million attributable to severance and other program costs relating to performance improvement initiatives.
Net income available to common stockholders for the three and nine months ended September 30, 2023 decreased to $19.7 million and $73.3 million, respectively, or $0.33 and $1.24 per diluted share, as compared to $37.6 million and $90.3 million, or $0.64 and $1.53 per diluted share, for the corresponding prior year periods. The dividends paid to preferred stockholders were $1.0 million and $3.0 million for the three and nine months ended September 30, 2023 and 2022, respectively.
On October 19, 2023, the Company’s Board of Directors declared a quarterly cash dividend on common stock of $0.20 per share. The dividend, related to the quarter ended September 30, 2023, will be paid on November 17, 2023 to common stockholders of record on November 6, 2023. The Board also declared a quarterly cash dividend on preferred stock of $0.4375 per depositary share, representing a 1/40th interest in the Series A Preferred Stock. This dividend will be paid on November 15, 2023 to preferred stockholders of record on October 31, 2023.
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Recent Developments
The banking industry continued to experience volatility through the third quarter of 2023, which began earlier in the year with several bank failures coupled with related industry-wide concerns including liquidity, funding, and unrealized losses on securities brought on by a rapid increasing rate environment. These developments, among other industry concerns, have created volatility in stock prices across the banking industry, including the Company's own stock price. Despite these industry-concerns, the Company has continued to maintain and strengthen its liquidity and capital position, and serve its customers and communities.
The Company will continue to monitor these industry-wide matters and the impact they may have in future periods, and will respond accordingly as economic and industry conditions change. Refer to the “Liquidity and Capital Resources” section for further information regarding liquidity.
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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. For the three and nine months ended September 30, 2023, interest income included net loan fees of $621,000 and $2.6 million, respectively, as compared to $832,000 and $5.0 million for the same prior year periods, respectively.
The following tables set forth certain information relating to the Company for the three and nine months ended September 30, 2023 and 2022. The yields and costs, which are annualized, 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 and costs which are considered adjustments to yields.
For the Three Months Ended September 30,
2023 2022
(dollars in thousands) Average Balance Interest Average
Yield/
Cost (1)
Average Balance Interest Average
Yield/
Cost (1)
Assets:
Interest-earning assets:
Interest-earning deposits and short-term investments $ 470,825 $ 6,440 5.43 % $ 65,648 $ 336 2.03 %
Securities (2)
1,873,450 18,039 3.82 1,748,687 10,022 2.27
Loans receivable, net (3)
Commercial 6,923,743 103,069 5.91 6,509,515 74,309 4.53
Residential real estate 2,918,612 26,765 3.67 2,791,067 22,818 3.27
Home equity loans and lines and other consumer (“other consumer”) 252,126 4,097 6.45 256,638 3,014 4.66
Allowance for loan credit losses, net of deferred loan costs and fees (53,959) — — (44,773) — —
Loans receivable, net 10,040,522 133,931 5.30 9,512,447 100,141 4.18
Total interest-earning assets 12,384,797 158,410 5.08 11,326,782 110,499 3.88
Non-interest-earning assets 1,252,416 1,191,173
Total assets $ 13,637,213 $ 12,517,955
Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Interest-bearing checking $ 3,692,500 14,938 1.61 % $ 3,873,968 2,671 0.27 %
Money market 832,729 5,698 2.71 793,230 721 0.36
Savings 1,391,811 3,311 0.94 1,603,147 187 0.05
Time deposits 2,867,921 29,340 4.06 1,467,297 5,659 1.53
Total 8,784,961 53,287 2.41 7,737,642 9,238 0.47
Federal Home Loan Bank (“FHLB”) advances 701,343 8,707 4.93 352,392 2,208 2.49
Securities sold under agreements to repurchase 76,620 261 1.35 96,147 35 0.14
Other borrowings (4)
317,210 5,159 6.45 194,755 3,053 6.22
Total borrowings 1,095,173 14,127 5.12 643,294 5,296 3.27
Total interest-bearing liabilities 9,880,134 67,414 2.71 8,380,936 14,534 0.69
Non-interest-bearing deposits 1,841,198 2,328,700
Non-interest-bearing liabilities (4)
272,982 266,564
Total liabilities 11,994,314 10,976,200
Stockholders’ equity 1,642,899 1,541,755
Total liabilities and equity $ 13,637,213 $ 12,517,955
Net interest income $ 90,996 $ 95,965
Net interest rate spread (5)
2.37 % 3.19 %
Net interest margin (6)
2.91 % 3.36 %
Total cost of deposits (including non-interest-bearing deposits) 1.99 % 0.36 %
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For the Nine Months Ended September 30,
2023 2022
(dollars in thousands) Average
Balance Interest Average
Yield/
Cost (1)
Average
Balance Interest Average
Yield/
Cost (1)
Assets:
Interest-earning assets:
Interest-earning deposits and short-term investments $ 304,184 $ 11,661 5.13 % $ 73,886 $ 472 0.85 %
Securities (2)
1,919,660 51,124 3.56 1,801,978 27,086 2.01
Loans receivable, net (3)
Commercial 6,892,456 295,199 5.73 6,275,836 198,054 4.22
Residential real estate 2,895,601 77,862 3.59 2,685,080 66,899 3.32
Other consumer 257,063 11,694 6.08 254,891 8,387 4.40
Allowance for loan credit losses, net of deferred loan costs and fees (52,626) — — (42,987) — —
Loans receivable, net 9,992,494 384,755 5.15 9,172,820 273,340 3.98
Total interest-earning assets 12,216,338 447,540 4.90 11,048,684 300,898 3.64
Non-interest-earning assets 1,234,942 1,191,358
Total assets $ 13,451,280 $ 12,240,042
Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Interest-bearing checking $ 3,757,417 33,171 1.18 % $ 4,088,759 6,433 0.21 %
Money market 744,689 11,136 2.00 773,666 1,317 0.23
Savings 1,336,497 4,034 0.40 1,617,354 473 0.04
Time deposits 2,388,299 64,210 3.59 1,060,027 9,373 1.18
Total 8,226,902 112,551 1.83 7,539,806 17,596 0.31
FHLB Advances 1,055,106 38,530 4.88 308,043 3,890 1.69
Securities sold under agreements to repurchase 73,441 544 0.99 105,821 117 0.15
Other borrowings (4)
302,649 14,008 6.19 205,796 8,306 5.40
Total borrowings 1,431,196 53,082 4.96 619,660 12,313 2.66
Total interest-bearing liabilities 9,658,098 165,633 2.29 8,159,466 29,909 0.49
Non-interest-bearing deposits 1,913,624 2,352,606
Non-interest-bearing liabilities (4)
253,014 193,147
Total liabilities 11,824,736 10,705,219
Stockholders’ equity 1,626,544 1,534,823
Total liabilities and equity $ 13,451,280 $ 12,240,042
Net interest income $ 281,907 $ 270,989
Net interest rate spread (5)
2.61 % 3.15 %
Net interest margin (6)
3.09 % 3.28 %
Total cost of deposits (including non-interest-bearing deposits) 1.48 % 0.24 %
(1) Average yields and costs are annualized.
(2) Amounts represent debt and equity securities, including FHLB and Federal Reserve Bank (“FRB”) stock, and are recorded at average amortized cost net of allowance for securities credit losses.
(3) Amount is net of deferred loan costs and fees, undisbursed loan funds, discounts and premiums and allowance for loan credit losses, and includes loans held for sale and non-performing loans.
(4) For the 2023 period, the average balances of derivative cash collateral have been reclassified from non-interest bearing liabilities to other borrowings.
(5) Net interest rate spread represents the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities.
(6) Net interest margin represents net interest income divided by average interest-earning assets.
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Comparison of Financial Condition at September 30, 2023 and December 31, 2022
Total assets increased by $394.3 million to $13.50 billion, from $13.10 billion, primarily due to higher cash balances and loan growth. Cash and due from banks increased $240.9 million to $408.9 million, from $167.9 million as the Company maintained elevated levels of on-balance sheet cash from net deposit inflows. Total loans increased by $205.5 million to $10.12 billion, from $9.92 billion, due to loan originations.
Total liabilities increased by $342.1 million to $11.86 billion, from $11.52 billion. Deposits increased by $858.7 million to $10.53 billion, from $9.68 billion. Time deposits increased to $2.65 billion, from $1.54 billion, or 25.2% and 15.9% of total deposits, respectively. Brokered time deposits increased $122.1 million and retail time deposits increased $988.0 million. The loan-to-deposit ratio was 96.10%, as compared to 102.50%. FHLB advances decreased by $605.1 million to $606.1 million, from $1.21 billion due to a change in funding mix.
Other liabilities increased by $65.6 million to $411.7 million, from $346.2 million, primarily due to an increase in the market values associated with customer interest rate swaps and related collateral received from counterparties.
Total stockholders’ equity increased to $1.64 billion, as compared to $1.59 billion, primarily reflecting net income net of dividends for the nine months ended September 30, 2023. Additionally, accumulated other comprehensive loss decreased by $7.2 million primarily due to increases in fair market value of available-for-sale debt securities, net of tax.
For the nine months ended September 30, 2023, the Company did not repurchase shares under its stock repurchase program. There were 2,934,438 shares available for repurchase at September 30, 2023 under the existing repurchase program . Book value per share increased to $27.56, as compared to $26.81.
Comparison of Operating Results for the Three and Nine Months Ended September 30, 2023 and September 30, 2022
General
Net income available to common stockholders for the three and nine months ended September 30, 2023 decreased to $19.7 million and $73.3 million, respectively, or $0.33 and $1.24 per diluted share, as compared to $37.6 million and $90.3 million, or $0.64 and $1.53 per diluted share, for the corresponding prior year periods. Net income for the three and nine months ended September 30, 2023 included net gain on equity investments of $1.5 million and net loss on equity investments of $1.3 million, respectively. Net income for the nine months ended September 30, 2023 also included merger related expenses of $22,000, net branch consolidation expense of $70,000 and net loss on sale of investments of $5.3 million. These items increased net income by $1.1 million and decreased net income by $5.1 million, net of tax, for the three and nine months ended September 30, 2023, respectively.
Net income for the three and nine months ended September 30, 2022 included merger related expenses of $298,000 and $2.5 million, respectively, net branch consolidation benefit of $346,000 and net branch consolidation expense of $602,000, and net gain on equity investments of $3.4 million and net loss on equity investments of $7.5 million. These items increased net income by $2.6 million and decreased net income by $8.1 million, net of tax, for the three and nine months ended September 30, 2022, respectively.
Interest Income
Interest income for the three and nine months ended September 30, 2023 increased to $158.4 million and $447.5 million, respectively, from $110.5 million and $300.9 million for the corresponding prior year periods. For the three and nine months ended September 30, 2023, the yield on average interest-earning assets increased to 5.08% and 4.90%, respectively, from 3.88% and 3.64% for the corresponding prior year periods, due to the impact of rising rates on interest-earning assets. Average interest-earning assets increased by $1.06 billion and $1.17 billion for the three and nine months ended September 30, 2023, respectively, primarily driven by commercial loan growth and increases in deposits and short-term investments.
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Interest Expense
Interest expense for the three and nine months ended September 30, 2023 increased to $67.4 million and $165.6 million, respectively, from $14.5 million and $29.9 million in the corresponding prior year periods, reflecting rising rates on costs, deposit mix shift to higher cost time deposits, and increased FHLB advances, and repricing of government deposits. For the three and nine months ended September 30, 2023, the cost of average interest-bearing liabilities increased to 2.71% and 2.29%, respectively, from 0.69% and 0.49% for the corresponding prior year periods, due to mix shift to higher cost of deposits and higher costs of FHLB advances. The total cost of deposits (including non-interest-bearing deposits) increased to 1.99% and 1.48% for the three and nine months ended September 30, 2023, respectively, from 0.36% and 0.24% for the same prior year periods.
Net Interest Income and Margin
Net interest income for the three and nine months ended September 30, 2023 decreased to $91.0 million and increased to $281.9 million, respectively, from $96.0 million and $271.0 million in the corresponding prior year periods, primarily reflecting the net impact of the higher interest rate environment. Net interest margin for the three and nine months ended September 30, 2023 decreased to 2.91% and 3.09%, respectively, from 3.36% and 3.28% for the same prior year periods. Net interest margin decreased primarily due to the increase in cost of funds outpacing the increase in yield on average interest earnings assets in the current interest rate environment and elevated levels of on-balance sheet cash.
Provision for Credit Losses
Provision for credit losses for the three and nine months ended September 30, 2023 was $10.3 million and $14.5 million, respectively, as compared to $1.0 million and $4.1 million for the corresponding prior year periods. The current quarter provision included the net impact of the $8.4 million charge-off noted above and, to a lesser extent, elevated risks and uncertainty in macro-economic conditions in a downside forecast scenario. Net loan charge-offs were $8.3 million for both the three and nine months ended September 30, 2023, respectively, as compared to net loan recoveries of $252,000 and $335,000 for the three and nine months ended September 30, 2022, respectively.
Non-interest Income
Three months ended September 30, 2023 vs. September 30, 2022
Other income decreased to $10.8 million, as compared to $15.2 million. Other income was favorably impacted by net gains on equity investments of $1.5 million and $3.4 million, for the respective quarters. The remaining decrease of $2.5 million was driven by decreases in commercial loan swap income of $1.5 million and fees and service charges of $1.1 million, which were adversely impacted by the current interest rate environment resulting in lower swap volume and mortgage activity.
Nine months ended September 30, 2023 vs. September 30, 2022
Other income decreased to $21.8 million, as compared to $31.5 million. Other income was adversely impacted by net losses on equity investments of $6.6 million, which included $5.3 million of losses related to the sale of investments in the first quarter of 2023, and $7.5 million, for the respective periods. The remaining decrease of $10.7 million was driven by decreases in commercial loan swap income on lower volume of $5.8 million, fees and service charges of $1.1 million on lower title activity, and income from bank owned life insurance of $1.0 million on non-recurring death benefits recognized in the prior year. Additionally, bankcard services revenue decreased $3.4 million, due to the Durbin Amendment which became effective for the Company on July 1, 2022.
Non-interest Expense
Three months ended September 30, 2023 vs. September 30, 2022
Operating expenses increased to $64.5 million, as compared to $59.0 million. The increase of $5.4 million was due to increases in professional fees of $2.8 million and $2.4 million in compensation and employee benefits expenses related to the Company’s ongoing investments to improve profitability and operational efficiencies, and one-time related severance and other program costs. The increase in compensation and benefits expense were partly offset by decreased employee medical benefit claims. The current quarter also included increases to federal deposit insurance and regulatory assessments of $800,000 primarily due to new assessment rates that went into effect on January 1, 2023.
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Nine months ended September 30, 2023 vs. September 30, 2022
Operating expenses increased to $188.7 million, as compared to $175.2 million. Operating expenses were adversely impacted by $92,000 and $3.1 million, for the respective periods, related to merger related expenses and net branch consolidation expense. The remaining increase of $16.5 million was due to increases in professional fees of $7.1 million and federal deposit insurance and regulatory assessments of $1.3 million that were driven by the same factors for the three months ended. The increase in compensation and benefits expense of $5.7 million was due to the $2.4 million increase noted above and merit-related increases.
Income Tax Expense
The provision for income taxes was $6.5 million and $24.1 million for the three and nine months ended September 30, 2023, respectively, as compared to $12.3 million and $29.2 million for the same prior year periods. The effective tax rate was 23.9% and 24.0% for the three and nine months ended September 30, 2023, respectively, as compared to 24.1% and 23.7% for the same prior year periods.
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Liquidity and Capital Resources
Liquidity Management
The Company manages its liquidity and funding needs through its Treasury function and the Asset Liability Committee. The Company has an internal policy that addresses liquidity and management monitors the adherence to policy limits to satisfy current and future cash flow needs. The policy includes internal limits, monitoring of key indicators, deposit concentrations, liquidity sources and availability, quarterly stress testing, collateral management, and other qualitative and quantitative metrics.
Management monitors cash on a daily basis to determine the liquidity needs of the Bank and OceanFirst Financial Corp. (the “Parent Company”), a separate legal entity from the Bank. Additionally, management performs multiple liquidity stress test scenarios on a quarterly basis. As of September 30, 2023, the Bank and Parent Company continued to maintain adequate liquidity under all stress scenarios. The Company also has a detailed contingency funding plan and obtains comprehensive reporting of funding trends on a monthly and quarterly basis, which are reviewed by management.
The Company continually evaluates its on-balance sheet liquidity, including cash and unpledged securities; and funding capacity at the FHLB and FRB Discount Window, and periodically tests each of its lines of credit. As of September 30, 2023, total on-balance sheet liquidity and funding capacity was $4.3 billion.
The Company has a highly operational and granular deposit base, with long-standing client relationships across multiple customer segments providing stable funding. The vast majority of the government deposits are protected by the Federal Deposit Insurance Corporation insurance as well as the State of New Jersey under the Government Unit Deposit Protection Act, which requires uninsured government deposits to be further collateralized by the Bank. At September 30, 2023, the Bank reported in its Call Report $5.27 billion of estimated uninsured deposits. This total included $2.16 billion of collateralized government deposits and $1.46 billion of intercompany deposits of fully consolidated subsidiaries, leaving estimated adjusted uninsured deposits of $1.65 billion, or 16% of total deposits. On balance-sheet liquidity and funding capacity represented 262% of the estimated adjusted uninsured deposits.
The primary sources of liquidity specifically available to the Parent Company are dividends from the Bank, proceeds from the sale of investments, and the issuance of debt, preferred and common stock. For the nine months ended September 30, 2023, the Parent Company received dividend payments of $73.5 million from the Bank. At September 30, 2023, the Parent Company held $70.2 million in cash and cash equivalents.
The Bank’s primary sources of funds are deposits, principal and interest payments on loans and investments, FHLB advances, other borrowings, and proceeds from the sale of loans and investments . While scheduled payments on loans and securities are predictable sources of funds, deposit flows, loan prepayments, and loan and investment sales are greatly influenced by interest rates, economic conditions, and competition. The Bank has other sources of liquidity if a need for additional funds arises, including various lines of credit at multiple financial institutions, access to the FRB discount window, and the Bank Term Funding Program (“BTFP”).
As of September 30, 2023, the Company pledged $7.25 billion of loans with the FHLB and FRB to enhance the Company’s borrowing capacity, and includes collateral pledged to the FHLB to obtain a municipal letter of credit to collateralize certain municipal deposits. The Company also pledged $1.09 billion of securities with FHLB and FRB to secure borrowings, enhance borrowing capacity, collateralize its repurchase agreements, and for other purposes required by law. The Company had $606.1 million of term advances from the FHLB as of September 30, 2023, as compared to $1.21 billion at December 31, 2022, reflecting a shift in funding mix to deposits. As of September 30, 2023, the Company had no overnight borrowings from the FHLB and no outstanding borrowings from the FRB discount window or the BTFP.
The Com pany’s cash needs for the nine months ended September 30, 2023 were primarily satisfied by the increase in deposits. The cash was primarily kept on the balance sheet to maintain liquidity on hand, and utilized for loan originations and the reduction of FHLB advances.
Off-Balance Sheet Commitments and Contractual Obligations
In the normal course of business, the Bank routinely enters into various off-balance sheet commitments, primarily relating to the origination and funding of loans. At September 30, 2023, outstanding commitments to originate loans totaled $131.2 million and outstanding undrawn lines of credit totaled $1.56 billion, of which $1.21 billion were commitments to commercial and commercial construction borrowers and $349.3 million were commitments to consumer borrowers and residential construction borrowers. Commitments to fund undrawn lines of credit and commitments to originate loans are agreements to lend to a customer as long as there is no violation of any condition established in the existing contracts. Commitments generally have
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fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company’s exposure to credit risk is represented by the contractual amount of the instruments.
At September 30, 2023, the Company also had various contractual obligations, which included debt obligations of $885.2 million, including finance lease obligations of $1.7 million, and an additional $20.6 million in operating lease obligations included in other liabilities. The Company expects to have sufficient funds available to meet current commitments in the normal course of business. Time deposits scheduled to mature in one year or less totaled $2.47 billion at September 30, 2023.
Liquidity Used in Stock Repurchases and Cash Dividends
Under the Company’s stock repurchase program, shares of OceanFirst Financial Corp. common stock may be purchased in the open market or through other privately-negotiated transactions, from time-to-time, depending on market conditions. The repurchased shares are held as treasury stock for general corporate purposes. For the three and nine months ended September 30, 2023, the Company did not repurchase any shares of its common stock. At September 30, 2023, there were 2,934,438 shares available to be repurchased under the authorized stock repurchase program.
Cash dividends on common stock declared and paid during the first nine months of September 30, 2023 was $35.4 million. Cash dividends on preferred stock declared and paid during the first nine months of September 30, 2023 was $3.0 million.
The Company’s ability to continue to pay dividends remains dependent upon capital distributions from the Bank, which may be adversely affected by capital restraints imposed by applicable regulations. The Company cannot predict whether the Bank will be permitted under applicable regulations to pay a dividend to the Parent Company. If applicable regulations or regulatory bodies prevent the Bank from paying a dividend to the Parent 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 may prevent the Company from either paying or increasing the cash dividend to common stockholders.
Capital Management
The Company manages its capital sources, uses, and expected future needs through its Treasury function and the Asset Liability Committee. The Company has an internal policy that addresses capital and management monitors the adherence to policy limits to satisfy current and future capital needs. The policy includes internal limits, monitoring of key indicators, sources and availability, intercompany transactions, forecasts and stress testing, and other qualitative and quantitative metrics.
Additionally, management performs multiple capital stress test scenarios on a quarterly basis, varying loan growth, earnings, access to the capital markets, credit losses, and more recently, mark-to-market losses in the investment portfolio, including both available-for-sale and held-to-maturity. As of September 30, 2023, the Bank and Parent Company continued to maintain adequate capital under all stress scenarios, including a scenario where all losses related to the investment securities portfolio are realized. The Bank and the Parent Company also have detailed contingency capital plans and obtain comprehensive reporting of capital trends on a regular basis, which are reviewed by management and the Board.
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Regulatory Capital Requirements
As of September 30, 2023 and December 31, 2022, the Company and the Bank satisfied all regulatory capital requirements currently applicable as follows (dollars in thousands):
Actual For capital adequacy
purposes To be well-capitalized
under prompt
corrective action
As of September 30, 2023 Amount Ratio Amount Ratio Amount Ratio
Company:
Tier 1 capital (to average assets) $ 1,200,832 9.14 % $ 525,331 4.00 % N/A N/A
Common equity Tier 1 (to risk-weighted assets)
1,071,480 10.36 723,689 7.00 (1)
N/A N/A
Tier 1 capital (to risk-weighted assets) 1,200,832 11.62 878,766 8.50 (1)
N/A N/A
Total capital (to risk-weighted assets) 1,392,971 13.47 1,085,534 10.50 (1)
N/A N/A
Bank:
Tier 1 capital (to average assets) $ 1,147,262 8.80 % $ 521,320 4.00 % $ 651,650 5.00 %
Common equity Tier 1 (to risk-weighted assets)
1,147,262 11.21 716,158 7.00 (1)
665,004 6.50
Tier 1 capital (to risk-weighted assets) 1,147,262 11.21 869,620 8.50 (1)
818,466 8.00
Total capital (to risk-weighted assets) 1,214,139 11.87 1,074,237 10.50 (1)
1,023,083 10.00
As of December 31, 2022
Company:
Tier 1 capital (to average assets) $ 1,150,690 9.43 % $ 488,297 4.00 % N/A N/A
Common equity Tier 1 (to risk-weighted assets)
1,021,774 9.93 720,641 7.00 (1)
N/A N/A
Tier 1 capital (to risk-weighted assets) 1,150,690 11.18 875,064 8.50 (1)
N/A N/A
Total capital (to risk-weighted assets) 1,336,652 12.98 1,080,961 10.50 (1)
N/A N/A
Bank:
Tier 1 capital (to average assets) $ 1,122,946 9.20 % $ 488,033 4.00 % $ 610,041 5.00 %
Common equity Tier 1 (to risk-weighted assets)
1,122,946 11.02 713,194 7.00 (1)
662,251 6.50
Tier 1 capital (to risk-weighted assets) 1,122,946 11.02 866,021 8.50 (1)
815,078 8.00
Total capital (to risk-weighted assets) 1,183,705 11.62 1,069,791 10.50 (1)
1,018,848 10.00
(1) Includes the Capital Conservation Buffer of 2.50%.
The Company and the Bank satisfied the criteria to be “well-capitalized” under the Prompt Corrective Action regulations.
At September 30, 2023 and December 31, 2022, the Company maintained a stockholders’ equity to total assets ratio of 12.13% and 12.10%, respectively.
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Non-Performing Assets
The following table sets forth information regarding the Company’s non-performing assets, consisting of non-performing loans. It is the policy of the Company to cease accruing interest on loans 90 days or more past due or in the process of foreclosure.
September 30, December 31,
2023 2022
(dollars in thousands)
Non-performing loans:
Commercial real estate – investor $ 20,723 $ 10,483
Commercial real estate – owner occupied 240 4,025
Commercial and industrial 1,120 331
Residential real estate 5,624 5,969
Other consumer 2,391 2,457
Total non-performing loans and assets $ 30,098 $ 23,265
PCD loans, net of allowance for loan credit losses
$ 18,640 $ 27,129
Delinquent loans 30-89 days $ 20,591 $ 14,148
Allowance for loan credit losses as a percent of total loans 0.63 % 0.57 %
Allowance for loan credit losses as a percent of total non-performing loans
212.23 244.25
Non-performing loans as a percent of total loans receivable 0.30 0.23
Non-performing assets as a percent of total assets 0.22 0.18
The Company’s non-performing loans totaled $30.1 million at September 30, 2023, as compared to $23.3 million at December 31, 2022. At September 30, 2023, non-performing loans included the remaining exposure of $8.8 million on a single commercial real estate relationship that was partially charged-off during the three months ended September 30, 2023. At September 30, 2023, total non-performing loans included $869,000 of modified loans to borrowers experiencing financial difficulty and $5.8 million of troubled debt restructuring (“TDR”) loans that existed prior to adoption of Accounting Standards Update (“ASU”) 2022-02 on January 1, 2023. At December 31, 2022, total non-performing loans included $6.4 million of TDR loans. Included in the non-performing loans total was $3.2 million and $3.9 million of PCD loans at September 30, 2023 and December 31, 2022, respectively. At September 30, 2023, the allowance for loan credit losses totaled $63.9 million, or 0.63% of total loans, as compared to $56.8 million, or 0.57% of total loans, at December 31, 2022. These ratios exclude existing net unamortized credit and PCD marks on acquired loans of $8.8 million and $11.4 million at September 30, 2023 and December 31, 2022, respectively.
The Company classifies loans and other assets in accordance with regulatory guidelines. The table below excludes any loans held-for-sale and represents Special Mention and Substandard assets (in thousands):
September 30, December 31,
2023 2022
Special Mention $ 44,940 $ 48,214
Substandard 86,597 50,776
The change in substandard loans was primarily due to a migration of certain loans from special mention to substandard risk rating, which partly consisted of two CRE-Investor Owned relationships totaling $16.1 million. The remaining increase in substandard loans was primarily due to three commercial relationships for $13.7 million, which were downgraded to substandard during the nine months ended September 30, 2023. Additionally, the change in special mention loans was primarily due to two commercial relationships totaling $22.9 million that were downgraded during the nine months ended September 30, 2023, partly offset by the commercial real estate relationship that was charged-off for $8.4 million for the three months ended September 30, 2023.
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Critical Accounting Policies and Estimates
Note 1 to the Company’s Audited Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 (the “2022 Form 10-K”), as supplemented by this report, contains a summary of significant accounting policies. Various elements of these accounting policies, by their nature, are subject to estimation techniques, valuation assumptions and other subjective assessments. Certain assets are carried in the consolidated statements of financial condition at estimated fair value or the lower of cost or estimated fair value. Policies with respect to the methodology used to determine the allowance for credit losses is a critical accounting policy and estimate because of its importance to the presentation of the Company’s financial condition and results of operations. The critical accounting policy involves a higher degree of complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. The use of different judgments, assumptions, and estimates could result in material differences in the results of operations or financial condition. The critical accounting policy and its application is reviewed periodically, and at least annually, with the Audit Committee of the Board of Directors.
Goodwill
Goodwill represents the excess of the purchase price over the estimated fair value of identifiable net assets acquired through purchase acquisitions. Goodwill is evaluated for impairment on an annual basis, or more frequently if events or changes in circumstances indicate potential impairment between annual measurement dates (i.e. triggering events). For the purposes of goodwill impairment testing, management has concluded that the Company has one reporting unit and the annual impairment test is performed as of August 31.
Testing of goodwill impairment comprises a two-step process. First, the Company performs a qualitative assessment to evaluate relevant events or circumstances to determine whether it is more likely than not that the fair value of the Company is less than its carrying amount, including goodwill. The factors considered in the qualitative assessment include macroeconomic conditions, industry and market conditions and overall financial performance of the Company, among other factors. If the Company determines that it is more likely than not that the fair value of the Company is less than its carrying amounts, then it proceeds to the quantitative impairment test, whereby it calculates the fair value of the Company. In its performance of impairment testing, management has the unconditional option to proceed directly to the quantitative impairment test, bypassing the qualitative assessment. If the carrying amount of the Company exceeds its fair value, the amount by which the carrying amount exceeds fair value, up to the carrying value of goodwill, is recorded through earnings as an impairment charge. If the results of the qualitative assessment indicate that it is not more likely than not that an impairment has occurred, or if the quantitative impairment test results in a fair value of the Company that is greater than the carrying amount, then no impairment charge is recorded.
As of the annual impairment testing date of August 31, 2023, the Company bypassed the qualitative assessment and proceeded directly to the quantitative impairment test based on the stock price on the measurement date and economic uncertainty and market volatility impacting the banking sector. To perform the quantitative assessment, the Company engaged a third-party service provider to assist management with the determination of the fair value of the Company. A combination of an income valuation methodology, comprising a discounted cash flow analysis, and a market valuation methodology, comprising the guideline public company method, was employed. Management then assigned weightings to the two approaches to conclude on the estimated fair value. The weightings took into consideration recent market volatility and suppressed stock price of the Company and the banking industry.
The discounted cash flow (“DCF”) estimated the present value of future cash flows. A DCF analysis requires significant judgment to model financial forecasts, which included loan and deposit growth, funding mix, income on securities, credit performance, forward interest rates, future returns driven by net interest margin, fee generation and expense incurrence, industry and economic trends, and other relevant considerations. For periods beyond those forecasted, a terminal value was estimated based on an assumed long-term growth rate, which was derived using the Gordon Growth Model. The discount rate applied to the forecasted cash flows was calculated using a build-up approach, which starts with the risk-free interest rate and then calibrated for market and company specific risk premiums, including a beta, equity risk, size, and company-specific risk premiums to reflect risks and uncertainties in the financial market and in the Company’s business projections.
The market approach utilizes observable market data from comparable public companies, including price-to-tangible book value ratios, to estimate the Company’s fair value. The market approach also incorporates a control premium to represent the Company’s expectation of a hypothetical acquisition. Management uses judgment in the selection of comparable companies and includes those with similar business activities, and related operating environments.
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The results of the quantitative assessment indicated that the fair value of the Company’s reporting unit exceeded its carrying amount, though not substantially, which resulted in no impairment loss at August 31, 2023.
Management continued to carefully assess and evaluate all available information for potential triggering events after the August 31 annual testing date. Though it observed some deterioration in inputs to the market approach, management believes that the banking sector continues to experience market dislocation and concluded no triggering events were identified subsequent to the annual test date.
Significant negative industry or economic trends, including declines in the market price of the Company’s stock, reduced estimates of future cash flows or business disruptions could result in impairments to goodwill in the future, which would result in recording an impairment loss. Any resulting impairment loss could have a material adverse impact on the Company’s financial condition and results of operations. Management will continue evaluating the economic conditions at future reporting periods for triggering events.
Impact of New Accounting Pronouncements
Accounting Pronouncements Adopted in 2023
In March 2022, the Financial Accounting Standards Board (“FASB”) issued ASU 2022-01 “Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method”, which made targeted improvements to the optional hedge accounting model with the objective of improving hedge accounting to better portray the economic results of an entity’s risk management activities in its financial statements. This update will be effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2022. Early adoption is permitted for any entity that has adopted the amendments in ASU 2017-12 for the corresponding period. The adoption of this standard did not have an impact on the Company’s consolidated financial statements, as the Company currently does not have any fair value hedges.
In March 2022, FASB issued ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures”. The amendments in this ASU were issued to (1) eliminate accounting guidance for TDRs by creditors, while enhancing disclosure requirements for loan refinancings and restructurings when a borrower is experiencing financial difficulty; (2) require disclosures of current period gross write-offs by year of origination for financing receivables and net investments in leases. For entities that have adopted the amendments in ASU 2016-13, Measurement of Credit Losses on Financial Instruments, this update will be effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2022. Early adoption is permitted. The amendments in this ASU should be applied prospectively, except for the transition method related to the recognition and measurement of TDRs, where there is an option to apply a modified retrospective transition method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption. The Company adopted this guidance prospectively, and the adoption of this standard did not have an impact on the Company’s consolidated financial statements.
In December 2022, FASB issued ASU 2022-06, “Deferral of the Sunset Date of Topic 848”, which was effective upon issuance. The amendments in this ASU defer the sunset date of Topic 848 (Reference Rate Reform) from December 31, 2022 to December 31, 2024. Topic 848, originally issued in 2020 and later amended in 2021, provides optional accounting expedients and exceptions for certain loan agreements, derivatives and other transactions affected by the transition away from London Inter-Bank Offered Rate (“LIBOR”) towards alternative reference rates. As of December 31, 2021, the Company adopted certain of these practical expedients in Topic 848 and will continue to apply prospectively until December 31, 2024. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
Transition from LIBOR
As of December 31, 2021, the Company ceased issuing LIBOR-based products and transitioned to Alternative Rates. For the tenors of U.S. dollar LIBOR utilized by the Company, the administrator of LIBOR extended publication until June 30, 2023. As of June 30, 2023, the Company has transitioned substantially all of its previously existing LIBOR-based products that were not expected to mature or settle prior to the cessation date. Contract language for all remaining LIBOR-based loans, securities, and borrowings has been reviewed and updated as necessary to automatically convert to an Alternative Rate at their next rate reset date with no action required.
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Recent Accounting Pronouncements Not Yet Adopted
In June 2022, FASB issued ASU 2022-03, “Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions”. The amendments in this ASU clarify that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. The amendments also clarify that an entity cannot, as a separate unit of account, recognize and measure a contractual sale restriction. In addition, this update introduces new disclosure requirements to provide information about the contractual sales restriction including the nature and remaining duration of the restriction. This update will be effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2023. Early adoption is permitted. The Company does not expect this standard to have a material impact to the consolidated financial statements.
In March 2023, FASB issued ASU 2023-02, “Investments - Equity Method and Joint Venture (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method”. The amendments in this ASU permit reporting entities to account for the tax equity investments, regardless of the tax credit program from which the income tax credits are received, using the proportional amortization method. This update will be effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2023. Early adoption is permitted. The Company is currently evaluating the impact of this standard on the consolidated financial statements.
In August 2023, FASB issued ASU 2023-05, “Business Combinations - Joint Venture Formations (Subtopic 805-60): Recognition and Initial Measurement”. The amendments in this ASU require that a joint venture, upon formation, apply a new basis of accounting and initially measure assets and liabilities at fair value, with exceptions to fair value measurement that are consistent with the business combinations guidance. This update will be effective prospectively for all joint venture formations with a formation date on or after January 1, 2025. Early adoption is permitted. The Company does not expect this standard to have a material impact to the consolidated financial statements.
Private Securities Litigation Reform Act Safe Harbor Statement
In addition to historical information, this quarterly report contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which are based on certain assumptions and describe future plans, strategies and expectations of OceanFirst Financial Corp. (the “Company”). These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “will,” “should,” “may,” “view,” “opportunity,” “potential,” or similar expressions or expressions of confidence. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to: changes in interest rates, inflation, general economic conditions, potential recessionary conditions, levels of unemployment in the Bank’s lending area, real estate market values in the Bank’s lending area, including specific loan exposures, such as lending for office space, potential goodwill impairment, future natural disasters, potential increases to flood insurance premiums, the current or anticipated impact of military conflict, terrorism or other geopolitical events, the level of prepayments on loans and mortgage-backed securities, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government including policies of the U.S. Treasury and the Board of Governors of the Federal Reserve System, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, changes in liquidity, including the size and composition of the Company’s deposit portfolio, including the percentage of uninsured deposits in the portfolio, competition, demand for financial services in the Company’s market area, changes in consumer spending, borrowing and saving habits, changes in accounting principles, a failure in or breach of the Company’s operational or security systems or infrastructure, including cyberattacks, the failure to maintain current technologies, failure to retain or attract employees, the impact of the COVID-19 pandemic or any other pandemic on our operations and financial results and those of our customers and the Bank’s ability to successfully integrate acquired operation s .
These risks and uncertainties are further discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, under Item 1A - Risk Factors and elsewhere, and subsequent securities filings and should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.