OceanFirst Financial Corp
NASDAQ:OCFC
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OceanFirst Financial Corp
Earnings Call Analysis
Q2-2024 Analysis
OceanFirst Financial Corp
In the second quarter of 2024, OceanFirst Financial Corp reported diluted earnings per share of $0.40, down from a prior quarter of $0.86, reflecting pressures on net interest income. Notably, net interest income fell to $82 million, a decrease driven by an inverted yield curve and elevated loan paydowns. The bank highlighted that despite these challenges, their operations remained largely unaffected by recent systemic IT disruptions, with customer access to services intact.
The bank demonstrated robust asset quality metrics, with criticized and classified assets declining 15% to $143 million. The provision for credit losses increased to $3.1 million, maintaining a low coverage ratio of 0.69% of total loans. Meanwhile, OceanFirst's capital position strengthened, with the common equity tier 1 capital ratio reaching 11.2% and tangible book value per share growing 7% year-over-year to $18.93.
The company is pivoting towards commercial and industrial (C&I) lending, with a loan pipeline of $259 million, significantly higher than the previous quarter's $137 million and the highest in five quarters. Five new C&I lenders have joined the bank, and the focus is on expanding these relationships, particularly in middle-market sectors. The outlook for loan growth in the second half of the year is optimistic, with expectations of new deposits and fee income offsetting declines in the commercial real estate (CRE) portfolio.
Depository balances witnessed a 2% decline, attributed to a 4% decrease in nonmaturity deposits. The reduction stemmed largely from a runoff of brokered CDs and high-yield savings accounts. However, the bank's noninterest-bearing balances remained stable, indicating some resilience in funding despite the overall decline.
The net interest margin dropped to 2.71% as the bank experienced a modest increase in funding costs. However, projections suggest that the bank may be at or near the trough of this metric as future loan growth and deposits could positively impact margins. Furthermore, the management expressed confidence in achieving a net interest margin above 3% once the economic conditions stabilize.
The management is focused on increasing organic growth through the remainder of the year and into 2025, targeting a sustainable loan growth rate of around 10%. They emphasized that prudent capital management and continued building of reserves would support this growth while ensuring asset quality remains a priority. The bank aims to return to its previous ROA levels of 1.20%, which it has achieved in the past, suggesting a strategic approach to leverage and performance amidst evolving market conditions.
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Good morning, all, and thank you for attending the OceanFirst Financial Corp.'s Q2 '24 Earnings Release Conference Call. My name is Brika, and I will be your moderator for today. [Operator Instructions]
I would now like to pass the conference over to your host, Alfred Goon, Investor Relations at OceanFirst Financial Corp. to begin. Thank you. You may proceed, Alfred.
Thank you, Brika. Good morning, and welcome to the OceanFirst Second Quarter 2024 Earnings Call. I am Alfred Goon, SVP of Corporate Development and Investor Relations.
Before we kick off the call, we'd like to remind everyone that our quarterly earnings release and related earnings supplement can be found on the company website, oceanfirst.com. Our remarks today may contain forward-looking statements and may refer to non-GAAP financial measures. All participants should refer to our SEC filings, including those found on Forms 8-K, 10-Q and 10-K for a complete discussion of forward-looking statements and any factors that could cause actual results to differ from those statements.
Thank you. And now I will turn the call over to Christopher Maher, Chairman and Chief Executive Officer.
Thank you, Alfred. Good morning, and thank you to all who've been able to join our second quarter 2024 earnings conference call.
This morning, I'm joined by our President, Joe Lebel; and our Chief Financial Officer, Pat Barrett. We appreciate your interest in our performance and this opportunity to discuss our results with you. This morning, we will provide brief remarks about the financial and operating performance for the quarter and some color regarding the outlook for our business. We may refer to the slides filed in connection with the earnings release throughout the call. After our discussion, we look forward to taking your questions.
Anticipating that there may be some questions regarding the impact to bank operations as the result of the global CrowdStrike IT issue, I'm pleased to report that the bank is operating with minimal disruption. We've had no issues with customer access to our online banking, mobile banking, customer care center, OFBCONNECT, which is our mobile platform for business clients, ATM machines, card and wire systems. Our branches are open and serving customers as well. We appreciate the hard work of our IT team this morning.
Our financial results for the second quarter included GAAP diluted earnings per share of $0.40. Our earnings reflect net interest income of $82 million, representing a decrease compared to the prior linked quarter of $86 million as the yield curve remains inverted, and we experience elevated paydowns in higher-yielding loans. Operating expenses remained stable at $59 million.
Asset quality metrics continue to remain strong, criticized and classified assets, which were already lower than our peers and below our long-term averages, decreased 15% or $25 million to $143 million. The quarter included a net ACL build of $1.6 million and net charge-offs of $1.5 million, which includes a $1.6 million charge-off on a single commercial real estate relationship that was moved to nonaccrual in the third quarter of 2023. The remaining exposure for this credit is $7.2 million and the sale of the collaterals contracted to settle during the third quarter.
Capital levels continue to build with our estimated common equity Tier 1 capital ratio increasing to 11.2% and continued growth in tangible book value, which increased by $0.30 to $18.93. Tangible book value per share has grown 7% over the past year.
Capital growth was sustained this quarter, while the company repurchased an incremental 338,000 shares under the company's repurchase program. Through June 30, 2024, we have purchased nearly 1.3 million shares at a weighted average cost of $15.35. The company has 1,638,524 shares available for repurchase under the authorized repurchase program.
Further on capital management, the Board approved a quarterly cash dividend of $0.20 per common share. This is the company's 110th consecutive quarterly cash dividend and represents 50% of GAAP earnings. With solid credit metrics and our bolstered capital position, we are now increasingly focused on driving organic growth in the back half of the year into 2025.
At this point, I'll turn the call over to Joe to provide some more details regarding our performance during the second quarter and our efforts to increase organic growth rates.
Thanks, Chris.
The bank's loan pipeline of $259 million reflects the marked increase over the $137 million in Q1 and was the highest in the past 5 quarters. This bank continues to pivot our organization engines or origination engines to growing and expanding C&I lending relationships from our historical CRE focus. The recruitment of C&I lenders continues with the addition of 5 new bankers this year and 4 offers accepted or pending with additional recruiting ongoing. This includes a new team build-out with a focus on middle-market C&I and government contracting. We've also added a middle market banker well known in the grocery space, which should expand opportunities for us in that industry.
While originations of new loans were modest in Q2, I expect growth in the C&I business in the second half of the year, which will bring with it new deposits and fee income while offsetting any small decline in CRE.
For the quarter, our C&I loan balances were impacted by 5 borrowers who paid down or paid off loans in the normal course of business in the amount of $86 million. Overall, the impact of declines in loan and other earning asset balances accounted for approximately $2 million of our decline in net interest income from the prior quarter. Our CRE portfolio continues to perform well, and we remain committed to methodically rebalancing our commercial loan portfolio towards C&I relationships over time.
Moving to deposits. Balances declined by approximately 2% as nonmaturity deposits decreased 4% compared to the prior quarter. This decline includes our continued runoff of brokered CDs of $142 million and decline in high-yield savings balances of $96 million, driven by targeted refinements to both marketing efforts and rates offered.
As Chris noted, we booked a net ACL build of $1.6 million and net charge-offs of $1.5 million, representing a $3.1 million provision for credit losses during the quarter, increasing our coverage ratio to 0.69% of total loans. The net ACL build was driven by external macroeconomic forecasts and our modeling rather than credit quality indicators within our own portfolio.
Asset quality metrics remain strong with nonperforming loans and criticized and classified assets representing only 0.33% and 1.42% of total loans, respectively. Meanwhile, loans 30 to 89 days past due as a percentage of total loans remained minimal at 0.10 basis points. These metrics remain low compared to pre-pandemic levels, and reflect strong credit performance in our portfolio.
With that, I'll turn the call over to Pat to review margin and expense outlook.
Thanks, Joe, and good morning to everybody.
Net interest income and net interest margin were $82 million and 2.71%, respectively, reflecting a combination of higher funding costs associated with the mix shift in funding and modestly lower average earning assets. Funding costs reflect cycle-to-date deposit betas of 42%, up from 40% in the prior quarter. We continue to believe that we're at or very near our trough in both net interest income and margin, but our outlook for both could shift modestly subject to interest rates, loan growth or repayments and funding mix trends in future quarters. We've said in the past that we are in a very conservative posture around new business growth and we're unlikely to expand our long-standing risk appetites to stimulate short-term growth.
As Joe mentioned, we increased our provision by $3.1 million, increasing our coverage ratio to total loans to 0.69% and to 0.75%, including purchase accounting credit marks. Despite strong asset quality metrics and stress test results, we've remained prudent and steadily continue to build reserve levels to address the uncertainty risk in the overall environment. It's worth noting that we've nearly doubled our allowance coverage ratio since adopting CECL 4 years ago, despite reporting an average of only 7 basis points of annualized net charge-offs during that same time frame.
Noninterest expenses remained flat from the prior quarter at $59 million. We continue to make every effort to hold operating expenses stable in the $58 million to $60 million per quarter range but modest quarterly volatility may occur.
Finally, as Chris mentioned earlier, capital strengthened appreciably with growth in our CET1 ratio to 11.2%, and we're pleased to report capital accretion even while repurchasing the 338,000 shares for $5 million during the quarter. Looking ahead, we would not expect meaningful repurchases in the near term.
At this point, we'll begin the Q&A answer -- portion of the call.
[Operator Instructions] We will take the first question from the line of Frank Schiraldi with Piper Sandler.
Curious to talk about the margin here. Obviously, the quarter in terms of loan yields, you saw not as much pickup as you would otherwise expect, which you noted and should be temporary. But just trying to think through some of the specifics around the potential pickup in loan yield as the book turns over here. And also what it might mean for credit migration in terms of criticized classified balances.
So like the $300 million or nearly $300 million in CRE repricing, I guess, in the back half of the year, those are at rates, looks like a 5.8%. Is that right? And then where are the new rates that you're repricing to? And do you expect a decent amount of this will migrate off balance sheet?
Okay, Frank. There's a couple of things there. I'll give you a few things, and then we'll probably turn it over to Joe for more comments about loans and Pat around margin.
Just as we talk about margin first, I would say that the deposit -- the modest increase in deposit cost was expected by us. That's just the trend we've been on, and we anticipated that. The paydowns of higher-yielding loans surprised us a little bit on the earning asset side. So the compression we saw this quarter was more a function, at least from what we expected of having the paydowns and loans that we're yielding that weighted average coupon of those loans is north of 8%. So we don't expect that to recur. That's actually probably a pretty good sign for credit. These are customers of ours who have ample cash and they're using it to reduce their leverage. So that's a good sign. In a minute, I'll ask Joe to talk more about perspective around the future loan growth and future loan bookings.
Just on your comment about the credit and the rolling CRE loans. We do a lot of stress testing, as you can imagine, on the CRE portfolio. One of the most critical stress tests we do is to take a look at the rolling loans, look at the coupon they're paying today and their ability to service that coupon as they roll. And not just for the remainder of this year, but going -- looking at the totality of 2025 and even into 2026, we have not identified any issue of any consequence around rolling loans. So we would expect that those loans would have the option to roll with us, pay current coupons and stay at the bank.
There is a little bit of a pressure valve in some places. There are market players like Freddie Mac who are still offering very attractive rates out there. So you might see some pressure on that. And frankly, in the CRE side, if we're getting paid, we're happy to keep it. These are good clients. But we're not going to compete on price in that market. We'll be focused on C&I.
So maybe I'd ask Joe to talk a little bit about the outlook for loan originations Q3 and beyond? And then maybe, Pat, anything you want to add to the margin discussion?
So I'll talk about just the outlook for loans. Look, Q2 was a pretty quiet quarter. It's evidenced by even our conservative approach in the way we report in terms of the pipeline as to where we're headed. The pipeline is very strong and I anticipate that we'll have a significant increase in activity in Q3, and that should bode well for Q4 as well. Not only with the existing team, but the team members that we're adding. So I think we had a very small amount, $56 million, in commercial closing in Q2, which is a very small number. I would anticipate that we're probably going to head back towards where we were in June of '23. I think we had a much higher activity in that period of time. I think that's probably the past.
And then yields are much better as well. I think that the pipeline shows that a weighted average yield of 7.98. That's a function of both floating rate C&I and floating rate construction, which dominate the pipeline content.
I guess, this is Pat, on the margin that we saw and that we're expecting, like Chris said, the paydowns were the part the margin decline that was a little bit unexpected for us. Notwithstanding that, we would have seen 3, maybe 4 basis points of compression on a combination of balance migration and rate change, but it was probably more mix than anything else.
On the funding side, we did continue to reduce brokered CD balances and some of our higher-cost institutional. Our noninterest-bearing balances, we were happy to see it remain pretty stable. So that wasn't a surprise.
I think going forward, notwithstanding the effect of any other paydowns we may see that were accelerated or growth, then I think that our margin should be relatively stable, but we're hopeful that we can generate some growth in the second half of the year that will be accretive to the margin, and we don't see further pay-ups and paydowns. Sorry for all the hopes.
Right. So I guess as you guys grow in the back half of the year, or you feel like you're going to be in a place that you're not going to NIM contract further because of that growth. I mean would you give up some NIM growth in the near term maybe to do something like position yourself a little bit better for a down rate environment? Is there any potential to see loan growth here in the near term kind of exceed deposit growth and fund with short-term borrowings with the idea that maybe you could lock in some lower deposit costs down the road?
Or how do you think about as you grow the loan book, the loan-to-deposit ratio here in the near term?
So I'll take that in 2 parts, Frank. It's Chris. There's no question that we're in the relationship business. We want to build those relationships every quarter. The margins may be a little bit better or worse because of that. So we find the opportunity to add good relationships, and we have to be a little more competitively priced, we'll do it. I kind of differentiate between net interest income and margin. We have our eye more focused on net interest income and building that. So if we had the opportunity to grow the loan book a little bit, improve net interest income, and we have to give up 1 point or 2 on NIM, that's a good trade-off as long as we're bringing in high-quality clients and good relationships. So that's kind of the way we would look at things.
And we're confident. We've got the teams in place. We know how to grow the loan book. We're just taking our time and doing it very thoughtfully and methodically.
Okay. I appreciate the color.
One of the things I just -- you did mention the loan-to-deposit ratio. So our views have not changed on that. We're comfortable operating at or near 100% loan-to-deposit ratio. We like being in the 90s. If a quarter comes up, where we're at 100 or 101, that's not a big deal for us, but we're not going to go to 110, 120. We're not going to push that measure. So we're comfortable we can originate deposits on loan growth in the second half of the year.
We now have Daniel Tamayo with Raymond James.
So I guess I just wanted to ask more about on that loan growth topic. You mentioned you're trying to reduce CRE concentration. You've got the C&I initiatives. How should we be thinking about the CRE book growth in the next couple of years? I mean, is that a book that you expect to see modest growth, stable and as it relates to the CRE concentration, like how quick do you expect that to come down?
So I guess the best way to think about that is, first, we like our CRE book, notwithstanding kind of the market tone around CRE. So we're not in any rush to kind of move to a certain ratio. We don't have a target to kind of reduce it in that sense. But we also noted, we would understand that we're going to be a more valuable franchise, that we have a little more diversification in our asset mix. So over time, I think you're going to see the C&I proportion of our balance sheet increase.
The CRE proportion remain flat, maybe decrease a little bit. And then within the CRE book, we're optimizing the best relationships we have kind of -- an interesting time because of the contraction in CRE lending across the industry, some of our best clients are bringing us really good and attractive opportunities. So we're still in the business of doing CRE lending. But proportionally, I would expect that to fall on the balance sheet, and you might see our investor CRE ratios decrease over time as well. But we're not in any mad dash to go try and run off a portfolio of customers that we like.
Okay. I appreciate that. And I recognize this is -- next one is a tricky question as it relates to regulators conversations and all that. But I think the market was spooked clearly by the FF -- the First Foundation equity issuance in the quarter and especially for banks with high CRE concentration.
So I mean, is there anything you can say or comment on regulatory discussions or pressure that they're putting on you guys? Or any kind of commentary around kind of what those conversations are like with the regulators, would be interesting.
Yes. I understand the question. Well, we certainly can't talk about our conversations with our regulators. I think our financial statements or outlook, and this discussion should give you some comfort. If you look at the way our portfolio has performed, if you look at the way we've handled concentrations, both geographically and by asset class, we don't have a lot of anything. We got a lot of stuff kind of put out different geographies, different asset classes. We have not had a lot of CRE growth in the last couple of years. The growth factor is a really important consideration that regulators look at. If you're growing quickly, then to you're going to attract more attention.
So when you look at our credit metrics in our portfolio, we don't -- we think they're holding up well. There's no cause for concern. When you think about the stress testing that we share with you in our disclosures, that gives you a sense as to how we're thinking about interest rate risk over time in that portfolio, that kind of maturity wall issue. So when you look at all that stuff, we've got a very good portfolio. We feel good about it.
But the second part of our consideration is we've always been pretty proactive about capital. So we went 18 months ago into a mode of preserving and building capital. It was very thoughtful. We wanted to protect ourselves from what might occur in the environment. And we're really happy with where capital is.
So I look at this 2 ways. The portfolio is performing well, and we feel good about it. There's not a lot of pressure. And then you look at your capital ratios and see that you've built them nicely over the last couple of years. That's kind of the -- what I would say is a kind of textbook way to manage your CRE concentration. So we feel good about it, but I wouldn't make any comments attributable to our regulators.
The next question comes from Tim Switzer with KBW.
I have a quick follow-up on your comments there about you're happy with where your capital is right now. You still have a good amount of capital though, and you've been doing buybacks in the last 2 quarters. Why do you not expect to do any more in the rest of the year? Is that given some sensitivity to valuation given the recent rise in shares? Or is it more you trying to preserve capital for either a potential downturn or maybe opportunities on the M&A side?
First, I would say that there's no reason we wouldn't buy shares back. We're just thinking about the best use of capital, which is organic growth. And we're playing that off against the opportunity to repurchase shares over time. So I think as Joe builds out his teams and the pipelines build and we get a sense to exactly how much capital we're going to use for organic growth. Any excess capital beyond that as long as we're trading below tangible book value, I think it's a pretty attractive financial decision for us to buy back shares.
So #1 priority is supporting organic growth. Number 2 priority is taking advantage of a valuation we think is attractive. So it wouldn't be zero but we just said it should maybe a little bit -- you might not see a lot of it.
Okay. So it's more based off of the anticipation of more loan growth given the pipeline you've seen?
Yes. And we think generally that we -- the capital levels we're at are adequate for the risk profile of our company. So we're not trying to use repurchases to lever the company at all. We're just taking excess earnings and applying them to repurchases. So to the extent we don't need it, we'll keep our capital ratios pretty much in this neighborhood and use any excess earnings for repurchases that we don't need to grow.
Okay. Understood. I was also interested in your comments about the hiring efforts you've made in the C&I space. I know the competition there has been -- I mean just for C&I loan growth generally has been a little tough as banks try to diversify. What's the competition been like on the recruiting side. Has that been tough? And what's the pitch OceanFirst makes to potential new bankers?
Okay. I think one I'd say that the competition is difficult in any environment, especially for revenue-producing people, whether it be classic C&I bankers, deposit gatherers, you name it, investment folks. But I think for us, the pitches have always been the very similar pitch, right? We're steady. We're going to be in markets. We don't change our minds about whether or not we want to do things. It's been very clean, straightforward. Management team has been consistent. And when people come here, they like it, and we don't have turnover.
So I think we have a good reputation in the marketplace, and I think that helps salespeople. Salespeople want to make sure, especially the people we target, which are people largely from what I consider to be the large regional and national banks. Those folks get in and out of markets and businesses all the time. And we tend to be -- if we're in a business, we tend to stay in the business. So we tell people that you don't have to worry about policy shifts and changes. If you can bring us good business, we'll do it. So that seems to always resonate.
We found over the years that the best bankers just want to know they can support their clients. And as long as you can demonstrate to them that they're going to have the tools and the support and the capital and the balance sheet to do that, they're going to feel pretty comfortable.
So -- and we have joked over the years, some of these sales processes for new bankers can take a while. We've had bankers we've pursued for up to 5 years before they actually signed up. So the folks we bring on, we bring on kind of deliberately, but they're top quality folks. They stay with us a long time. They've built really durable relationships and extend our brands. So we're adding people every quarter. We're going to add more between now and the end of the year. And we've got a positive outlook for it.
We now have David Bishop with Hovde Group.
Chris or Pat, just curious, we spent a lot of time talking about the loan growth side. But on the funding side, you said you paid down some of the brokered and high cost savings accounts this quarter. Are there any sort of tranches or big tranches of maybe CDs or broker deposits that are maturing that there's an opportunity to reprice here in the next couple of quarters? Just curious what sort of the funding side of the balance sheet looks like from a repricing perspective?
David, it's Pat. It's actually pretty steady around, I don't know, $200-ish million on average that rolls every month, I guess, over the next 6 to 9 months or so. So we deliberately ladder into these so that we don't have any big slugs of it coming due at any one time. So that gives us opportunities to kind of manage how we roll. Brokered CDs are a little bit lumpier than that. I'm talking about more on the retail CD side, but we only have about $250 million, I think, that's rolling between now and year-end. And we'll continue to look at that and decide whether we want to keep it or not.
If it's economic, we generally would roll the brokered CDs. It's proven to be less economic this year. You remember last year, when we layered in about 8% or 9% of our total deposit base, it was actually a 20 to 30 basis point advantage over other sources of funding. And so we thought it was a good deal, and we've been slowly letting it roll as it became less economic to do that. So it will be pretty steady in kind of normal way cash flows for us.
Got it. Appreciate that. And then Chris, sort of a holistic question, maybe it's a tougher question maybe to answer that. But obviously, our rate has been depressed here. It's been a tough yield curve over the past couple of years. From a Board perspective, is there sort of a sense that is there a bright line ROA that you have to hit to sort of -- sort of earn or maintain independence. Does that come up on the dialogue any? Is that something that's in the lexicon state in terms of reaching a return on equity or return on assets?
We -- as you can imagine, that comes up often, comes up among management, certainly with the Board. I think if you back into the world this way and think about leverage, there's only a kind of a range of leverage that would be, I think, workable for a regional bank like us. Once you know that leverage, you're going to have to have a certain ROA in order to be able to return cost of capital.
We have for years felt that required investor return for us over the long haul should be in the upper teens that reflects our risk -- the risk position of our company, things like the dividend yield and liquidity and all that. So that's our aspiration.
If you back into our leverage position that requires an ROA that is north of 1%, probably approaching 1.20%. We have done that in the past, and I think we can get there again. The last 2 years of the inverted yield curve, it's not helped with that. And I'm not sure that goes away in the next 2 or 3 quarters. I think that inversion may stick around for a bit. But our thought is with the loan growth we're talking about building second half of this year going into 2025, although margins may still be tight on that, the operating leverage will pick up, and we have an opportunity to build back to that level. So we certainly recognize that to earn our independence, there's a little bit of a line in the sand that you better have a path to get yourself north of a 1 ROA. And we think we have the visibility on that for now. But there's a lot, obviously, going on with rate markets and things like that.
Interestingly, with all the discussion about what is the Fed going to do or not do, we're probably more impacted over the next couple of years by what the 5-year and the 10-year do. That's got a significant impact to our business. So the longer end of the yield curve is something we watch as much as the short end, even though it gets less attention.
We will move on to the next question. And we have Manuel Navas with D.A. Davidson.
Just a quick follow-up on that 1.20% ROA long term. Does that also assume a kind of return to, I think, more aspirational 10% loan growth?
Yes, I think that's the way you get there. That's the path. And if you think about just building that over time, it's not something that's going to happen certainly this quarter. But -- and the other complication just may add a little bit of time to this is we're not just rebuilding or building the loan book. We're also doing a mix shift. And while we think that's really valuable for us over the long term of the company, it just takes a little bit longer. Most of these C&I relationships are only partially drawn. So you're not putting out dollar for dollar like you were in commercial real estate. Undoubtedly, we think that's much more valuable for our company, but it does complicate the time it takes to kind of rebalance a little bit and achieve that 10% growth rate. But we've always thought that that's a nice prudent level of growth that you should be able to sustain year after year.
And I'd point out that prior to COVID, quarter of 2019, we achieved that 1.20 ROA after working on operating leverage for a few years. COVID set us back. We had achieved it again fourth quarter of 2022 and then we had the liquidity crisis we went into. So we know how to get there, and we're comfortable we'll get on the path to get there. But I would just hesitate to give you a very precise date on which we think we'll be there.
I appreciate that. Stepping back towards discussing the C&I team, some of the new lenders and those that are still to come. Have they been ramping as expected? Or is competition kind of slowed the ramp? Rates could be part of it too. And how is the C&I team doing on the deposit generation as well?
So I'd tell you that the folks that we've hired have met or exceeded expectations. I think that the interesting sort of semi answer to the question is -- I'll use the example of the last quarter. We had 5 of our better C&I borrowers pay us down on their loan balances because they're doing so well, and they have cash. So the good news is I have cash from my C&I borrowers in the bank at reasonable rates and some in operating accounts or I'm not really paying a rate. The bad news is they're done so well with cash that they're paying down my floating rate yielding assets because they have the ability to do so. So it's a little bit of a balancing act.
Look, there's competition out there. The only thing I really worry about in the C&I space today in terms of competition is we have an environment where there are people getting into this space that don't understand the space. And you always worry about people putting on assets in the C&I space that are not structured properly.
I'm happy to compete on price within reason. I'm not going to compete on the structure aspect. That's just a long-term road to ruin. But our folks so far that we put in place have done fine.
That's good to hear. In terms of the NIM outlook, you talked about some of the wholesale funding is coming up. Is -- what are the assumptions around wholesale funding? Is it the assumption that they stay at current levels and just reprice or is it assumed in the guide that you pay them off? Like is deposit growth a wildcard here potentially? How should I think about how you're viewing and planning for on wholesale funding payoffs?
We don't have a ton of overnight wholesale funding that's out there. We've got about $800 million or so of borrowings, but $600 million of that is termed. Seems like years and years and years ago, I guess it was about 5 quarters ago, we termed out 3 buckets, $200 million per bucket FHLB borrowings and those start to mature in 2025 and then 2026 and then 2027. So that's 3 quarters of that. We also, aside from that, really don't have much in terms of longer-term funding that's out there even in our CD book. It's relatively short. So we're pretty well positioned to take advantage of lower funding costs as they occur.
The flip side of that is just to maintain our current liquidity levels, growth means that we're funding at today's shorter-term higher rates, which again, can squeeze profitability but does make us think carefully about the profitability of any loans that we're going to do because we are kind of funding incrementally as we go along.
Does that help or answer your question?
That does. That does. Shifting gears for my last question. Can you discuss the upward trajectory of the loan loss reserve? It's just ticking up and you're not responding to regulatory pressure, but you are building capital and building reserves. Is that kind of part of seeing the landscape and trying to be proactive? Is that the right way to think about it rather than being responsive to any particular regulatory concern on the CRE concentration issue?
It's exactly and we're little bit -- about like the land. So first part of the question is easier than the second part. But I would say it's completely an external function where we're thinking about the environment, we're thinking about peer loan loss reserves. We're looking out at what the credit conditions might be, let's say, the soft lending isn't quite as soft as people would like it to be. I just want to have a little bit of an extra margin there. It's not a giant difference. There is nothing inside our loan book that is driving us to feel that we need any significantly higher reserve than we have today. So it's just been a gradual evolution as we've watched things like the Moody's forecast and where unemployment is going and things like that. We just want to make sure we're a little bit more prudent.
I would say that it is clear to us and CECL is terrible in this regard, but CECL really anchors you back to your loss histories and our loss histories have been really good. So it's hard to kind of satisfy the standard you would need around quantitative allowance.
As we build the C&I book, I think we also have the opportunity to maybe have a little bit higher reserve level against C&I. First of all, it tends to deserve that anyway. And although we've done C&I for decades, this is a little larger concentration for us into some new verticals. So I think we're taking the opportunity, and I wouldn't be surprised if you see us take the opportunity to build a little reserve as we build that book up to a bigger part of our balance sheet.
But at the end of the day, we're not going to change our credit discipline. We don't expect different outcomes in credit performance. So I don't see us being -- heading towards a reserve heavy bank but you might see what you've seen over the last year. You might see if economic conditions continue to be a little questionable, you might see a couple of basis points a quarter from here from time to time. No big moves.
We now have Matthew Breese with Stephens.
I was hoping you could provide an update on the percentage of loans at a pure floating rate, I mean, priced off something like prime or SOFR. And what the blended yield is on those loans?
Sure. Matt, it's Pat. So our pure floating rate is just under 29% of our loan book. It's about $2.9 billion. And those are split about 1/3 prime, 2/3 SOFR. I don't have the exact numbers right in front of me. I want to say it's about $900 million that's based off prime.
So when we talk about our fixed and floating rate makeup of being 55, 45-ish, which we've said in the past frequently. It's been 54, 55 fixed rate. The floating includes adjustable. When we talk about that, which is about $1.7 billion and then the fixed rate is 5.5.
And is it safe to assume that the pure floating rate paper is capturing a spread of 2 points over SOFR, 2.5 points over SOFR. I'm trying to get a sense for -- if we look at that fixed rate portion of your book, what is that yielding and what's the repricing opportunity? And when does that start to kick in for the NIM?
Yes. I think historically, it kind of depends on the age -- the vintage of it. But historically, we kind of averaged about 250 over benchmark. That obviously is compressed over time with competition, it's probably more in the 2 to 2.25. So I think you're in the right ZIP code.
Matt, it's Chris. One of the things that we do watch really carefully. This was my comment about watching say, the 5-year is a lot of those adjusting loans as they roll, they're indexed off the 5-year. So it's the 5 year and the 10 year kind of fall a little bit, that can affect outcomes as well.
So just for the fixed rate and the ARM book, what is kind of the roll-on versus roll-off dynamic that you're referring to, Chris?
So I think if you look at our maturity wall, that's probably the best number as you can see. You can see by period how many loans we have rolling through, what rate they're coming from. Just to caution, we were trying to show a credit perspective in that, so we're using the rates the customer is paying, not the rate we are earning. We're actually earning a little higher than those rates because of swaps. So probably -- I mean it's a 30, 40 basis points difference between the stated rates in that maturity wall slide in terms of what we're being paid today. And you kind of roll that forward and look and pick a number, 2.25 over the curve as they roll.
Okay. And just playing this out, I mean, at what point do we start to see this dynamic really take hold and propel the margin higher? In quarters past, we've talked about kind of the natural landing point for the NIM for a bank like yours being kind of the 3% to 3.25% range. When can we start to see meaningful progress towards that?
I think -- look, we can make progress between where we are now and just to kind of pick a number and say, 3% over time. But to get much above 3%, you're not going to see that in an inverted yield curve. So we would need a normalization of the curve to get much beyond that.
It is really important, the new growth we do and what rates that comes in at. As Joe mentioned, our pipeline today, we're really concentrating on that C&I borrower carries almost an 8% handle. That will help. That will help us get back towards 3%. But if you're looking at our long-term average, closer to 3.25%, I don't see us being able to achieve that without moving the yield curve.
Okay. And then what is a good tax rate to use from here?
24%. I keep saying 25% approximately and we keep printing 24%. So I'm changing it, it is 24% now.
Okay. And then just the last one for me. You have, I think, $125 million of sub debt reaching its call date about this time next year, maybe a little earlier. One, what is kind of the current thinking around that in terms of paying it off or reissuing? And then secondly, just curious, at this point in the game, does the sub debt count towards the CRE concentration? Or have we moved to the Tier 1 plus allowance methodology?
I'll give you the first part of that, and then Pat will follow up in a second. So the thinking on it is, look, when it matures next May, if rates are what they are today, it's going to be more expensive than we'd like, and we'd probably look to refi that. At the issuances that we've seen in the last, call it, 60 days, we're not excited or anxious to do anything with that today. We're watching carefully whatever the Fed does. We're watching carefully to see if capital markets activities by other regional bank issuers come out. We're kind of watching that market. But it's conceivable, we might take an opportunity to issue in advance of that, but not at today's rates, and we don't feel any pressure on that.
So -- and look, it still continues to be available to us next year, just reprices and with the margins would be more expensive than today's issuance rates. So there is an opportunity for us to refi that.
But Pat, just on the capital treatment?
Yes. So the sub debt Tier 2 and typically, everybody issues from the holding company, your listed vehicle. And then to the extent that you need or wanted to have Tier 1 treatment for your bank, you would then inject the capital down in the bank. So that would kind of drive the denominator of the Tier 1 plus allowance is any sub debt that's been put down into the bank, and it would be for the calculations of where all your loans are and where the bulk of your capital is residing, which would be in the bank.
We've also -- just remind you, it's May of next year. We have the 125 that will reprice. And we also have 57, I think, of preferred that also reprices in May of next year. And those are at 5.25% and 7%, respectively. So the sub debt issue is benchmarked off of a longer-term treasury. So the short-term rates are much less important when we think about it and where we think the longer end of the curve is today versus where it might be then. So it's not that big of a difference. It's really just the additional months of carry if we were to issue anything in advance of that date versus the higher interest rate that we'll pay once those coupons reset in May which the shorter the time gets, the less it kind of matters. And so with capital thinking, kind of like to do it when you can, rather than when you have to. And so we've been thinking about this and talking about it already for some -- for the better part of this year, and we'll be opportunistic and thoughtful about it.
But net-net, in this environment, more capital is good, just like more allowance is good. So there's an intangible trade of the extra cost of carry for that capital versus the perception of the strength of your balance sheet. So...
Understood. Any -- that sort of sub debt, any change in thinking on how to navigate the preferred prepricing?
Not really. Retail seems to be -- there is such a thirst for retail preferred and folks seem to be relatively indifferent if it's rated. So that's a pretty easy out on the replacement of the preferred, and it's a fairly small issuance bucket. The sub is generally whether you price it institutional or retail or not consumed almost entirely by institutional investors. So you need to be kind of thoughtful about the timing and the competition for capital and how the issuance is going to be viewed by the street, of course, which we've seen positive reactions and negative reactions to capital issuance just in the last 90 days by banks of our size or community to small regionals. So we're also trying to navigate that perception challenge as well.
We now have Christopher Marinac with Janney Montgomery Scott.
Chris, I wanted to follow up on the allowance point you made 2 calls ago. So when you have the idiosyncratic losses like you had this one-off credit, does that give you any positive evidence to build that component, particularly as you have new loan growth?
It would Chris, if we could find other loans like that in the book. And the problem is we don't have them. Our central business district concentration is now $125 million. We've been through that with a fine-tooth comb, I understand everything about it. And we don't have any other credits that meet the same criteria as the one where we had the issue last year. So it's kind of hard to extrapolate and push that out.
As we did our stress tests, looking at the maturity walls, we did our stress test looking at different asset classes, looking at all of our construction loans, as we go through all these things, we're obviously looking for information that would support either the allowance we have today or require us to adjust the allowance. And the positive news is those stress tests have been so positive, that it hasn't really given us a lot of support to move the allowance in any particular way. But we understand that we're a little bit of an outlier in the total allowance, and we don't like being outliers in anything. So we look at it really carefully every quarter and make thoughtful decisions about it.
No, I understand. And then just, I guess, a bigger picture question, the production that you anticipate the next 2 or so years, how much of that will come by region? I was just curious about would you have more in the Northeast and in the Baltimore, Washington area, just as those are newer to contribute to a bigger percentage?
You're still going to see the majority of activity happen in our -- kind of our most concentrated market, which is the corridor between Philadelphia and New York. But we do get meaningful numbers out of the other regions as well. And some of the hiring we've done has been down in the Baltimore, Washington area, especially that government contracting work. So there will be measured growth in other areas.
But given the size of our franchise, we still -- our strongest markets are the ones closest to home. So I think you're still going to see the majority call it, 50% to 75% of the growth comes right in our core market in the Northeast. We really like being in the Northeast, especially as we see some of the volatility, you've heard this around multifamily in certain parts of the country. You've seen residential home prices starting to waiver in certain places, rents falling. Fortunately, the Northeast tends to avoid both the up and down swings. So we feel pretty good about our market, and we're not going to change it materially.
Thank you. I would like to hand it back to Chris there for some closing remarks.
All right. Thank you. We appreciate your time today. and your continued support of OceanFirst Financial Corp. We look forward to speaking with you again after our third quarter results are published in October. Thanks very much.
Thank you all for joining. I can confirm that does conclude the OceanFirst Financial Corp. Q2 '24 Earnings Release Conference Call. Please enjoy the rest of your day, and you may now disconnect from the call.