Q3 2020 OceanFirst Financial Corp Earnings Call
Good day and welcome to the Oceanfirst financial Corp. earnings Conference call. All participants will be in listen only mode should you need assistance. Please take my conference specialist by pressing the star keep all advice Bureau.
After todays presentation, there will be an opportunity to ask questions. Please note. This event is being recorded I would now like to turn the conference over to Joe Hewitt Investor Relations Officer. Please go ahead.
Great. Thank you good morning, and thank you all for joining us until Hewitt Senior Vice President and Investor Relations Officer at Oceanfirst Financial Corp.
Begin this morning's call with our forward looking statement disclosure.
Please remember that many of our remarks today contain forward looking statements based on current expectations.
Or to our press release and other public filings, including the risk factors in our 10-K, where you will find factors that could cause actual results to differ materially from these forward looking statements.
And now I will turn the call over to our host this morning, Chairman and Chief Executive Officer, Christopher Maher right.
Thank you Jill and good morning to all who've been able to join our third quarter 2020 earnings conference call today.
It's 40 I'm joined by our Chief operating Officer, Joe with Bell, Chief Risk Officer, graceful watching and Chief Financial Officer, Mike That's better.
As always we appreciate your interest in our performance and are pleased to be able to discuss our operating results with you.
It's Marty will cover our financial and operating performance for the quarter discuss the strategy behind the liquidation of certain loans and.
And address our plans to manage the business to the next phase of the pandemic economy.
As we did in the second quarter. Please note that our earnings release was accompanied by a set of supplemental slides that are available on the company's website.
We may refer those slides during this call.
After a discussion we look forward to taking your questions.
In terms of financial results for the third quarter GAAP diluted earnings per share was 10 cents.
Quarterly loss was driven by a $35.7 million provision for credit losses taken during the quarter.
The $35.7 million provision included a reserve build $20.7 million.
Net charge offs related to loans held for sale and email to $14.2 million.
And ordinary course charge offs just $800000.
The $20.7 million reserve build was driven by commercial lowered risk rating changes.
Related to pandemic forbearance wells and other qualitative factors related to generally weak economic conditions.
Yeah outsized provision this quarter reflects a comprehensive risk rating review of the commercial forbearance portfolio and represents our best estimate for the credit risk related to the pandemic.
Our reserve estimate is not reliant upon additional fiscal stimulus nor does it reflect an overly optimistic view the resolution calling for the pandemic.
Grace will be walking through our approach to credit risk management and the allowance.
Reported earnings were also impacted by merger related expenses branch consolidation expenses. The net unrealized loss on equity investments that totaled $5.8 million net of income tax.
As a result, we take the core results for the quarter to be a $266000 loss or less than one cents per share.
Regarding capital management, the board declared a quarterly cash dividend was 17 cents per common share and approximately 44 cents per depository share preferred stock.
The common share dividend represents the company's 95th consecutive quarterly cash dividend.
The 17 cents common dividend reflects our view that earnings will rebound in the fourth quarter and into 2021.
There are no plans to reduce or eliminate or common dividends at the present time.
Capital levels remain strong with tangible equity to total assets of 8.4%.
Please note that this ratio was negatively impacted by P.P.P. loans.
Which decreased this ratio by 37 basis points.
The Tc ratio, excluding PPP loans would have equaled 8.8%.
As noted in our earnings release, we moved a significant portion of our PPP loan portfolio to held for sale at quarter end.
The sale those PPP loans was completed this week at a net gain of approximately $5.3 billion.
The combination of both sales and a forecasted improvement in profitability in Q4 will return us to position of internally generated capital at a healthy rate.
The company's suspended common share repurchases on February 28.
Since that time, we've been working with our clients to better understand how the pandemic has impacted their businesses.
That understanding has allowed us to address our credit risk position as demonstrated by our sale of high risk loans and reserve.
This data also informs our annual stress test process, which is currently underway.
Following the completion of that stress test in early November we will consider reactivating our share repurchase program.
At this point it appears that share repurchases could begin as early as the fourth quarter.
The company is slightly more than 2 billion shares remaining in the current share repurchase program should.
Sure our level of surplus capital support a larger repurchase program. The board will consider an expansion to the current authorization.
Before we discuss the outlook for our business I'd like to spend a minute revealing market conditions in our area of operations.
When we last spoke in July our core market of Central New Jersey, and the New Jersey shore were beginning to reopen and there was a sense of optimism.
That optimism continued throughout the summer and into the fall as a substantial number of people chose to leave the urban centers of New York and Philadelphia to spend the summer at the shore.
In fact, many of these visitors have remained well past the traditional summer season.
The influx of homebuyers from Metropolitan areas is fueling a mini boom in residential real estate.
Median single family home prices in our core markets rising more than 10% compared to 2019.
The population expansion and robust residential real estate market, although many of our clients to salvage is solid summer season.
The latest regional unemployment figures support the sharp snap back in New Jersey.
Unemployment across New Jersey has dropped to just 6.7% from a high of 16.3% in April.
New Jersey unemployment is well below the 13% and 11% results reported in the New York and Philadelphia Metropolitan Statistical areas, respectively.
Welcome to the cases are surging nationally they remain manageable throughout most of our markets and there are no signs that are broad based economic shutdown will be required in the near term.
Although we remain in uncertain times and circumstances could deteriorate very quickly.
The recovery is uneven with many businesses and consumers continuing to feel the pain of the economic recession.
Additional targets stimulus is absolutely needed, but as I mentioned before our forecast did not rely on additional round stimulus.
Turning to the bag our strategy is simple and conservative.
We're using the same playbook as we would to address any economic crisis.
First we secured liquidity increasing deposits by $1.4 billion this year.
Second, we bolstered capital with $181 million in subordinated debt in perpetual stock issuances.
Third we ring, we ring fenced the credit risk in the balance sheet and disposed of the highest risk assets.
The fourth and final effort will now be the rebuilding of margins and boosting operating margin problems.
The decisions, we made this quarter address downside risk to the balance sheet and a.
Now is to focus on earnings and capital management strategies.
The decision to accelerate the resolution of high risk credits drove our financial results for the quarter.
We're certainly disappointed to be announcing a GAAP loss, but oceanfirst has a history of acting quickly to corral risk in difficult times.
In the first quarter of 2007.
First was among the first banks to acknowledge the developing recession.
And recorded a 47 cents per share loss during that quarter.
Moving quickly in early 2007 allowed the bank to realize recoveries that were far higher and would have been the case later in 2007 and the years that followed.
Our early action during that crisis about the bank to be firmly on the road to recovery more than a year before the bear Stearns and Lehman collapse has been hit later in 2008.
We certainly hope that the current challenges will come close to reflecting the 2008 crisis, but.
But we believe in the edge, sometimes the first loss business models.
These actions also liberate the resources, we need to focus on building our business.
Our path to build margins and improved profitability is centered on executing a mix shift from cash into a combination of liquid securities and loans.
During the third quarter, our average cash balances exceeded $800 million and we experienced an additional $300 million of deposit growth during the quarter.
Even after running off $80 million of certificates.
Robust deposit growth has driven our loan to deposit ratio to under 90%.
A ratio that will go even lower as we generate an additional $388 million in cash proceeds from the loan sales plans this quarter.
While the deposits raise this year aren't immediately accretive we are winning new relationships and we'll be patient as we deploy that cash over time.
The mix shift will provide a significant opportunity to fuel earnings growth for quite some time.
Excess deposits will be deployed in the same way we have built the business in the past by recruiting commercial lending talent throughout our markets.
Joe will walk you through our plans to accelerate recruiting and hiring to expand our lending capacity in 2021.
Organic growth is our top priority heading into the fourth quarter.
But it will take time to prudently deploy the massive amount of cash on the balance sheet. So.
So we expect traditional measurements of profitability to be challenged until the mix shift is completed.
And additional motivation to accelerate the resolution of pandemic related credit risk.
To allow us to entertain additional capital management strategies, including share repurchases and acquisitions.
I've already covered share repurchases, but should also address acquisitions.
Thus far in 2020 economic conditions and the need to focus on our core business have precluded consideration of acquisitions.
However, as we wrap up 2020 and look forward into 2021, it appears that opportunities to acquire valuable franchises might begin to appear.
Third quarter results in the banking sector. The signal that many institutions have moved past peak credit provisions.
NIM pressure is now the focus and will probably continue to impact many banks over the coming quarters.
Perhaps the best mitigating strategy for a protracted low NIM environment will be improvements in operating leverage and relative expense reductions through increased scale.
Shedding or highest risk loans on an accelerated basis will allow us to consider strategic acquisition opportunities should they present themselves.
At this point, let me hand, the call off to Joe Lavelle.
Thanks, Chris I'll touch on deposit activity in a loan originations and the effects of.
Both net interest income our net interest margin.
Before some brief comments on expenses in the 2021 loan growth plans.
We continue to grow relationship deposits with quarterly growth of 316 million and year to date growth of 1.4 billion well ahead of our expectations.
Importantly, this growth was included several high profile.
And nine figure relationship wins and since we've seen most of the PPP loans utilized by borrowers.
Very substantial portion of the excess liquidity is now available to be deployed into higher yielding investments and loans.
These new deposits are the result of the maturity of our corporate cash management business, which has increased by 33% year over year as.
As weve doubled staff to support the growth.
You may recall that just a few quarters ago, we had discussed a loan to deposit ratio in the high Ninetys.
And strategies to raise deposits to provide the foundation for more loan growth.
The current loan to deposit ratio was 86% and having lower as we complete the loan sales mentioned earlier.
We believe we built a comprehensive competitive suite of treasury talent and products and can continue to accelerate deposit growth in 2021 and beyond.
At the same time, we've continued the repricing of existing deposit accounts, reducing our cost of deposits from 57 basis points to 49 basis points quarter over quarter.
Deposit cost continue to decrease as indicated by a quarter end weighted average deposit rate of 46 basis points.
In the fourth quarter of 2020 in the first quarter of 2021 over $705 million of Cds with a weighted average rate of 157 basis points will mature.
Providing additional deposit cost reduction opportunities.
Loan originations for 418 million for the quarter with continued strong residential closings in solid commercial activity despite the economic environment.
Exclusive of PPP originations loan volume of 1.3 billion year to date, it's 30% ahead of 2019.
Loan growth was muted as we continue to exit some weaker acquired loans as is our long time strategy.
We are continuing to sell most newly originated conforming residential loans.
With sales of 169 million through the nine months of 2020.
Loan originations from the commercial team were 188 million and while the overall pipeline is stable quarter over quarter Theres no doubt that the pandemic has adversely affected what we expected to be a very strong year in commercial.
Primarily from our Philadelphia, New York regions after they hit their stride earlier in the year.
The residential business just help in recent quarters with the combination of all time low rates movement back to suburban living in a scarcity of inventory all generating record activity in 2020, and a continued near record pipeline.
As these interest rates, we've chosen to continue to generate mortgage banking income.
Managing balance sheet exposures.
Loan growth for the remainder of the word the year should be modest or flat.
Businesses and individual borrowers regain their footing.
Moving on the state of the economy as it recovers from the pandemic.
In the weeks to follow the election, we hope to hear more clarity from our customers as you can imagine the lack of clarity regarding future public policy.
For more data regarding public health trends continues to restrain commercial investment in lending opportunities.
Moving to the net interest margin, we saw a 27 basis point reduction.
Core NIM declined by 19 basis points due to a few factors, notably the excess liquidity on the balance sheet.
Which we calculate a 13 basis points.
And six basis points from the lower interest rate environment.
Additionally, purchase accounting reduced the overall NIM by six basis points.
New loans continue to be originated at lower market rates with average yields on interest, earning assets down 34 basis points quarter over quarter.
Commercial originations contain swap loans with floating rate LIBOR spreads that continue to affect margin.
Provide floating rate flexibility for balance sheet protection.
Moving to brief comments on expenses.
Excluding merger related and branch consolidation expenses.
Our operating expenses increased 802000.
Primarily attributed to covert it related expenses totaling 1.7 million.
Increased to 600000 over the private over the previous quarter.
We've also recorded increase in the cost of employee benefits and higher professional fees.
No branches were consolidated in the quarter.
We expect some branch consolidation to 2021, and we'll provide more details next quarter.
I'll finish up with some comments about the markets, we serve and the expectations for loan growth.
Even with the advent of Cove, and we're very optimistic for loan and deposit prospects in 2021.
Our newer market geography to New York City, and Philadelphia Metro's have exceeded expectations.
Oh, I expect flatter modest growth for the remainder of the year exclusive of underperforming loan sales.
Our investing the addition of commercial banking talent.
We will be prepared for strong loan growth to return.
Now some 21.
That said.
The pandemic may restrain growth in Q1 and Q2.
The interest rate environment is challenging and where we acquire incremental investment in commercial lenders and teams strengthen them provide earnings momentum in 2021 and beyond.
We have a track record of opening commercial loan production offices in new markets.
Attracting top tier talent.
And we will accelerate similar investments in 2021.
I expect a few new lpos during the 21 fiscal year.
As well as a deepening of our existing markets.
At this point I will turn the call over to Grace.
Thank you Joe.
As Chris mentioned Oceanfirst has a long history of proactive identification and recognition of risk.
We believe this philosophy enables more effective management and leads to the best outcome.
With regard to credit risk, which typically means in the nation.
And just simply.
[music].
And I believe is a key factor in our loan loss history bumped it to our peers.
Economic cycles. This.
This concludes cumulative losses since 2007.
43% lower than our proxy peers, and 70% lower than our peers.
Specifically, we have been and remains to the pandemic quick to downgrade credit where appropriate and take active measures to workout problems.
As mentioned, our proactive approach to the developing recession in the first quarter of 2007.
More recently, the active safety risk the sub Cape Bancorp shortly after acquisition.
Exiting several hundred million dollars of exposure that was inconsistent with our credit risk appetite and the current zero lost through this process.
We maintain this philosophy of proactive risk identification during the pandemic.
While the care docs device exemption from non accrual and troubled debt.
Structuring status. It does thats all thanks from appropriately at that type of risk in your portfolios.
We mentioned on the first and second quarter calls, we expected risk rating migration of the third quarter, that's forbearance period to get to.
Over the course of the third quarter, we continue to stay in close contact with our borrowers and monitoring their financial condition.
Okay.
This means we've talked with our borrowers discuss their financial condition verify their liquidity and have a reasonable basis for assessing their ability to continue or region payment.
As a result, we've updated risk rating to a significant portion of the commercial portfolio, including all of the commercial loans that received forbearance.
During this process, we made no substantive and additional stimulus funding.
Timing of a potential vaccine or any other factors that may impact economic recovery.
Given our close contact with our borrowers and these proactive efforts to measure and monitor credit risk. We are optimistic that we've identified and quantified all current material credit risk in the portfolio.
During this process, we identified 80.
$1 million in commercial.
Commercial forbearance exposure and chose to accelerate resolution of these credits for loan sales. This includes $30 million in New York exposure and $51 million in New Jersey, Pennsylvania and recovery rates 85.
Percent respectively.
Sales increased $15 million in hotel exposure.
12 billion and restaurant and food related exposure.
Over $4 million and Jim and fitness exposure.
18 million or substandard rated credits and $32 million or special items.
Net of these loan sales, but inclusive of all other risk rating migration. This quarter total classified balances, including residential and consumer loans remained very manageable with just 2.2% held for investment loans.
Commercial and residential class type credits are well secured.
We did average loans.
Overall, the loan portfolio continues to perform well over six months after the pit gimmick driven shutdown.
Oh, sorry.
4.1 billion or 77% of our 5.2 billion dollar commercial loan portfolio never received forbearance.
As of October 23rd 1 billion or 91% of the 1.1 billion commercial exposure that received forbearance has returned to payment.
This leaves 88 million in commercial loans remaining full forbearance as of October.
The 23rd all of which are expected to do 10. Thank you first.
In the residential portfolio 207.
63% of the 329 million received forbearance has returned to payment.
This leaves 122 million and residential loans had been there.
October 23rd.
Inclusive of these forbearance lungs returned to payment.
Total loan portfolio delinquencies are just 17 basis points and nonperforming loans held for investment.
37 basis points as of September Thirtyth.
Multi doors.
Generally unchanged at 23 million.
Net charge offs exclusive but the discount on loans yields were just $800000 in the third quarter.
Oreo balances remain negligible at 106000.
No thats it portfolio, we have just 9 million first 90 day forbearance period.
Hundred 13 million remaining second 90 day forbearance carrying exposure.
Weighted average Ltvs are just 61, and 68%, respectively and weighted average FICO scores of 724 and 741 sector.
I'll point out that over 75% of our residential forbearance portfolio is located ocean Cape May Mamas and Atlantic County Annual median home prices have increased substantially over the past year.
It's quite reasonable to conclude that currently.
And thus our risk of loss is even lower LTV figures indicate.
The third quarter provision includes a qualitative credit reserve associated with residential forbearances.
Spending on the final resolution of this book we.
We may choose to sell a pool of residential loans in the fourth quarter.
Commercial loans held decision residential collateral valuations and then Sean.
And it may be economical to accelerate the final disposition of any remaining loans demonstrate.
Thanks.
Existing reserves should support that approach as necessary.
Inclusive of both commercial and residential loans and exclusive of loans held for sale.
Parents loans totaled 210 million or 2.6% total loans as of October 20 Threerd.
Allowance for credit losses below 27 billion Reais, the funded loan loss reserve balance to $56.4 million or 70 basis points of total held for investment loans.
This coverage increases to like 10%.
31.6 million unamortized credit marks.
As Chris noted earlier.
Once the credit loss increase was driven by commercial loans grading changes related to pandemic forbearance as well the qualitative factors will make the general weak economic conditions. The allowance for credit losses. Currently represents our best estimate of the credit risk related.
We expected some third quarter with ratings migration as carriers acts forbearance period at the end.
The impact of the economic shutdown next question on individual borrowers became clear.
And at this migration to drive an increase in quantitative restarts.
Qualitative adjustments were made to account for the potential for further and talk to our borrowers repayment capacity, both within commercial portfolio and as residential forbearance periods come to ahead this quarter.
To conclude I'll reiterate that our credit risk position is modest and manageable.
We have a comprehensive understanding of our current credit risk profile, given our assessment of individual borrowers capacity to pay that.
We have identified the current risk lots in our portfolio in light of today's economic conditions.
And that these losses are reflected in the Hcl build and loan sales.
We have elected to sell a portion of higher risk commercial credits to de risk the balance sheet and redirect our resources toward growth initiatives.
Reserved for risk associated with the end residential for parents payments during the quarter.
Currently updating our stress test, which will include the federal reserve's latest adverse severely adverse scenarios access.
Excess capital at the holding company further strengthens our position and provides ample capacity.
I'll now turn it back to Chris for concluding remarks.
Thank you Grace at this point, we will open the line up for questions.
Thank you we will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone.
If you are using a speakerphone. Please pick up your handset before pressing the keys to withdraw your question. Please press Star then two at this time, we will pause momentarily to assemble our roster.
The first question today comes from Eric Slick Boenning and Scattergood. Please go ahead.
Hi, Good morning, everyone. Good morning, Eric.
Hi, first just some questions on the loans you decided to liquidate.
Liquidate just trying to think about.
So they got about 67.5 million and then I think the related.
Charges that you recognized or 14.2 mine. So just curious one if I'm thinking about those two if there's the right to numbers to compare and then Uh huh.
How did you estimate does losses and have you received any any bids on the loans or just trying to kind of understand that the loss ratios there.
Sure. So those numbers are correct and so the New York pool has already closed post quarter. So that has realized that the figures we expected and we have what I would classify as firm bids from multiple bidders on the New Jersey, and Pennsylvania pool.
So we expect to close that in the next two weeks, but the.
The marks that we took at the end of the quarter are reflective of those clearing prices. So we think we've got a reasonable assurance for New York is closed in Pennsylvania, New Jersey or pending closure.
Thanks for that color, there and with respect to the beds are these coming from other banks or Nonbanks, just curious what the buyer pool. It looks like at this point, that's really interesting because they're very different markets. So in the New York Metropolitan area, There's a long.
History of real estate investors being involved in note purchases for a variety of reasons, including the default rates are stronger or upheld more strongly by the courts in New York and elsewhere. So in the case the New York credits. It was really a matter of matching a specific credit and asset class to buyers who specialize in those.
Kinds of assets.
So over the years, we've done business with them and so loans from time to time prices are a little weaker than you would typically expect in New York you'd expect a little better price, but I think thats the pandemic discount.
The buyers in New Jersey, and Pennsylvania with different that's much more of an institutional kind of credit fund buyer that is looking for distressed loan notes and prices them accordingly.
So Conversely, a new York came in a little bit lower than the historical average New Jersey actually is coming in a little better than the historical average so but but neither are very far off what we would expect to be pretty good recovery rates.
Okay, and then Oh that pool of loans that you decided to sell any short maybe a mix, but any kind of breakdown between which loans were acquired through some of your recent acquisitions and some of where their relationships may have originated at oceanfirst.
Sure there was not any overwhelming patter of whether they came from particular acquisition. So there was no clustering of concern around maybe a credit underwriting criteria or anything like that there were a few that were long term oceanfirst customers and a sprinkling probably is not sure every acquisition that maybe almost every acquisition.
I had one or two credits so it was a little bit of everything and that gave us comfort to because it indicates that there wasn't.
A a pattern in the loan book that might be more problematic overtime.
And then previously spoke and Favourably of the experience using forbearance following the hurricane Sandy.
Kind of an impact just curious you know what are you seeing this time that thats different does that lead you to believe that working with some of these borrowers longer would not lead to a more favorable outcome versus selling them today.
So it's a good question. So one of the things we look at is the chances that if we had held these loans would we have recovered more than weve recovered today and the answer is almost certainly yes. So if we had decided to hold on to these loans up many were paying in fact, a good section. These were pass credits.
However, what we had to weigh against that was ultimate recovery, which may take us several years.
And the ability to kind of put these behind us and focus on other things. So we certainly took a little bit of an extra liquidity discount I guess, that's probably a few million dollars.
But we bought ourselves the time and attention by accelerating those.
We don't think it was a giant cost.
The other thing is that there is a finality that comes with the final disposition.
And we're very we're very conscious that had we merely kept these on the books established risk pool and taken lets say a reserve for the $14 million.
That may have proven to to earn us more money in the long run but it may also have led to several quarters of discussions about valuations with a lot of cycle with our regulators with our investors were now you'd be in a position of having to explain why you thought a fitness center or a or a hotel proper.
Property was actually valued where your thinking is so this way we get the final disposition, we know exactly what the answer is that we can be certain that we took those risks off the balance sheet.
Then last one from me and then I'll step out of that step aside with respect to the third quarter net interest margin did it reflect any interest reversal related to any that the downgrades are they transfers that dallas or sale.
It did not so there were no unusual entries in the net interest margin for the quarter.
Thanks for taking my questions. Okay. Thanks, Eric.
Your next question today comes from Russell Gunther of D.A. Davidson. Please go ahead.
Hi, Good morning, guys, Hey, Russell.
Just to follow up on some the Eric's questions on on the credits that you move this quarter are you able to share how the loss rates translated from an asset class perspective. So.
Discount on hotel restaurant, and Jim and fitness.
So given that there was a little bit all over the place and in any one category. We only had a couple of loans, but the Grace you may have some extra data you can provide on that work or Joe if you've got those figures.
Hi, Chris I can give you a little bit I Russell I think in the hospitality were about.
75 cents recovery.
Again, it varies a bit but.
You are an example in the.
Food and beverage very similar about 75 cents up so I think almost everybody was somewhere in that range.
I mean overall scope it was interesting to watch.
How the bids came through and how things work I do want to add one other comment relative to the sales of 66% of the sale was criticized or classified.
So while some more paying we had a branded them appropriately based on our expectations for long term health.
Okay.
Thanks, Joe.
And then where any of the let's say 12 million in restaurant loans any of that relates to the New York City portfolio.
Interestingly that portfolio seems to be doing rather well. So those owner operators have a significant amount of liquidity and then they've got the liquidity in the bank in the form of bank deposits that we have and we can see.
It is also in for those families. It is their primary and only asset in many cases, where they are operating so.
So couple of things they have been able.
Able to demonstrate more liquidity than you might expect from a real estate investor.
There are also much more protective of their collateral so as we talk to those folks and said look and we like to stand with you, but we need you to post the liquidity in some cases post payments in advance and those kinds of things.
That was a particularly strong portfolio at the end of the day.
Got it thanks, Chris and then last one on this line.
You mentioned that [noise].
Joe 66%. This was out of the criticized classified which I think now is at 2.2% of held for investment ex those.
I know that these were particularly troubled assets and in terms of hit hard hit from the pandemic and the classified portfolio is not made up of all of these types, but can we is there any read through from the clearing rate.
Out of the criticized classified to what remains on criticized classified today.
So I've got a couple of comments I think Grayson, Joe may chime in as well.
We are a.
An active.
Commercial bank, which means we're not we don't look at things exactly the same way maybe a primary real estate lender, what we're used to managing relationships and credits and we have we've.
We have a couple of tools, we have covenants, we have guarantors they have significant liquidity, so moving alone into special mention or substandard for us doesn't necessarily mean that were significantly afraid of a loss. It means that the risk has increased and then we need to work on it and we need to work through it and we've done this in the past when we.
Acquired some of the banks Cape concern in particular, we moved several hundred million dollars of loans into special mention substandard and then in the quarters to fall we worked right through them.
Cases, you got pay downs or restructures or collateral additional collateral posted or you would get a sale of an asset or get refinanced out of it. So I wouldn't read through that we're overly concerned with these categories were just pretty aggressive about those designations because they give us and transparency to feel comfortable with the credit risk.
Joe embrace some of your.
Intimately involved in that process, even China.
Before Oh alternate the grades but before I do I'll just.
As a Christmas comments that.
Well go back to Eric made a comment earlier about Sandy. Good example, even in that environment is that we had with borrowers that were downgraded to criticized or classified that.
Taking that bucket for a period of time and then we turn to pass rated credits in this instance, I think we're going to see a lot of the same.
The credits that we sold we felt long term would not have the same capability to return to the.
The kind of performing asset.
The two that we needed so that the fair gross.
Absolutely and I guess, what I would add to it.
In context, what Chris was talking about so you guys can you hear me better now than when I was speaking earlier.
We tend to even though we have a preponderance of real estate collateral, we consider ourselves commercial lenders and so we take that more proactive approach to.
Risk rating and dealing with our customers in general.
So thats uploads to perhaps waiting for delinquency status to inform our risk ratings. So like both Chris that doesn't necessarily mean that borrowers even have a payment issue at this point and I can tell you that there is no real concentration in.
In the nature of the downgrades since they are all in one sector there.
Okay kind of random.
In that sense.
Okay, great. Thank you each of you for your thoughts on that and then just switching switching gears if I could quickly on the expense side of things.
This corridor you mentioned some of the moving pieces one of its kind of Kobin related expense I think was 1.7 million. So I'm. Just wondering just trying to think of what the run rate would be perhaps that one seven moves lower overtime, but could you quantify what.
Expenses are kind of below normalized based on you know, perhaps less traveling expense. For example, does two things kind of net each other out or how should we think about that I.
I think you should think about our expenses being elevated now predominantly because the cove and the two factors that you mentioned, obviously direct cobot expenses and and we are investing a lot of time and energy into protecting our employees and our and our clients and our community. So there we've got a significant amount of expenses with healthcare professionals we are.
Doing active testing.
Within our employee base, we have outsourced health management, where we got health care professionals, making decisions about People's work status and return to work. So we think all those things are responsible but they are at a significant cost those.
Those.
Expenses will decrease over time as we go into 2021 up the health care expenses, just want to make a note about that.
We are self insured so we there a portion of the risk on health care and our healthcare systems were closed in the second quarter. So even if you wanted to go do something as an employee you couldn't find a place to go do it so any procedures that people needed to the second quarter became procedures. They got in the third quarter. So I don't think that that was a that that should probably.
Prevail.
But thinking about where expenses today, where are they going I think you're going to see two factors you're going to see things like the pandemic expenses decrease Joe mentioned, we'll probably do a little bit of branch consolidation next year, there's not as much of that available as there was in prior years up but then at the same time, Joe also also mentioned a country.
Moving to higher commercial bankers, so you're going to see a redirection of spend it's hard to say exactly where that will net out I.
I don't think you're going to see a dramatic increase and you're not going to see a dramatic decrease in expenses. It will bounce around kind of where we are now.
Okay.
Thanks, Chris I guess you got.
Got it my follow up question already so the last piece of it would be.
Given that expense outlook or some of the other moving pieces on the topline you discussed.
Do you think you're going to be able to generate positive operating leverage in 2021.
We do so the positive operating leverage really needs to come from a fair amount of organic growth and let's be clear about organic growth. We have about just under a $1 billion to deploy before the balance sheet moves by a nickel. So we have a ton of cash we average cash balances in the third quarter of over $800 million.
So the the first order of business.
Is that our balance sheet says for an 11.6 billion dollar bank, we're really like a 10 and a half billion dollar bank and that's why some of those margin numbers and return on asset numbers may be difficult to compare going forward.
We have to grow into the cash we have so when I say organic growth I mean organic growth in the loan book.
So that will occur over the next several quarters as we do that that will produce operating leverage because you'll see a NIM stabilized and then start to increase and then.
We will be working at operating leverage more on the revenue side, then on the expense side.
Okay, Great I'll step out thank you very much. Thank you.
Next question comes from Zach Westerlund of Stephens. Please go ahead.
Hi, Good morning, guys. It's a exact question I'm filling in for Matt Breese.
Correct.
Hi, So just on the under the deferral front in the presentation. You mentioned that the remaining 200 should be worked out by year end or just kind of curious about what factors give you confidence that that's going to be those.
Those deferrals will be worked off the balance sheet by the end of the year.
So I think the main factor is that we have done a loan by loan review of everybody in forbearance and actually a significant amount of the commercial book, that's not even in forbearance to make sure we understood not just a quick call how you're doing.
We had in depth discussions about their access to liquidity.
In some cases, we required liquidity to be brought to the bank and posted in advance of those payments. So we've done a fairly methodical review to make sure.
Not just the people that said, okay I'll go back to making payments because our biggest concern was that we might have people come back.
Hadn't made payments maybe in six months, they've got some cash put aside they'll make two or three payments and that in February we've got an issue.
So we want to get ahead of that and make sure we understood who really had the capacity not just to make a couple of payments were to hit a target for four was contingent upon you know something happening that was external to the business right well I'll make a couple of payments, but then I've got to have 100% capacity my dining room before I can make paint.
After that so it was a pretty rigorous review to draw out.
And he can any areas, where we would have concern and if you think about the pattern in those loans we sold.
Those were the loans, where we couldn't find a way forward, where we looked at it and say look there's good collateral here. The good people, but you just couldn't put together a string of circumstances with liquidity and operating characteristics, where you could see a path out so.
We don't think they're going to get better and we don't think even if kobin.
Eases more quickly than we think it's not going to be a miracle.
Understood. Thank you and then just on.
On the provision expense there was a little bit of a reserve build this quarter higher than in the past couple of quarters.
Are you comfortable with the level of reserves you have now or should we expect a continued build going forward.
I think we've had a lot of conversations over the last several quarters about the aggregate coverage of the loan portfolio.
And if you think we've got this anomaly in the.
Unamortized credit Mark, which kind of has a portion of the reserve is not quite as apparent if you add those together, we wind up to now it is gray said it about 110 basis points hundred 11 basis points.
For the credit risk profile of our institution.
We think thats, a pretty adequate reserve as Grayson noted even with these charge offs.
We took this quarter our long term credit performance is quite favorable to our proxy peers as well as the U. BPR peers. So our reserve should be a little bit lower than average. So we think we're in the ballpark of where we should be.
In quarters, one and two we were taking provisions not knowing exactly how the forbearance is we're going to.
Fallout, we've gotten through that process now.
The main concern would be.
What we think is very small chance, but a chance that economic conditions will deteriorate considerably from where they are today, so that that would come in the form of maybe a regional very significant kind of stay at home order or those kinds of things. So hopefully we avoid that we don't see any signs of that today, but that would be something that we have.
Not taking into account.
Sure.
Got you. Thanks for the color. That's helpful. And then just last question moving over to the margin we saw.
27 basis points compression this quarter.
Moving into 2021 do you see that as a bottom or do you think that there is a there is room to run lower there.
We're close to a bottom I don't know I'd be very careful about declaring things like the absolute bottom to things, but I think we're close and what we have going on now is well have two factors in the fourth quarter and then im comfortable will be through the bottom. The first is that look we are liquidating $388 million worth of loans.
That most of those were PPP loans, but they were still paying us interest last quarter. So we're not going to get that interest in on the flip side.
The $800 million, we keep referring to that was earning is 10 basis points. So even moving into mortgage backed securities you get a pickup. So we have some portion of the balance sheet. That's at a negative carry and Mike maybe talk a little bit about just what that negative carry means in terms of margin to give you a sense as to what our stabilized margins will look like.
Yes, so when we look at the at when we look at the margin.
If you look at.
Short term.
Yes, eight $805 million from Q3, a year ago. It was $40 million. So round number is 750 may and excess cash, earning 10 basis points.
If we just dropped the denominator of average earning assets right by that amount $750 million.
That picks up 24 basis points of margin our margin would go from 297.
Treat to treat 21, if we just thought that the 10 basis point, though earning at the fed would 10 basis points last and deposit costs and offset it. So just you know just by Chris has it at that.
$7.6 billion balance sheet.
Really.
Really intended to have trained our balance sheet and then the other thing is we've talked about brokered deposits. We we had $250 million in April only concerned about liquidity.
You have a negative carry on that at 1%.
So that's another three basis points in March and those start rolling off in October.
In January than April So just fair, you 24 basis points of negative.
Second the margin so that they can margin back at 324 so.
So it's not it's not a margin problem, we have an exit we have excess liquidity that we need to prudently invest that's what we need to do.
Got you. Thank you. That's that's very helpful. And then one quick last follow up for me.
The $350 million in Securities that you mentioned in the deck, that's coming on in Q4 could you give a sense for what those securities are you open.
There is a blend of securities so we'd be careful obviously not to put it all in one asset class, so and it will range from things like.
Garden variety mortgage backed securities.
Those are not going to earn us a lot of those may wind up being 90 basis points, maybe a little better than that.
It's not sexy, but it's a lot better than 10 basis points.
And then we've got some other investments, we'll make we have done some subordinated debt investing.
We will continue to do a dividend paying equities that we believe in and a few other things like that.
Municipal bonds will be another portion that we can we have the opportunity to increase our municipal bond book, but we used to be a thoughtful about that because the.
Credit risk in the municipal bond World.
Evolving and we want to make sure we stay away from entities that may have higher than expected credit risk I should mention too we talked a lot about asset quality in the loan book.
We've done a review of our fixed income book as well and that led to the sale of about $17 million worth of securities and CMBS pools that that we think are at very high risk. We were able to we did that in the fourth quarter at negligible gains its not up.
Rounding error, but we've been through not just our loan portfolio. We've been looking through every aspect of our balance sheet to make sure that in this case. These were CMBS portfolios that were invested in the hotel sector that had very high vacancy and very high non payment ratios and were able to get.
Ed clean and I think we've got a clean because we were early.
Great. Thanks for taking my questions guys.
[laughter].
As a reminder, if you have a question. Please press Star then one.
Our next question comes from Frank Schiraldi of Piper Sandler. Please go ahead.
Good morning.
Just wanted to ask Chris about as you've gone out and marketed these.
Loans.
From a timing standpoint, I assume you had to go through the loan by loan review. So maybe you guys just weren't ready earlier to get something done but was there any market earlier anyway, I'm just trying to get a sense as youve marketed these things if you've seen a significant pickup and interested parties and what seems like pretty palatable pricing.
No we up it was a very interesting timing Frank because first we wanted to be on the early side, but not first and there were a couple other banks that we watch closely that were actually liquidating portfolios.
In some cases, our execution I think it was a little better, but but we wanted to see if you exit a few trades cross so we understood roughly what we were talking about in terms of value up but then we didn't want to wait until there was a rush at the door either because of the supply and demand. So we knew there was a robust buying pool, they're all rational buyer so they're not going.
To go a little crazy, but.
It was a robust pool, but we wanted to make sure that our sales were conducted earlier in the fourth quarter. Just in case. There is some rush to liquid assets late in the fourth quarter in particular after the election. So we want to take as much of the election risk off the table as we could.
Makes sense and then.
You mentioned the loan by loan review, having been completed is that.
In the I guess, all the higher risk categories and does that imply that.
The the sales that you know that the u.
That have taken place or that are in our loans held for sale. At this point is the bulk of what you are looking.
To move off the balance sheet.
The sales that we're talking about now or the bulk of what we expect and we have been through both the forbearance pools in totality and a significant amount of the non for Baylor ferrets portfolio and we've obviously focused on the higher risk industries and geographies I have to make a point here the G.
Rafi can be as important as the industry. So for example, we have cases, where restaurants that were in resort locations, New the Jersey shore.
Did pretty well and they're in good shape going into next year. They are used to having kind of a tight winter season, because they don't really have one.
So the geography makes a big difference.
Right.
And in terms of the.
I just want to understand that I make sure I understand when you talk about the the these moving back from forbearance by the end of the year and if I look at for example, the $88 million in full forbearance that that isn't making payment right now.
Are you, saying that you feel pretty good that this.
Pool is going to move back to just regular payments or or could there be a portion that does need some additional attention through.
TDR or what have you.
So this will be a very modest pool of loans that will go to interest only.
And in that pool, we are highly confident that.
We've seen the liquidity that is going to make those payments and in many cases, we have asked for that liquidity to be moved into the bank here. So the majority of that is either going to go full payment.
Or go to Io and here's our outlook on how to talk about Forbearances and had to.
Be doing disclosures going forward.
We think that this quarter, we will have wrapped up this.
This kind of pandemic for forbearance related activity, especially so barring no return to a bigger issue and the pandemic.
So we think the most important thing to do now is to just move to traditional credit metrics going forward. So as you see our year end and going into next year.
We're going to classified loans as performing or nonperforming delinquencies TD ours. The way, we would normally and we'll show you exactly what's going on the balance sheet, but we don't expect to have a forbearance portfolio into next year and we don't expect to be reporting on it that way. We'll show you delinquencies will show you Tdrs will show you know.
Accruals will show you those those kinds of metrics and I think we'll be providing complete visibility into the loan book So.
Okay great. Thank.
Thank you thanks.
Thanks Frank.
Your next question comes from Christopher Marinac of Janney Montgomery Scott. Please go ahead.
Hey, Thanks, Good morning, Chris you May have alluded to this earlier in the call, but the criticized loans that Anna and assets that we will see in the 10-Q that does get include the held for sale loans, but theres a chunk of those loans that already kind of selling in the quarter. So we kind of have to pro forma that the criticized number is going to be lower than what the upcoming Q is going to say.
Do I have that kind of right in my mind, absolutely. So we have to two events first the New York sale has closed so that is done.
I do a set of criticized asset, but the pp will PPP loan sales is also close.
And the remaining New Jersey, and Pennsylvania sales will close it's going to be tight probably around the Q.
But if they close after the Q I would imagine we will provide an 8-K.
Just assuring people that those sales have been conducted with the final metrics are.
Okay. So the level of the ratios will will obviously change go lower from here. So I guess my other question would be you know is it are you comfortable that the migration of other things beyond this quarter should be limited just based on what you see right now.
It's two things first we have done an exhaustive review of loans. So there is nothing if we saw we have market were dealt with it up there is always the chance that something might pop up in a loan portfolio.
What we've done to address that risk is taken a fairly significant set of qualitative adjustments into our reserve to account for the risk that there may be a credit here or there that pops up.
The other thing that I think gives us great comfort is when you look at our largest loan customers. We have they're all performing really well. So the top 20 customers will all be on some form of payment.
There are only a couple of cases of iOS in that case, and we have a very granular loan book for a company our size. So even if you have an individual credit for relationship. It is unlikely to be one of scale that would come back in.
Cause an issue to once you get through the top 20 of our clients you fall below probably $25 million.
A relationship exposure.
Okay. Great. That's helpful. And then just one last question that might be for Grace is just be on the reserve calculation within.
Economic forecast how different is that today compare to back in March and April and do you see that changing a little or a lot as these next quarter or two come up.
Hi, Chris its not as bad as it was in March and April it's about it I think an average of 8% unemployment next year. So that's an average obviously, that's how you're now to go down.
Tom I think GDP levels out between one and 2%.
And then the two.
Senior reasonable unsupportable forecast so.
So.
Not great.
Pretty much very similar to last quarter and 10.
Slightly better.
Okay. That's helpful. Thank you Grace and thank you all for all the information this morning.
Thanks, Chris.
Again, if you have a question. Please press Star then one the next question comes from William Wallace of Raymond James. Please go ahead.
Thanks, Good morning all.
Oh, sorry, I apologize if I missed this course, but I'm trying to reconcile the difference between the gets its 51 million in New Jersey, and Pennsylvania, and 30 million in loans in New York.
Being sold to the text of the release that says 45.5 million.
Loans moved to held for sale and I assume that's net of the $14.2 million charge us I'm just trying to figure out why those numbers don't.
Ed or match it will let them like reconcile but you're right, we're showing the net amount in the earnings release.
We're taking that to the in the supplemental presentation, we're showing you the the principal balance.
Yes. So yes go ahead 45 to 45 million Westport parents loans.
That were transferred into held for sale.
So they were okay price, we're performing loans that were okay.
Okay.
That that 80 million of principal value what was the original or average loan to value of those look I assume these are all real estate funds.
They will have almost all of them had the real estate collateral.
Gracie the weighted average.
Yes, I don't think I can look <unk> question. So I will say you know what if you think about.
What's been going on in our markets you think about places like the or can be loves New York right. So we've got a good franchise there we're going to continue lending there.
We don't believe it's smart to bet against the New York City up all that stuff said.
It's under a great feel stressed right now and you've got the highest unemployment rate in New York City. That's been recorded I went back and looked you know since the seventies.
You've got the issues pre pandemic about rent stabilization now you have the pandemic, we're watching vacancy rates for watching.
Concessions.
Which which is for the drop in actual realized rent in certain units.
And if anyone is kind of walked around new.
New Yorker, frankly center city, Philadelphia, there are a lot of closed and empty buildings and I know a lot of those rents are being paid but just because the rents being paid doesn't mean that it will continue to be paid so it's.
It's a very hard market and we went through and looked at each of our credit and came up with some that we thought you know it's better to be out be out, especially if these dollars we're very happy with the.
The the recovery rates.
Okay.
And then I don't know if still big enough to the weighted average ltvs or not but.
There was nothing on the other question I had I would say this there's nothing unusual about those LTV. So these were not like an 80% LTV pool or anything like that and that was not the driving factor that we were using to liquidate the driving factor was.
Our visibility into that liquidity and cash flow to continue to pay these loan that was the primary yep yep.
Yeah, No I'm I'm actually just kind of.
To your point about the first loss.
Maybe usually being the best I'm, just kind of get trying to gauge where the market might be on on original value. If we have banks continuing to need to sell.
Well tell you that's.
You know if you have a very small change.
In vacancy so if you take a like a multifamily building that Scott.
Manhattan is a historical like a 2% vacancy now it's just under six the latest figures I saw were an 11% decrease in rent.
So what did some math yesterday, if you if your vacancy goes from like 2% to 4%.
Your rent.
Rents dropped by about 10% of the actual rents on the unit.
And your cap rate goes up by a point to have that you could see an average building a 30% to 40% decrease in the appraised value that building because your NOI drops and then is your initial eyedrops and vacancy rates go up you would expect cap rates to go up on a slightly riskier assets.
Right Yeah.
And then on the on the PPP loans, you may have given this but Tom do you have the premium that you will make on that sale. So that the net will be $5.3 million is the net.
And does that include the fees that that what would bring to be accelerated so that's the net we actually sell them at a discount and then we take all that we accelerate the fees related to those loans.
And that was as it was only about half of the portfolio. We retained the other half and then frankly those customers and the loans, we retained where the more strategic customers for the bank. They were also the customers who were being very prompt about providing us the information we needed to file for forgiveness. So they were helping us it was easy to move them through if we thought those were going.
To be long term difficult loans to get through forgiveness, we decided to.
Barclays.
Okay, and none of that was booked in the second quarter correct.
That's correct is that will be booked in the fourth quarter.
So what was the net interest income contribution from the PPP loans in the second quarter.
Okay, right and we're earning 2.25% in the second quarter.
Okay great.
Third quarter, 2.25%.
Okay, the third quarter Dark horse right Yep.
Okay. Thank you guys I appreciate that all.
All right. Thank you take care.
Again, it is star one to ask a question. The next question comes from Collyn Gilbert of KBW. Please go ahead.
Well, it's especially afternoon. So good afternoon guys.
This is great color and coverage that you've offered just won a couple of couple of things to first on the on the TPP front just to make sure is that again going to be recognized through and I are fees.
On the sale.
I actually haven't thought about that like do you have the answer for that.
Yeah, it's not see that gain on gain on sale, whether it's not and I hope okay. Okay got it and then it I know Chris you had indicated to the buyers, whereas the the nonperforming loans that you're moving but what about the buyer for the TPP slog.
[laughter] Yeah, we found the old will give you a specific name, but we found.
Because it's actually a robust market for that so there is little cottage industry going around the people buying these loans.
Loans and and look part of their calculation I believe is that their pending hopes that Congress will do a mass forgiveness.
And that they will then not have to do any work and get the forgiveness and that they had.
That happens that we realized a little more had we held them but.
But the company that we sell to and bought from at least two is probably close between a half a dozen and banks prior to us.
And there were a few then there were a couple of bidders. So there are a couple of people putting together these pools of PPP loans in aggregate.
Okay. That's helpful. And then just on the on the comment that you guys made in the slide deck that you are assuming that.
A lot of the consumer deferrals are gonna dropped to nearly zero by the end of the year. Just curious what gives you that sense of comfort I mean I get it on the commercial side as you said you're in touch with the borrowers you're having discussions you know the businesses, but [noise].
What gives you confidence and insight into these consumer forbearance loans that they'll become.
You're you're right, it's a little more difficult to assess in the consumer side, we will get a few factors. They are probably the most important thing is we do have conversations with them as well. So we do have some information from our communication up I think in the slides, we indicate that $13.4 million of the customers have come up to date have requested additional.
Combination that doesn't mean, we're going to give it we're kind of looking through those on a case by case basis Weve required they submit an application with more current information about their liquidity and all that.
So we had $13 million, where the requests may increase a little bit we don't think its going to be an unmanageable number the other thing to point to Grace his comments.
We expect some of that to appear in the fourth quarter.
So in our reserve calculations for the third quarter, we anticipated that and that provision helps cover that so in the fourth quarter. If we have a pool at this point.
Our best guess would be it might be $10 million might be 20 million of loans that are higher risk on the consumer side, we have an adequate reserves to be able to sell those too so.
So weve kind of cover that risk through the provision in Q3.
And the underlying issue there is the number one default characteristics around a residential loan.
He is not actually income or FICO.
Number one default characteristics LTV and our LTV is we're we're fine, but if you look at our lending area and that's why we included the.
Slides on the median home price values of May.
Most our loans are heavily concentrated in the shore communities that had sharply increasing values and those values continue to increase so early in the summer. We saw some anomalies that Cape May County was up the median home price in Cape May County June to June from 2019, 2020 went up 37.
<unk> percent.
So that's wonderful, but just stop and say is that sustainable is that going to continue to happen certainly watch July August and September the four counties and we include this in the supplemental that constitute most of our loans and most of our forbearance. They all have double digit median home price increases over the past 12 months. So it doesn't seem to.
Maybe just a quick surge of a couple of panic buyers in April it seems to be an enduring shift and.
At the end of the day, if people can make money selling their home.
They're not going to let slide into foreclosure. So we are we're waiting that as well.
Okay. That's great and then just to make sure so tying what Grace's space just comment on you know selling potentially selling some resi mortgage or higher risk consumer loans in the fourth quarter is that then you're when you just said, Chris said 10 to 20 million. That's all that you that you expect to do in that Okay and you think at this point those credits are sufficiently reserved.
So no additional provisioning would be needed.
Correct.
Great. Thank you.
Count.
This concludes our question and answer session I would like to turn the conference back over to Christopher Maher for any closing remarks.
Right well, thank everybody for taking the time to join us today.
Enjoy the holidays I hope everyone will stay safe and we look forward to talking to you with our results in January take care.
The conference is now concluded. Thank you for attending today's presentation you may now disconnect.