OceanFirst Financial Corp. (OCFC) Q3 2016 Earnings Report, Transcript and Summary

Good day, and welcome to the OceanFirst Financial Corp. Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ms. Jill Hewitt, Senior Vice President and Investor Relations. Please go ahead.

Thank you, Aaronson. Good morning and thank you all for joining us. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer at OceanFirst Financial Corp. We will 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. Refer 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. Thank you. And now I will turn the call over to our host today, Chief Executive Officer, Christopher Maher.

Thank you, Jill and good morning to all who've been able to join our third quarter 2016 earnings conference call today. This morning I'm joined by our Chief Financial Officer, Mike Fitzpatrick; Chief Risk Officer, Dave Howard; and Chief Lending Officer, Joe Lebel. As always, we appreciate your interest in our performance and are pleased to be able to discuss our operating results with you this morning. As has been our practice, we will highlight a few key items and then add some color to the results posted for the quarter, and then we look forward to taking your questions. As part of our discussion this morning, I'll ask Dave Howard to comment regarding the credit risk management approach we are executing in relation to our recent acquisitions. Joe Lebel will be available to discuss any questions regarding our commercial lending activities during the Q&A portion of the call. In terms of financial results for the third quarter, diluted earnings per share were $0.35. Quarterly reported earnings were impacted by merger related charges of $0.05 or $1.1 million after-tax, resulting in core earnings per share of $0.40. Core earnings per share increased 25% versus the prior year, largely driven by the initial efficiencies achieved with the Cape acquisition. The second stage of efficiencies from the Cape acquisition is on track to be fully realized in the first quarter of 2017 as the Cape systems integration and rebranding were completed on October 15, and some additional integration expenses to be realized through mid-December when acquisition related expense reductions will be fully implemented. Regarding capital management for the quarter, the Board declared a cash dividend of $0.15, the company's 79th consecutive quarterly cash dividend, and an increase from the $0.13 from prior quarters. The quarterly dividend was supported by the advancement of core earnings and the outlook for additional efficiencies from the Cape merger to be realized in the fourth quarter of 2016 and the first quarter of 2017. The dividend represented a 37.5% payout of core earnings, which is both conservative and well within our historical payout range. Strong earnings combined with the deleveraging strategy implemented last quarter allowed the tier 1 leverage ratio at the bank level to rise to 8.54%, now falling within an optimal range. During the quarter, the holding company issued $35 million of subordinated debt with the state of maturity of September 30, 2026. The offering was substantially oversubscribed allowing the issue to be priced at a coupon of 5.125%, which represented an all-time low coupon for issuances of this rating structure by a community bank. The proceeds may be used for a variety of purposes, including supporting increments of growth at the bank, the possible redemption of $22.5 million of callable trust preferred securities, and the potential repurchase of common shares outstanding. No shares were repurchased during the third quarter as the company focused on building capital and tangible book value. As of September 30, the company had 244,804 shares available for repurchase. The Repurchase Program does remain active given positive earnings trends, a strong capital level at the bank, and the ample liquidity available at the holding company, the company will consider repurchasing shares on an opportunistic basis. In terms of acquisition activity, we’re pleased to have completed the Cape integration on time and without concern. With the Cape integration behind us, the bank is in a strong position to begin the integration of Ocean City Home Bank. The acquisition of Ocean Shore Holding Company is contingent upon obtaining regulatory and shareholder approvals, but is proceeding well and tracking towards the late fourth-quarter or early first-quarter closing. Provided the closing occurs as anticipated, the integration of Ocean City Home, including the consolidation of overlapping branches is planned for completion in the second quarter of 2017. Operating results for the quarter were strong as core net income for the quarter produced a 1% return on assets and 11.9% return on tangible common equity. This places us well on the path to reach the 2017 targets on the 1.05% ROA and 12% return on tangible common equity. Margins remain healthy at 3.56%, demonstrating our continued focus on high-quality deposit growth and relationship lending. There are a few primary trends that affected operations during the third quarter. Our continued focus on commercial lending and the care with which we've integrated the Cape franchise has supported continuing strong core deposit growth. Deposits grew $118 million this past quarter, a 14% annualized pace, while the cost of deposits remains a highly competitive 25 basis points. Core deposit growth, the proceeds of loan sales, and the proceeds of the subordinated debt offering have increased our cash position by $245 million since last quarter. This excess liquidity is available to be deployed over the coming quarters as we complete the integrations of Cape and Ocean Shore, and look towards the possibility of a more favorable commercial lending market in 2017. In terms of deploying liquidity and asset growth, you will have noted the commercial loan portfolio contracted in the third quarter. The contraction is the result of loan sales and the deliberate process to apply the OceanFirst Commercial Credit Program to the acquired loan portfolio. While we expect continued pressure on the loan portfolio during the fourth quarter, conditions appear favorable for loan portfolio growth in the first quarter of 2017. Ongoing originations have been reasonably stable with quarterly loan originations totaling $115 million versus $109 million for the prior quarter, and $120 million for the prior-year quarter. These originations, however, have been largely sourced from the central New Jersey markets, as we methodically assess the opportunities in our new markets. Our approach in the new markets has been to ensure that we have the staff processes and local market knowledge to support prudent commercial loan growth in southern New Jersey and the Philadelphia metropolitan area. As we focus internally, external market conditions appear to be improving. The recent regulatory focus on CRE underwriting standards appears to be making a difference as both credit structures and pricing are showing signs of positive movement. The total loan pipeline has increased $24 million since June 30, while maintaining an average yield in excess of 4%. We are monitoring market conditions and interest rate trends in the hope of more favorable lending conditions in 2017. With the loan-to-deposit ratio of 91%, a 25 basis point cost the deposits, and a 254% investor CRE to risk-based capital ratio, the bank is well positioned to capitalize on loan growth opportunities in the coming quarters. In fact, after the completion of the Ocean City Home acquisition, our investor CRE to risk-based capital ratio is projected to fall to 225% providing even more room for prudent commercial real estate lending in the coming quarters. However, the process of integrating the acquired loan portfolio continues to be a headwind during the fourth quarter. Finally, we made the decision to de-risk the acquired loan portfolios by selling pools of loans with higher risk characteristics. Dave Howard will walk you through our approach to credit risk management and how we intend to continue to adhere to the conservative credit culture that has been a hallmark of our commercial lending efforts. With that, I'll turn the call over to Dave.

Thank you, Chris, and good morning everyone. With two acquisitions completed in the last 15 months and one more pending approvals, I wanted to spend a few minutes discussing how OceanFirst is integrating these balance sheets, while demonstrating a continued commitment to the credit risk management that has been a hallmark of our lending strategy. The Colonial American Bank acquisition added about $121 million of loans in July of 2015. The Colonial American loan portfolio has been fully integrated into OceanFirst and the loan quality and performance have met the expectations we developed during due diligence. The Cape acquisition added another $1.2 billion of loans just this past May. We are again seeing the portfolio perform as we expected given the size, geographic scope, and product diversity of the Cape portfolio. I'll walk through a few specific credit risk management initiatives under way for this integration. First, for all loans, we fully applied the OceanFirst credit underwriting standards across our entire lending footprint on the date of acquisition. This included ensuring that all newly underwritten loans and renewing credit facilities need OceanFirst's existing loan policies and approval procedures. A natural part of this process is that a few loan officers and credit staff with different views of credit risk management, pricing, or underwriting standards, are no longer with the organization. However, we've retained some very talented people that are well aligned with our credit and pricing philosophy. We've been fortunate to attract several highly experienced professionals to the credit team. So, we're comfortable the new loans being approved meet the credit standards that we've been careful to maintain. On the portfolio management side, we began pre-grading the existing Cape loan portfolio on the date of acquisition using the OceanFirst risk-rating scale. That process is more than half way complete, and we're targeting to have re-underwritten and updated the risk ratings for all of the commercial loans that are over $250,000 by year end. Our team is busy with the staffing I mentioned a minute ago. We now have a strong and deep bench in the region. When we performed our diligence on the Cape loan book, we knew that there would be a significant number of loans, which would be downgraded when we applied to our risk-rating scale. This is bearing out as we expected, and thus far we've downgraded 36 loans with balances of $33.3 million to lower than past ratings. It's imperative to note that these results are in line with our due diligence findings and reflective of the credit mark taken at the time of the acquisition. Having an accurate risk-rating process is a critical pillar for credit risk management who are committed to maintaining this discipline for any loan on the OceanFirst balance sheet. We expect a vast majority of the loans from the Cape acquisition will honor their obligation to repay the loan. By and large, they've been making full and timely payments for years, but at this time, have not provided timely financial information or documented sources of funds to warrant a past rating under the OceanFirst guidelines. I want to emphasize that we're not seeing anything from a credit perspective that's materially different from what we identified in due diligence. As a matter of fact, there's only been one Cape loan downgraded that's due to credit deterioration that occurred after the acquisition. That loan is extremely well collateralized with very little risk of loss. We're confident that the credit marks that we determined at acquisition are appropriate, and we’ve not seen any need to adjust those values. We expect that over time, we'll be able to upgrade some of these credits back into past status. Many borrowers will want to continue our relationship, but they were not in the habit of submitting their financial statements. Thus, we re-established portfolio management relationships with the renewed emphasis. We anticipate that many of these borrowers will be willing and able to provide us with the financial statements we require. On the risk mitigation front, I'd like to give a few details about our loan sales efforts. Part of our acquisition strategy was to evaluate the purchased loans and consider the economics of loan sales, either for strategic reasons or credit reasons, and we've done both. First, on September 30, we fully exited the SBA lending business by combining the Cape and the Colonial American SBA loans and selling them in a single-bulk sale. There were 72 loans totaling just under $10 million in principal outstanding. There was an additional $15 million of residual risk related to the guaranteed portions of these loans, which was eliminated with the loan sale. The SBA business can be a profitable business line for community banking, but it is a highly specialized business. OceanFirst has not traditionally maintained the depth of staff to conduct SBA lending on a meaningful scale, and SBA lending opportunities in our market area suggest that developing properly resourced SBA business would be a challenge. We also recognize that SBA lending often involves a different type of borrower than our typical customer. The borrowers in our acquired SBA portfolios were enough outside of OceanFirst's standard risk appetite that we decided that a complete exit of the SBA business line was the best strategy for us. This sale resulted in approximately $497,000 net loss that was charged to the allowance during the quarter, and $504,000 in increased goodwill from adjusting the fair value of the Cape acquired loans. Our second de-risking strategy was a bulk sale of most of Cape's nonperforming residential loans and a few others that were underperforming or demonstrating credit weakness. This included 63 loans with a principal balance of $8.7 million. We were prepared to retain these loans and work them out ourselves, but were pleased at the market reception, and exited this book of loans for more than the fair value mark that we established at acquisition. This results in approximately a $646,000 reduction in goodwill. Finally, we're in the process of marketing a pool of underperforming commercial loans. This pool consists of 58 loans with principal balances of $22.7 million and is made up of loans from Cape, Colonial American, as well as OceanFirst. As with the residential loans, we are prepared to retain and work these loans, but think that market conditions may make a bulk sale to better outcome than prolonged work-out efforts. We've received indicative bids from a number of interested parties and expect to come to terms and close on a sale in the fourth quarter. In anticipation of a sale, we've designated this portfolio of loans to be held for sale. With this change in designation, we've marked the loans a fair value based upon the indicative marks received and took a charge of $1.1 million to the allowance. Of this amount, $915,000 had previously been set aside as specific reserves for these loans. For the Cape loans, the indicative bids are higher than the credit mark and will likely result in a reduction of goodwill of $545,000. These three initiatives will result in the removal of 193 loans totaling $41.4 million on the balance sheet and exiting of a residual off-balance sheet risk of another $15 million in SBA guarantees. Taking these actions will impact the loan portfolio size and will sacrifice some spread income in future quarters. However, setting the highest risk portions of the balance sheet is considered a high priority as we see current market conditions for these sales to be favorable. We believe exiting these credits will materially reduce our credit risk profile. Further, the sales allow us to avoid the distraction and resource allocation required to address a large number of loans that could require work-out handling in the future. As we prepare for the closing of the Ocean City Home Bank acquisition, we expect to implement similar credit risk management procedures. I'd like to point out that the quality of the Ocean City loans is very strong. The portfolio is largely first lien home mortgages with very high underwriting standards. As of the time we were conducting due diligence, the residential loan portfolio was on average 6.2 years seasoned, and had a current FICO score average of 759, an impressively high score as this includes all loans, even those that have deteriorated since origination. On the commercial side, nonaccrual loans are insignificant. We expect that the integration of Ocean City Home Bank's credit portfolio to be relatively straightforward and will not require the same degree of credit risk mitigation. Finally, I wanted to point out a few other details from the press release. Walking through the components of the total charge-offs of $1.9 million in the third quarter; $497,000 was from the SBA sale, and $1.13 million is from the pending commercial loan sale. The remaining $321,000 is from the ordinary course of business losses. Excluding the loan sales, the normal annualized charge-off rate was only 4 basis points. The overall credit reserves for OceanFirst are robust. The allowance for loan losses is at 0.51% of total loans receivable, which is quantitatively low-reserve level. However, when we include the unamortized credit mark with the purchased loans, the total coverage ratio rises to 1.07%. With the significant de-risking of the portfolio in the last several months, we're comfortable that this is a healthy level of credit reserves. With these two acquisitions completed and the third expected to occur shortly, we're pleased the credit risk is consistent with our due diligence expectations and fair value marks. We anticipate a focused effort on organic growth initiatives in 2017 and this may coincide with more favorable lending conditions, improved interest rate environment, and a more rational market who invest around commercial real estate. Now, I'd like to hand the discussion back to Chris for the closing comments.

Thanks, Dave. At this point, Mike, Dave, Joe, and I would be pleased to take your questions this morning.

We will now begin the question and answer session. [Operator Instructions] Our first question comes from Bernie Preston of Piper Jaffrey. Please go ahead.

Hi guys. I'm filling in for Matt Breese this morning. How are you?

Very good. How are you?

I'm doing well, thanks. I just have a few questions for you. I wanted to start off, thanks for the color on the loan sales. It helps to answer some of my questions about cash balances being up. But in the past, you guys have talked about certain opportunities, given your CRE concentration being below 300 and a sub 100% loan-to-deposit ratio. I want to know if you're going to use any of the cash for any potential loan purchase opportunities you're seeing in the market or any whole bank M&A.

It's Joe Lebel. We absolutely are having fruitful conversations today about utilizing some of the cash for additional CRE opportunities, and we expect, based on what we've seen most recently, that market terms have improved both in terms of structure and pricing. So, I think that's going to be a benefit to us as we head into the first quarter of 2017.

Okay.

And just to follow up on Joe's comments, there's a distinct possibility that interest rates may move up a little bit in December. So, as we go into next year, I think this cumulative focus on investor CRE by the regulatory agencies and the interest rate movements, we've been in no rush to deploy that, and we've had our credit folks really drilling down into every loan in the portfolio that we've acquired. So, what I think as we go into 2017, we see a return to growth in the commercial loan book.

Okay, great. And so do you think that will help offset some of the loss spread from the loans that you're currently selling or looking to sell moving forward?

Yes. We think we're going to be back in the position where we'll be able to grow both the loan book and net interest income during 2017.

Okay. What is the outlook for organic loan growth and deposit growth [indiscernible]?

So, the first comment I'd make is towards deposit growth. Yes, the deposits are doing quite well. I think any time that you get into an acquisition the size we did with Cape, you try and be conservative about your expectations about retention because if you make a mistake there and you wind up not retaining as much as you thought you might, you'd have a liquidity squeeze. On the positive side, that portfolio has performed better than we thought. I think so the combination of our continuing commercial lending efforts plus execution on the Cape strategy allowed us to come into the third quarter with deposits higher than, frankly, we forecasted. So, we're working through that and making sure that we understand the durations of the deposits before we rush to deploy them. And also, we wanted to get through the system's conversion, which was about a week ago and which went swimming, so we're very happy with the way that turned out. So going into that conversion, we thought it prudent to keep higher levels of cash balances. As we look into next year, I think we said in our prepared comments that there's a still a little bit of headwind. We have probably, at this point, maybe another 40% of the Cape book to re-underwrite the risk rate. That will happen between now and the end of the year, and as we apply our pricing minimums and structure constraints to that portfolio, that does put pressure on some of the renewals that will come through. So the fourth quarter is probably still a little bit of a headwind, but as we go into next year, we will have, with that integration behind us, we have - what we see is slightly improving structures and pricing in the investor CRE market. We may have a Fed rate hike. So, going into next year, we feel more comfortable. That said, we're not going to rush to deploy everything all in one quarter because we're just conservative by nature, and we want to dollar average it, and so I think is what you'll see is you'll see return to growth. But, as we've done in the past, we will focus on consistent growth quarter after quarter rather than rush to deploy all the excess liquidity in any one quarter. With our margins where they are in the 350's, and earnings where they are, we don't feel under pressure to go out and deploy this liquidity too quickly. We'll do it methodically, and probably most significantly, starting the first, second, and third quarter of next year.

Okay, great. Thank you. The last one from me, I was hoping you could remind us of NIM guidance with and without a rate hike in December.

I would say that our NIM has been pretty stable the last several quarters. We expect that stability to continue, while - let's say, for example, there is a rate hike. I think our overall expectation is very similar to the rate hike that happened last year, which was a nonevent. So, we expect very little pressure on deposit pricing, and we don't expect a whole lot of jump on the loan book, and that's for a couple of reasons. Many of the loans we have that float are at a floor, so until you get a couple of increases in, you're not going to start to pick up that incremental shift. And the non-floating loans, we've got to work through that over a period of time, so each quarter, there's a portion of those that would renew and re-price. So, I think the first interest rate moves probably will net in neutral. It helps maybe a little bit in origination yields, but then that's going to dollar average in over a series of quarters, not over one or two quarters. So, if the Fed were to move rates in December, we don't expect a near-term positive effect, but over time that would move itself through the balance sheet in a positive way.

Okay. All right, great. Thank you very much.

Thank you.

Our next question comes from Collyn Gilbert of KBW. Please go ahead.

Thanks. Good morning guys. I just want to thank you. That was really good color on what you guys offered on the risk mitigation efforts; you just really did great. So, I don't say things like that very often, so I just thought that was really good. One question on that though is, just trying to connect the dots, and you touched on it a little bit Chris, but the difference in when you first - when you guys assigned the mark on the Cape book being what it was, why you're still so comfortable with that relatively low mark, but given though the intense process that you're undertaking now with the portfolio. I guess I would have thought maybe there would be a tighter correlation there. So, I'm just trying to understand. I know you mentioned financial statements, so maybe it's just a process. You just have to check the boxes differently, but I'm just trying to understand those two parts.

Sure. Let me start with the kind of risk rating approach and although there's industry conventions around risk rating each bank kind of has its own risk rating guidelines, and every bank has a little different policy and application of, let's say, structural requirements or requirements for tax returns, and all that. So it's not uncommon for different banks, particularly you'll have banks that have different regulators, we're an OCC bank, and Cape had been an FDIC bank, they're not tougher or lighter, they're just different. So as you take a loan portfolio, which was of size, it was a $1.2 billion portfolio, and you move it from one set of guidelines to the other, you're just going to have changes. And if we moved the portfolio from us over to Cape, you'd have similar changes. So the risk-rating nomenclature is going to be different. You're exact ratings will change from time to time. Interestingly, I think this is the finer points of tuning a loan portfolio and making sure you've got uniform risk ratings. It doesn't speak that much about the aggregate level of risk in the portfolio. And in fact, the risk ratings that have changed below pass are actually a very small portion of the overall portfolio. So it's not a big deviation, and it's more moving from one bank's risk-rating scale to the other. It's not easier. It's not tougher. It's just kind of different. We do place a high emphasis on the reporting of annual financial statements from our clients. We review loans every year, and that's just a discipline that I think, in our size and our complexity, that we've got to maintain. So when you move loans when that are underwritten one way into a risk-rating scheme that's a little different, you're going to have the movement. The overall level of credit risk though, we've been very pleased, is bearing out to be exactly what we thought it would be. So as Dave mentioned, we had only one loan that shown deterioration in a $1.2 billion book. That's a rounding error. And even that loan we feel is very well secured. It's got trophy property behind it, so I think we'll be fine. Then when we look at the loan sales, and we look at the opportunity to mark these loans as we did in acquisition, and sell them pretty much at the mark we took, that gives us a second sense of confidence that we got the risk ratings right. So, in varying pools, some of the goodwill adjustments were a little up or little down, but net-in-net, it was almost on dollar-for-dollar. So that gave us a high degree of confidence. I think the process for us is about making sure there are no surprises. We don't want to go into next year and come out and say, hey, you know, we didn't catch this, or we didn't see this. So, we would rather re-underwrite, re-risk rate the entire loan book, make sure we’ve got the credit marks exactly where they are, and if we don't, we take extra provisions to cover it or we'll adjust goodwill appropriately. But as of right now, we think the book is exactly where we assessed it to be. The second part I think is an important comment that Dave made about Ocean City Home. Ocean City Home is predominantly a residential lender, so a very different balance sheet than the balance sheet you found at Cape, which was a diversified commercial lender. Those are going to be very different risk characteristics. The Ocean City Home portfolio is homogenous, is very similar, a lot of the same underwriting characteristics. We don't expect the need to do this level of re-underwriting, risk rating, or risk mitigation that we did in the Cape portfolio. There just very different banks.

Okay. That's really helpful. Thank you. And then, I think you talked about this, but just in terms of the outlook for 2017, obviously, with a re-ignition of the loan growth, you mentioned pricing and structure seems to be improving. Is that across the board in all loan categories or is that multifamily? Is that, I know I think you mentioned unoccupied CRE, but just - because it sounds like we're getting mixed messages from a lot of the banks as to how this pullback or pressure on CRE is impacting pricing. Some are saying not at all; others are saying it is. So, just trying to get a little bit more color as to what you guys are seeing.

Well, I would say that in the - we're not a big participant in the multifamily market, so I really can't offer much guidance around that. We don't do a lot of it, so my comments would be related to investor CRE that's not multifamily, so either office, retail, some construction, those kinds of things. What we're seeing is it's not a wholesale change, right? So we're not seeing things are way better than they were, but we are seeing - let's start with this, fourth quarter last year or second quarter this year, we would compete for deals where the structures were out on the edge in multiple areas. So, you would have a combination of risk characteristics. You might have a relatively low debt-service ratio, high LTV, nonrecourse, and long amortization periods. And when we look at loan, often they're very good loans that have a weakness. It might be a little bit weak on the debt coverage or a little bit weak on the amortization because it's a new building, but when you get into multiple weaknesses, that's where the credit risk starts to really balloon, and we were starting to see that. We saw a lot of deals that were coming through that we were either declining to pursue, and we had deals in our portfolio refinancing out for terms that we would never have matched. So, we saw that heating up end of last year and the first couple of quarters this year. That slowed reasonably in the, probably, tail end of second quarter now into the third quarter. So, while we haven't seen this pendulum swing where everything is great, we're seeing more rational competition. That's not easy, but it's something you can at least compete with. We can't say whether that trend is going to continue, but it looks like it will hold. So in incremental deals, we may see two or three bidders that had been in every deal prior to that may not be bidding, and maybe that's - I don't know why, but maybe that's because they've reached certain internal limits over concentration. And then as a result of that, if you’ve only got two or three or four banks under consideration, instead of five, six, or seven, you're tending to get structures that make more sense. So, we're cautiously optimistic. As I said, the pendulum is not swung back, but it's firmer, and we're seeing more deals that we think we can execute on within our risk parameters. So, you combine that with the potential rate increase in the fourth quarter, and we look at 2017 as having the opportunity to return to the kind of loan growth we've been posting, let's say, in 2015.

Okay. That's great. And then just one final question on operating expenses, given the ebb and flow of the cost saves, given some of the cost maybe still around this re-risking process, how should we think about maybe kind of a run rate or just an expense level in the fourth quarter, and then once - I know once we fold into Ocean Shore, but putting Ocean Shore aside, just the core with you guys and Cape, and how those expenses probably are going to run here in the near term?

Yes, Collyn, it's Mike. In the fourth quarter, we have some anticipated cost saves from the Cape Legacy system. I'll tell you that in the third quarter, the Cape Legacy costs were $7.1 million in total, about $4.7 million in compensation, so that's got to trend down a little bit. Also, service bureau was about $700,000. There'll be some reductions there, and there'll be some reductions elsewhere. So, the OceanFirst run rate, Legacy bank will probably trend at a stable level and there will be reductions in the Cape Legacy system, in that $7.1 million expense base and those will be layered in throughout the quarter. So there will be some benefit in the fourth quarter, and they'll be fully realized in the first quarter. So, I can't say what the exact number is, but there will be some expense saved realized in the fourth quarter and then more fully realized into the first quarter.

Okay. Okay, that's helpful. Thanks, guys.

Thanks, Collyn.

[Operator Instructions] Our next question comes from David Bishop of FIG Partners. Please go ahead.

Hey, good morning gentlemen.

Good morning, Dave.

Hey, Chris, you spoke about the inflow deposits exceeding your expectation in terms of the retention, has that caused you to maybe go back and look at the Ocean's City acquisition in terms of okay, what happens post-acquisition there, just in terms of the potential impact, post-liquidity upon completion of that merger? Is that - are you guys revamping the estimates there in terms of what happened in the post-merger?

Yes, we're thinking about that very carefully because you don't want to take one quarter's worth of trend and rely too heavily on it. You like to see this stuff persist. But the deposit trends came in a number of different areas; some of it our northern markets as well. I think one of the things that we learned is that the single biggest, I think, threat to deposit runoff from Cape was probably Ocean City Home because they were big players in the market. So I think the opportunity which some of the benefit is, you're seeing the benefit of combining both those franchises where you have two of the top players in the market. Not to say there are plenty of other competitors in the market, good competitors, so it's not an empty market by any stretch, but the two largest players were Cape and Ocean City Home. So, if you wind up on both sides of that, I think you've got fewer customers kind of going out and taking a look. So, I think that was a benefit that will also affect in our expectations around the Ocean City Home portfolio. So, we've always been a company that really valued core deposits both in growing them and having a high-quality base, 25 basis point cost of deposits. So, we're going to continue to push that as fast as we can, and we're comfortable. If that means we lag our loan growth a couple quarters and have a little bit of extra liquidity, at this cost, those deposits are worth holding on to, and then catching up the loan growth a couple quarters down the road.

Got it. Was there any sort of seasonality that impacted this quarter that maybe inflated that end-of-period cash that might flow back out in the fourth quarter to alleviate some of that short-term liquidity pressure?

There was certainly a little bit of seasonality, but actually, it wasn't as seasonal as you might think. Certainly, now having a little bit more concentration to depositors along the shore, I will say that the summer season was very good. Although we're not a big hospitality participant, we do have a lot of customers that have tangential connections into the hospitality business. And the summer was very good for all of our markets, so you would expect that receipts for all the local retailers and hospitality businesses were up and that transits to everybody else having a little more cash, but I would say that it's less than half of the deposit gain. This far into the quarter, we're not seeing that reverse. I would say we were also pretty conservative; whenever you're going through a data conversion, you're always very careful about maintaining liquidity and not having any issues arise. I will say that we had an extraordinary team of professionals within the bank; 70 or so people working on that conversion. They pulled it off flawlessly about a week and a half ago, and just a hat's off to everybody who's spent a lot of time and effort making sure that that worked as well as it could.

Got it. And I think in previous calls and just discussing with you, the cautiousness regarding investor's theories, saw a little bit of growth this quarter. Did that reflect just maybe some signs of life on just specific deals where you were able to get good risk-adjusted pricing and structure? I was just somewhat surprised to see growth in that category just given some of the overall cautiousness heading into the quarter. I'm just curious what sort of drove that growth.

Well Dave, I think you hit it on the head. It's Joe Lebel. We saw and closed a couple transactions that met both our pricing and more importantly, our credit standards. And as we’ve talked a little bit about it, we're cautiously optimistic that we're going to see and continue to see more of those. The pipeline is up with some additional transactions that we anticipate fourth-quarter, first-quarter close, and we're having better conversations in the market place around those types of transactions that meet our hurdles.

Got it, and then just one final question. I think, Chris, in the preamble, you noted maybe some departure of some lending officers that just had different views of credit risk underwriting there. Do you get the sense that that sort of departure from a staffing perspective was greater in line with expectations? Just curious in terms of just the overall trends of relationship managers there; did that leave you with a hole to plug? Are there opportunities to backfill those areas and really get more on the offensive from a loan generation standpoint moving forward?

I think yes, that's a very good question, Dave. The departures of a few loan officers and credit staff, whenever you go into an acquisition like this, and you do as much diligence as you can, and you talk to people and meet people, and all that, what you'll find is that in the months following the actual acquisition, you get to know them better. And you guys decide whether it's a good fit or not a good fit. By and large, these were all very good people. They just had a focus in areas of credit that might not have been for us. For example, maybe a lot of participations in larger bank credits, which are good credits, but we're not focused on lending $10 million as part of a $50 million deal and being a minority participant to that degree. So that's an example where you could make a very good loan, but it's not the relationship blending that we have been focused on. The second thing is that we have a pretty rigorous pricing model. I don't think any pricing model is perfect, but every time we make a new commercial lending decision, it goes through our pricing model and that's a challenge. It's a challenge for our experienced lenders in every market we're in, and it requires a certain discipline around structures and interest rates and deposits and fees. If you're a relationship lender, I think you can work very well within our format. If you're a transactional lender, and there are a lot of very good transactional lenders out there, it's going to be much harder to get the deal through that pricing formula. And I think for good reason, because you don't have the deposits compensating and the other costs. So, it wasn't a wide disparity where we talked to lenders who were not quality people or not good lenders. It was just the difference between how we focus our business, which is all relationship focus, and I would classify most of the lenders or credit staff that departed had been traditionally more focused on transactions rather than relationships. In terms of your question about whether that's a whole, we have to plug; it's obviously something where we want to rebuild with the staff that kind of matches our credit and relationship focus, and we've been doing that. So, we've made several hires already. It takes a little time for them to get productive, and as we're working through that, the credit staff has been making sure that we've got all these loans documented and risk rated as they would be under OceanFirst. So, you have a pretty herculean effort of re-underwriting and re-risk rating over a billion dollars' worth of loans in a short period of time. We're almost through that. That will allow us to focus with the new staff we brought in. And I think we're going to be very competitive throughout southern New Jersey, and I think we're going to be very competitive in metropolitan Philadelphia. The last thing I would say is, we also consciously have decided not to jump into that market before we know it well. The fact is that after you underwrite, re-underwrite all these loans, you get to know the businesses that you're lending into in those markets, you get to know the accounting firms you're dealing with, the lawyers who close the deals. So, I think as we go into 2017, we will be more confident about pursuing opportunities in metropolitan Philadelphia, or at least more confident than we would have been just jumping into it and going full bore, let's say, in May.

I got it. I appreciate the color; it's much appreciated.

Thank you.

[Operator Instructions] It appears that we have no further questions at this time. This concludes our question and answer session. I would like to turn the conference back over to Mr. Christopher Maher for any closing remarks.

All right, once again, thank you for joining us this morning for the call. We will look forward to presenting additional updates as the year progresses. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.