OceanFirst Financial Corp. (OCFC) Q4 2017 Earnings Report, Transcript and Summary

Good morning. And welcome to the OceanFirst Financial Corp Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Jill Hewitt. Please go ahead.

Thank you, Brandon. 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, Chairman, President, and Chief Executive Officer Christopher Maher.

Thank you, Jill. Good morning to all who've been able to join our fourth quarter 2017 earnings conference call today. This morning, I'm joined by our Chief Financial Officer, Michael Fitzpatrick; Chief Administrative Officer, Joe Iantosca; and Chief Banking 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. As has been our practice, we will highlight a few key items and add some color to the results posted for the quarter and then we look forward to taking your questions. In terms of financial results for the fourth quarter, diluted earnings per share were $0.30. Quarterly reported earnings were impacted by the additional income tax expense related to the reduction in the corporate tax rates, which totaled $3.6 million or $0.11 a share. And merger related expenses and branch consolidation charges totaling $1.3 million or $0.04 per share. Excluding those amounts with results in core earnings per share of $0.45. Regarding capital management for the quarter, the board declared a cash dividend of $0.15 the company's 84th consecutive quarterly cash dividend. The ex-dividend [ph] date is February 5, so our new shareholders from Sun will be eligible to receive this dividend provide the Sun closing occurs as we anticipated on January 31. The $0.15 dividend represents a 32% payout of core earnings, which is in the low end of our historical payout range. As mentioned in lest earnings call, we expect to differ any consideration of a change in the dividend until the second half of 2018at that point we expect to be in a better position to assess overall economic conditions and for the earnings accretion from the Sun transaction to be well established. As we consider the dividend later in the year our valuation will include both the quarterly dividend rate and the opportunity for special dividends as appropriate. No share repurchases were made during the quarter leaving 1.8 million available to this purchase. I would note that despite the impact of merger related charges during the year and the impact of tax reform on the company's differed tax assets strong current and careful tax management have lead intangible book value per share to increase by 5% over the last 12 months. I would also draw attention to the developments regarding corporate governance and board constitution. We previously announced the additions of Sun Directors, Anthony Coscia and Grace Torres which will be effective at the Sun closing. In addition, we are pleased to welcome John Llyod to the board effective immediately. All three of these additions strengthen the board bringing board and management experience from large and complex organizations including Amtrak, the Port Authority of New York & New Jersey, Prudential and Hackensack Meridian Health. The company is committed to ensuring that the board has the resources and experience to provide the appropriate governance for a bank that has increased its operating scale dramatically over a relatively short time period. Finally, we noted Director Dorothy McCrosson announced her decision to retire from the board at the end of our term at our Annual Shareholder Meeting in May. Dorothy has been a pleasure to work with and was particularly important as we integrated the Ocean City Home franchise in 2016 and 2017. Operating results were generally in line with our expectations with strong loan growth decreasing core operating expenses and stable deposits. Our progress against important benchmarks including core ROE of 1.09% return on intangible common of 13.27% and then efficiency ratio of 53.7% for the quarter was generally in line with our targets. Loan growth came late in the quarter commuting them interest income and quarterly margins. Mr. Lebel will discuss lending conditions later in the call. Off course changes in the tax rate require the acceleration of certain income tax expenses to account for a revaluation in our deferred tax assets. The company actively managed our response to the tax changes during the quarter. As a result, our finance and accounting team was able to realize the significant portion of the DTA in 2017 thereby preserving $0.30 of book value per share that would otherwise have been lost. Going forward our normalize tax rate should approximate 19%. Off course certain merger expenses are not fully tax deductible so than normalize tax rate might fluctuate during the sun integration. I'd also like to provide some additional color regarding the company's response to tax reform. As previously announced the company has implemented a $15 minimum wage policy in order to ensure that we retain an incent new employees have spent the most time with our customers largely branching call centers staff. The change in completive landscape is fundamentally but we are asking of this group of employees. In the past much of the responsibility revolver on handling cash conducting routine transactions and supplying basic information such as account balances or verification of transactions. While those tasks still exist we now expect our customer contact staff to be digital experts capable of helping a customer, download our mobile app, training them on remote deposit transactions or even answering questions regarding PayPal, Apple Pay or Android Pay. So, reflecting this new paradigm the bank has graduated 65 staff to our certified digital banker curriculum in 2017. 80 more employees are currently working through that program and additional 60 Sun employees begin training under the Digital Banker program in February. These folks are our competitive advantage. We're investing in them and we want them with us for the long term. In addition to the $15 million minimum wage policy, we also wanted to address the broader pool of employees who contribute each day to our long-term success. We determine that the best way to reward our staff and to pass alone the portion of the benefits of tax reform will be to increase the stock ownership levels of all our employees. The planned purchase of 300,000 additional shares to be added to our -- trust represents an $8.1 million investment in our workforce. The additional shares will increase annual share grants beginning with a 2018 grant cycle through 2026. Finally, to ensure the senior officers are highly focused on achieving the bank's long-term profitability targets a portion of the equity grants provided the senior officers will now be performed qualified and will only best upon achievement of certain ROA targets over the coming years. Each of these decisions was made to ensure that we maintain the most competitive workforce in a highly competitive in relationship centric business model. That investment while material which balance sheet and shareholders' interest as well. While these programs are significant, we estimate that approximately 90% of the benefits of tax reform will pass directly to our shareholders in the form of improved profitability. Of course, with us restock program employees are material constituency in our shareholder base. Finally, the bank's increased profitability post tax reform provides a significant advantage to the OceanFirst Foundation which currently owns 1.3 million shares of OceanFirst common stock. OceanFirst pioneer the concept of creating a foundation in connection with our demutualization and initial public offering in 1996. Since then total grants have exceeded $34 million. In response to the bank's decreased tax rate, the foundation board has approved a 2018 grant budget of $2.4 million almost double the grant budget of 2016. In this way we're able to invest a portion of the tax reform proceeds directly with non-profit throughout our market area. Our approach preserves majority of tax benefits for our owners which was an easy decision when considering how many shares are currently owned by our employees, will be newly available to employees in the expanded EOSP program and the shares held by OceanFirst Foundation. Our governance structure made these decisions relatively straightforward. Turning to the Sun acquisition. The company is on track to close that transaction on January 31. Average time the company will convert to a bank holding company and the bank will convert to a national commercial bank charter. Estimated consolidated assets will be in the range of $7.6 billion, making OceanFirst the second largest commercially chartered bank headquartered in New Jersey. As previously announced, this transaction will be dilutive to earnings during the first half of 2018 until the efficiencies can be realized during the second quarter. We're pleased with the strong earnings improvements Sun has managed since the transaction was announced and remain confident of achieving the earnings accretion originally projected last June. Of course, the decreased federal tax rate will make the new earnings stream attributable to Sun even more valuable than average that we anticipated. Although much of that opportunity will come in the second half of 2018 and 2019. At this point, I'll turn the call over to Joe Lebel for some perspective on conditions in our lending and deposit business. And then on to Joe Iantosca for comments regarding our plans for Sun integration and the consolidation of an additional 17 branches in the second quarter.

Thanks, Chris. Fourth quarter loan originations of $233 million, represented the highest quarterly originations for the year and annual loan production in excess of 825 million represented record loan activity for the company. Total loan originations for the quarter including a 141 million in commercial originations also the best quarter in 2017. However much of the growth came in December which diluted the impact on net interest income. As much of the loan growth is funded by cash the incremental loans booked late in December will have a modestly positive impact of a net interest margin in the first quarter. The quarter also saw the largest loan growth for the year at 96 million, led by commercial growth of 71 million. We've spent much of the last year reducing exposure to acquire commercial construction participations. We've slowly begun to build out the participation book, by purchasing seasoned cash flowing commercial real estate loans, some of which carry lower coupons but demonstrate a lower risk profile. Our asset quality remains strong, the pipeline is solid and economic conditions support consistent loan growth in the coming years. The addition of the Sun Bank commercial and [CRE] lending teams should also bolster 2018 originations. Regarding deposit growth we saw flat fourth quarter with solid deposit growth for the year of 155 million. This growth is particularly important as a part of our efforts to retain and expand customer relationships subsequent to the consolidation of 15 branches and the Ocean City systems conversion in the second quarter. Retention of deposits has exceeded expectations in all of our acquisitions to-date. Additionally, our average branch size has improved from a respectable 68 million at the beginning of the year to a robust 94 million at year end as we approach our goal of 100 million per branch in the second half of 2018. Moving to the net interest margin, we saw a decrease from 3.50% to 3.42% quarter-to-quarter, largely due to higher funding costs and lower loan yields. Loan growth is weighted late in the quarter progressing the rotation from cash into loans from offsetting other NIM pressure. Purchase accounting contributed 2 basis points of contraction. We anticipate the NIM to remain at a current level in 2018 with anticipated loan growth offsetting modest reductions from purchase accounting. The average costs of deposits for the year increased only 4 basis points over the prior year to 29 basis points from 25 basis points; one of the best funding profiles of our markets. We calculated deposit data of roughly 4% since December 2016 rate increase by Federal Reserve. Our loan to deposit ratio remains conservative at 91%, providing flexibility regarding how we react to deposit pricing pressure in 2018. With that I'll turn the call over to Joe Iantosca who will provide an update regarding the integration of Sun.

Thanks Joe. As Chris stated, the legal closing for the Sun transaction is scheduled to occur on January 31st. Following the closing, all former Sun locations will remain open and we'll operate the Sun, a division of OceanFirst Bank NA until the systems integration is completed. Scheduled for June, the system's conversion and full integration progress is progressing on schedule and as planned, concurrent with the system's conversion, all locations will be rebranded as OceanFirst Bank. Additionally, at that time, the branch consolidations anticipated in the merger model will be completed. Specifically, 17 branches will be closed and consolidated into neighboring branches in the second quarter. Of the 17 branches being closed, eight are less than 1 mile from the nearest OceanFirst branch, six are between 1 and 3 miles away and the remaining three are approximately 5 miles from the receiving branch. As we have in prior branch consolidation efforts, we continue to obtain representing both OceanFirst and Sun officers and coupled with customer analytics and coupled customer analytics with the observation and experience of those working in the various markets to determine the candidates for closure. As you may recall, we’ve consolidated 17 branches in three groups over the past few years. We continue to gather data and analyze the results of each of those consolidations, measuring deposit, retention levels and the combined branch from the date the closure was announced. Today, our experience is an overall deposit retention rate of 97.9%. We believe this was achieved because of the multiple initiative we take to retain our customers and play a very high touch communication protocol with most impacted customers getting personal calls from the local bankers in addition to clear written communication. Additionally, our team led by the certified digital bankers Chris mentioned earlier were diligently to encourage use of the banks high quality self service offerings including our online, mobile and wearable apps and our interactive televisions. Also, we typically stepped from consolidated branches with a mix of personnel from both the closing and receiving branches providing our customers with a familiar phase when they visit us. We will be able to staff in the same way for this round of consolidations as well, since both OceanFirst and Sun have been carefully monitoring and managing open positions since the merger and outlet. In fact, OceanFirst has offered continued employment to 100% of the Sun branch staff members. Financial impacts of consolidation planned through the second quarter will need the expense reduction target and the one-time cost estimate anticipated last June when we modeled the Sun transaction. As a result of the above timeline and actions, the bank will recognize a relatively low level of the anticipated cost savings from the merger in the first and second quarter with virtually full recognition occurring beginning in the second half of 2018 as the branches are closed and duplicate systems are eliminated. Additionally, by the end of the second quarter, we expect to have the Red Bank administrative building operational and occupied and the Toms River facility renovations largely completed allowing the back-office consolidations to be well under way. This consolidation initially presents an expense headwind, but was substantially reduce operating risk, establish a firm foundation for further growth, enhanced professional recruitment opportunity and lead to longer term efficiency improvements. Turning now to a brief comment on asset quality, there was an increase of 5.7 million in non-performing loans from the linked quarter. This was primarily attributable to one commercial relationship which has been classified while performing through several years. The bank subsequently received the payment of 3.7 million from this borrower in January reducing the balance by over 50%. Charge-off through the quarter of $2.3 million including 1.1 million attributable to residential loan sale and $880,000 as the bank shows to choose to charge offs those amounts that have been specifically reserve for in previous periods was in the allowance. I'd like to now turn the call back to Chris for questions and answers.

Thanks Joe. At this point we are happy to take your questions.

[Operator Instructions] Our first question comes from Joe Gladue with Merion Capital Group.

I guess first off, just based on the loan portfolio just wondering in third quarter you had noted that pay-offs were particularly high, unusually high, just wondering how much they contributed to both the loan balances and any net interest margin impact?

We did get a couple pay-offs in the fourth quarter I think it was largely neutral to the NIM because the returns of our similar where NIM is today and did not obviously impact loan growth. We are pretty much I would say 90% through this stuff that we wanted to exit so I think there might be one or two popping up in the first quarter but nothing significant.

And just the little bit on the pipeline it looked like it came down a little bit versus in the third quarter and you mentioned that you allowed that the originations were late in the quarter, is that I guess temporary decline because of the late closings or just put beyond.

Pipelines are always it's did total we do the pipelines for the reports because of the day and time the pipeline is significantly higher today as we are speak than it was at the end of the year. We did also see some closings at year-end for tax reasons that we thought it would push into January so but either way I think we're pretty bullish at where we are to start off '18.

And on deposit side there wasn’t a whole lot of change in quarter-to-quarter balances but there was some shift in the mix that looks like really supplying in almost all of the deposit categories with the one exception of interest bearing check, give us some color on what's going on with that ship?

So, Joe some of this is seasonal slower comment for us to see some run out in the core deposits from the fourth quarter based on what our market area is and some of the mix shift had to do with some seasonally increases in government and then we have seen several new accounts in government for the year where we take a little bit more to acquire those accounts for nothing significant.

And also, just one I guess small item. The decline in the one expense line the FDIC and other insurance line from quarter-to-quarter, wasn’t a huge amount, that's just one in what's going on there? Is that a sustainable level or is that something temporary?

Well overall, our FDIC insurance expense decreased for the year because our risk profile changed a little bit. And some of the calculation we did have a benefit for this year to get in '17 versus '16. With respect to the fourth quarter specifically, there was a little bit of an over accrual in the third quarter that will adjust in the fourth quarter. So, if you put the third fourth quarter and split the difference that will be the run rate.

Our next question comes from Russell Gunther with D.A. Davidson. Please go ahead.

I just want to follow up on the margin commentary earlier. I think the expectation you laid out was for a flattish margin going forward. Should we think about that off of the 342 results this quarter or the full year '17 margin?

I think of that of the 342.

And then what does that assume for purchase accounting impact for 2018 as we layer on the Sun. Obviously that will be still to be finalized I would imagine and volatile. But just kind of what's embedded in that stable 342 from a purchase accounting. And if you could just comment on rate outlooks in there as well?

Sure, there is a couple of questions there. I'll take a few and Mike may jump in as well. So, the first thing is obviously when we closed Sun for the purchase accounting exercise which had to be done at the time of closing. We don't expect to see big changes from our merger model done last year. We think we were -- both companies had a relatively balanced interest rate risk positions. So acceptable yields are not going to be a giant number. And I would point out if you look at Sun's progress through their third quarter earnings release, they made significant progress in building their margins. So, the margins of both companies are pretty close on top of each other. You're not going to see a dramatic change in margin, there will be a little bit of purchase accounting impact from Sun. And then we'll have obviously the purchase accounting from the prior transactions rolls off a little bit each quarter. As we think about margin going forward, if you take that kind of 342 and say that I don't know if you can see that moved dramatically in either direction you may see it up couple of basis points to down a couple of basis points. And there is a variety of headwinds and tailwinds. You got the headwind from purchase accounting; tailwind prime went up in December and we'll get some impact from that in the first quarter. So, I think we're going to have a relatively stable margin. So hopefully that helps. Mike anything you add to it.

Yeah when we say the margin looks like it got to be stable going into the first quarter, we're just talking about the OceanFirst margin, not necessarily rolling in Sun that purchase accounting adjustments that we're working on those now, but they're adds up the closing date. And we certainly after the closing dates, so that was have to be impacted. As Chris said, there is a little bit of headwind with respect to the core purchase accounting for OceanFirst. In the fourth quarter there was 2 basis points of purchase accounting benefits from own debt that we sold and we accelerated the accretion to that was 2 basis points of benefit. Then the cotenant recurring purchase account went down modestly every quarter. So, it's about 2 basis points of headwinds, then it's overall 4 basis points of OceanFirst purchase accounting headwind, and that'll be offset by what was probably done with Sun but to offset that on the core OceanFirst book we've a rotation, added cash and into loans and half of it at the end of the fourth quarter that'll probably add four or five days of point to the margin. We also have the increase in the prime rate in December that's 25 basis points, $340 million of loans that repriced, so that benefit would be about 2 basis points in the first quarter, we also have cash and securities that will modestly reprice up, that's already repriced up because that's the yield on those portfolios was higher at the end of the year than it was on average for the quarter, so that's another basis points of incremental yield, so when you put that all together it looks like kind of an offset -- basically positives and negatives offset each other.

And then just last follow-up on that line of question just what your assumption is for incremental rate hikes for '18?

Look if we know for sure we could probably make heck lot more money than running to the bank, but the assumption we use is we take the forward curve, so we use the market assumption about where just rates are going, that's rebuilt into our budget, but I think from the philosophy standpoint we've been trying to run the company in a very balanced interest rate risk position. So, if the fed were to increase a little faster or a little slower, I don't think that has a big impact on our margins or the way the year looks. That said, depending on what the environment turns into and to be more concerned about the slope of the curve the number of fed increases, there could certainly be more favorable and less favorable slopes going into the year. We've the additional capital, one of reasons we're deferring the dividend decision is to look at what economic conditions are, it looks like there're very good conditions to grow a little faster, we want to have the capital inside the company to do that, but we're going to watch those conditions in the first and second quarter, understand what the slope of the curve looks like, what economic conditions look like, how much capital we want to reserve for organic growth and make that dividend decision in the second half of the year.

And then you guys have done an excellent job managing that core expense number down, obviously we'll get a bunch of noise with the Sun integration beginning next quarter but that 26.4 million for 4Q, how much do you expect sort of the legacy OceanFirst expenses to trend?

There're certainly going to trend up, and for a couple of reasons, I mean the main reasons we've mentioned earlier in the call we've got the $15 million an hour wage, plus we've got the ESOP expenses and other equity expenses, so that's heading up, but being offset by the lower tax rate, so there's -- going to be give or take there, so I think you're going to see that come up, it's going to be a significant number but our overall profitability targets would be well in line. I hesitate to give you a specific number and then the other thing is that we're going to have as you point out the noise of adding the Sun expenses in and then the Sun expenses coming in will only be in for two of the three months, so I'd rather give you a better run rate after we complete the first quarter.

And maybe perhaps just if you were to isolate for the minimum wage increase, right, how would you expect the OceanFirst to churn?

So, the total expense for the minimum wage increase which includes -- it's like it's going to include the Sun employees is they're going to come to $15 an hour when we close, or minimum $15 an hour is about $613 on annualized basis but then there is some other cost to come into that. I think when you look at all of our initiatives, you talked a little bit more that couple of million dollars a year in incremental compensation expense for all three of the initiatives we talked about.

Okay.

The other way to look at that Chris commented earlier, 90% of the tax benefit we expect to include the shareholders, but we did with 10% for other items that you can look at that as a starting point in terms of building up that 10% goes into compensation that’s the minimum way that the EOSP increase, but if you kind of look as kind of a starting point.

Yeah, very good. Thank you, Mike. And then just lastly guys you mentioned as part of the stock-based comp that they are going to be performance based around certain profitability hurdles I believe ROA was the target. Could you be able to share what your ROA target is?

I don’t want to get into the specific numbers because it’s a full plan, it has bunch of different targets on it for different situations over the next couple of years. We’ll be disclosing those targets in our next proxy so you will be able to look through the plans and all that but to give you comfort though I can say that in order to achieve full vesting on those we got to meet our strategic objectives that we’ve laid out. So, its ROA based. We talked before about where we target the company to be and in order to get the best performance out of those grants we are going to have to meet and actually exceed all those ROA targets.

Our next question comes from David Bishop with FIG Partners. Please go ahead.

Chris, I know heading into the past version, you might have kind of little bit more liquidity on balance sheet and then obviously you had good deposit retention here. Did any that plan the fourth quarter excess liquidity that may have impacted the margin as well and any more cash or securities setting on balance sheet and might be usual on sort of a leverage basis?

Sure. So, you caught the tail two parts of the quarter. So earlier in the quarter, we had more cash than we felt we needed by the end of the quarter we felt comfortable of where we were, but it didn’t really have the chance -- now with the December closing some of the closing late in December. So, you had very little impact on the net interest margin. To your broader comment, so it was the first got a low 90% loan deposit ratio as Sun at their last reporting, there was plenty of cash available to us and depending on a condition that this we’re getting a little being careful to watch what happens in the coming months. We might choose to maybe hold the line tougher on deposit pricing and allow some of that cash to help us preserve margins or if we think that the loans markets are favorable, we might choose to grow a little faster and deploy that cash out in loan. So, we’re weighing all that, we’re looking at what loan demand would be like post the tax changes so we wanted heavy optionality to either lend a little faster or use the excess cash to protect deposit cost of margin.

In terms of deposit cost are there anything changing into quarter from a competitive standpoint that we had to become more defensive to sort of retained deposit, just curious what maybe in the current quarter-over-quarter in terms of interest bearing deposit cost?

No. We do have the portion of the deposits in interest bearing checking relate to institutional deposits that are a bunch of municipal there and they could be school district and things like that. They have a base rate and we rated that base rate in the end of the third quarter I think it was in September so we had a full quarter impact in the fourth quarter. We don’t anticipate raising that base rate in the foreseeable future but we are going to watch things and see what competitors do. We don’t feel lot of pricing pressure around deposits but that can change in a moment's notice so. As of now I wouldn’t expect much move in between the fourth quarter and the first quarter but we're going to react to our market conditions.

I think conversely, I think I know it was last quarter two quarters ago you sort of noted that some of the larger banks and special integrator really got more something that some of the phenomena maintained into the fourth quarter of 2018?

We are certainly seeing it in segments, so I think the only thing everyone saw I think most everyone was obviously CD pricing moved first. The second thing that moved pretty sharply was these promotionally priced money markets and those appear to still be under a fair amount of pressure we have not seen a lot of pressure beyond that. so, kind of ordinary course savings and money market accounts we are not seeing a pressure today. that could change but for now it's limited to the CD portfolio which is not a big segment for us and the promotional money market rates which has never been a big market for us. We are not very active in it.

How about on the loan side that are house?

Well I think when we saw I think was in 2017 was a great year to be a borrower and I think when we see late in the year as longer-term rates have trickled up just a bit that we've nothing able to test a lot of that along to the borrowers just competition. The good news is we're still getting the spread that we've like but that spread is not always optimum. that's just a nature of the piece of the stage of the economic cycle.

One more housekeeping question. as the narrative notes the rental income from the former tenant on the headquarters there, is there a thought that how to redeploy that, will that be we would be running out some of that space to sort of offset once they leave?

We are assuming this space isn’t going to lend itself of that and we are going to use the majority of it anyway so that'll be forgone and it won't be replaced, although over the next couple of quarters we have other real-estate moves we are making, there are other facilities we are consolidating other things we will exit. so, there will be an initial drag and then I think you'll see that drag offset first by other real-estate moves as we exit other facilities and then second, once everything settles down as Joe mentioned in the -- we have not projected any incremental operating efficiencies from having people under the same roofs. So intellectually we know that is going to be the small efficiency and we don’t have a number for it so we want to get everybody kind of moved into the new places and then when departments are sitting next to each other instead of an hour away from each other we can look at staffing levels again so I think you are going to see this initial headwind. it will decrease the first time as we consolidate some of the other locations and then as we go into 2019 that will be an opportunity for us to really benchmark processes, procedures, workloads and trying to get a little more efficiency out of things.

Our next question comes from Matthew Breece with Piper Jaffaray.

Just maybe to start obviously there was good loan growth at the end of the year. it was softer getting up until the fourth quarter. I guess it's a long-winded way of asking just what is your growth outlook for 2018 just on an organic basis?

So, I think a couple of times over the last few quarters, we've kind of reiterated that we think that we should be able to grow somewhere in the range of $50 million or more each quarter. But there has been noise in that not because of originations but more because of prepayment levels. So, as we went through 2017, the originations they were high in the fourth quarter but they were pretty consistent all year along. It was the pace of prepays that dampened the growth. So, I think whereas Joe said earlier, we're largely through the credits that were coming up renewal, where we had less of an appetite. So, I think we're feeling more comfortable that $50 million a quarter target should be achievable and then maybe quarters we do better then.

And how would you break that down between your resi portfolio CRE and C&I?

So, it's a bit opportunistic, depends on what's in the market in that quarter. But we like a blend. So, one of the reasons I think that we've been able to manage our investor CRE percentage which is obviously something everyone closely watches, is because we've got a balance sheet that has different parts to. So, our focus is commercial, we like the majority of the growth to be on commercial. But we like the risk managed aspects of having a significant residential portfolio especially if you know if you think about 2020 or 2021 is there a possibility to credit event. You've got portfolios that will be non-correlated. So, I think commercials are focused, we like to see that grow the fastest. But we're welcoming some growth in residential, because I think it's an important leg of the stool. And then in that, the best growth we can have is obviously C&I and older occupied CRE. And our older occupied CREs is underwritten in price just like C&I. So, it's got the same performance attributes bringing deposits within its relationship price and all that. So obviously I like to see very strong growth in C&I and owner occupied CRE. But we've got room in the balance sheet from more investor CRE. And we welcome the opportunity to good residential when it comes up.

Got it, okay. No, that's helpful. And maybe a bigger picture question. To date your retention after closing these, I think you said 17 branches is 97%. You're on your way to $100 million in deposits per branch. I have to imagine that retention number gives you enormous confidence in being able to do these kinds of strategic initiatives. And do you think that beyond this next slate of branch closures that we could see that $100 million become something higher? And then as you push the reform the dots on the map, perhaps something to 125. I mean could you frame that for us?

Sure. I think you're absolutely right. So, there is two things going on here. Obviously, the acquisitions gave us a lot of branches that are close to each other. So those are relatively low hanging fruit. But beyond then, it's something at least internally we've been devoting the time and energy to because we want to be good at this. We want to understand how to make the right decisions about which branches are important to people or which branches are not so important. So, each time we go through this we refine our model w capture additional data points and we look at the performance of variety of factors. That's I think giving us the institutional confidence to continue to right size the branch network. to match our customers' needs. So independent of our acquisitions you've got this long-term issue of people needing access, or less frequent access to their local branch, so essentially the branch trading area is getting larger. Joe shared with you some of the radius numbers, and what we found is that the consolidations under five miles are very low risk, as long as you're careful to make sure you're engaging with your customers and your employees and handling the systems right. Look, our deposit market is largely suburban, so if you're going to go to the bank, that means you're getting in a car, so if your trip to the bank is an extra half a mile or mile and a half that’s no big deal. So, it's a thing we're getting good at, I think we're holding our skills at, and I think it's something as a sector and an industry, everyone is going to be faced with this. So, I would not rule out additional consolidations going into 2019, I'd also say that we've thought about relocations, because some cases you've branches you've opened 20 years ago that were in the right location 20 years ago and not in the right location today, so you might do a combination of consolidation, and moving a branch. But it's a big process, there's disposal, properties, there's renegotiations, leases, there's something that we want to be institutionally confident at. I think we're doing that, and I think we're showing that through the numbers. In terms of your target, there is a target north of a 100 million probably, I don't know that I have enough information to put a number to it today, but I think over the next five and 10 years if you're not making these changes, I don't know how you're going to be able to handle the operating expense you need to cover things like cyber security and regulatory compliance and those kinds of things.

Two other ones, one being discussed today is part of legislation proposal for like a New Jersey state bank that would collect municipal deposits and so want to get your thoughts on that, and what is your percentage of deposits are tied to local municipalities?

So, it is a very complicated issue, because the state bank, obviously it's in discussion now but it doesn't really have a full form, so I'll make some general comments but I don't know what full form is actually going to come out of the legislature, so you kind of need to see the end product before you have significant comments on it. But I'll make some broader comments. the premise that we need the state bank to fill lending needs in the state and I think is a flawed premise. we have several 100 financial institutions operating in the state. there's a wide availability of credit for the people who need it and deserve it. so, I don't know that there's a giant need that is unmet. so that's the first thing I would say. but let's see what proposal comes out. In terms of competition for deposits, obviously we thought about this a lot, we do a good business in municipal deposit gathering but we also bank school districts and utility authorities and all that, I think the risk to our municipal and the institutional deposit business are going to be based on the complexion of our customers. so, we do a lot of operationally centric cash management, so things like payroll accounts, things where school districts want their teachers to be able to drive down the road and cash a cheque. in those cases, I think the services we'll delivering are not going to be attractive, services of state bank will not be as attractive because they're not underpinned with the ability to go down the street to a branch and cash a cheque. The other thing is that this is a widely diverse market today. I checked the day I think there about 109 banks that are listed by the State of New Jersey that offer municipal deposit taking today. So, we compete today with 108 other banks for these dollars. The State Bank may be another competitor, but it would be the 110th competitor. It not like we have don’t have competition today. So, in that aspect I don’t think it changes a lot. If our business was centric on high yield, CDs, those kind of things, I would probably be more concerned. So, we are not overly concerned at this point. I felt that kind of frames it. when we see the final proposal, I think we’ll be able to put more details to our thoughts about it, but we’re not overly concerned.

Okay. That’s helpful. My last one is given the changes to the ESOP, should we expect any sort of change to fairly outstanding albeit common or average diluted and to what extent?

So, when the 300,000 shares that goes into the ESOP. It is actually same way as base like repurchase. So, the ESOP trust will go out and 300,000 share that put them into trial on day one, those shares not considered outstanding. So, reduced the share by getting little bit as they get allocated to employees each year and get allocated to the retirement calculate, considered outstanding in employees and share, etc. So, the initial transaction will reduce shares outstanding.

Got it. And when you expect that to recur like the first quarter event or already been done?

That has already been done first quarter event.

[Operator Instructions] Our next question comes from Collin Gilbert with KBW. Please go ahead.

If I could Mike just to clarify your comments on the NIM if I heard you correctly it sounded like in terms of NIM headwinds there was going to be in this from 4-Q to 1-Q but two basis points it sounded like I think you said due to accretion and then was it another two basis points of funding cost pressure?

It’s on the purchase accounting it’s a total four. There were two basis points that were included in the fourth quarter for where we saw some loan then we accelerated the recognition of some credit marks. So that was the two basis points benefit in the fourth quarter that will go away in the first quarter unless we have the same kind of activity. And then regarding the core purchase accounting trends down overtime so that’s another two basis points going down. So, it’s down little bit more from fourth quarter to first quarter as compared to the second, third and fourth quarter so that will be the other two basis points. So, in terms of purchase accounting altogether is four basis points of kind of headwind there.

Okay. And then in addition to the purchase accounting what were other margin headwinds you are assuming?

The other margin headwind would be deposits. We are not sure how that would reprice but in the fourth quarter there was a three basis points of increase in deposits. So, if you add that as the headwind with the purchase accounting that’s about seven, but we think that offset by the change in the asset mix, the prime weight increase and the security repricing upwards that I mentioned earlier.

Got it. Okay. That’s helpful. And then Chris you've given some color on your sort of outlook for loan growth and what you are hoping to see there what about just in terms of cash and security. it sounded like you may have said that the liquidity position at the end of the fourth quarter you were sort of comfortable with but then as you fold-in obviously additional liquidity with Sun how are you thinking about the kind of the balance of securities and cash you want to hold?

I think that strategically objective it's a many good loans as we can and then what's ever left that goes into the securities book. so ideally, we've like to see that securities book run down and allocate more to loans but as we know as we mentioned earlier some of the loan growth is muted in 2017 because of pay-offs so we don’t necessarily target a securities cash position. it's really kind of the dependent on loan and deposit growth and we would obviously prefer slow loan growth and a lower securities book.

Okay, all right so tying that to Chris comment about you guys are going to be thinking sort of little bit more broadly little bit more strategically on what you do with the liquidity maybe some loan purchasing or just your deposit pricing is there a period in time is there a metric is there some sort of catalyst that will cause you to make that decision sooner rather than later on how you are thinking about the balance sheet overall?

Sure. So, because the two factors we would be looking at one external and one internal. The external factor would be watching the slope of the curve. most of the commercial lending we do has got a high correlation to the five years. so, looking at where that moves and whether those are translating into improved yields is the external metrics that we would look at most closely to say this is something where we think we should be little more aggressive in terms of growing the loan book. The internal measure around cash and the whole liquidity question only relates to the Sun integration. So, I'll start by saying we have a high degree of confidence to better our ability to consolidate branches and retain deposits. We also have a high degree of confidence in the Sun deposit base because I think Sun has done a great of job of managing that well over the last several years. So, they decreased the deposit base, gotten rid of the sensitive money and if you look at their deposit costs if they are kind of create it I would say it's the high-quality deposit base. So, I don’t think that the Sun deposit base is highly acceptable and I think we are very good about integration. With all that said until the integration is complete and until the customer is getting OceanFirst statement and until we know how folks are reacting to things we are going to be able to conservative. So, we will probably run with a little heavy, we well probably consider our liquidity within extra dose of caution until the Sun integration is complete so that it would be done in June and we will be watching deposit balances in July and August. so, in the I guess the best outcome if we see some steepness to the curve, if five year moves up it starts to translate into yield in the markets and we feel very good about our progress points and deposits. I think you would see us grow more quickly in the second half of the year, push that loan to deposit ratio up and take advantage of the situation. And I guess the bare scenario would be that for whatever reason the five years does not move or moves in the wrong direction and we evidenced any concern in the way how deposits are flowing as part of the Sun transaction we would be more conservative.

Okay that's very helpful. Mike just want to hop back to you. On the margin just two things, is there an FTE adjustment that we should be thinking about on the NIM for the first quarter?

Yeah, we don't reported the tax event by that. So, what you see in press release you don't have to adjust that.

Okay. And then any change in the day count does day count in the first quarter affect your margin much?

We do day count. So, fourth quarter was 92 days and first quarter days will be a little less. So, you have to adjust for day count.

Okay, alright. And then just finally back to you Chris. So, you had mentioned you guys are committed to the profitability targets you've led out in the past ROA targets. Can you just update us on those? And I guess I'm asking, because obviously the tailwind of the tax bill right sort of -- I don’t want to say artificially inflate your earnings. But what are inflation rates with respect to ROA? So, are you adjusting your ROA targets accordingly, or how should we think about those you achieving those targets and what are those targets?

Absolutely it's a great question. So, the message I would send is that we had strong ROA targets given the Sun acquisition we expected by the end of the year. Our targets were to get to ROA of 120. And we said earlier that we won 90% of the benefit of the tax reform to go to our shareholders. So, we would adjust our ROA targets up accordingly and that's what we're looking at it. We think that the majority of the benefit of tax reform should go to our shareholders. And in the second half of the year that's tied into the question you had before about growth conditions and dividend, we don't want to be making long term dividend decision now, we want to see what the economic environment is and look at what the internal earnings generation is, and then we'll calibrate to that and make decisions about the dividend.

Okay.

But there is still question we're moving targets up to reflect approximately 90% of the tax benefit going to shareholders.

[Operator Instructions]. Our next question comes from Brian Zabora with Hovde Group. Please go ahead.

Just one question now with the change in tax laws, the tax cuts. Do this impact how much DTA or the valuation recapture that could be with the Sun transaction. Is it any different than what you initially thought?

Okay. So, I guess it does affected although not directly. Obviously, Sun will have to right down their DTA as of 12-31 which they've done. And the impacts you'll see is actually in purchase accounting. So, they'll affect the goodwill number that we wind up putting through purchase accounting. Now we anticipated when we announced the Sun acquisition, we actually modeled a more advantageous interest rate, I'm sorry, tax rate scenario which could have gone down as well as 15% at the time. At that time, we announced the merger, we explained that we thought the DTA right down would be in the range could be as high as $40 million and that we would recapture that over about 4 years. And that really has these numbers will change a little bit, but the recapture rate is about the same and the total number is about the same. So, the way we look at it we rather have the earnings stream than the book value. But it's working as we thought it might when we model the Sun transaction last year.

This concludes our question-and-answer-session. I'd like to turn the conference back over to Chris Maher for any closing remarks.

Thank you. I'd like to thank everyone for their participation on the call this morning. We look forward to providing additional update as year progresses. Thank you. Good bye.

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