OceanFirst Financial Corp. (OCFC) Q1 2018 Earnings Report, Transcript and Summary

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

Great. 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, Chief Executive Officer Christopher Maher.

Thank you, Jill and good morning to all who have been able to join our first quarter 2018 earnings conference call today. This morning, I'm joined by our Chief Financial Officer, Mike 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 then 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 first quarter, diluted earnings per share were $0.12. Quarterly reported earnings were impacted by merger related expenses and branch consolidation charges, net of tax benefit, that totaled $14.6 million or $0.33 per share. Excluding those amounts would result in core earnings per share of $0.45. Regarding capital management for the quarter, the board declared a cash dividend of $0.15, company’s 85th consecutive quarterly cash dividend. The $0.15 dividend represents a 33% payout of core earnings, which continues to be at the low end of our historical payout range. We expect to refresh our capital management strategies in second half of the year. At that time, we will consider this strategic landscape and we will evaluate our approach to dividends. No share repurchases remained during the quarter, leaving 1.8 million shares available to repurchase. On the governance side, we continue to progress through the board renewal process I discussed in our last earnings call. As part of that process, Director Don McLaughlin who has served our company with distinction for 33 has announced his retirement from the board, effective at our annual shareholder meeting. In addition, the board has determined that declassifying our board would provide for a critical evaluation of the entire board each year. We think the declassification is a best practice as governance change and one we are asking shareholders to approve this year. Additional details on our board renewal process are available in our proxy, but the theme is that we're taking action to ensure the board structure and composition provide strong governance at a time when the company is growing quickly, and becoming increasingly complex. Operating results were slightly ahead of our expectations as margin expansion fuelled enough earnings growth to boost the core return on assets to 1.19% and core return on tangible common equity to just over 14%. While purchase accounting accretion associated with the Sun acquisition provided a significant impact, excluding that impact, earning asset yield advance by 15 basis points and deposit costs rose by just a single basis point. The improvement in asset yields was related to the recent interest rate increases and improved asset mix and the addition of the Sun portfolio, which carried a slightly higher loan yield. In addition, the expense reductions we expect to realize, as we integrate the Sun franchise over the next 90 days will provide for a substantial reduction in operating expenses, which Iantosca will provide more detail regarding that integration timeline and the expense impact in his discussion. Net loan growth disappointed largely as a result of weak loan originations during the quarter. Our price discipline directly impacted production, but we are committed to protecting our net interest margin, but we simply will not put on loan growth that deteriorates our overall profitability in the short term and increases interest rate risk in the long term. We’re encouraged that after a very slow January and February, loan pipelines are picking up and our pricing discipline seems to be paying off, as both the total loan pipeline and the weighted average rates are the highest we've seen in years. Loan growth may continue to be choppy, as the Fed continues to tighten monetary policy and the market reaction is anything we gear for. Mr. Lebel will provide more color regarding our loan and deposit outlook in his comments. Before I turn the call over, I’d like to reiterate our strategic priorities. We continue to focus on a few critical items. First of course is the Sun acquisition, which is exceeding our expectations thus far. The business continues to improve, right up for the closing date and our first quarter results indicate, has boosted our net interest margin and operating profitability even before the application of purchase accounting. Purchase accounting marks are always subject to some variability, but in the Sun transaction, the final goodwill allocation was very much in line with our original projections. Virtually, all the net variance in goodwill was attributable to the impact of the tax reform and even that impact was in line with our due diligence estimates, which were disclosed when the transaction was announced. [indiscernible] purchase accounting marks did vary materially, but the variance was entirely driven by external market factors. Core business at Sun is performing better than expected. Interest rate movements since due diligence last June had a measurable impact. In our view, the credit cycle caused us to be more conservative regarding the credit market. Those differences largely offset each other and to be expected in the period between diligence and closing. Importantly, there has been no change in our expectation for a rational earn back period. Beyond the financials, we’re thrilled with the talent that joined us from Sun at all levels and the teams are really beginning to come together. Our second priority is the consolidation of staff currently working at 19 different operations offices into two primary and large scale locations that will support continued growth for years to come. The cultural transformation of our workforce is one of our most critical projects this year, as we position the company for the future. Joe Iantosca will walk you through the details of that project where we expect it to be complete in mid-summer. Finally, the foundation of our business is organic growth of community bank relationships. We continue to attract highly professional commercial lenders and are now making inroads in other areas as well. As we reach the critical mass in our markets, our competitive postures improve and pipelines are building. We remain highly focused in the geography where we are meaningful part of the community. I’ll now turn the call over to Joe Lebel.

Thanks, Chris. I'll start with the net interest margin, which increased from 3.42% to 3.70% quarter to quarter, largely due to improving asset yields, stable funding and purchase accounting accretion from the Sun acquisition. We expect the core NIM to remain stable throughout 2018 with the possibility that net loan growth could offset modest reductions of purchase accounting accretion. Turning to deposit trends, we saw our typical seasonality in the first quarter with deposits down by 52 million due to the normal seasonal runoff in our government business, which decreased 49 million. We expect the government deposits to swing positive this quarter. Although our business is far less seasonal than it once was, our deposit levels tend to peak in the third quarter each year. Importantly, Sun deposits were largely flat for February and March and we continue to grow core business and retail accounts. We continue to see strong retention in the acquired bank deposits with all portfolios retaining more than 90% of their respective balances since our acquisitions. This is even more impressive when you recall that we have consolidated 15 branches in the last 12 months. Just as significant, the average cost of deposits for the quarter increased only 1 basis point over the prior quarter, 33 basis points from 32 basis points, continuing as one of the best funding profiles in our markets calculated deposit beta of roughly 8% over the past year. Our loan to deposit ratio remains conservative at 92%, providing continued flexibility regarding loan and deposit pricing in 2018. First quarter loan originations of 143 million represented seasonally quiet quarter of activity, evidenced by commercial loan closings of only 59 million as we held to or disciplines in credit and pricing, foregoing loan growth to maintain our margins and credit standards. Loan closings in late December were quite high as some borrowers focused on meeting year end deadlines, which depleted the commercial pipeline heading into January. While we saw a solid volume in our residential and consumer portfolios in the first quarter, we don't expect significant growth in that space, rather anticipating originations there will offset normal amortization. The best organic growth potential remains in commercial where we continue our focus and effort. We also continue to see success with new hires, adding lenders and credit staff in the first quarter from Bank of America, TD Bank. Optimistically, loan pipelines are improving in size at yields that meet our hurdles and credit terms that meet our risk appetite. While it is too early to forecast sustainable growth, current pipelines are a very positive sign. We think the growth quarter-to-quarter may continue to be uneven for a variety of reasons previously outlined, such as credit structure and pricing pressure. However, we expect a more rational approach by competition as interest rates rise, common sense dictates passing along rising costs to borrowers, something we have seen very little of to date. We are preserving our liquidity and capitals, we assess loan betas throughout the year. A few final comments about recent hires and products. I mentioned earlier that we continue to add seasoned lenders and we’re in ongoing discussions with several additional lenders throughout our geography. We've also recently hired a new head of cash management, Jeana Piscatelli from JP Morgan Chase, continuing our focus on building deeper treasury relationships with clients. Our cash management business now approximates 2 billion in corporate and institutional deposits. The continuing focus on commercial cash management growth is the foundation of our low cost, low beta deposit strategy. We're also preparing to launch our new capability and interest rate derivative hedge products, more commonly known as interest rate swaps for qualified commercial lending clients to provide longer term fixed rate options, while helping manage our interest rate risk position and generate incremental fee income. While we expect this line of business to generate modest returns in 2018, with the third quarter entering into the market, the value of fee based revenue is a focus and necessary growth area. Providing swaps will also allow us to compete in a wider market of commercial credit transaction, including the refinance of existing commercial debt currently structured with the swap component. With that, I’ll turn the call over to Joe Iantosca.

Thanks, Joe. As Chris stated, while the Sun transaction has closed, the customer facing systems integration and branch consolidations have yet to occur. Scheduled for mid-June, these actions will be the driver of the major portion of the cost savings, which I’ll describe in a few months. Activities reintroduced to milestones are tracking well and are in line with the plan. Importantly, while the conversion is pending, staff integration is well underway and our employees are coming together and operating well as a cohesive unified team. In fact, the bank is benefited by integrating some very talented officers in various roles throughout the organization. One specific example of note is in our strong technology and cybersecurity management rights, where we created the role of Chief Information Security Officer and filled it with Brian Schaeffer, a highly qualified and credential senior officer who is the CIO at Sun. The branch consolidation project, which will occur concurrently with the systems integration [indiscernible] and will result in an average branch size of $98 million, approaching a year end 2018 target of 100 million. As a result of our investments in both the self-service technology options we offer to our customers and the personal outreach in service for our staff to those impacted by the changes, we expect minimal deposit attrition from the closures, as our experience to being on branch consolidations shows a retention rate of 97%. We previously discussed with you our efforts to consolidate administrative and operations staff into two major large scale locations, in Red Bank and [indiscernible] in New Jersey. Prior to this initiative, as a result of acquisitions, new staff were housed in 19 locations, sometimes with us always just two or three people sharing space in a branch. That's not only inefficient, it makes it very difficult to build a culture throughout the staff, especially for those newly joining the team from an acquisition. A highly distributed workforce also increases the level of operational risk for a company. This consolidation project is well underway with initial staff moves into the newly acquired Red Bank building occurring earlier this month. Renovations in Toms River are underway to build the state-of-the-art customer contact center, done with the capability to accommodate multiple communications channels in a closely integrated manner, including video, broad suite of interactive tele machines and future video based and chat technologies. The center will also support our growth initiatives related to direct banking. Importantly, this new customer contact center will enhance our service levels as we bring over 40 customer contact staff together from three different sites. We expect to have completed our facility’s realignment and have all effective staff relocated into the final offices by mid-summer. All of these activities will drive the improved expense run rate and efficiency ratio beginning in the second half of the year. Recall though that Sun is in the run rate for only two of the three months during the first quarter, so the expense level for the second quarter will peak as Sun is included with an inclined period and the efficiency gain in the systems integration and branch consolidations have come to fruition. We expect to see operating expenses in the second quarter, net of one-time merger and branch consolidation charges to range between $42.5 million and $43.5 million. As the staff reductions, systems integration and branch consolidations begin to positively impact the run rate, we expect third quarter expenses to range between 38.5 million and 39.5 million. Also as we continue to dispose of surplus properties in to the consolidated back office operations throughout the second half of the year, we anticipate additional decreases in operating expenses during the fourth quarter. I’ll now turn the call back to Chris for questions and answers.

Thanks, Joe. At this point, we’d be pleased to take a few questions.

[Operator Instructions] First question today comes from Frank Schiraldi with Sandler O'Neill.

I just want to start with the deposit costs, up just 1 basis point linked quarter, seem pretty remarkable given what we've seen elsewhere. Just wondering if you could share, is there any sort of purchase accounting adjustment with the Sun deal that might have benefited that number. And if so, if you had an estimate or an idea of what a legacy Ocean cost of deposits, the increase look like linked quarter?

Yes. Frank, it’s Mike. So I think the components of that, the legacy OceanFirst deposits are up 3 basis points. The Sun deposits were slightly higher than ours, but not by much, so that is, when we merged those and that was an extra one, but that was up 4 and there was purchase accounting offset the minus 2, brought it down and then there was 1 basis point of rounding. So that’s the component to get you to the net increase of 1.

Frank, maybe just a qualitative statement about how much pressure we're seeing in deposit costs. We certainly see a lot of deposit cost pressure in categories that we're not a big competitor, and so CDs and the high yield money market. So because we don't have big portfolios of either of those products, we haven't experienced it, but we do see it in the market. Most of our focus has been against folks like Wells Fargo or Chase or BoA and if you look at the rack rates they're paying, there has not been -- they really have not moved their rates. So that’s helped us a great deal in our marketing.

And then I was surprised by the accretion, purchase accounting creation in the quarter from SNBC and I guess it makes sense if you increase the market comes alone, you have more coming back through accretion, but just kind of a two part question, wondered if you could talk Chris to the profitability picture. Is this baked in -- this sort of income stream baked into the probability profile, you've talked about reaching by year end or is it additive to that? And then secondly if you guys can just talk a little bit about the scheduled accretion income that you have running through the NIM for the remainder of the year.

So it sounds like a couple of comments. I will turn to Mike if he can give you the schedule for what we think accretion will look like for the rest of the year. It was a little higher than we thought, but it's directly related to the fact that the credit market is a little bit higher and I’ll just talk a minute about the credit market. The loan portfolio at Sun is exceptionally clean and there is no deterioration in the loans, but it is the portfolio that has a number of larger loans to it, so it tends to have higher dollar loans than we’ve historically done and it's the -- this market is the life of the loan market, you're looking out over six or seven years, so when we look at the market diligence last year, just kind of roll back the clock, we were not even -- and I will tell you that I was probably pessimistic about the prospects for tax reform and all that. So I saw a slower growing economy with less of a risk of having a setback in the next few years. I think the device is a little different now. The economy's growing a little more quickly and I think there is more discussion that, maybe it's probably not going to be in the next year or two, but we might have a little bit of a credit event in two or three years, which would be outside your allowance, the typical allowance window or within your life of the loan, more of a season kind of a look like even purchase accounting. So as we thought through all that, we said we’d better off to buy us into a little bit of a larger market. If credit performs well and that market is just going to come back to us in earnings and just one thing offsets the other. So, we thought it was prudent to do that. In terms of is it baked in the run rate, I would say that as we look at margin going forward, I think Joe Lebel will cover this well. Take the 370 and we know that we're going to have a couple of basis points of accretion run off each quarter as we move forward. So the question is, will our loan origination be strong enough to offset that and keep that 370 margin where it is. That’s going to be a little bit depending on market conditions. I think the core margin, we know what's repricing, we know what -- we think we can do over the course of the year. If the loan portfolio is relatively flattish or very low growth, I think you are going to start to see that margin come off a couple of basis points a quarter each quarter. If we can get loan growth, which we have done in the past, as loan growth and mix change gives you enough positive benefit in the margin so you can offset the runoff on purchase accounting. Mike, just to give a sense of where we think the purchase accounting accretion.

Frank, to your second point, the second quarter purchase accounting accretion will move over that $500,000 because we only have the impact of Sun for two months. The plus 500 of that in the second quarter and then it starts trending down. It would be about 400,000 reduction in the third quarter and a 500,000 reduction in the fourth quarter.

And what is -- is there a state, I can recall this, I know prior to tax change, there was stated possibility goals and I think you've talked about getting somewhere by the end of 2018. Is that something that you guys are comfortable talking about from an ROA standpoint?

We’ve circled an ROA in the 130 range and we circled the efficiency ratio probably approaching, but not -- it won’t get as far as 50%. Those would be run rates by the fourth quarter. So that's what we think we're capable of doing with the franchise. It will be dependent upon, let’s see what interest rates do and let’s see how the loan markets react. We do have -- we've got plenty of liquidity, plenty of capital. One thing we didn't talk about is a tangible common equity is well over 9% now. So, we're about at 9 to 11. So we have the ability to put on additional growth, with the earnings stream that we expect, we’ve got optionality around the dividend. So I think if the market's good, if loan pricing comes up, we'll grow more quickly and we can outperform, but at this point, we are a little bit cautionary about what the loan market would be for the rest of the year.

Next question today comes from David Bishop with FIG Partners.

Chris, a question in terms of the market and pricing and such, you guys are being cautious in terms of your loan portfolio. Just curious how far away are we talking about in terms of the pricing dynamics out there? Are we talking a quarter basis point, 50 bps, just curious how far I guess the pricing environment is sort of versus your internal ROA targets?

It's not terribly off, it's probably in that 25 basis point range, but we have selected experiences that are kind of shocking. Actually, Joe, you may want to share, in the first quarter, when the loans, we like, but pricing just completely failed.

Yeah. I would -- as a good example for you Dave, we had an $18 million transaction for a single tenant property that we liked a lot that we were outbid by a fairly wide margin by a competitor that locked the rate in a plain vanilla fixed forward for 120 days and if you fast forwarded the math on the Treasury, they’ve had their property margin cut in half by locking that rate for that period of time. So it's just not sustainable like on a market that's just going to be an impediment, they're going to be stuck with that loan for 7 years.

What would be the yield on that?

A quarter, 125 over the threshold. That’s quite a tenant like rates for someone who's not a credit seller.

So those are the kind of things we're seeing in the market that credit structure was terrific, but we're not going to, that’s an iffy proposition today and you hold that over the next seven years, that could be very painful transaction for them.

And then I know last quarter, and realized there could be choppiness. I was thinking about 50 million loan growth per quarter, is that still sort of the thinking as you move forward into the second half of 2018?

Based on where our pipeline is, things will be encouraging for the second quarter, but I would take it quarter by quarter as we see – we’re kind of describing the market is a little bit like a rubber band. Scheduled rates up, loans rates really haven’t moved, almost no beta. It’s got to kind of snap itself up a little bit. Depending on when that happens, I think we have more consistent loan growth. We're kind of picking through transaction now and being selective. So second quarter looks good and we’ll give you more guidance at the end of that quarter and probably we think the third quarter.

And then back to the expense outlook here, I think a little bit about what we had expected and I guess the street on a core basis, anything jump out from an outsized hirings or compensation perspective that drove the increase this quarter and how should we think about core expenses in the second quarter.

We gave you a little bit of information on the second quarter. When you look at the first quarter, we noticed some things in buildings with snow clearing, but on the compensation line, we’ve always been very conservative and regulatory aware. So we've made some changes, both short term and long term in hiring and consultant use, but things around BSA and cyber security. So our feelings is that we can be preventative in that, in the long run, it’s a much less expensive option for us when should we have a problem.

There's no question that as the year progresses, we have the known expense reductions in the branch consolidations and systems and then we really don't have a number today for you and the efficiency improvements we'll get of being in the two centers. So we get towards the end of the year, we're going to be tuning those processes now with the right people in the right places and we'll have a little more work to do there, but I think the efficiency ratio is the best way to guide it, which would be approaching 50 by the fourth quarter.

Dave, just a little more color on this, some of these costs we highlighted for you in the January call, but we had increase in our minimum wage to $15. We increased our, because our employee base is so much larger now, we increased some stock award with the performance testing, so those went into the run rate. We also had annual merit increases in the beginning of the year and as Joe just indicated, we had some new hires in our risk and IT areas. So that explains some of the salary lines and then snow removal cost was $400,000 in the first quarter, so it’s not likely to repeat in the second quarter. That gives you a little more color.

And what was the guidance for the third and fourth quarter, it was like between 8.5 million and 29 million. Sorry.

42.5 to 43.5 for the second and 38.5 to 39.5 for the third.

I’m sorry. Can you repeat that again?

42.5 to 43.5 for Q2 and 38.5 to 39.5 for Q3.

The next question comes from [indiscernible].

Nice performance for the quarter, really nice. Have you thought strategically a couple of years ahead when sort of the market gets pretty tight? I was looking at your profile of your location and thinking about the 9 million people in New Jersey, a few million of those people go to St. Peter Sarasota or Tampa or somewhere. Just having an outpost or a defensive proposition so that when they want to do banking for three or four months out of the year that they come back home to Ocean, so they don't -- you don't have the results or the risk of having a change in affiliation as you're migrating patterns sort of have more of a semi-permanent home in the south or the southeast and especially in Florida. Have you thought about at least having some kind of outpost that basically protects your deposit base and ensures that you're going to be competitive, so the money doesn't flow from the north to the south?

Sure. So, there's certainly migration patterns that happened from the northeast down to the southeast and I would say this in today's stated technology, we absolutely need to follow our customers wherever they go and what we found is that the better we can service them, which is typically as much defined by how you handle them on the phone or through online banking or their mobile device, the better you service in that way, the less likely you are to lose them, even when they move to faraway places. So the biggest investment we're making right now that serves a lot of purposes is our build out of the direct bank operation, which is really to have us be best in class and interestingly two of our locations where we’ve put video terminals in place, interactive video terminals, these are essentially tower stations that can be handled even without a card. Two of those redundant retirement communities in New Jersey and the adoption rates have been great, customers have received them really well. So I think you've got a great point that following our customers would be an important thing to do. I think for now, we're going to follow them with technology. I think for us to take on a much bigger geography would be too far for us to go today.

Thank you. And my only thought was that, you're absolutely right, it but it may take you a couple of years to sort of figure out how you don't lose money and you protect your backside, but following those customers is central because eventually you're just going to see that big flow down to those non income tax states with almost 30 million people in Florida that just draw us from the Northeast and I mean Michigan's an example, they lost 1 million people in the last decade, like a big vacuum. So I think strategically, you just have to think about that. That’s all I am saying. Thank you.

Next question today comes from Russell Gunther with Davidson.

I just wanted to circle back to the pipeline. Appreciate the comments there. Wondering if you could give us a little color on how the legacy Sun footprint is contributing.

It's contributing fine actually. Their pipeline has been fairly consistent since we on boarded them in February. So I don't see any regions that I think that's going to change. About a third of the commercial originations in the first quarter were derived from the Sun teams. That’s a great contribution. And I think, you'll see many of these processes, as they integrated, they really kind of get used to reach other and how do I get this done and who do I call and I think we're getting all that behind.

That's great. I appreciate the color there. And then just last question, I wanted to circle back to expenses briefly. Is it fair to say that there were zero cost saves recognized this quarter? You guys gave some nice color on where those expenses are headed on a quarterly basis. So by the end of the year, does that sort of translate to a 100% recognition of the identified saves?

By the end of the year, it will be 100% of recognition and we’ll be north of 90% by Q3. So almost all of it's done by Q3. And then there were some expenses that come out of the first quarter. So there were kind of – when you immediately closed the transaction, there are – the board goes away so your board expenses go down. Some of your restructuring insurance, you restructure some things you don't need. So it wasn't a giant number, but we took some expenses out immediately at closing. When we took other expenses out, but it wasn't a big percentage of the number. Most of it would be taken out in the second quarter, but you won't see it in to the third quarter. The conversion is and branch consolidation will happen in June and then for a couple of weeks after that, you want to make sure that you keep a lot of excess staff around the case people have questions and all that.

[Operator Instructions] And our next question comes from Collyn Gilbert with KBW.

First, I just want to get a little bit more clarity on the purchase accounting. So what was the total dollar amount of purchase accounting this quarter.

We disclosed that in the press release. It's 3,930,000. It’s on page 15 of the press release at the bottom.

And then Mike and then how that splits between Sun and then legacy acquisitions. Is that in the press release as well? I apologize?

But the Sun piece, about 2.4 million and then the legacy piece would be about 1.5 million.

Okay. And again just wanted to make sure I heard you correctly. So then in the or in the second quarter, we see that 3.93 million go up by 500,000 and then drops by 400,000 in the third quarter.

Yes.

Okay. So they work off that total dollar amount. Okay. That's helpful. And then do you have an update sort of on where your asset sensitivity stands now with Sun on the balance sheet and maybe asked differently like was for every Fed hike, how much impact are you expecting that to have on the margin?

So the asset sensitivity has not really changed much and kind of more of a core than anything else. Sun’s asset sensitivity and ours were about the same and they're about evenly balanced. So we're expecting to see, I think, the margin expansion you saw this quarter, the core margin for the purchase accounting was a little bit on the high side. We do expect pressure on deposit costs. We're not sure when that's going to kind of hit us. It really hasn't hit us hard yet. So I’m just being a little bit cautious. It might get another quarter or two where there are additional Fed hikes where the asset yields will come up, deposits may hold down to two, three, four basis point decrease. So we don't feel a lot of the deposit pressure now, but I would just expect we need to be careful. So Mike, do you have any numbers you want to share.

Yeah. Collyn, when we disclose our interest rate risk position in the 10-K, if you look at our GAAP ratio, it’s 4.6% positive. So asset sensitive based on that. If you look at our simulation, if rates go up 200, our net interest income goes down 1%. So very modest decline, if you look out over the first year with a 200 basis point increase. So pretty neutral.

Okay. That’s helpful. And then do you have what percent or what amount of the new expense run rate I think to kind of, to Dave’s point, your expenses are running higher than what I think most of us were anticipating, the core expenses. How much of that could be attributable to the new Red Bank location?

Yeah. Well, actually if you look quarter to quarter, you didn’t see the increase because we closed down that November 1. So we had two months, November, December in the fourth quarter and then we had well three months this quarter. So it didn’t have a big impact if you look quarter to quarter, but on an absolute basis, there is going to be 500,000 a quarter to operate depreciation, taxes and utilities.

And our next question today comes from Matthew Breese with Piper Jaffray.

I have to try for on the expense stuff. So I really appreciate the detail for 2Q and 3Q and I just want to try to better understand the rollover from 3Q to 4Q. And so, you mentioned we’ll go from 38 to 39 in 3Q to something lower. There's additional save and I just want to get a sense for if that additional saves number sounds like 1 million or 2 or are we talking in the hundreds of thousands at that point?

It's a seven figure number, but don't get too excited. Hopefully that gives you some sense. It's not going to be a couple of hundred thousand. We think there is at least, we have well more than $1 million to take out in that last quarter. It's just a little bit early for us to tune things out and Joe made a really important point, in our business, especially in the last few years, any mistake you make can magnify, especially in the compliance side, have a magnified impact down the road. So we're trying to do everything we can to protect our regulatory compliance. So we're just wired if there's an issue that we feel we need to address, we try and jump on it and spend, so that we don't give you a bad surprise down the road. So I think that some of what you're experiencing in the first quarter, we've had a lot of moving pieces and parts, we've got a lot of people moving around, we've chosen to keep duplicate staff in different places and we've made a series of small decisions, the right decisions in the long term that keep expenses a little higher. So I think the fourth quarter you can see it notch down. I wouldn't be surprised if we continue to tune after that.

Understood. Okay. And then I understand the choppiness and the uncertainty on the loan outlook. You do have excess capital, understand you have some options with that. But just wanted to get a good sense of what you think about the securities portfolio and whether or not that might be a lever you can pull in the interim.

It's probably two levers that you see is pulling a little bit. The securities is one. The other one is, look, the residential business that we have is producing some nice assets now and while the commercial loan markets have had a very low beta, the residential markets are a little more rational. So that pricing has moved up. As the tenure moves, it's a much closer relationship there. So I think we're going to look in to opportunities in both of those. We have, I think, we're in a market that has enough transaction volume that loan growth should not be an issue for us in the long term. We have the lenders in the team to produce that growth. We continue to attract lenders. I think this is a temporary kind of point in time where the loan betas have to catch up, but you guys -- you're meeting all the releases and looking at every bank out there, but when I look at the folks that had loan growth but had to sacrifice margin, those margins are getting pretty thin. I don't think that's sustainable forever. So we’re waiting and watching and trying to be careful. I think that those loan yields come up. When they come up, we have the capital, we have the liquidity, we have the funding and we have the lenders and the credit infrastructure to take advantage of that. So we're just being a little cautious because it's, I think the jumping out of the gates in the first quarter I think in January in particular, we saw that was kind of the apex of people offering rates that shocked us. And then you saw less of that in February that we saw our pipelines kind of build in March kind of little more certainty. So I think even since the beginning of the year, we're starting to see some movement in loan rates. So we're just trying to be cautious about it. But to your point, we've got the capital, the funding and the team, so our bias would be to keep the capital, grow loans faster and build the bank organically.

Followed by where do dividends and buybacks and M&A kind of follow in that pecking order.

And so it's a great question. So when you think about tangible equities over 9% now and actually leverage of the bank which is where the OCC spends a lot of time looking like is more there as well. That gives us room. So our first, we'd love to deploy capital organically. Typically that's the lowest cost and the highest way to do it. I think we feel more comfortable now given our record with acquisitions that if acquisitions came up, we're prepared to continue down that road. So deploying capital that way is another great way to deploy it. That's our first choice, right, deploy it by growth, either organically or through acquisition. If we look at it, we say, look, we don't see a really good way, it’s persistent and we're accumulating capital and we think this is excess and we've got a lot of options. We have both a regular dividend we can look at. We have – we will consider a special dividend. We have buybacks that are available to us. So we have those levers, but in order of importance, I'm holding out to see. I think organic growth will pick up over time. In combination with that, whether it happens or not, I think we have the team that's proven in ability to handle acquisitions in national bank. And if either of those things happen, then I think we take the unused capital and look at a way to get most effectively back for shareholders.

And then two quick ones. One, you mentioned some investments and gearing up for cash management type opportunities. Two was on the swap fee income front and I just want to get a sense for, it seems early you to say what the immediate outlook could be for fee income, but perhaps longer term, what you're thinking as a proportion of revenue, as you'd like that fee income to be.

So I’ll talk cash management first. We have had significant focus on cash management for years. As the company has gotten larger, we found ourselves more credible in larger sales cycles. So a few years ago, we really were not at a size we could pitch a $50 million cash management account. We’re at that size now and we have all the necessary technologies to handle that and have been taking on increasingly larger customers. Our higher, that Joe referenced, was another hire to add to the team, very experienced senior cash management person, can help us penetrate larger accounts. That said, I view that business as a funding advantage, not a big fee income driver. So I think that's an opportunity for us to get funding. It's highly competitive. Everybody wants cash management to count. So, the funding really just kind of offsets technology expenses, fees of technology expenses and that sort of thing. The funding is really where you make it, it's a margin play. On swaps, there are a couple of things. It’s going to start late in the year. So you don't expect it to be a significant contributor this year. We know we have a number of customers that would enter into the swap arrangements with their commercial loans and would prefer that actually. So, but I don't have a really good handle on how many of them are actually going to take the swaps and then interest rate movements themselves will drive customer appetite over swaps, so there could be a lot of variability about how many of our customers choose to take it, but we think it makes us kind of like the cash management business. For used fees, and as we get a better handle on that, we’ll certainly share our expectations with you, but more than that, it will get us into commercial loan transactions we can't be in today. It would allow us to competitively, to try and competitively acquire customers at other banks who currently have a swap embedded in the loan and it was more about being competitive in the commercial lending side and creating a giant swap in fee income. So, the last question you asked, what would we like the mix to be. We know that we are heavy on spread income. I'd love to over time get that back to maybe where we were 20% to 25% fee income. I think it may take a little while. It might take, look, gain on sale income in residential was – has been essentially zero. As our residential production increases, we may look to apply things off that way and go back to selling more to the secondary. But I think we're getting a little piece from cash management, a little bit from swap, we may over the next year, so start to sell more residential loans in the secondary market and that will build and I think it’s going to take us a long time to get to the next one we want.

Last one is just what's a good tax rate to use from here? There's a lot going on this quarter's a little low, but just wanted to get a good sense there.

Yeah. The effective tax for the quarter, the core tax rate for the first quarter was 19% and I would stick with that. Core meaning, that was the rate on our core income was back as the merger and the tax effective merger and then you tax effect that, it’s 19% and that’s the 21% marginal rates less 2% for tax exempt items, tax exempt income et cetera.

Okay. So use 19 going forward then?

Right.

[Operator Instructions] The next question is a follow-up from Collyn Gilbert.

Sorry. I just asked it. It was on the tax rate. Thanks guys.

So with that, I’m not seeing any more questions in the queue. So I’d like to turn the conference back over to Christopher Maher for any closing remarks.

All right. Thank you. So I’d like to thank everyone for their participation in the call this morning. We look forward to providing you additional updates as the year progresses. Thank you.

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