OceanFirst Financial Corp. (OCFC) Q2 2018 Earnings Report, Transcript and Summary

Good morning. And welcome to the OceanFirst Financial Corp. 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. At this time, I would like to turn the conference over to Jill Hewitt, Senior Vice President and Investor Relations Officer. Please go ahead, ma'am.

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 expectation. 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 and Chief Executive Officer, Christopher Maher.

Thank you, Jill, and good morning to all who've been able to join our second quarter 2018 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'll 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 second quarter, diluted earnings per share were $0.32. Quarterly reported earnings were impacted by merger-related expenses and branch consolidation charges, net of tax benefit that totaled $6.7 million or $0.14 per share. Excluding those amounts, core earnings per share were $0.46. Quarterly core earnings per share increased 15% as compared to the second quarter of 2018, with additional progress expected as expenses decreased for the remainder of 2018. Regarding capital management for the quarter, the board declared a cash dividend of $0.15, the company's 86th 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 plan next quarter, which considers economic conditions and balancing the opportunity to effectively deploying internally-generated capital against the ability to enhance near-term shareholder returns. No share repurchases were made during the quarter. We have 1.8 million shares available for repurchase. On the governance side, we continue to work through the board renewal process outlined in our proxy and discussed in prior earnings calls. The company received strong shareholder support at our Annual Meeting, allowing for the adoption of a declassified board, which provides for improved shareholder participation in the governance process. In addition, we're pleased to appoint Kim Guadagno to the Board of Directors, filling the seat vacated by former director, Joe Burke, who sadly passed away unexpectedly this past quarter. Ms. Guadagno's strong professional experience, including her time serving the state of New Jersey as lieutenant governor, expands the board's capabilities and provides for an important connection for the business community throughout the state. The primary driver of our business continues to be commercial lending and commercial cash management, and we believe adding Ms. Guadagno's experience to the board strengthens our competitive position. Operating results were slightly ahead of expectations, as our margin stability maintained a core ROA of 1.19%, and a core return on tangible common equity of 13.7%. During the quarter, we completed the integration of Sun National Bank, which drove the consolidation of 17 branches, the elimination of duplicate operating systems and staff reductions, and we reduced operating expenses approximately $20 million per year to be fully reflected in our fourth quarter run rate. In addition, the bank completed the migration of bank office staff from 19 separate locations to 2 primary locations, which reduces our operating risk profile, allows us to consolidate our culture, and will support expense reductions going forward. And it also positions the bank for additional expansion. One miscellaneous note for the quarter is the large cash position held at quarter end. On Friday, June 29, our primary wire system was impacted by a national data circuit outage on the Comcast backbone. As you can imagine why our activity in the closing date of the quarter is particularly robust, especially given the size of our corporate cash management client base. The Comcast outage required that we activate our secondary and tertiary backup wire systems, positioning liquidity with several counterparties, which effectively multiplied our normal cash position. Given the timing of events, the excess liquidity was held over the weekend and our cash position returned to normal on Monday, July 2. As a result, you can consider our cash balances in the overall balance sheet is inflated by $125 million at quarter end. At this point, I'll turn the call over to Joe Lebel, who'll discuss business trends, including loan and deposit volumes; and then Joe Iantosca who'll discuss our efforts to achieve efficiencies as we originally anticipated in the Sun acquisition. Joe?

Thanks, Chris. Commercial loan originations were measured in the quarter as we held to our disciplines on price and credit structure. Interestingly, as the quarter went on, we began to see more opportunities at better yields and stronger underwriting criteria as evidenced by the significant quarter end commercial pipeline, which has grown consistently since mid-May and should benefit us in the second half of the year. More importantly, we continue to attract seasoned lenders from well-regarded competitors, landing in-market lenders from Bank of America [indiscernible] and local competitor to River Bank in the last few months. Our residential originations were strong for the quarter at $109 million, and we expect a solid third quarter as well given the healthy pipeline. As we have stated previously, we don't expect significant long-term growth in the residential book, but we'll be opportunistic in our robust local markets that continue to see good activity. Originations should continue to outpace normal amortization for the next few quarters by a slight margin. To bolster our own originations in the quarter, we purchased a few diverse loan pools, totaling approximately $122 million. These purchases included some well-seasoned residential loans, a student loan pool and a small group of seasoned commercial loans, all from motivated sellers. The student loan pool consists primarily of refinance loans to borrowers holding enhanced graduate, medical or law degrees with full-time employment and strong credit profiles. Net interest margin was stable at 3.70% quarter-to-quarter and up 13 basis points from the second quarter of 2017. Included in the NIM was 29 basis points attributable to purchase accounting accretion income, including 18 basis points from the Sun acquisition. The yield on earning assets rose to 4.22%, up 5 basis points from the prior quarter, and included an additional 3 basis points from the aforementioned purchase accounting. We expect the NIM to remain at its current level for the remainder of 2018, with second half loan growth offsetting modest reductions from purchase accounting. Turning to deposit trends. We saw a slight decline of approximately $88 million due to seasonal government draw downs and CD attrition. Typical for the second quarter, municipalities utilized their cash as they came to the end of their fiscal year. We expect those deposits to increase in the third quarter as historical tax collections and state government funding takes place. Our pricing discipline also resulted in some CD run-off for the quarter, largely due to acquired bank CD specials, maturing at rates that we declined to extend. CD attrition of $50 million and the government seasonal draw downs comprised the bulk of the second quarter deposit decline. We continue to see strong retention in all of the acquired bank deposits since their respective acquisitions. Retention has been notable given the branch consolidation and recent systems conversion from the Sun acquisition. Just as significant, the average cost of deposits for the quarter increased only 2 basis points over the prior quarter to 35 basis points from 33 basis points, continuing one of the best funding profiles in our markets. We calculated deposit beta of 8% for the quarter and for the trailing 12 months only 9.3%. Our loan-to-deposit ratio of 95% provides continued flexibility moving forward. With that, I'll turn it over to Joe Iantosca.

Thanks, Joe. As Chris stated during the quarter, we successfully completed the Sun integration. This project converted the accounts of over 70,000 Sun customers to the OceanFirst platform, along with transitioning all their customer-facing systems to OceanFirst's. These customers generate on average over 41,000 transactions daily. Concurrently, we effected the branch consolidation as anticipated in the merger model and rebranded the remaining Sun branches to OceanFirst. Customer response to this transaction has been extremely positive. By quarter end, we completed the staffing actions planned for this transaction, which resulted in a reduction of 126 staff in back-office and administrative functions. Recall that we offered ongoing positions to 100% of Sun's branch staff. We planned for this by refraining from hiring in the branch network leading up to the merger and then aligning with optimal staffing levels through attrition. With the 17 branch closures in the quarter, our average branch size is nearly $100 million as of quarter end. When looking at the retention rate across all the branch consolidations we've completed in 2017 and 2018, our deposit retention rate is running north of 98%. We also managed the deposit retention by acquisition. And across all our acquired businesses to date, retention exceeds our expectations. We attribute this retention rates to several factors, one of which is our focus on enabling our customers to use our self-service banking options, and training our staff to both promote and support these products. During the quarter, we also completed the renovations needed in our Toms River headquarters to accommodate staff relocations, including our new customer contact center, which became operational in the quarter. The customer contact center alone saw a consolidation of staff from across 4 locations into 1 modern designed facility. Here we service our customers across channels, including those at our interactive teller machines throughout our footprint. We now also have co-located our BOSS, which stands for business online support services team with the contact center, which permits for both synergies and servicing our customers, and additional visible career pathing for junior team members. The majority of our staff relocations have been completed, with virtually all of our support and administrative team now in their final location in 1 of our 2 headquarter facilities. The benefits of the interaction between teams and team members and the resulting synergy is already beginning to be realized. The systems integration, branch consolidation and consolidation of operating facilities will improve efficiency beginning in the third quarter. As expected, the expanse base net of merger-related and branch consolidation charges grew in the second quarter, the only full quarter in which Sun was operating on its legacy platforms. We expect to see third quarter core expense rate decrease by approximately $4 million to the $38.5 million range. This may vary slightly based on the timing of events. Since most of the efficiency from the Sun acquisition will be realized in the third quarter, we expect a more muted incremental improvement in the fourth quarter, with core expenses expected to increase by another $1 million to approximately $37.5 million, as we continued to dispose our surplus properties and fine-tune consolidated operations. I'll now turn the call back to Chris. Christopher Maher Right. Thanks, Joe. Before we open the line up to questions, I'd like to note that we've scheduled an Investor Day to be held at the banks' administrative offices in Red Bank, New Jersey on Wednesday, September 12. We're holding this day as a forum to discuss strategic initiatives of the bank, including our approach to digital banking and corporate cash management as well as several other areas of interest. One of the most important aspects of the day will be the opportunity to hear directly from the senior officers managing these initiatives, which is something that's more difficult to achieve in a traditional investor outreach activity. In addition to the in-person presentation, access will also be provided via webcast. To register for the event, please contact Jill Hewitt following the call. We hope to see you then. All right. At this point, we can move to the Q&A portion.

[Operator Instructions] The first question will come from Frank Schiraldi of Sandler O'Neill.

First, I just wanted to ask on the deposit side. You talked about some CD attrition. First, is that -- when you talk about the retention of deposits, do you include those CDs or is that excluded from those numbers?

That's inclusive of CDs, so the retention is actually higher.

Okay. And just trying to think through, as we see these, I guess, continue to roll off, your thoughts on further attrition on that side? And then, with that thoughts on where the loan-to-deposit ratio moves in the near term?

I appreciate that question, because those 2 -- the answers were actually linked. So we managed the loan-to-deposit ratio and the competitiveness of our rate position on CDs, kind of, acting off each other. So at the 95% loan-to-deposit ratio, with the expectation, usually the third quarter is our strongest deposit quarter. So if we get the seasonal uptick that we expect in our government entities, I would imagine we're not going to have too competitive on the CD side in the near future. But as we approach and, hopefully, the loan pipeline works through, if we approach a 100% loan-to-deposit ratio, you would see us start to be incrementally, I guess, more aggressive in pricing CDs. And that would be our primary -- if we went out to the consumer market, and wanted to raise money more quickly, we would focus on CDs, because in a rising rate environment we'd rather pay what we need to pay and get some duration out of it than wind up having to pay a rate now that could wind up moving up on you next quarter, and so forth.

Okay. So it sounds like you do expect the loan-to-deposit ratio to start -- to pickup as you let some of these CDs roll off even with the backflow, I guess, back in terms of seasonality?

That's right. It's going to depend on this -- obviously, the pipeline was pretty strong going into this quarter. So we expect a lot of loan closings. If that closes a decent amount of portfolio growth, it is going to depend on how much of depository been during the quarter. As long as we stay at 95% loan-to-deposit ratio in that range, you're not going to see us be aggressive on pricing. But as we start to get towards 100% loan-to-deposit ratio, we'll pay a little more on CDs.

Okay. And where do you think that -- where is that market now if you were to, I guess, try to hold on to these CDs and as opposed to letting them roll off?

So I think, it really depends on how much duration you're looking at, right? So the terms that would be attractive to us are probably longer-term in nature, meaning 1.5 year, 2-year, 3-year term, something like that. So I think, those -- you can usually use the FHLB advance rates as a proxy for that market. But those are in the high -- if you're going out for that kind of duration, you're going to be in the high 2s, it really depends on what happens with the market.

Okay. And then, I'm sorry if I missed this in Joe's comments. But was there an update or what are your thoughts on loan growth expectations for the back half of the year?

I think that, as I mentioned earlier, Frank, that the opportunities that we've seen and the increase in the pipeline has been how fully [ph] driven by better structure and better pricing. So what we saw earlier in the year was some of our competitors utilizing the tax cuts as the opportunity to be more aggressive on loan pricing, even though yields have been trending upward. We didn't share that philosophy. And more recently, we've seen a better opportunity to gain some pricing discipline back. So we're cautiously optimistic. I never like to go too far. But for the quarter, anywhere in that $50 million to $100 million range, I think, is fair

Okay. And then finally, just wondering the 2 basis point increase in the cost of deposits, does that -- is there any impact from the full quarter of Sun in terms of not necessarily just their deposit book coming in, but in terms of purchase accounting adjustment that might impact that number?

Yes. Frank, it's Mike. There is purchase accounting in the deposit line. It all relates to the CD book. And that typically amortizes pretty quick over a year or 2. But for the quarter. In the second quarter, there was 3 basis points of purchase accounting benefit in the deposit line, total deposits. And for the first quarter, it was 2.6 basis points. So quarter-to-quarter was the rounding difference.

The next question will be from Brian Zabora of Hovde Group.

First, I wanted to start on M&A. We've got -- with the systems conversions done and closing the branches, what's your thoughts about the potential for looking for additional opportunities?

Well, I'll make a couple of comments about that. The first is, fortunately, with where margins are, where we see loan growth and the outlook for operating expense reductions, we don't feel any pressure to have to do anything. So we would be selective about doing things that make -- they have to make a lot of sense. That being said, I think our track record of having completed the transaction we've done on time, getting the expenses out, managing through those processes and having that all in the rear view mirror, I would feel very comfortable evaluating opportunities at any point, including now. But they have to be meaningful for us. So we're not going to do something to do it. We get a lot of things we can do organically with the business. But the right thing came along, we're in a position to act.

Great. And then, just on the loan book again. Were there elevated payoffs in the CRE book? Or how are they trending versus last quarter?

I don't think the -- there were a few early payoffs in the CRE book, but nothing that I would still consider out of the ordinary -- as the company has grown, you're going to expect now a higher level of payoffs, but nothing concerning.

I would also add that, the nature of our CRE book is such that prepayment penalty income have never really been a big part of our margin, and really haven't -- effectively no impact on last quarter.

Okay. And then just lastly, you mentioned a few hires recently. Is that something o -- that you're putting more focus on? Or maybe just some thoughts around adding to the lending staff?

We're continually focused on it, and we never really -- I think, Chris, likes to reference, we don't have a budget for good lenders, meaning, we'll take anyone that we can get. And we tend to focus on those lenders from -- seasonal lenders from larger regional banking companies.

Are you seeing additional opportunities? Is it disruption in the market? Or just any thoughts around that?

I think, it's fair to say that there is always opportunity with lenders that have worked for larger companies, and that's where we found a sweet spot in terms of our recruiting.

The next question will be from David Bishop of FIG partners.

Chris, you mentioned, I think in the preambles of the average franchise now, right below that $100 million mark. As you think ahead, is there a critical mass that you're targeting that you're thinking we have to get to may be optimize profitability as you move forward farther and farther close to Sun acquisition integration?

I think, your kind of critical scale or minimum operating size in a branch does depend a bit on your geography. So if you're heavily in urban environment, those franchises are going to tend to be more expensive for a lot of reasons in a real estate staff. So for a largely suburban environment like ours, $100 million, we think is a great baseline, and probably better than most institutions like us. I don't think, we're going to have the ability to move that much north of $100 million in the short-term. Although we're entering our planning process for next year and as a discipline, each time we go through the planning process, we look and see -- we look at customer usage patterns. We look at growth rates. We look at where our locations are. And I would not be surprised to see us look at some additional consolidation into 2019. And then occasionally, we also look at places where you may have just a branch in the wrong neighborhood and meaning that it's not providing the right value and moving to a busier street or something like that. So we look at all of that. I think you'll see some fine-tuning next year. I don't think it will meaningfully change the average franchise, though.

Okay. Got it. And then Obviously assets continue to drive towards that $10 billion mark. From a large number perspective, does that change the way you're thinking in terms of the bankers, you're trying to go after and in terms of may be larger middle market loans, the types of loans you're underwriting? And does that imply any change in how you're pricing disciplines moves as you move maybe up market for larger loans?

Sure. I'd say a few things about that. Maybe just comment about $10 billion because we've had some regulatory relief around that mark. On the good side, the prescriptive stress testing and things like that, we've gotten a little bit of room on that, which will be helpful. However, a company that has had a risk committee for many years, we've done stress testing for many years. So those expenses aren't going to go away. We're going to be doing those kinds of things. And the Durbin Amendment, obviously, is still in place and would still be a factor as we cross $10 billion. So the way we think about $10 billion is, if you're crossing it for a good reason, then don't get hung up on the marginal incremental expense, because we keep growing your company would be okay, but certainly is a number. In terms of the nature of the loans we do and the lenders and all that, there is a little bit more opportunity as we've gotten to the scale we are today to be able to handle larger or slightly more complex transactions. One good example that as we talked last quarter about adding interest rate swaps to our product line. So that allows us to be -- to take our pricing model, which won't change, right? Our pricing models are going to be consistent. But it will allow us to do for the first time to competitively price 10-year paper, so as -- with a swap. So as we go forward, we've got borrowers who may want -- are asking for bids on larger loans, obviously, they're looking to fix their rates. We've historically not played in the 10-year money space. I'm very glad we didn't based on where interest rates have gone. But at this point, with swaps, with the larger lending limit and attracting a little more talent from the large banks, I think it does open something up. But we're going to continue to make those $1 million, $2 million, $3 million loans. We love them. Our customers are great. They bring -- in many cases, they bring a lot of deposits to those relationships. So we're not leaving the markets we're in. I think, we're just a little more competitive in some of the larger deals.

Got it. Is the plan still for the swap program to maybe start opening up this quarter -- third quarter?

It's going to -- it's actually in process right now. It's already been -- and it's been approved by all of our risk and credit folks, and we're operating under the assumption that we'll close our first swaps sometime in September.

Okay. Got it. And Chris, probably your favorite topic here, that the golf course hotel credit continues to play here. But are there any update maybe eventually solving that and getting that off balance sheet and resolve once and for all, any movement there?

Sure. It's still for sale. If anybody certainly calls after the call if you have any interest. That's just -- it's a unique property. We have considered whether we sell it in a single piece or whether we sell it in components. We've been favoring trying to do a single piece sale, which is a little more complicated. If it stays very much longer, we might look at other alternatives for it. But not much more to say. Although I would add, we always have active -- we always have interest in it. It's just -- it's a unique buyer that wants to be operating that kind of property.

[Operator Instructions] The next question will come from Joe Gladue of Merion Capital Group.

You mentioned the, I guess, very low deposit beta, you've been seeing. Just wondering what your assumptions are for the -- for deposit betas going forward?

So I would tell you, based on the competitive nature of the market that we see today, I don't think you're going to see anything different. We don't feel more or less pressure than we felt in the past. So you're going to see probably being under pressure of a couple of basis points a quarter. I would say and we often get the question about why our cost of deposits would be where it is? And I focus on that being, we've got $2 billion worth of corporate cash management, and that's what drives, I think, our lowest cost funding. As long as we stick to that, I think we're going to do well. The other thing that I often say to folks is, although our market is perceived to be a secondary market as compared to Metro Philadelphia or Metro New York, it's a very large market. So we've got a $130 billion worth of FDIC deposits in our retail footprint. Of that, there is $68 billion worth of deposits that are controlled by 4 large commercial banks. Those are 4 National banks, the highest rate they pay on a rack rate $100,000 and below money market, 9 basis points. So we focus our staff, and we focus our efforts against that $68 billion in our market, not against the kind of promotional money market or high rate CD. That causes us to grow more slowly, but you have a deposit base that has a very different character to it. And so I think, we're going to have some pressure, to your question, a couple of basis points a quarter would not be unusual. Maybe some quarters will run a little harder and a little slower, but we are not -- we don't see it's going to materially change anytime soon.

Okay. Thank you. And that's relatively small numbers. But just wondering if you could touch on what the plans or outlook are for the wealth management? I guess, there was a little bit of a decline in assets under management in the quarter. Just what's the outlook there?

Sure. So I think, to understand that, our wealth management is the biggest value proposition we provide is acting as a fiduciary for our clients. So some of that is a state settlement services and things like that. So we will occasionally have money that's part of the assets under management. It's reasonably temporary in nature. Or we will have funds that we custody, but at a very low effective earnings rate. So in this case, we had a client that have been accumulating money, that was then swept out for a longer-term purpose. But it wasn't something we are earing a lot of money on, so it didn't affect revenue very much. So that's the reason for the contraction. In terms of the strategic position of that business, it is a nice add-on for many of our commercial clients, many nonprofits we deal with, and it provides the ability for us to be full-service to them. We recognize the growth rates have not been robust. But we're comfortable with that. We've got good margins on it. It's a profitable business for us and it meets the customer needs. It's just not something that we expect to be an engine of growth in the near term.

The next question will be from Russell Gunther of D.A. Davidson.

I wanted to follow up on the expense conversation. Appreciate the color you guys provided there for the next couple of quarters. Is it right then to assume that all of the, kind of, cost savings from Sun and the branch consolidation will be in that 4Q run rate? And if so, given continued franchise investment you might be thinking about, what's a good, kind of, core growth rate for the company as we look out to 2019?

So to answer the first part of your question, yes, we expected the -- fourth quarter is really everything related to Sun, who have been in there. In terms of the growth rate going forward, we would think of it being under kind of inflationary level pressure, meaning that, health care costs, wage increases and those kinds of things is kind of the normal ordinary course pressure against the expense line. We don't at this point know of any significant investments we need to make over that. So technology is in good shape. We don't have any infrastructure needs. We took care of the facilities realignment this year. So I think, you take the fourth quarter and then look at it on an inflationary basis.

Okay, great. That's helpful. And then, will that still kind of translate into your targeted 50% core efficiency as we think about '19?

That's right, yes.

Okay, awesome. Thank you. Following up on the margin guide, mike, the stable guide for the back half of this year, is that off the reported 370 number and does that reflect any Fed fund increases?

Yes, it's based on the 370 run rate now, the reported margin. There will be a little bit of a headwind, because purchase accounting amortizes off a little bit every quarter. So there will be less purchase accounting. But we expect that to be offset probably by 1 -- well, we just -- we already had a Fed funds increase at the end of June, is not reflected yet in our numbers. So we have a benefit from that. We have $500 million of loan that reprice up a quarter for this -- for the third quarter. And then also the loan growth in the second quarter, $120 million came in right in the last 10 days of the month. So that will be reflected -- that will benefit the third quarter margin. It didn't really have any impact on the second quarter. So we think that those will kind of offset each other and will be about the same level.

Okay, great. Thanks for that. And then, the last question for me, Mike, just your thoughts on the back half of the year for where the tax rate could shake out? And any early look at 2019 tax rate?

The tax rate that we -- is 19% for effective rates. Next year, that's a wild card because of the New Jersey, the change in the New Jersey tax situation that just went into the -- that just was implemented July 1. So I would say that for next year, it's still 19%, excluding whatever adverse impact might come from the change in the New Jersey tax structure.

Okay. And too early to get a sense for what that could be in any potential way to offset it?

Too early to say. There may be ways to mitigate that. But it's fairly adverse to all companies doing business in New Jersey. And it's too late to say what the impact is, but it would certainly be adverse.

Okay. And then last question, I guess, just kind of thinking about that, do you guys have any updated thoughts on profitability targets, be it ROA or ROTCE going forward?

I wouldn't change our thoughts on profitability yet. As Mike mentioned, the only adverse thing that we're facing in 2019 is potentially what is the state tax rate wind up being. And when these things happen, the tax rate -- the tax that gets passed, you have to read through it. We've got teams of people doing that now and trying to figure out exactly how it applies to us. And then there are things like the net operating loss carry forwards that we have, which maybe we will apply to that and other strategies. So it's too early to tell what that would be. But that's the only headwind we're looking at for next year. We think -- everything else seems to be kind of in the greenlight stage. So -- and as we go into our budget process, obviously, we'll do -- we tend to mitigate not just the tax strategies, but we'll look at growth opportunities. We'll look at operating expense opportunities and see if there's someway we can blunt some of that. So I wouldn't give you any new guidance regarding targets at this point.

The next question will be from Collyn Gilbert of KBW.

Just a follow-up first, Mike, on the tax discussion. Just -- so a simple question. Why no impact in 2018 on the state tax surcharge?

On the State tax surcharge, specifically the surcharge goes into effect January 1, 2019. There are some elements that go into effect for 2018, but they do not impact -- those elements do not impact us this year. The elements that go into effect January 1, we do expect that to impact us next year. We're just not certain of the extent.

Okay, okay. And then, just any updated thoughts on the DTA? And how any treatment of that going forward?

No. Actually -- well, actually, it's the -- it's possible that the DTA could get written up, unlike at year-end with the federal rate going down from 35 to 21. You recall, we had to write-down our DTA asset and that was a onetime expense, and then, of course, we had the benefit of the lower tax rate going forward. This is just the opposite. So it could be that our deferred tax assets get written up by virtue of the new tax rates, so there is a positive benefit initially, but then an adverse benefit in future periods to the income statement.

Actually behind that, Collyn, is that the net operating losses that we may have the ability to apply, don't originate directly through OceanFirst, because we didn't have operating losses at the company to qualify. So they were through acquisition. So you've got to work through all the math of the acquisitions and see what's actually eligible, and we're working through that now.

Okay, okay. That's helpful. And then, just on the -- some discussion on the loan book and asset growth outlook. So first, the portfolio that you guys bought this quarter are blend of portfolio, the $120 million. What was the blended yield on?

It's just north of 4%.

Okay. Would you -- do you have an appetite to do more of those types of purchases?

It's not uncommon for us to look on. We tend to be -- as we do typically with our own credits, we tend to be fairly judicious on what we pick. So we turn down more than we end up buying, but we're always outlooked.

Okay. And then, how should we think about -- I know you explained that you'll make up on the cash at quarter end with Comcast. But the securities book, how do you sort of see that trending for the back half of this year and then into 2019?

Yes, we don't target that in our balance sheet. It's really kind of a balancing number, if you will. And, Obviously, we want to make it many quality loans as we can make. If we have a slow quarter in terms of loan growth, then cash flow will go into securities book. If we have a very strong quarter for loan growth, then we let the securities book run down. So we don't manage it like it has to be 15% of our balance sheet. It's really kind of a balancing function. I mean, there has to be some level of securities for liquidity and pledging and other things of that nature, and we're at that -- we're already at that level. So if it moves up or down a percentage or 2 on the balance sheet because of loan flows, that would be typical.

Okay. So your NIM guide, Mike, then doesn't factor in necessarily a mix shift from...

No. No, it's basically...

So it's purely just the resetting?

Right. It basically assumes the same mix.

Got it. Okay, okay. That's helpful. And then, just finally on provision and reserve. Now with Sun under the roof, how should we be thinking about the needing -- the need to sort of build the provision going forward?

I think, there's a couple of things going on there. So the short-term in the next 12 to 18 months, we're really thinking about the provision relating kind of to your loan growth, right, so you're covering that. And we have the situation with the acquired loan portfolio where you've got 2 different kinds of reserves. You have the allowance, which looks statistically low on the portfolio, because most of the portfolio is actually more from purchase accounting. So in aggregate if you add that allowance and the unamortized credit margins, you get close to 100 basis points of overall coverage, I guess, against credit risk. So I don't think you're going to see much of a significant change one way or the other in that. Depending on loan volumes and some experience, we'll have to provide to cover where we're going. On the other side, though, we're actively engaged in CECL. So beginning with the third quarter of this year, we'll be kind of running 2 models in parallel. We have not circled an adoption date for that. But that is much more of a purchase accounting markets of life of the loan market. So we've got the near-term -- we don't expect a whole lot of noise. We're also watching CECL. We don't think there is a dramatic change in our reserves with CECL either. But we've got to work through that and probably of estimates on that by the end of the year. So eventually we'll move over to CECL and be in that mode. That may happen -- it could happen in '19, depending on where we are? How ready we are? And where the markets are?

Collyn, the way that's close to the income statement on a quarter-to-quarter basis is right now about half of our loans are purchase loans. And so those are not mark -- we don't consider a credit mark. And they already had a credit mark through purchase accounting. As those loans turn over, as the lines get renewed or they're repaid and new loans originated, there might be about $100 million-or-so each quarter that comes from the purchase book into the own book. And so we have to provide for those loans. So that's how we consider what our allowance and provision should be every quarter. We increase -- if we look at now the own book versus the purchase book, the purchase book keeps getting -- winds down every quarter. If the own book increases and then we set the appropriate allowance level.

Okay, okay. That's helpful. And then, just sort of a -- a part of that in terms of the provision and outlook for net charge-offs. So are you not anticipating any sort of pickup in net charge-offs either tied to the, of course, credit or any other credit that you see kind of in the books right now you feel pretty good about loss rates in the near term?

All the underlying credit trends. So what we look at is, we look at delinquencies. We look at risk rate migrations in the commercial portfolio. We do look periodically at FICO drift and the residential book. And that dashboard is remarkably clean. So there is nothing on the surface that would expect us to have a much of a difference. So that's about 6 basis point charge-off figure. I don't think that's going to change materially, based on the informations available to us today. And you always have to be careful of these things, because we can get a phone call this afternoon that we don't like, right, that stuff happens in our business. But at this point, there is no information that would cause us any concern.

And, Collyn, on the golf course hotel banquet golf course, that's real estate owned property. So those losses don't go through the loan loss allowance. You see that in REO operations.

Okay. Yes, got it. All right. That's helpful. And then just one final question for Joe. Joe, just can you give us what the pipeline metrics were in the first quarter? And then where they stood at the end of the second quarter? Just for the total pipeline.

So the total pipeline for us in the first quarter is about $140 -- let me see here. $157 million. And at the end of this quarter is $240 million round numbers, with an average yield improvement as you would expect.

Did you want to take one step further and say what that was?

No, I have to actually go back and do the math from last part. Mike, you have [indiscernible]

Well, the yield for this quarter is $486 million.

$486 million, yes.

On that -- on the $240 million.

[Operator Instructions] Your next question will be from Matthew Breese of Piper Jaffray.

Just on the NIM. With the accretable yield declining, should we be figuring on 2 or 3 basis points of core margin expansion for the next couple of quarters? And do you think that's kind of expansionary momentum? Can that carry through into the early part of 2019?

I think if we continue to see Fed movements like we have, that's kind of our expectation as well. That's why we're comfortable that those 2 things will kind of offset each other, right? So we're going to pick it up in core and lose it on the purchase accounting, but stay in that 370 neighborhood.

Got it. Okay. And then just thinking about the pipeline. A better pipeline, yields are improving. That commentary and that performance versus some of your mature -- more mature New York City peers is stark contrast. And so I just wanted to get a sense for why do you think that is? And how much of that is geography driven? Is there -- are you getting that much better pricing and origination ability in your neck of the woods than theirs?

No. I don't think it has a lot to do with geography, because in many cases, our geographies overlap. I mean, a lot of the commercial lending we do tends to be across Central New Jersey. We do a fair amount in the Philly metro and a little bit more and -- a little bit in New York. I think there's a couple of things going on. Joe has mentioned in the last 2 calls, we had a couple of hires this quarter, a couple of hires the quarter before that. These are high-quality people. And they are coming in. And they're actually -- when you hire a high-quality lender, they walk in and they got 3 deals to talk about, right? So they are kind of immediately helpful if you're bringing the right folks in. I think that's been a help. I think that there is a natural transition. As you acquire institutions, you're going to have slightly different processes and procedures and credit cards, and your lenders have to get used to that, right? So the folks at Sun, which did a great job for Sun, I'm really happy to see some of the work they're doing in the last 1 month, 2 months. But fairness to them, they needed to get used to how OceanFirst does things. And before them, we had the same situation with folks out of Ocean City and Cape before that. So I think, getting the acquired franchises to produce takes a little bit of time, because you're changing your model. It doesn't mean one model is better or worse, it's just change, right? So change kind of slows the things down and gums the gears up. So I think, working through the majority of that, getting people used to pricing models, getting used to our -- we've got online credit files, the system and all that. So they have to get onboarded. The addition of a few people. And then I think we've been able to be a little more meaningful player in some geographies that we were not in. So we opened a commercial loan production office in Bucks County, that's now hitting stride, but it takes a year to open it, and we've got to hire a couple of people, it takes a little while. We've added folks to our Newtown Square facility in -- which is also in Metro Philadelphia, as well as the addition of the Sun office in Manhattan. So we're doing an occasional deal in Long Island, an occasional deal maybe out in King of Prussia as well as doing our traditional business across Central New Jersey. And that a couple of deals a quarter makes a difference. So I don't think it's a market necessarily. I think, it's relationship lenders, hiring the right people kind of keeping your head down and focusing on building those relationships.

Understood. Okay. Just my last one. Mike, you mentioned on that, the REO line item closer to $1 million this quarter. How should we be thinking about that going forward? Can we see that lighten up a bit?

Of course, the $1 million included a $500,000 write-down to the basis. So that was kind of a one-off, and then the other $500,000 was just the operations of the property itself. It's an income-producing property. Unfortunately, it doesn't cover its expenses. So -- and it's so much seasonal. Probably the third quarter will do a little bit better than the second quarter, and then the fourth quarter will be a little worse than the third quarter in terms of seasonality. So the operations -- so like I said, the operations lost about $500 million and then the write-down was another $500 million. And it's actually -- all that, that $1 million -- the other thing, Matt, in that REO loss of $1 million, that's not all related to the -- we have other REOs and that flows through there, so that's not all related to the golf course.

[Operator Instructions] And the next question will be a follow-up from David Bishop of FIG Partners.

I just wanted to follow up on Matt's question, maybe on the lending side. Chris, thus far happy with the retention with the Sun Bancorp, with their bankers up in the New York region?

We kept some really talented folks on, so I'm very happy with those -- with them.

Got it. And in terms of the commercial purchase loan, mentioned yields just shy north of 4%. Just curious, obviously a lot of banks are trying to grow that C&I portfolio. May be a little color surrounding the nature of the collateral where these -- with end market loans, just maybe a little bit color in terms of the types of underlying industries or sick codes for these C&I loans?

Sure. I maybe follow up on my comments before to Matt's question. We've seen more growth in CRE than C&I. We find -- we love C&I for all the reasons. Everybody loves C&I, right? You're getting true relationships. You're getting deposits. Those relationships take a little longer than to pull over though than as portable. I think, things like swaps will be one way to help that going a little bit up market. But I would say, you're going to see C&I grow methodically here. You're not going to see a jump. We don't think we can double the C&I book over the next year. And it's going to be a combination of C&I doing okay, owner occupied CRE doing okay, investor CRE. We still got plenty of room on that. We're well under 300% investor CRE to risk-based capital. And as Joe mentioned in his comments, you get a little bit of growth out of residential. It may not be a primary driver of things. But if we can pickup a little bit of growth there, keep your interest rate risk position balanced and have contribution from many different places, we like that better than -- we're not trying to do a big mix shift and get away from -- rotate out of 1 asset into another, we're just trying to have all these categories contribute in the way they, they best can.

And ladies and gentlemen, this will conclude our question-and-answer session. I would like to hand the conference back to Christopher Maher for his closing comments.

All right. Thank you. I appreciate everybody's attendance this morning. Look forward to giving you additional updates throughout the year. And for those of you that are able to join us on September 12, look forward to seeing you then. So thank you,.

Thank you, sir. Ladies and gentleman, the conference has concluded. Thank you for attending today's presentation. At this time, you may disconnect your lines.+