OceanFirst Financial Corp. (OCFC) Q3 2018 Earnings Report, Transcript and Summary

Good day, and welcome to the OceanFirst Financial Corp. Earnings Conference Call and Webcast. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Ms. Jill Hewitt, Senior Vice President of Investor Relations. Please go ahead.

Thank you. Good morning. My name is Jill Hewitt, Senior Vice President and Investor Relations Officer for OceanFirst Financial Corp. Before we begin, I want to remind you that many of our remarks today contain forward-looking statements based on current expectations. Please refer to our public filings, including our recently filed investor presentation and the Risk Factors section in our 10-K, where you will find examples of factors that could cause actual results to differ materially from these forward-looking statements. For any forward-looking statements made in our remarks today, or in any related documents, OceanFirst and Capital Bank of New Jersey claim the protection of the Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Our remarks today relate, in part, to the proposed transaction involving OceanFirst and Capital Bank. These remarks are not a substitute for the prospectus of OceanFirst or the proxy statement of Capital Bank. This communication shall not constitute an offer to sell or the solicitation of any offer to buy any securities. In connection with the proposed transaction, OceanFirst intends to file with the SEC a registration statement on Form S-4 containing the prospectus of OceanFirst, and proxy statement of Capital Bank, and other documents related to the proposed transaction. Before making any voting or investment decision, the investments and stockholders of Capital Bank are urged to carefully read the entire proxy statement prospectus when it becomes available and any other relevant document filed by OceanFirst with the SEC as well as any amendments or supplements to the documents, because they will continue important information about OceanFirst, Capital Bank and the proposed transactions. Investors and security holders are also urged to carefully review and consider OceanFirst's public filings with the SEC, including but not limited to its annual report, its proxy statement, its current report and its quarterly report. When available, copies of the prospectus of OceanFirst and proxy statement of Capital Bank will be mailed to the stockholders of Capital Bank and may be obtained free of charge at the SEC's website at sec.gov. Capital Bank stockholders can also direct a request for a copy of the proxy statement prospectus to OceanFirst at its address of 110 West Front Street, Red Bank, New Jersey 07701, attention Jill Hewitt. Thank you for your patience. Now I'll turn the call over to Chris Maher, CEO and Chairman of OceanFirst Financial Corp.

Thank you, Jill, and good morning to all who have been able to join our third 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 add some color to the results posted for the quarter, and then we'll look forward to taking your questions. In terms of financial results for the third quarter, diluted earnings per share were $0.50. Quarterly reported earnings were impacted by merger-related expenses and branch consolidation charges, net of tax benefit that totaled $1.6 million or $0.03 per share. Excluding those amounts, core earnings per share were $0.53, a 15% increase over the prior linked quarter. Core earnings reflect an 11.7% or $5 million decrease in operating expenses as additional Sun efficiencies were realized in the quarter. We currently anticipate approximately a $1 million decrease to our operating expenses in the fourth quarter as the final Sun efficiencies are realized. Performance metrics for the quarter met our near-term objectives as the core ROA was 1.35%, the core return on tangible common equity was 15.35%, and the core efficiency ratio was 53.7%. Those results occurred despite the negative impact of elevated OREO expenses, and the decision to defer the application of deposit fees against former Sun clients who were converted to OceanFirst in June of this year. These factors impacted core earnings by approximately $0.02 per share. Joe Lebel will walk you through the dynamics of the quarter, and provide some insight into market conditions later in the call. Our bias has been to protect our net interest margin as the forward curve flattens, and to protect our credit risk position at the economic expansion lengthens. This approach is deliberate, and is intended to ensure we have the liquidity and overall balance sheet capacity to grow loans and deposits more quickly when market conditions improve. With stable net interest margins, low deposit betas and a modest loan-to-deposit ratio, we have the liquidity to fund future growth. With a GCE ratio of 9.35% and low dividend payout ratio, we also have the capital base to support more rapid balance sheet expansion at the right time and under the right conditions. Regarding capital management for the quarter. The board increased the quarterly cash dividend by 13% to $0.17, the company's 87th consecutive quarterly cash dividend. The $0.17 dividend represents a 32% payout of core earnings, which remains at the low end of our historical payout range. The decision to remain at the low end of our historical payout range reflects our optimism, and we may have several opportunities to deploy this capital for the benefit of our shareholders in the coming years. In addition to organic growth opportunities, the recent volatility in equity markets has materially affected regional and community bank valuations. As a result, we may have the opportunity to effectively deploy capital in 3 ways. By lending into a more rationally priced market, if and when it arrives, with share repurchases that are beginning to look financially attractive or through additional acquisitions. The timing of these opportunities is uncertain, but our well-positioned balance sheet and our improving profitability allows us to be patient while retaining a modest amount of excess capital for deployment, as conditions allow. As earnings have grown and we maintain a conservative dividend payout ratio, we have the opportunity to build tangible book value per share in the coming quarters. In the third quarter, we added $0.37 to tangible book value, increasing it by 2.7%. No share repurchases were made during the quarter leaving 1.8 million shares available to repurchase. I'd like to now spend a few minutes discussing the Capital Bank acquisition. Capital Bank is a $500 million input pre-commercial bank with excellent performance attributes. Dominic Romano and 26 other local business owners organized the bank in 2007. Since that time, they have built an impressive track record, being named as one of the American Bankers' Top 200 Community Banks in each of the past 4 years. We've been very impressed with their CEO, David Hanrahan, and his team, and we look forward to adding them to the OceanFirst family. A presentation regarding this transaction has been posted on our company website. While I won't be reviewing those slides in this call, they may serve as a reference during the Q&A portion of the call. Capital Bank boasts an excellent deposit base, with a 46-basis point cost of deposits and a low 70% loan-to-deposit ratio. The bank is strongly profitable, as indicated by their 1.32% return on assets and 55% efficiency ratio. With a 100% branch overlap, operating cost reductions will materially increase that level of profitability. In fact, in what we consider to be one of the most important measures of acquisition value, the purchase price is just 8x Capital Bank's earnings after considering cost saves. While the 50% cost save number is significant, bear in mind that all of Capital's branches are within 5 miles of an existing OceanFirst branch. And our last 4 whole bank acquisitions have provided the opportunity to build the core competency around systems integrations and expense reductions. At this point, I'd like to turn the call over to Joe Lebel, who will discuss business trends, including loan and deposit volumes. After's Joe's discussion, we'll be happy to take questions.

Thanks, Chris. Loan originations were robust in the quarter, as loan pipelines delivered the closings we expected, and overall loan production of $279 million was the highest on record. We continue to see strong activity in residential lending in our geography despite the increased interest rates. Residential closings were the strongest in some time at $124.4 million. That growth, coupled with growth in the consumer portfolio, largely offset runup in the commercial book as we ended the quarter with a $9 million decrease in the overall loan portfolio. Commercial originations had their best quarter in 2018, with $136.8 million in closings. However, as in previous acquisitions, we employed a disciplined approach to acquired bank loans that did not meet our credit structure or pricing hurdles. During the quarter, we exited certain purchase participations in acquired loans, totaling over $75 million, which impacted the overall portfolio growth. On a positive note, the commercial pipeline continues to expand across all geographies, and our sales teams have been presented with opportunities that meet our credit and pricing metrics, boding well for a solid fourth quarter, as evidenced by the current pipeline. We regularly consider expanding our participations in purchase loan portfolios, but have held off as we assess interest rates trends. We're watching not just the short-term movements by the Federal Reserve, but also activity in the 5- and 10-year treasury market, which underpin the CRE and residential mortgage markets. During the quarter, we allowed our construction and investor CRE portfolios to decrease, creating even more dry powder in both segments. We believe this capacity may vary -- may be very valuable in the coming quarters as we expect deposit cost pressures will force competitors to pull back from the aggressive loan pricing that has been prevalent in our markets for some time. Our net interest margin of 3.64% represents a 6-basis point decrease quarter-to-quarter, largely attributable to a reduced purchase accounting in the margin, which declined from 29 basis points to 24 basis points during the quarter. Core NIM was stable at 3.40%, down just 1 basis point from the last quarter. The yield on earning assets was unchanged versus the prior quarter at 4.22%. We expect the NIM to remain close to current levels for the fourth quarter with any reductions from purchase accounting offset by modest gains in the loan portfolio. Turning to deposit trends. We saw an increase of approximately $35 million due to seasonal government and core business and regional growth, despite attrition from acquired bank CD and money market accounts. We expect those seasonal municipal deposits to fluctuate in the fourth quarter, as historical tax collections and state government funding takes place in November and begins to run off in December. Although the private pricing discipline results in some CD run-off for the acquired banks, we continue to see deposit retention of 93% for the total acquired banks since their respective acquisitions. Retention has been notable, given the fierce competition for deposits, and our own branch consolidations and midyear systems conversion from the Sun acquisition. Despite the competitive nature of the market, the average cost to deposits for the quarter increased only 4 basis points over the prior quarter, to 39 basis points from 35 basis points, continuing one of the best funding profiles in our markets. We calculated deposit beta of 16% for the quarter and only 10% for the trailing 12 months. Our loan-to-deposit ratio of 94.7% continues to provide flexibility into 2019. Regarding noninterest income. As Chris noted, we elected to waive deposit fees related to converted Sun clients during the quarter. This fee holiday is part of our prudent approach to build strong relationships with acquired clients. It allows our staff the opportunity work with our clients to ensure they have been placed into the best account type and avoids the most common conversion challenge of mapping products. Regular deposit fees will apply to the former Sun clients during the fourth quarter, and should result in deposit fee revenue improvements in the order of $500,000. Also related to noninterest income. We launched the Nest Egg hybrid robo advisor in the second half of September. As we noted during our recent Investor Day, Nest Egg is expected to grow slowly, but should provide a highly valuable revenue stream over time. Another initiative discussed during Investor Day was the launch of our digital consumer deposit product offering. This initiative will compete with Chase's Finn product consumer offerings, and will enter the marketing phase during the fourth quarter. The product will be branded Amigo by OceanFirst. Similar to the Nest Egg strategy, Amigo is expected to grow slowly, but will address increasingly important market segments over the long term. Beginning in 2019, our regular investor updates will include performance metrics for each of these important initiatives. With that, let's move to the Q&A portion of the call.

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

Joe, you already touched on reduced purchase accounting accretion linked-quarter, I think. Is there any other noise in there that's leading to sort of lack of loan beta, commercial loan beta in the quarter?

I don't see any other noise.

We're originating -- I think the originations that we have, it was rolling off or very close to where the portfolio yield is today, so you're just not seeing a lot of jump. We do have a segment, prime-linked loans, but it's not a change giant segment of our commercial loan book. Mike, do you have the total on that?

Yes. So there's -- Frank, it's -- if you're looking at -- yes, the commercial loan book didn't reprice. The biggest component of that was that there was, as Joe mentioned, there was significant paydown, mostly from the Sun legacy book. And those tended to come off at higher than portfolio rates. It was higher -- so that kept that constant. We have about $500 million in prime-based loans. They all reset with the increase in prime. But probably the biggest factor that was running in place there is that higher yielding loans tended to pay off.

Interestingly, Frank, the pipeline loans from the last quarter actually were booked at about a 53-basis point increase over the prior quarter. So we're seeing the -- seeing improvements in the overall market, and seeing the pipeline yields pull through to originations.

A couple of large facilities that were booked during the quarter were credit lines that did not have drawdowns at closing. So although the structure is good it won't -- those will earn over time.

Okay. So the loans coming on the books are coming on at higher levels than the what's -- not in the quarter, obviously. Mike, you mentioned the higher paydowns. But are you kind of through that at this point in terms of what you want to see exit the portfolio? And then on a more normalized basis, do you expect what you're putting on the book here as you look at pricing to be similar or higher than what's coming off the books?

As we've seen the 5 and 10 years start to move, we think that over time, the yields we're putting on are going to provide the opportunity to move up total loan yields in the portfolio. It's not a big gap today, but they are coming in higher. It's not going to come in -- it's not going to wind up diluting that yield. It's actually going to improve it. So in terms of how much the additional runoff might we see, it's kind of hard to estimate because these were perfectly fine loans. The question was that they -- a couple of them were construction to perms, where we decided we didn't want to be in -- they tend to cash out at that point. So the credit structures were a little bit more aggressive than we would typically do. And then the pricing. So the pricing was pretty competitive. But as we watched this earnings season, it strikes us that there's a lot of deposit pricing pressure out there. So we've seen loan yields come up a little bit. We expect they're probably going to come up more because people are going to need to do that, based on how their funding is moving. So that's one of the reasons we've been careful to preserve the capacity to grow.

Okay. And who are you losing the business to? I mean, as this stuff goes permanent, maybe the credit gets a little -- the structure gets a little too aggressive, maybe LTVs get a little too aggressive. I mean, who are you lose -- is it insurance companies? Is it just other local banks? Is it larger players? All of the above?

It's a variety of players, and I think it's everybody that you mentioned. And these aren't -- they're decent deals. They are just -- were at a point in the cycle that on the structure side, it's the cashout that we get really concerned about, because we're -- it's in commercial real estate. But these are properties that are -- they cash flow today, but they cash flow under a set of ideal circumstances where the buildings are pretty full and the rents are pretty good. And as you stress them is where you start to see maybe our stress scenarios are a little more aggressive. So these are not, by any stretch of the term, kind of bad credits or anything. They cash flow, they're responsible. They just did a stress scenario and there's a lot of talk about where the credit cycle is. We don't think credit cycles die of old age, but they do die. So whether that's late in '19 or early in '20, the stuff you're booking today better be able to withstand some setback. Joe, anything you'd add to that?

I think you hit in on the head, especially on the cashout scenarios and where we are. We've enjoyed a very strong market for the last 8, 9 years, and you look at cap rates and where they can go from here versus -- and the impacts on values, and that could be substantial. So when there's an opportunity for us to look at an exit where there's a significant cash out of equity and limited cash equity remaining in transactions, that's just not our credit appetite.

Okay. And then finally, just -- it looks like a very good deal. I'm just wondering, seems like something pretty very easily digestible and something you can sort of do and not change the rest of your strategy around it, certainly, and just wondering if you see any other deals down in -- and any other opportunities down in South Jersey sort of similar size where you could pick off a couple more of these banks? Because I would imagine you guys are the acquirer of choice down there.

We would hope that we're viewed that way. I think we have to -- we need to make sure we continue to deliver and make sure that we kind of earn that repetition with each transaction that we do. I think as we look at the market, Frank, to your question, we would look at the broad Metropolitan Philadelphia market, the Southern New Jersey, so that kind of home Eastern Pennsylvania piece, and look -- we think very highly of the markets in North Jersey and New York. It's just those are very competitive prices right now, and interest rates are a real challenge there. So it's been harder to find opportunities that would make that kind of sense. We view this as a kind of straight-down-the middle hit all of our requirements. It's a really, really well-run bank. Our only wish would've been -- it would be nice if it was a little bit bigger, but you can't have everything. So...

The next question will come from Dave Bishop of FIG Partners.

Chris and Joe, I think -- and Mike, you may have alluded to it, but one of the things -- looks like you had a nice increase here, sequentially, on the origination side, but I think you may have alluded to it. There might have been some funding there, or some loans included in that origination that didn't fund because, trying to do the math, I think you mentioned about $75 million of payoffs or so. Maybe walk through the math in terms of why didn't that translate, I guess, to greater sequential loan growth on a reported basis.

Yes. So we had the -- Dave, so we had the payoff figures that Joe was saying, were overweighted, higher-yielding loans, so that brought down -- that was an adverse effect. Also, in the originations is that we -- $279 million, there's about $45 million in construction lines in there, most of which would not be funded until later on to that. We're not a big construction lender. That number was unusually large for us in this quarter. So the fundings were not as much as the $279 million would indicate. So those are kind of the offsets that you might think of.

Okay, got it. And as we look at the pipeline here, just curious. I know you don't break this out, but geographically, I'm just curious how much of that is weighted? You mentioned the Northern New Jersey and New York market is relatively competitive. How much is in that Northern New Jersey market or maybe give a sense on the commercial pipeline? How much is -- or the geographic dispersion there?

Yes. Dave, I'll tell you that when we reference geography, for us for the most part, it's that core market, so I would say it's weighted largely in that Central, Western Philadelphia and Southern Jersey market. Although we have a couple of our LPOs in that Middlesex, Mercer market, one in Edison, and one in New York City that have all provided alternatives, or should I say, additional loans into the pipe. But more weighted toward the Central and Western, Southern Jersey market, better yields.

And Joe, I think I heard you say that the waiver of the deposit fee income, that's sort of, I guess, tree, is expiring this quarter, there's going to be about a $500,000 pickup?

Yes.

And then finally, Chris, the share is off again today, so you're obviously -- the sector is under pressure here. Is there a sort of a bright line valuation level where you're going to probably look that much more closely in terms of share buybacks here as the valuation comes under pressure?

The way I would guide you about that is, if someone was an outside observer who just wanted to get a sense of that, is think about our dynamics about how we acquire other banks, and that is that the tangible book dilution is something we're very careful about and, the earnback periods apply. So I think most observers will be pretty good at doing the math and looking at where we're trading today. If we were to purchase a share and forecast whatever earnings we think are appropriate, and then look at that earnback, it's still something that want to make sure we earn back in 5 years or less. So when we hit that -- when we cross over that inflection point, we have the capital, we will continue to accrete the capital, we have an authorized buyback, and when those numbers come into alignment, we would stand ready to purchase. I think one of the things that's happened in the last week or so in the sector is that a lot of the weakness in the sector has coincided with all of us being out of the market. So I think a number of banks might have been in the market buying their own shares in the past week or so. But obviously, with restrictions, we're not able to do that.

Our next question will come from Russell Gunther of D.A. Davidson.

So I thought we could start, maybe help me understand the dynamics between what were sort of more traditional paydown headwinds this quarter versus the intentional derisking of acquired loans that you were speaking about?

So the $75 million that I referenced in the call are the intentional deriskings, I don't think our normal annual or normal amortization, is anything different or elevated. I just wanted to draw attention to those because those were loans that were a focus of ours to make a decision.

And loans that we might we had the opportunity to stay in, I wouldn't -- we don't view those as competitive losses. Those are -- in some cases, we're working with other banks and their participations and we just opt to not stay in the deal. So there's about $75 million of kind of headwind from that. What we've seen in previous acquisitions is that happens in the first quarter or 2 it's a little elevated, and then it tapers off because you kind of worked through that. Most of these facilities kind of come due, or the kinds of facilities we're talking about would come due early in our ownership of the franchise. So in over in the first year. And we're closing -- in January, we'll have ownership of Sun for a year.

Okay, great. And then, kind of how would you guys quantify what sort of where that targeted potential runoff bucket stands today? Is there an order of magnitude similar to this $75 million left or are you pretty much through that?

I don't know if I'd say that we're through it, but I don't if the magnitude is near that number. We tend to, as Chris mentioned, in the first year of ownership, you tend to touch the vast majority of those types of credit that have either maturities, or in the case of participations or large transactions, annual reviews and make credit decisions based on where you think the market is going and where the credit, on an individual basis, is going. So it's normally tended to be heavier in the first couple of quarters just because that's when you're touching them. And after that, it tends to taper off.

Okay, great. Thank you. And then last one for me, guys. I think you had mentioned that 4Q looks a little bit better from a growth perspective. In the past, we've talked about sort of a $50 million a quarter net growth number. Is that the type of bogey we should be thinking about near term and going forward or how would you size up the near-term loan growth opportunity?

I would just say that we're calibrating what I would call kind of our production capacity, the commercial teams and the number of people we have on board in the processing engine to be able to do $50 million to $100 million a quarter in growth. And then, the market kind of determines how much of that we can achieve. We see a reason why we're not going to be as productive in the fourth quarter as we were in the third quarter, which is a nice number for us. So if we get at a little less of a headwind, I think you could start to zero in on that range.

[Operator Instructions] Our next question will come of Collyn Gilbert of KBW.

Just to sort of circle it out on the loan growth discussion. So of the -- when you guys -- that $50 million to $100 million that you sort of have been targeting for loan growth or you at least were sort of targeting for the third quarter, were you anticipating at that point the $75 million sort of intentional runoff within that Sun's legacy portfolio or did that sort of develop as you pushed into the quarter little bit more?

That developed as the quarter progressed, and one of the tricky parts of about that is, we would have stayed in every single one of those deals under the right set of circumstances. So if it had turned out that the perm structures were less cash out or you -- where you got the guarantee to stick in the loan or -- under different circumstances, we might have kept it. So until you actually work through each one of these and then go through that process and you negotiate with the involved parties, sometimes you're able to keep it and sometimes you're not. But we're trying to be dispassionate about it. But it did develop over the course of the quarter.

Okay, okay, that's helpful. And then, just curious -- if you said this at the beginning, I apologize, but your appetite for purchases, obviously, there were fewer purchases this quarter than there were in the second quarter. Just sort of how you're thinking about that going forward?

That's a great question. I'll let Joe talk about some of the things he's looked at. But they're out In the market today. So there's a lot available. And we have tried to be discriminating, not just about kind of structure and pricing, but about timing. And as we look and see the potential for future rate increases, we can't help but think that time is our friend. And then we think about funding, in a sense, it's the other side of the equation, but when you look at what's happening in funding and we hope that that translates, if we're patient enough, into price power on the loan side. Because as people wind up having liquidity and funding stresses, they're going to have to turn to having a different price philosophy on the loan side. But Joe, if you want to talk about opportunities -- you looked at a bunch of opportunities. It's just hasn't cleared for you.

I think the -- I think you hit it on the head. For us, some of it is yield-driven. Some of the stuff we've looked at has been very good from a credit perspective, just the yields are just not where we need to be, and we've actually bid on a couple of pools where we've been outbilled on a -- outbid on a premium basis. So I think for us, also keeping some powder for clients is important in certain markets. I think Mike mentioned we've done some decent construction lending in this last quarter. We'd like to do some more in the right markets. So as a result, we've tended to stay away from some participation opportunities we've been offered for nonclients on the construction basis, and keep that powder dry for our own.

Okay, okay, that's helpful. And then, just more broadly on the outlook for loan growth. So you guys have been so disciplined about adding credits and mindful of structure and pricing now for a couple of years. Do you see -- and now it seems like the market is catching up with you, right? We've heard everybody just really just sort of curtail their loan growth expectations for '19. Do you think we're there yet? Or when -- I mean, it's probably hard to say, but just when you then start to accelerate, right? Because as other start to leave market and you sort of alluded to this I think, Chris. But just trying to just see what the timing might be? I mean, you've been ahead of it and conservative for the last couple of years. Do you think that the inflection maybe is coming in '19 or '20 for you to then to reaccelerate because the rest of the market pulls back? Or do you think we're not there yet?

No, I think you captured that very well. It certainly feels like, with the mounting funding pressure, right? So that one kind of lever that's being pushed and you could see it really strongly these past 90 days. So we think that the funding pressure helps us by driving, we think hopefully, market loan yields up. The second part of that is that folks have been expanding their balance sheets, compressing their NIM to create net earnings growth. So they've taken on lower margins for faster growth, which works for a little while, but you can't do that forever. We're seeing that model feel a lot of stress right now. So we think that may also translate into less appetite in the market for very aggressive loan structures. And last thing is, we're no experts on when there may be an economic setback or recession. But there is enough chatter in the marketplace that maybe that's a 20 -- late 2019 event or 2020 event, and this may sound contrary. But we've, often for a commercial bank like us, the best loans you do are in that market, because other folks can, and you have the opportunity, you've preserved your liquidity and your balance sheet, your equity position. So that -- I mean, we could grow very quickly if the stars come into alignment. We've got the staff, the infrastructure, the balance sheet for it. And frankly, we've been looking at our -- the other levers we have available to us. We have more expense saves coming in the fourth quarter, we continue to tune that. We look at our acquisition as a capital, as a growth opportunity to add seasoned assets that have been originated over the last 5 years. So we say, I go back to the kind of patient comment that we still think that being a little patient is going to make sense. But to your point about how patient for how long, hopefully that's some think we've got more opportunities in 2019 and 2020.

Okay, okay, that's helpful. And then Mike, just on the NIM, if you could just remind us again on your outlook there? And just what you're assuming for purchase accounting or purchase accretion income coming in the fourth quarter?

Yes. So we have fourth quarter accretion is down $600,000, third quarter to fourth quarter. So that comes out to about 4 basis points, so that's a headwind. The -- our prime-based loans are $500 million, so we'll get the -- those are repriced with the prime rate increase at the end of September. That comes out to about plus 2 basis points. So between those 2, you're down 2. If we get a little bit of loan growth and some repricing in the loan book, maybe that'll offset that. So that's why we think NIM probably close to where -- close to slightly less than where we are now.

Okay, okay, that's helpful. And then just finally, just background on capital, Chris. Just a little bit of history there. Have you known those guys for a while? Was this the timing on how this came together, a negotiated deal versus a bid transaction? Just trying to understand the history little bit there on that deal.

Sure. We're happy to help you with the history. The -- look, we make a practice of trying to make sure that we've got good visibility with as many of our peers as we can, and we hope to demonstrate that we'd be a good partner if they're looking for a partner. In terms of how long we've known Capital, I've been fortunate. I serve on the advisory board for the Philadelphia -- the Federal Reserve Bank of Philadelphia, and got to know David Hanrahan through that exercise of meeting regularly and participating in sessions and really came to admire what he was building down there. And as I got more familiar with the bank, I mean, each of their performance characteristics are outstanding. So well, we -- all the ins and outs and the details are for the S-4. But I was be really pleased that when they were looking for a partner, we were at the top of the list, and we were able to put something together that I think is good for everybody. I think it's good for their shareholders, who will get liquidity and other things out of it, as well as for ours. And I stressed this in my comments, but we really like the team there. Our acquisition model is a little different, I think, than some. In many cases, if you went back 20 years, the model was pretty simple. You fire everybody in the back office and you keep all the branches. And that's how you built your bank. And it's a complete flip now. We get rid of the real estate. The real estate is not where the value is. But we keep a lot of people. We keep -- we've kept more than 70% of the employees in the acquired companies. And that's kind of how our model works, keep the people, keep the relationships, that's why we retained the deposits. The buildings don't matter, and in this case, we've got four extra buildings. We don't know which ones they are and how we'll play that out. That will work out over the coming months. But that's kind of how it came together and that's how we look at the world.

Okay, okay, that's helpful. And then just finally, on tax rate. Mike, I know you gave us certainly some color at the Investor Day. But can you just sort of remind us how you're thinking about the tax rate? I know you mentioned it in the press release, but do we infer that '19, there really won't be too much of an impact on the tax rate and that the pickup really comes in 2020? Or can you just walk through that one last time for us? Or it won't be the last time I'm sure, but one additional time.

Okay. Yes. Well, it won't be because it's still a moving target. They did the -- they signed the bill July 1, so it's a third quarter event. Then we had to evaluate it. There was a -- evaluate the impact. They also had a technical corrections bill just like a couple of weeks ago to fix kind of the flaws in the rush-through legislation on July 1. So that's sort of -- that was passed about two weeks ago. So there will likely be another corrections bill at some point. So this is a moving target. But we said that we would evaluate the third quarter, the impact, going forward. We did not -- we said in the press release, that there's no impact in the third quarter either with respect to the surtax or with respect to the higher tax rate going forward. If we anticipated higher tax rate going forward, we would've revalued our DTA. The fact that we did not do that and left it, left the DTA loan would imply that there's no impact going forward right now.

So I think to reiterate, Collyn, to be clear as what we said at the Investor Day, we expect our tax rate to remain stable in 2019. And although we will not provide guidance for 2020, so we said -- we thought we'd take every action to mitigate the majority of it, and as of right now, it appears we can do that.

Okay. And then, in the no impact on '19, or no change on '19, is that because you just -- there are offsets that you're anticipating? Or is it the...

There are two scenarios under which '19 could develop, right? Mike mentioned the technical correction bills, which, as the legislation is bouncing around, it's very difficult to say exactly where is the ball going to land. But either way -- no matter what happens in 2019, we have the tax loss carry forwards that would offset it even if we were subject to the worst case scenario. Actually, it looks to be quite a bit more favorable than worst case right now. So we don't think it's going to be a meaningful headwind. But that's based on the current legislation that was tweaked 2 weeks ago. That could tweak again in 2 weeks. So '19, we're very confident there's no headwind, there may not be a headwind after that.

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

Just one question from me on the expense side. You had a cost savings, it looks like, ends after the third quarter. Just any thoughts around -- what's the core expense run rates for the company kind of -- as I look at [ 2004 on ] at your underlying growth, and do you have any initiative either on the investment side as you're rolling off new products? Or conversely, you've definitely shrunk the real estate footings. Is there anything more to do on that side? Thanks.

Sure. I think if you started with our core earnings for the third quarter, and then as we said earlier, we expect those may decrease another $1 million in the fourth quarter. That kind of gives you a baseline kind of long-term run rate, at least until Capital falls in. As you go into 2019, you're talking about inflationary pressures to that total budget. Things like health care plans and all that. But you're not -- there's no specific initiative that would drive that number materially higher than, say, the rate of inflation.

[Operator Instructions] Our next question will come of Don Koch of Koch Investments.

I have 2 quick questions here. One is, I -- everything you're doing is really quite brilliant in a tactical way. I worry a little bit about the strategic notion, and that is, you're in a state -- you're sitting in a state with 9 million souls, half of which vacation in Florida, and you've to got somehow follow that deposit growth to keep those low cost deposits in a higher -- in a rising rate environment. I mean, one of the things you just got to do is make sure that you protect the right side of the balance sheet and ensure that those people who migrate or move or do whatever they do, don't get sort of rated by the characters in Florida. So what kind of steps you are taking for that?

I appreciate the question. And then, your reference to the right side of the balance sheet and liabilities and funding. That has been the fundamental -- of fundamental importance to us, which has kind of guided our strategic decisions, including the acquisitions. In terms of geographies, we never rule out expanding our geography, but the first thing we're trying to do in the near term is to make sure we're really good where we are today, and we feel that defining that is greater Philadelphia, greater New York and all of New Jersey provides a wide open space for us to do a lot of work. Down the road, we watch migration patterns as well, and we're thoughtful about things. But we wouldn't rule anything out. But for now, we want to be focused on being the best bank we can in our markets. And I would kind of refer you to, in the case of Capital, the acquisition of Capital will improve our market share in Cumberland County to 33% and then our market share in Atlantic County to north of 24%. And we think that we deliver value in our business model by being really good where we are. Now as we -- you can't get much more market share than 33% so we're going to have to look at new geographies. So we'll keep your thoughts in mind and appreciate your interest.

So -- and all I say is, take a look at Michigan. They lost 1 million souls in the last decade. And so there is a migration pattern from high tax states to low tax states. My second question is, on almost every call I listen to in this period, exactly what you mentioned came true, and that is almost all the participants, for some reason, had blackout periods and they really could not be -- they just could not be in the market. Have you ever thought about just some kind of signaling where directors even acquire 1,000 shares or some kind of signaling that the corporate management is thinking that the stock price is too low and it's very valuable? Because I mean, a lot of us look at how the directors are behaving in buy and sells. And even though you can't come in there with an acquisition from corporate, you certainly can signal that your price to book is too low and the valuation is very compelling by just even 1,000 shares by some of your directors.

Yes, appreciate the thoughts. We're -- the compliance has always been a high priority for us. And so we're guided by being really careful to make sure that we all live by the rules we have to live by. So I think over the long term, those things even themselves out. And I don't think blackout periods make much of a difference over a long period of time. So I think things will get to where they're going to get to. So I appreciate the thoughts.

Our next question is a follow-up from Dave Bishop of FIG Partners.

Chris, had to hop off and hop back on, so apologize if these questions have been asked. But the narrative makes note of the writedown on your favorite banquet facility there. But it sounds like you got a letter of intent with a buyer. If you had to handicap it 50%, 100%, it's out of OREO at the end of the year? And just curious how big of a chunk is that property in terms of the OREO balance right now?

Sure, so I can -- let me just share the facts, right? We have a contract with a nonrefundable deposit, closing scheduled in the next 30 days. We have seen proof of financing and proof of funding to get to the closing. So terms of handicapping, I don't know how to handicap. But I would tell you, we have those facts lined up positively. We have written it down to a price now of about $5.1 million, so it's actually the majority of our OREO. And at that price, I can tell you we have other buyers standing by. Either we're exiting this in an orderly fashion, but expeditiously so.

Okay, got it. Good color. Then I think you said the core or outlook for operating expenses down about another $1 million or so in the fourth quarter. Just curious. Is that through headcount occupancy and equipment? Just curious maybe from a granular perspective where we see those cost savings being realized? Thanks.

Dave, it's Joe. Part of that comes from occupancy and equipment. Part of it in a little trailing data-processing and part of in comp. But comp is probably the smallest piece left.

And that's basically legacy Sun expenses, Dave, that carried over into the beginning of the third quarter, because our conversion, as you remember, we've -- our system conversion was June 7. So most of those costs came out of June 30, but we had some personnel stay through July 31 and have now exited, and there is some, like Joe said, some systems and occupancy costs that trickled into July and August which will be in be out in the fourth quarter.

Ladies and gentlemen, this will conclude our question-and-answer session. At this time, I'd like to turn the conference back over to Christopher Maher for any closing remarks.

Thank you. With that, I'd like to thank everyone for their participation in the call this morning. We look forward to providing additional updates following our year-end financials. Thank you.

The conference has now concluded. We thank you for attending today's presentation. You may now disconnect your lines.