OceanFirst Financial Corp. (OCFC) Q4 2019 Earnings Report, Transcript and Summary

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

Thank you, Jason. 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 statements disclosure. Please remember that many of our remarks today contain forward-looking statements based on current expectations. Refer to our press release and other public filings including the Risk Factors in our 10-K, where you will find factors that could cause actual results to differ materially from these forward-looking statements. Thank you. And now I will turn the call over to our host today, Chairman and Chief Executive Officer, Christopher Maher.

Thank you, Jill, and good morning to all who have been able to join our fourth quarter 2019 earnings conference call today. This morning, I'm joined by our Chief Operating Officer, Joe Lebel; and Chief Financial Officer, Mike Fitzpatrick. As always, we appreciate your interest in our performance and are pleased to be able to discuss our operating results with you. This morning, we will highlight a few key items from the quarter, add some color to the results, and then discuss our views regarding the operating environment for 2020. After that, we look forward to taking your questions. In terms of financial results for the fourth quarter, GAAP diluted earnings per share were $0.47. Quarterly reported earnings were impacted by merger-related expenses, branch consolidation charges, non-recurring professional fees, and a reduction in state income tax expense related to a change in the New Jersey Tax Code that totaled $2.3 million net of federal tax benefit. That results in core earnings per share of $0.51. Earnings were subject to headwinds related to net interest margin and some accelerated IT expenses related to end-of-life equipment migrations. Net interest income plateaued during the quarter, and is positioned to improve in 2020 as net loan growth may compensate for any additional margin compression over the next few quarters. Operating efficiency is also positioned to improve as we have the scale benefits of the Two River and Country Bank acquisitions which both closed on January 1 of this year. Joe will provide more color on operating conditions and the integration of the acquisitions later on the call. Regarding Capital Management for the quarter, the board declared a quarterly cash dividend of $0.17, the company's 92nd consecutive quarterly cash dividend. The $0.17 dividend represents a conservative 33% payout of core earnings. We remain at the lower end of our historical payout range for a few reasons. First, our organic growth trajectory provides the opportunity to put internally generated capital to work. Second, our acquisition experience has provided the opportunity to deploy capital; the Two River acquisition provides an opportunity to deploy $48 million worth of capital just this month. Finally, share repurchases are efficient and effective at our current valuation. The Board approved the new repurchase plan in December which provides the opportunity to purchase 2.5 million shares. At today's valuation, that repurchase plan would enable $62 million of capital to be returned to shareholders. During 2019, the company has repurchased 1.1 million shares at an average cost of $23.12 returning $26.1 million of surplus capital to our shareholders. Core net income fell slightly from the prior-quarter but appears to be leveling-off and is positioned for improvement in 2020. Net interest income was flat due to margin compression, but should build going forward. The year-end loan portfolio was approximately $45 million larger than the average quarterly balance in Q4 and approximately $200 million larger than the average quarterly balance in Q3. Loan pipelines remain strong moving into 2020. Fourth quarter operating expenses were elevated as we opted to augment our IT staff to accelerate workstation and server lifecycle upgrades. In addition, renegotiated core processing in digital banking contracts reduced infrastructure costs materially beginning in January of 2020. Finally, the addition of Two River and Country Bank businesses will provide some immediate financial benefits and their contributions will strengthen over the course of 2020 as integrations progress. Our balance sheet remains quite strong. Net charge-offs for the year were less than three basis points. Delinquencies and risk rating have used no signs of concern and non-performing assets totaled just 22 basis points of total assets. Tangible book value per share ended the year at $15.13, a 6% increase over year-end 2018. Over the past three years, tangible book value per share has increased by $2.19 or 17%. During a period of significant acquisitions, we remain focused on this metric. I will let Joe speak to the quarterly operating metrics later, as I'd like to take this opportunity to talk about the longer-term performance of the company. At a recent investor presentation, I was asked which investor question I found most disappointing. After considering I responded that the focus on short-term metric changes can make it difficult to assess trends and the outlook for long-term value creation. In the current environment, the emphasis on net interest margin, tax rates, and quarterly provisions falls into that category. As we consider the long-term prospects for our business, we look toward indicators of an ability to thrive over a wide variety of operating environments. That said there are certain table stakes which are required bank performance metrics. Those include net interest margin, return on assets, return on equity, operating efficiency, net charge-offs and non-performing asset levels. Our performance metrics in each of these areas are competitive. 2019 core results include a NIM of 3.62%, return on assets of 1.30%, return on tangible common equity of 14.2%, core efficiency ratio of 55.8%, net charge-offs of just 2.3 basis points, and non-performing assets totaling just 22 basis points of total assets. The current interest rate environment will cause some additional compression in margins for another one to two quarters, but our performance measures should remain competitive regardless of that. In the meantime, our longer-term value creation opportunity rests in an ability to improve revenue growth and operating efficiency on a consistent basis. We have three levers that provide the ability to produce revenue growth. Those are traditional organic growth, growth via acquisition, and digital customer acquisition. During 2019, we demonstrated performance in all three areas. On an organic basis, our entry into New York and Philadelphia resulted in the origination of $450 million in new commercial loans in those markets, helping to lift annual organic loan production by 60% to over $1.5 billion. Regarding acquisitions, we completed the Two River and Country Bank acquisitions which were our sixth and seventh whole bank acquisitions. They deliver important scale as well as the opportunity to increase efficiency. On the digital acquisition front, our multi-year efforts are beginning to evidence results. Mobile activation rates drive high levels of customer satisfaction which have enabled the bank to address branch operating expenses more quickly than most of our peers. By June 30, 2020, branch consolidations over the past five years will total 53 branches. We've completed these consolidations while growing total deposits and delivering one of the lowest deposit costs in the Northeast. In addition, our mobile account opening process and our hybrid robo advisor product are generating meaningful numbers of new digital customers. Combined these products have delivered over 4,300 new relationships. These figures are not high enough to drive profits in the short-term but they represent a meaningful portion of total new relationships. Our digital experience is teaching us how to attract, service, and retain digital clients. The unit economics associated with both products is highly attractive as our products are priced very conservatively. The ability to increase revenue organically through acquisitions and digitally is an incredibly important advantage. Equally important is our ability to drive efficiencies over time. Organic growth provides consistent improvements in scale, while acquisitions provides step function opportunities to improve operating efficiency. And our digital focus reduces the cost to service our clients in addition to enabling rapid branch consolidation. We remain highly focused on the table stakes of margins, profitability, balance sheet quality, and earnings per share growth. The business performs well today and is strongly positioned to thrive in the long run. I'd also like to be clear about our strategy related to the $10 billion regulatory threshold. As the economy stabilized in 2019, and our organic loan originations picked up steam, we’ve become more optimistic regarding the opportunity as far as high quality organic growth in the upcoming quarters. Based on the external environment shift and increased confidence in organic growth, we have positioned the bank for consistent organic growth over the next six quarters. Having begun 2020 with approximately $10.2 billion in total assets, the additional growth is able to offset the revenue reduction associated with the Durbin Amendment. We time the closing of our most recent acquisitions to fall just after midnight on January 1, 2020. As a result, the Durbin Amendment impact will be effective on July 1, 2021, provided we finished calendar year 2020 with more than $10 billion in assets. Building additional scale in the coming years is important, but can be accomplished in an organic manner. It is important that we continue to evidence a conservative bias regarding acquisitions. While acquisitions provide an important lever to improved performance, organic business growth needs to remain our most important strategy. At this point, I’ll turn the discussion over to Joe Lebel to provide more details regarding operating conditions and some additional color regarding many of the initiatives I've outlined earlier.

Thanks, Chris. Record loan originations of $504 million drove loan growth of $125 million for the quarter. Commercial lending closings were strong at $265 million with all regions of the company providing meaningful contributions as our new geographies in New York and Philadelphia closed $148 million and our Legacy New Jersey markets closed another $117 million. The commercial bank grew $59 million for the quarter. Residential real estate concluded 2019 with another stellar quarter with $239 million in closings and then $66 million in portfolio growth. The total pipeline at $328 million remains robust and at an all-time high despite the record closing quarter. More importantly, we’re seeing a shift in the mix of the loan pipeline to commercial from residential which will help as commercial originations typically carry a higher interest rate. Accordingly, we anticipate a solid first quarter 2020 in loan activity despite very difficult competition in credit terms, pricing, and non-bank. Our swap products had a solid quarter. And while fee income from swaps can be volatile quarter-over-quarter, we expect this income stream to build in 2020. Operating in new Metropolitan markets amongst fierce competition in this rate environment and originating the volume of residential loans we do in our markets has impacted the net interest margin. For the quarter, average yields on new originations were impacted by Fed cuts and competition in new and existing markets causing the net interest margin of 3.48% to decrease by seven basis points. The effect of prior Fed cuts and longer-term treasury rates were seen in lower weighted average originations of 4.05% for the Commercial Bank and 3.49% for the residential book. Much of the loan growth was later in the quarter. So, we will see a positive impact on the net interest income in 2020. The change in loan mix into more commercial will help offset pressure on the NIM and deposit costs are stable. Our cost of deposits was basically unchanged this quarter at 64 basis points, up two basis points. Moving to expenses, the $2.2 million increase quarter-over-quarter was related to higher compensation, data processing partly due to system upgrades, and professional fees mostly related to technology and consulting services. On a positive note, we recognized savings in early 2020, on data processing contracts which are recently negotiated. The merger integration for the recently closed acquisitions of Two River Community Bank and Country Bank are going well. We're working through the final underpinnings of some branch rationalization related to the Two River acquisition and our existing branch footprint. Some of the rationalization savings will continue to fund initiatives in digital acquisition, additional expansion in treasury services, information technology, and to support our growing customer base in New York, Philadelphia, and New Jersey. Chris mentioned our continued success and focus on digital acquisition of clients through Nest Egg and AmiGo. Nest Egg, our hybrid Robo advisory product introduced early last year has gathered over 1,000 accounts and $35 million in assets under management as of year-end. AmiGo, our digital online checking accounts has also seen solid growth of over 1,000 active profitable accounts. These digital checking accounts pay a modest 0.25% as we focus on quality digital growth. Similarly, Nest Egg asset management fees are 110 basis points keeping with our goal to build a profitable digital business. As I stated before, this represents small dollars to-date with little impact on financial performance in 2019 and likely 2020 but unit economics are excellent and growth remains well ahead of plan. Looking into 2020, we expect solid loan growth in the face of competition as we remain bullish on our talent, sourced internally, through acquisition and recruitment. We saw loan originations grow over 60% in 2019 to just over $1.5 billion and while we anticipate lower residential activity, the Commercial Bank momentum should continue to deliver growth. We anticipate the bulk of the loan growth to come from Philadelphia, New York although as we saw in the fourth quarter, we see continued opportunity in our legacy markets as well. Deposit growth will be challenging but attainable and ably supported by our burgeoning digital focus and product set. With that, I'll turn the call back to Chris.

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

We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Frank Schiraldi from Piper Sandler. Please go ahead.

Just wondered if you know there's a lot of -- well there's obviously with the deals closing earlier this year there's significant changes to the income statement as you fold those two names in but just wondering if you could help us maybe think about expense base levels post deal where you expect those two to flush out in the near-term?

Frank, its Mike. Yes, so the first quarter would be the highest for the year as there is not less opportunity to take out costs saves. There's a little bit of cost save that happened right away but not that much. And then they trend -- and then they trend in over time. So we're probably -- we're expecting first quarter would be roughly $53 million in operating expenses and that might trend down to about $50 million in the fourth quarter.

Great, okay. And then just secondly on the margin, Chris, you talked about perhaps a couple more quarters of NIM compression. Looking at the pipeline and I realized that it's more skewed to commercial which helps but still if I look at that, the average yield there versus the average yield of the book, if I would imagine that's what's driving the near-term compression. If you could just talk a little bit about the NIM mechanics and how you reach stabilization there in one or two quarter’s time?

So I think you have to look at both sides of that equation. Frank, you're right that the loan yields will be under a little bit of pressure even as we shift to more commercial than residential, we're still going to be putting loans on slightly lower than the portfolio yield. So we expect for the next couple quarters, you're going to see a little bit of that. Where we're going to make it up is unlikely on the loan side. And the reason I say that, this is a very competitive market particularly as we expand into the urban areas where there’s a lot of good, high quality competition. You're going to wind-up if you stick to your credit terms and your structures. You’re going to have a pretty competitive yield. That said our deposit costs plateaued for the last three quarters of the year, staying within a range of about two basis points. At some point, we do hope to start to bring those costs down as well. There's a little bit of a lag effect. Many of our treasury clients have rates fixed for a period of time, even on their transaction accounts. So we're hopeful that as we move through 2020, we might be able to pick-up a little bit of an opportunity on the deposit side. So it's really two things, less pressure on loans going out a couple of quarters and then maybe being able to pull some off the deposit side. There is little bit of a mix shift we can replace some securities loans, but that's probably not going to be a big impact.

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

A quick follow-up on the expense guide, Mike, the $50 million general target for the fourth quarter. Could you just give us a sense of what's included in there from a cost save recognition from the two deals that just closed as well as what the vendor contract savings be in that kind of $50 million run rate as well?

The last point here, the vendor contracts that were renegotiated in the fourth quarter, the Legacy OceanFirst contracts the benefit will start in January -- to that this month January 2020. So that's in -- that'll be in the first quarter and the fourth quarter numbers. With respect to Two River and Country, we were -- this is consistent with the merger announcement we expected 54% cost saves for Two River, 33% for Country. So those -- some of those as I mentioned happened day one, but most of those happened subsequent to system conversion dates for Two River that would be May, for Country it would be later in the year. So like I said the expenses will gradually wind-down over the year from $53 million to about $50 million.

Okay. And then because the deal-related cost saves are largely with the systems integration as well as once you've recognized day one, Mike, it sounds like the $50 million 4Q run rate would be inclusive of pretty much all of the deal-related costs saves, is that correct?

It'd be pretty close to little bit, Russell, it’s Chris. The Country integration is probably going to happen in the fourth quarter. So you're not going to get a full-quarter benefit from that. That said, as you roll into the first quarter of 2021, you'll have some pressure just from ordinary inflation items like benefit plans and that kind of stuff. So that won't represent the full efficiencies. But it's a decent kind of trajectory from there.

Yes, thank you, Chris. Got you. And then apologies because I missed the first two minutes of your table stake commentary and particularly around the core efficiency ratio. So is that a result that you anticipate achieving for 2020 that I believe you said the 55% mark, if you could just clarify comments there for me, that would be very helpful.

Sure. So there’s two sides to that efficiency ratio. On the expense side, we feel really comfortable with that, obviously with NIM having compressed in the last couple of quarters and not knowing the exact shape of the yield curve as we go into 2020. It's the revenue side that would be a little bit more sensitive. So we still think that we can be below 55 and approaching 50 but it's going to be, the exact numbers can be driven more by net interest margin and revenues than it would be by expenses, we know kind of where the expenses are going to come in. There's a little bit of movement on the NIM depending on the exact shape the yield curve throughout the year.

Okay, very helpful. Thank you. And then I heard you guys on the loan growth side of things, particularly slower single family resi and trying to tie that together with being through $10 billion in assets, what that would imply for the mortgage gain on sale within fees?

So we have not been running that business for a lot of gain on sale, obviously, I think we might have the opportunity to do more of that as we go through 2020 especially because we really don't want to build a concentration in any of especially the 30-year paper. So I think you'll see some mortgage gains gain on sale during the year but it's not going to be a material number.

Okay, great. And last one from me again apologies if missed it, but any guidance on the tax rate for 2020?

Yes. So we’ve said for OceanFirst we've guided about 21%. When we merge the three banks, Two River’s tax rate was higher than was higher than ours, Country was similar. So we'll probably, we start the year maybe at a higher rate 22% or actually or maybe little more Two River and then over the course of the year, we can kind of apply our tax strategies to the Two River portfolio and wrote that tax rate down. So it's likely be a little bit higher in the first and second quarter and then a little bit lower maybe later in the year. So for the full-year maybe about 21.5%, 22% something like that.

The next question comes from Sean Tobin from Janney. Please go ahead.

First to touch on the buyback, you bought back around 1.1 million shares in 2019 given where shares are valued today, would you expect that your appetite for buybacks to be even healthier in 2020? And then just a follow-up to that, what are some of the thresholds that will determine how aggressive you are on that front?

So I think if you look back into 2019, our buybacks were a little bit limited due to just the windows in which we could buy back. We had the acquisitions pending and there's certain math over how many shares you're allowed to purchase in any given period. So we had a stronger appetite than we were able to execute on in 2019. As we go into 2020, the valuation hasn't changed much. While we don't release any specific guidance over prices, we have in the past talked about tangible book value dilution and earn backs. So I think if you were to go out and solve for keeping our earn backs in the five-year or less range that would give you a sense as to where appetite is. I think in 2020, it's going to be more execution bounded. So if we can find the shares at the right price, you'll see this repurchase decent amount of shares. But if the market is not there, we're going to be disciplined about it. It's one of the nice, I think advantages we have is buybacks are one tool we've been able to deploy the capital through organic as well as acquisitions. To give you a sense, we deployed $108 million worth of capital essentially during the last year. So that was $26 million of buybacks, $34 million of regular quarterly dividend, and $48 million was consideration in the Two River acquisition which we closed on January 1. So we think we've got a number of levers if we can do it in buybacks we’ll do it but if we start to get concerned about the earn backs to the price, then you'll see us use a different tool or we’ll let the capital build-up for a little bit, you can always use it hopefully down the road in organic growth and acquisition.

Got it, that's very helpful. Then switching gears to the loan to deposit ratio. And on the past you guys have said that you prefer to stay under 100%. But it sounds like deposit growth may be a bit of a challenge going forward. Would you be comfortable kind of surpassing that 100% mark or is the plan still to kind of fund loans and deposits dollar-for-dollar?

The way we look at loan to deposit ratio is that there is a kind of your perfect target would be just at 100. But it's hard to manage perfection. So we've tended to stay a little bit under 100. It gives us a lot of optionality. But if we found it economical to go to 101 or 100.5, we wouldn't allow it to serve as a too restrictive measure. That said, we're not a company's that’s going to 110, 115, 125 loan to deposit ratio. We don't think that's the appropriate risk position to have. But I wouldn't look at 100 is a limit, I would look as 100 as an ideal place to be.

Got you. Then just one interest rate related question do loan floors, are they possible for you to get done today? Is that something you're looking at for 2020 within your commercial contracts?

Yes, Sean it’s Joe. We’ve been employing loan floors for a while once we saw the direction where the Fed was going to go last year; we started implementing them mid-year largely in the commercial book.

[Operator Instructions]. The next question comes from Collyn Gilbert from KBW. Please go ahead.

Thanks, good morning guys. If we could just start on the loan growth that you saw this for the quarter and just kind of the dynamic as you're thinking about that broadly, obviously resi came in a lot stronger than perhaps what you were thinking or I was thinking. So just curious as to the dynamic there and what you see the drivers to be as to why that might be less in 2020. And then, Joe, I appreciate your comments around kind of the pipelines and that type of thing. But maybe if you could give a little bit of a tighter outlook as to what loan growth you're expecting for 2020 if you guys can still hold it at that? I know you for a while you've been targeting kind of that $100 million or so quarter-over-quarter. So just two questions there on that loan growth?

Thank you, Collyn. I think on the resi side look it was a little bit of a perfect storm last year. Not only do we have talented folks in a broader reach in the markets that we serve, we also had the benefit of a really solid and decreasing rate environment. So I look at it even seven, eight, nine, 10 years after the financial crisis people possibly couldn't afford to refinance those years back refinance with us at lower rates. What was really fascinating to me is that over the volume of resi business we did, the internal refinance rate was less than 30% which is just fascinating compared to prior low rate environment. So I think just by normal course, you would expect that just to dissipate. If it doesn't dissipate good for us. But we're anticipating that, we're not going to have a year where we're going to originate $580 million in resi. The good news is that you start to see the pickup in the new markets in Philadelphia, New York, we're bullish on those. Most of those teams are fully staffed; we continue to look for more people. So and we've noted the mix in the pipeline. So I think we're going to continue to see that growth will be more slanted towards commercial and we still believe that $100 million a quarter is attainable despite the change in the mix, there might be a little lumpy on occasion, but for the most part, we think that's a real solid clean number that we can focus on.

Okay, that’s great. That's helpful. And then Mike, just a question on the NIM and Chris, I know or one of you had said relative stabilization in the core NIM going forward but just curious as to what you're expecting, like in terms of accretion for 2020? I think you guys would put up like close to $14 million in 2019 and just maybe sort of how you see that running down in 2020?

Okay. So there's some -- so that's the Legacy Ocean’s first accretions. So for that there's about a $500,000 decrease in the first quarter. And then it's very modest after that about maybe $150,000 to $200,000 a quarter, second, third and fourth quarters. So it's really most -- so it’s fairly modest impact. And then we're going to be adding to that accretion purchase accounting adjustments on Two River and Country. We don't have all those scheduled out yet, but those are not going to be -- they're going to have a relatively modest impact because of the rate environment and where it is some of the interest rate more are actually premiums then not discount. And the credit marks were not that much different than what their existing allowance was. So those will have an impact, but not a significant impact.

Okay, okay. That's helpful. And then did you provide any or can you guys provide any guidance on CECL?

Yes, so we didn't provide any guide chip, let me just reiterate what we discussed after the third quarter results because we don't think it's shifted very much. We have a complicated allowance because it includes the purchase accounting marks on all the banks acquires, we have five banks for the purchase accounting mark kind of part of the soup. A portion of that mark carries over to CECL. So it carries over a portion does not after the third quarter in our investor presentation, we said that we expect that the incremental add to the allowance related to CECL might range between $5 million and $10 million. So that's kind of a net impact on the OceanFirst portfolio after the third quarter. And we don't see that changing much in the fourth quarter. So we rerun the fourth quarter and it's almost identical. So that's the OceanFirst portion. We're still in the process of going through the CECL marks for Two River and Country. But we don't expect a big impact from those either. So we're kind of categorizing this as a reasonably modest additional provision. Now we'll have to run the Two River and Country provisions through the income statement in the first quarter because those happened technically after 12/31. So you'll see they're kind of going through the GAAP net income statement at this point, but I think $5 million to $10 million in the Legacy OceanFirst and then a little bit more for Two River and Country. But it’s not going to be a joint number.

Okay, okay, that's helpful. And then Chris, just finally if you could kind of give us your thoughts on additional M&A, the consolidating market, if you're seeing any change in the landscape, or how you're thinking about the acquisitive component of your business going forward?

Okay, we've obviously -- we like using acquisitions. We've done it on a number of occasions. We think that there are industry-wide pressures that should cause more consolidation over the next few years. And those pressures are really they’re technology digital and continuing pressures over compliance, although the compliance environments may be a little bit more friendly than it was a few years ago, it's still a pretty big burden, right. There's still a lot of new regs that came out of Dodd-Frank. So we think that there's more consolidation ahead for us as an industry. In terms of our appetite, we're comfortable, we think we've done it, done these acquisitions well in the past; we would be open to doing others. But it's only really important to me that we don't feel forced to do that because you have some issue, you're trying to resolve in your core business. That never works well; you have to have a good core business. And then if you find an acquisition that furthers your goals and accelerates your strategic plan that makes sense. So I put us in a position of kind of ready, willing and able to make an acquisition that the smart one came along, but not feeling any pressure to do so especially over the $10 billion and the Durbin comments. So we start the year at $10.2 billion. And as Joe was talking earlier, we like to see, let's say, we can get loan growth of $100 million a quarter, we have six quarters to get to that kind of Durbin beginning points. If we add another $300 million, $400 million, $500 million worth of assets between now and then that should overcome the Durbin headwinds. So we thought it was the right environment and the right time for the company to push through the $10 billion. And we think we can do so without acquisitions. That said, if the right acquisition comes along, we’re prepared to move forward on.

The next question comes from Brody Preston from Stephens Incorporated. Please go ahead.

Just wanted to quickly follow-up on the M&A discussion and most of my other questions have been answered. But wanted to get a sense for what size you thought the balance sheet needed to be to fully offset the Durbin-related hit?

So we think the minimum size probably somewhere around $10.5 billion to $10.6 billion. And we say that because every bank is different in the composition of their interchange income. So when you look at the interchange income, you have to understand there are two parts to it. There's a section that is think of it as a signature-based transactions and pin-based transactions. So the signature-based transactions in the market continue to earn a level above the Durbin maximum charge. So that's where you're going to see the compression. So it's not even all of your interchange income because the pin-based interchange for us anyway is right on top of the Durbin level anyway, it's that way today. So when we've modeled it by 2021, we think that's about a $5 million pre-tax item. So it's probably a $4 million after-tax item. And if you use kind of a rule of thumb and say you’re going to earn 1% more return on assets, you need several $100 million to get to break-even. So that's kind of how we back into the number. The other thing to keep in mind is that Durbin number has been falling for us for the last several years. And the reason it's been falling is all goes to transaction mix. So as our customers do more pin-based and less signature-based transactions, less of our revenue is subject to -- practically subject to Durbin, but it's all subject to Durbin. But as a point, the market price for pin-based is really right on top of Durbin. So I hope that provides guidance. Now, that said if we could do an acquisition on top of that and it was accretive that'd be a great thing, but we don't think we need that in order to overcome it.

Okay. And I guess as I -- just as I think about the timing of future acquisitions. Chris, it sounds like with the, I think it was the Country conversion you said has inflated to go through until the fourth quarter. If you were to sort of maybe jump back into M&A, does it -- would that be a first half of 2021 type of event or would it be more second half 2021?

We don't think that those integrations would limit our ability to be in the market in 2020. The right opportunity came up; obviously, we're squarely focused on making sure we do the right integrations with the banks we have going on now. But I would point out in 2016 we integrated both Cape and Ocean City Home in the same year and just staggered them out, so overlapping the integration timeline with an acquisition timeline is not a terribly difficult thing to do. So we're focused internally now but there's no reason that we couldn't enter into the market in 2020.

[Operator Instructions]. The next question comes from Erik Zwick from Boenning & Scattergood. Please go ahead.

Good morning. Maybe just a quick follow-up on your last response with regard to Durbin. So the $5 million pre-tax figure you mentioned is that based on the run rate you saw in 4Q 2019 or that's where you estimate the impact will be in July 2021 given the dynamics you outline the declining portion of signature base, as well as any growth that you would expect in customer balances and activity between now and then?

So that's based on where we think will be but that’s not materially different from where we are today. There is a difference in there's a migration but it's a slow and steady migration. It's not dropping like a rock.

Got it. Thank you. And then just one last one from me. In terms of what you can see into commercial pipeline today wondering if you can provide a little color in terms of the split between commercial real estate, C&I and then if there's any particular industries or product types, where you're really seeing the most attractive risk adjusted opportunities for lending today?

So most of the pipeline is skewed in CRE although we do have some C&I opportunities in all of the footprints. I would say that probably over 60% of it is CRE, none of those are limited to any one, whether it's retailers or multi-year or any of those types of areas. I think it's fairly dispersed in different and similar with the -- similar with our expectations as we go forward in all the markets. Everybody, I think would love to do more C&I relationship-based business as would we; it's very difficult in the marketplace to do it. We have the talent and teams to do it. So but at the moment, the pipeline is much more in the CRE space.

I would just add to Joe's comments. Within CRE, there's a lot of different segments and a lot of different geographies. So we're very thoughtful, we don't have anything that we would kind of put on a list and say we won't do. But I will say there were certain CRE asset classes, where the hurdles we would expect to clear in order to do a responsible deal are higher. So we're very thoughtful about industrial warehouse lending, we do it, but we're thoughtful about tenancies that's been a really high growth rate kind of subset. We're very thoughtful about multifamily in New York based on the cap rate changes that appear to be going on that are kind of an outgrowth of where the lease revenue changes that are being enacted in New York. And then even looking in Philadelphia, there have been some changes around tax credits and tax incentives around new developments. So we're thoughtful we will do any well-structured loans in any of those markets, but we do have our eyes open and you're not going to see us over concentrate in any one asset class. And you're going to see us be pretty careful about those and in construction, especially spec construction. So we've been keeping our construction portfolio to a reasonably modest level.

I appreciate the color there, maybe just one quick follow-up, you have mentioned the desire to potentially do more C&I, it sounds you've got the right lending team, they've got the right relationships. So it sounds like it's more of a borrower issue at this point and is it just the interest rate environment or the economic growth environment or what do you think is keeping potentially the demand there in check today?

There’s two factors. The net new demand is somewhat tepid in the Northeast, which means that most of the C&I opportunities are gaining share off a competitor. So that is an expensive thing to do. You're going to have margins; they’re going to be compressed because of that. And then I think if you were to sampler listen to a lot of these earnings calls, a lot of people have been charging into the C&I market. So you have a lot more players going into a market that is not growing organically very quickly. So we've had some great opportunities where the pricing was just -- I mean is well south of LIBOR plus 100. And as much as we love those opportunities, you can't really make money at that. So for us, I think there are opportunities out there. We’re in a competitive moment where pricing has been really pressed. And that'll probably abate over time.

The next question comes from William Wallace from Raymond James. Please go ahead.

Hi, good morning. I have just one follow-up question on net interest margin and then I apologize if you addressed this in the remarks but last quarter I believe there was a negative impact from prepayment penalty income. I'm just curious what the prepayment penalty income was in the fourth quarter and the impact was to net interest margin?

It’s a little bit higher than the last quarter. So it was probably about three or four basis points for this quarter.

Is it three to four basis points higher than last quarter or three to four in total?

It’s -- this quarter was four, last quarter was one, so it’s three basis points higher, the total was four.

Historically, prepayment has not been a big line item in our NIM.

Yes. Okay, thanks. And then, Chris as it relates to the commentary around going ahead and crossing 10 because you believe you can, I guess grow the asset base enough to share to offset that impact, when you initially introduce these acquisitions, I believe the plan was to manage and cross in 2021 unless you saw growth opportunities that were higher, so should we -- should we expect then that the EPS impact from crossing Durbin earlier will not impact the tangible book value pay back or EPS accretion expectations that were given to us with the deal announcements?

Yes, I think it's going to be about even and the way I would look at that is when we announced the deals, the big change has been more external than internal. So we announced the deals in the beginning of August. And if you recall, like, that's the point where we weren't quite sure how much more work the Fed had to do in terms of how many more cuts, the yield curve was in fact great today, but it was particularly terrible, then. We looked at that as an environment that would not be the best environment to organically grow through at least not in the numbers we're talking about today. So the environment shifts a little bit of the steepening of the yield curve I mean still not the curve we would want but at least it's got some slope to it kind of put us in a position to say this is an environment we can operate in. If you think about it this way, when we announced the deals we said, we stay under 10. And we had certain earn back projections. Now we're going to grow over 10. But by the time Durbin impacts us, we should have enough assets to offset those charges. So it's about a neutral ball. And one of the things that we've always done is we've looked at acquisitions over the years, some of which that would cross us over 10. And we don't think it's appropriate to apply Durbin to that last acquisition because it would cause you to maybe make the wrong decision in the long-term interest to your shareholders. So even with our example, right, if we were to model both of these, would we model it, we tag Durbin into Two River or we tag into Country and it causes the decision criteria, it's a little bit silly. If you're going to be around in the long-run, and you're running your company for that and you think you can be materially above $10 billion, then it's only a matter of time before you overcome Durbin. So it's not a perfect exchange by the third quarter of 2021 within a couple of quarters after that we’ll be through it. And we do think it's a barrier, we have to put behind us. And we want to make sure that everyone understands that we don't feel any pressure to go out and have to acquire something to overcome that.

Understood. And then I'll just ask one more question on net interest margin. I understand that there's a ton of moving parts. And it's hard to predict from one quarter to the next, what your NIM might do. But if you just think about where the curve sits today, the shape of the curve today and assuming that we don't hear and have any more cuts or any more movement from the Fed, do you think that the pressure that you would expect or anticipate we might see in the first and possibly the second quarters would be more than offset by what we see by the time we get to the fourth quarter or do you think that it's just kind of like we see some pressure in the first half, we get some benefit in the second half and we end up the year kind of around where we are now.

As you understand it's really hard to say about that.

I got you.

If there's no change in the yield curve, I think that's not an unreasonable scenario. Then one of the other things we're very much aware of is that we're in the midst of what is going to become a giant Presidential election cycle. And I think during the course of the year, we're prepared for some pretty wild swings in things like the markets and anticipation over interest rate movements and things like that as people handicap how they think the Election is going to play out. So we're expecting volatility this year. We've got a relationship business. We think that over the long-run, we've got a net interest margin that is well into the threes. We're not a company that's organized to have a net interest margin of 2 or 2.25. But there'll be some quarters that are better and worse than others. So we're not looking for a lot of movement in either case.

Okay. Fair enough, thank you very much. Appreciate it. I will step-out. Great, thank you.

[Operator Instructions]. The next question comes from Brody Preston from Stephens Incorporated. Please go ahead.

Hey guys, just one quick follow-up for me. You mentioned some of the negative cap rate dynamics occurring in rent regulated multifamily right now as a reason why you're sort of avoiding the space. Just wanted to know if you could give us a sense as to what you're seeing in terms of cap rate moves in that asset class on your end?

Yes, the most recent reports out within the last week, our coding cap rates getting as high as 6%. And that is a giant jump -- cap rates are material diminishment of value. I don't know yet. I think the market is stabilized. That may turn out. When we look back a year from now that may 6% may have turned out to be higher low. As we will do a multifamily deal today, so we're going to do it under pretty disciplined credit characteristics. So we're not going to be the last dollar out and we're going to stress it. We're going to look at the rent mixes and so it's not that we're out of the market, we don't want to send that signal. There are very prudent operators in multifamily housing. And we think they're going to be good in the long-run. But the sponsor matters a great deal to us, the leverage matters a great deal to us. So if you get the sponsor and the leverage right, we'll be in that and we don't know there may be an opportunity over time as other lenders leave that space to be a very discriminating, very thoughtful lender and to be paid for doing so. I will say that thus far, we have not seen that in the market rates. So the deals that are getting done even though there are fewer, they're still very thinly priced. So we have our eye on it, we're very thoughtful about it. We do not have a concentration in that asset class today. We don't want to build one. But that's different from saying that we won't do a deal, we’ll certainly do a deal tomorrow to the right borrower or the right leverage point. And we have the capability and the personnel that know that market and know how to do that, do that at the right risk trade-off.

[Operator Instructions]. There are no more questions in the Q&A. This concludes our question-and-answer session. I would like to turn the conference back over to Christopher Maher for any closing remarks.

Okay, thank you. So with that, I'd like to thank everyone for their participation on the call this morning and we look forward to providing additional updates as the year progresses. Thank you.

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