Good day, and welcome to the OceanFirst Financial Corp. Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] I would now like to turn the conference over to Jill Hewitt. Please go ahead.

Good morning and thank you all for joining us. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer at OceanFirst Financial Corp. We will begin this morning's call with our forward-looking statement disclosure. Please remember that many of our remarks today contain forward-looking statements based on current expectations. Refer to our press release and other public filings included in the Risk Factors in our 10-K, where you will find factors that could cause results to differ materially from these forward-looking statements. Thank you. And now I will turn the call over to our host this morning, Chairman and Chief Executive Officer, Christopher Maher.

Thank you, Jill, and good morning to all who've been able to join our second quarter 2020 earnings conference call today. This morning, I'm joined by our Chief Operating Officer, Joe Lebel; Chief Risk Officer, Grace Vallacchi 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'll cover our financial and operating performance for the quarter and provide updates regarding pandemic conditions in our markets and the progress we are making to return to more normal operations. Please note that our earnings release was accompanied by a set of supplemental slides that are available on the company's website. We may refer those slides during this call. After our discussion, we look forward to taking your questions. In terms of financial results for the second quarter, GAAP diluted earnings per share were $0.31. Quarterly reported earnings were impacted by merger-related expenses and branch consolidation expenses totaled $3 million, net of income tax. As a result, we pegged core earnings of $0.36 a share. Given the headwind of our COVID-related credit provisions and operating expenses, we were pleased with the quarter and have positioned the company to improve a number of financial metrics in the next few reporting periods. Regarding capital management, the Board declared a quarterly cash dividend of $0.17, the company's 94th consecutive quarterly cash dividend. The $0.17 dividend remains a conservative payout of core earnings. There are no plans to reduce or eliminate per common dividend at the present time. Capital levels remain strong with tangible capital assets to total assets of 8.8%. Please note that this ratio was negatively impacted by the PPP loan growth, which decreased the ratio by 37 basis points. The TCE ratio, excluding…

Thanks, Chris. As you mentioned, our credit metrics remained strong and stable through the second quarter. We had record loan 30 day to 89-day delinquencies, as well as continued low non-performing loans relative to total loans. TDRs and classified balances remained stable and low, and even OREO balances were nominal at $248,000. We had net recoveries of about $230,000 this quarter, and our loss rates continues to decline. As a result, we feel confident that those customers experiencing pandemic-driven distress are in our forbearance pool, and that our forecast for forbearance balances in the third quarter effectively captures our near-term risk position. Being highly accommodative to our borrowers has not only helped our clients and our community, but it's also helped us better assess our near-term risk position. Although, as Chris mentioned, any setbacks in regional public health conditions, any faltering in fiscal support programs or other stresses on business conditions could change this assessment. Earlier in the quarter, the forbearance pool peaked at $1.6 billion, including $1.240 billion in commercial and $329 million in residential loans. Since that time, the balance has declined, as only a portion of these borrowers require an additional forbearance period and new forbearance requests have been near-zero for several weeks. We expect almost two-thirds of our commercial customers on forbearance to return to regular monthly payments in the third quarter. This estimate is based on conversations with 90% of our commercial forbearance pool. Currently, we identified second commercial forbearance pool totaled $386 million. These loans have a weighted average LTV of just 53%, a weighted average debt service coverage ratio of 1.9 and an average deal size of just $2.1 million. Within our forecast peak exposure, the restaurant and hospitality industry represents the largest component at approximately $200 million. These credits have a weighted…

Thanks, Grace. I'll discuss our loan business including PPP, as well as some comments on the interest - net interest margin, deposits, expenses and operations. Loan originations of $975 million drove record loan growth of $450 million for the quarter, after $105 million in performing residential loan sales. PPP loans totaled $504 million of the total originations and $479 million in outstandings at quarter end. Our team did a remarkable job in quick fashion in building the capacity to do these loans and automating the documentation to close efficiently in the face of the pandemic. We've now built an automated system to take our client applications for forgiveness and eagerly await the opening of the SBA portal or delivery of those requests. In regard to the fee to be earned on these PPP loans, we expect to recognize over $15.5 million in the coming 12 months to 18 months as loans are forgiven or repaid. To date, we've recognized roughly $1.7 million in fees from PPP loans through June 30th, which is reflected in net interest income. Loan originations from the commercial team were strong at $217 million, as the bank experienced very little pipeline fallouts despite current economic conditions. Commercial pipeline is off its highs from last quarter, but still 20% better than a year ago. Residential business is very strong, as we experienced record originations for the quarter at $242 million and the pipeline remains at elevated levels. I'll echo Chris' earlier comments and add that the local real estate market is benefiting from limited inventory, motivated buyers and all-time low rates. We're taking the opportunity to sell many of our 30-year conforming originations with solid gains to generate some mortgage banking income while managing balance sheet exposures. In this rate environment with solid gains available from loan…

Thanks Joe. Before we open it up to questions, let me just close with the following summary. There was noise in the quarter in terms of excess liquidity, the PPP program, weak deposit fees due to COVID and even the Two River integration. That noise is temporary and should work itself out in the coming quarters. We have a clear handle on our current credit risk position. The vast majority of our loan book did not require forbearance and is performing well. The forbearance loan portfolio appears positioned to decrease materially over the near term. Given conditions today, we're confident that we have the earnings power and capital position to address credit risks we face in the coming quarters. Deposit costs are positioned to be reduced further, and that effort will be critical to defending our margin as we move forward. Operating expenses will benefit from the elimination of 13 branches this quarter, as well as additional cost saving strategies that will be addressed in the coming months. We're in a position to improve operating performance over time and earnings should recover as the credit cycle moderates, which may result in decreased credit provisions. Our ability to forecast either the end of the pandemic or the strength of the economic recovery is very limited. We are closely watching public health conditions in our markets. They have improved dramatically, but could turn at any moment. Fiscal stimulus, which has played a pivotal role in supporting the economy. The continuation of that support must continue in the near term in order for additional progress to be made. Collateral values. So far residential real estate is holding or increasing in value and even CRE cash flows are remarkably steady. Our credit risk models are quite sensitive to collateral values, so we're monitoring them closely. At this point, let's move to the Q&A portion of the call. Thank you.

[Operator Instructions] Our first question comes from Frank Schiraldi with Piper Sandler. Please go ahead.

I'm trying to get a sense as always about provisioning. And the - seems like the model stabilized a bit. So if that's the case, is it fair to say the qualitative builds are mostly behind and from here, it's just really quantitative factors and credit migration, specific credit migration, that's going to drive the provision going forward?

I think that's fair, Frank. Absent the change in the environment, right, where we have a big change in the reopening process or something like that, that doesn't appear and present to be an issue. We have been building up qualitative reserves, knowing that as these loans come out of forbearance, some of them will become TDRs or even non-performing. And at that point, the quantitative factors will be taking over. You'll be making risk rating changes and the quantitative portion of your reserve will probably increase. But at the same time as you're getting that certainty, a lot of the qualitative reserves we've established are due to the uncertainty. So, you may see - you'll see one category growing and the other category hopefully reducing. And there is no - we can't be really precise about the allocation of that or the timing of that. But we're encouraged by what we've seen. And actually, Grace, you might just talk a little bit about the process of the conversations you've had with clients in order to establish your comfort with where we are today in terms of those reserves.

Sure. So it's part of our monitoring of the forbearance exposures. The credit team and the lenders reached out to, I think I mentioned 90% of our commercial borrowers. And then we had discussions with members of senior management team on both sides, credit and lending. Talk about each credit, at least the larger exposures, I think goes everything over $2.5 million. So it's a significant portion of the commercial forbearance. And it was through those conversations that I was informed on how can we inform what key factor adjustments we should make to capture the risks that Chris mentioned when you were talking about.

In terms of - it seems like then, if the risk weighting story is probably going to be more of a 4Q story, I think that's kind of what you indicated, Chris. Then it seems like, I don't want to put words in your mouth, but 3Q might be a little bit of a lull in provisioning as long as the qualitative stock holds up. But we start to see migration into lower risk weightings and NPAs perhaps, you guys gave, I think, a best guess of where, I'm not sure what, Grace, is. 9% I heard by the end of the year, I think. But what is - what are your best guesses in terms of provisioning levels versus earlier this year versus the first quarter and second quarter. Do you think 4Q could very well be higher because CECL really is a quantitative model, right, more so than qualitative? So, could that overwhelm the qualitative improvement? I know that's tough to say here in July, but just wanted your thoughts there.

It is. It's very tough to say, Frank, because we don't have our crystal ball. But when we have these conversations with clients, we are delving into their liquidity position. We're delving into the leveled operation, whether they plan to reopen or not open. We're trying to evaluate the real estate values and things like that. So if we thought that we were facing a wave of additional provisions later in the year, we would be taking them now. That's the whole point of CECL. But we do recognize the uncertainty. And I think what you see in our provisioning now in the first quarter, it reflects that uncertainty. And we're - based on the calendar today, it would appear that most of these things are going to be worked out by the fourth quarter and then we're going to be left with what is the TDR pool and the non-accrual loan pool. And then our precision around reserve then, I think will be much better. You shouldn't - at that point, you shouldn't be sitting on a reserve that has a big qualitative piece. It should be a reserve that is, in many cases, quantitative. So, we think we are calibrating that right. But there's a lot of questions and there could be a lot of changes between now and then.

And then just finally on the loan growth. Joe, I think you mentioned maybe moderate to flattish. Just wondering if that is correct. Given your pipeline is 20% stronger than last year and I guess, Two River and Country helped that out. But if we look at the loan growth graph here on Page 11, is it kind of - is that kind of the story? Are you going to see some decent sized loan originations and then you're seeing a decent amount of payoffs to offset that? And then just curious where those, if centered on any geography in terms of the originations. Thanks.

Interestingly, Frank, for the first half of the year, we saw pretty even growth and activity throughout all the regions. So legacy footprint of the bank probably generated 40% and then we got 30% of the growth in New York and 30% in Philly. So it's nice we're seeing activity from everybody, which is good. And I think what we're going to see is continued opportunity. We're open for business, which is good. We hear a lot of anecdotal commentary about people not entertaining opportunities for either their clients or God forbid, you entertain something for new clients. So that's a positive for us. The pipeline is down a little bit quarter-over-quarter, year-over-year. You're right. It's up 60 million bucks. It's up 20%. And I'll give you an example. We just did another $50 million in loan approvals this week. So, I'm bullish, but we're also selling residential loans in the secondary market. We believe for balance sheet management, we should continue to do so. So, I think that - I think that it's prudent just to recognize that there may be some fits and starts on the economy as well.

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

Could you guys spend a little time addressing how the customer transaction data you gather that you believe can lead to some cost reductions later in this year and into 2021? Can you just provide a little more detail in terms of how that informs your view on the expense run rate into next year?

Sure. We've been, Russell, very aggressive in closing branches and have consolidated 53 branches in the last few years. So, we have not been slow to pull the trigger when we see patterns that makes sense to us. And I want to emphasize that in most of those cases, we were following our customers' win. So as customers move to digital channels, we want to put our expenses and our people and our tools and our technology in the channels they want to be in. So then the pandemic comes along and we see a spike in use of mobile banking and the digital channels, that would suggest that we now have a much higher number of customers that are willing to bank without a branch. It's certainly not sensitive to having a branch or having a branch as close by. But given the stress of the environment, given the pandemic, given that we just closed 13 branches, we don't want to be heavy-handed and go and rush to make a decision today. That said, we look at the early - the branch counts that Joe mentioned, right, about 80% are pre-pandemic. And that's not uniform for every branch. Some branches have all the customers back and some don't. And we're watching this pattern to understand, which of our branches might be candidates for consolidation later in the year. So, I think that's kind of the crux of it. We just don't want to - we've been a fast and early mover. So, we think we can take 90 days, 120 days, understand what the customers are telling us and then react in a way that helps the company but doesn't sacrifice our customer satisfaction.

And I appreciate that, Chris, and that's kind of what I'm wondering, given that you guys have been so ahead of the curve here, both on the digital platforms, also on the branch reduction as well. I'm just trying to get a sense of how much meat this might possibly have, as it would benefit earnings next year? Or are there other franchise investment that may absorb some of that potential cost savings?

It is always net to your point about investment. There is a net save, typically, as we do this, but we do invest in the other areas. And we've made a lot of investments into the digital side. We're not staring at any giant capital investments in digital. I think we're very happy with what we've built and we incrementally improved those kind of on a quarter-to-quarter basis. But it is personnel shifts where, if we consolidate a branch that might have a half a dozen people in it, but the save is not a half a dozen people because we move people into the call center or into our video banking group that does face-to-face interactions with people across video. The early transactions after we reopen lobbies were quite strong. They appear to have fallen off pretty dramatically now in the last week or so. So it's unclear. Was there a bubble of customers that missed the branch? And the minute we reopened them in mid-June, rushed in to take care of something and they won't be back. Or is this just noise we see in - so I don't think it's going to take us a long time to figure it out. But we want to be careful. The strength of our franchise is always been our funding and our funding comes from the strong relationships, both commercial and retail. So, you don't want to hurt the baby.

That makes sense. I appreciate your comments there, Chris. And then just a final question for me is really a follow-up. And I just - just to confirm what Grace was talking about and the conversation around the reserve. So kind of a pro-forma deferral around the end of the year of 9%. Now, is that captured in your reserve today and in the - it sounds like in the qualitative factor? Is that expectation currently reserved? Or is that going to show up incremental in the fourth quarter as that risk migration formalizes?

So, I would tell you that we've made an assumption. There is an internal assumption that we're not going to kind of share, that a portion of those credits will become TDRs or non-performers, then we need a reserve to cover that. Now if we are spot on to that, then we've got - the reserve is perfectly calibrated. I don't expect that. I expect it's probably going to be a little higher, a little low. And it's all going to be based on that final yield. But, Grace, you had some figures about the coverage of the deferral portfolio that I think are probably informative.

Sure. So, I thought it would might be helpful to see reserves against our expected peak forbearance. Just another way to look at the adequacy of the allowance. So with the current balance of $38.7 million and ACL that's for loans, if you take out our day one CECL reserves of $21 million, that leaves just under $18 million and that is 2.4% of our forecasted second forbearance pool. So it's - but the short answer, Russell, is it's a general. There is not specific credits that we are saying, oh, I think that one might - that one might be downgraded. So, we don't have like a column of those that we then calculate a reserve against. The conversations I was referring to before, really, really were striking to me that there weren't obvious downgrades. There's - companies are doing better than they thought. They have liquidity. But as Chris emphasized in his comments, those are lot in flux still and things could go in a variety of directions. So, we are trying capture that risk as we go along. And I think 2.4 against our estimate for second forbearance totals is pretty healthy.

And I just want to emphasize to the process. If we have known bad information on a credit, we're going to downgrade. So, we're not waiting to do a downgrade. What's happening is we have a lot of situations where we have no information. It's not good. It's not bad. Let's take a restaurant that may be open in the last week in June or the first week in July. We have no idea whether that's going to be a good story or a bad story. So, we're deferring action until we have data. But as we went through even during the second quarter, we mentioned - it's kind of odd, we had only a single liquidation issue in our commercial base. But that credit, for example, that's known bad information, right. They're not going to reopen it. It happens to be a fitness center. So, we took action on that. We marked it. We did what we needed to do. So, this process is not putting off making decisions. It's making every decision we can, when we get the information we need to make that decision. And we know that most of this is going to require a few months worth of operation for our commercial clients. We'll analyze that information. It's just the calendar lines are being - that's probably more of a fourth quarter timing than a third quarter timing, but we're not deferring the decision. I want to be really clear about that. Where we know we have bad information, we're downgrading those loans.

[Operator Instructions] Our next question comes from Christopher Marinac with JMS. Please go ahead.

Just wanted to continue on the same line of questioning. And Grace had mentioned the additional reserve angle and I was curious how we think about the acquired reserves and the additional disclosure that you gave in the last couple of quarters. Should that come down kind of slowly or quickly? And then as those loans transition, how does that play into the overall reserve coverage in the future?

You're talking about the - I'm sorry, I'm not sure I understood the question. You're talking about the qualitative component or the credit marks on acquired loans?

Really the credit marks and obviously, if we add all of it in to the existing reserve and exclude PPP, you're around 1%. And I'm just kind of curious how that's going to look a couple of quarters from now? And those loans may pay off more? If there's acceleration, how does that play into kind of your reserve? Just the considerations.

So in other words, would we keep the overall level at around 1% work to plan on buildings. The answer to that question is going to depend on the risk characteristics or the profile of what's in portfolio at that time. So if the riskier of those credits were to pay off or roll-off or be generally exited, or not necessarily, you can generally. And that dramatically changed the overall risk profile and risk of loss, then the number as a percentage of the total portfolio would potentially come down

Chris, it's Mike. Let me take a shot at that, too. So $35 million, $11 million of that is specific credits, that we've marked. So to the extent that those credits default and charge-offs, we could offset those charge-offs if it's $11 million. And that's effects that specific loan. And then another $24 million, that's more general and that - it's accretive in income over the life of the loan and that's - generally, most of that comes in over the next three years or four years.

And I'm going to clarify something to that. Our forecast for peak second forbearance of just under 9% of total loans, we certainly don't expect all of that to become non-accrual or TDR loans. In fact, it's anybody's guess at the moment like Chris just described, the conversations we are having with these borrowers. But there is enough positive stories and that's part of the difficulty, right, in estimating the allowance. But I can't imagine, it's all of those. I mean, I won't venture a guess here in this environment, but it's certainly not going to be all of them.

And I guess my follow up is just about the LTVs that you've reinforced the last couple of presentation. Have you had any total evidence where you have had property? So just sort of confirm those values in recent months.

I think the values depends a great deal on the segment. So, there is some oddities about this recession, if you will. It is different than other recessions we've experienced. First is the residential property values are not only holding up well, they're probably understated because I think the values have come up. And they've come up sharply in the suburban markets we're talking about. In most of the markets we operate in, you're seeing 10% to 15% year-over-year price gains and I know that happens in some parts of the country. That usually doesn't happen in the Northeast or certainly hasn't happened since the Great Recession. So the residential pools, I think the LTVs are fine and probably conservative or understated. On the commercial side, we've not seen as many properties move. So it's really hard to get a precise kind of valuation, but it is very much based on the property types. So to the extent we have, our assumption is that our LTVs and things like industrial warehouse, logistics, even multifamily, at least for our multifamily portfolio, it's been reasonably steady rent collections. So maybe cap rates come up a little bit, but it shouldn't be a disastrous experience. So, we won't know for sure, until we see properties trade. But our exposures and what we're most worried about the rest of the industry, right, is what is a restaurant property worth and what is a hotel property worth. And unfortunately, we don't have - that's an even smaller portion of even the forbearance portfolio.

Our next question comes from Collyn Gilbert with KBW. Please go ahead.

Chris, just to sort of segue from that last comment that you just made and it's kind of a big picture question. But you always have really thoughtful answers in the way you think about all of this. So, I'm going to ask you. As you indicated obviously, OceanFirst has been very good at consolidating branches and that's maybe going to be part of the plan going forward. Do you have a thought as to in the future for what maybe OceanFirst is going to experience or what the industry could see in terms of the re-purposing of a lot of this branch real estate, bank real estate, as the industry looks to consolidate away from that and you guys as well? Like any thoughts on what happens to that real estate? I mean you just sort of indicated, too. We're not sure really what property values within a restaurant or a hotel would be worth. Like how do you think about your own branch real estate and how that gets re-repurposed?

It's a really good question. And I think there are - well, first, we're not in the camp that you shrink all the branches and you have tinier branches. So, there is a lot of discussion over - look, I change my average square footage of a branch. We're more in the camp of how many branches do you need to support a geography because the people are only coming in once a month or so or once every six weeks. They'll drive a little bit longer. And especially in our suburban market, if you're coming to a branch, you got in a car. And if you got in a car and you're going an extra three traffic lights or 0.5 mile in one direction or the other, it really doesn't matter very much. I mean, you might be little bit put off that you changed the location, but you don't need to have the same density. So, we're more in the camp of - we consolidate the locations and you get really good at digital, not having a lot of smaller locations or little more efficient locations. I will tell you that we were in the hard way, that branch real estate when it is no longer occupied by a bank is not particularly valuable, especially outside of the urban markets. So, one of our first acquisitions, we took in properties at a certain value, closed branches and we did not realize the real estate value we thought we put. So, we've been much more careful about valuing real estate and lease exit cost and things like that. And one of the reasons we've been aggressive about trying to get it out is that it does - it's a drag on the balance sheet. There are exceptions to that. I know peers that are in urban markets where their branches are actually held well below book value, and they have embedded gains if they wind up exiting. But for bank like us, it's kind of a push. We have actually gone into a disciplined though of having a group within the bank that does nothing but liquidate bank facilities. And as you can tell, 53 of them. That's a lot of places to resist the negotiate down or sales to make. And - but it won't be at a gain. I'll end up telling you just a funny story. One of the more aggressive bidders on one of our branches was a cannabis distribution companies that loved the idea of both a drive through and the vault. So maybe that's in future branches.

Interesting. Okay. That's helpful. Just then two other questions. One on deposit costs rate. So, I hear you are messaging that you want to be cautious there and you have a customer base you need to preserve. But can you just give us a sense of what your kind of current LTV offering rates are? I'm just trying to gauge kind of the magnitude that you could see some of those deposit rates drop.

Collyn, it's Joe. Probably a great example of where we're going is where we've been, right? So, Country and Two River acquisitions, Country especially. But I'll just try to give you a couple of thumbnail numbers real quick. We have, for the remainder of the year, so from now to the end of the year, we have from now to the end of the year, we have $571 million worth of CDs repricing. Average yield on those CDs today is $149 million. And in 2021, I have almost $664 million at an average yield of $169 million. So, those are going to come down markedly. I think our one-year CD today is 50 basis points and that's probably the highest bank rate and offer, so unless you want to go up six years or seven years. So, I expect fully to continue to reduce deposit costs and we're doing that as well in our government municipal business. That is very sticky business. That's a business that we do really well. And much like some CDs, there are some guarantee pricing. We continue to reduce that quarter-over-quarter as these guarantees come due and we're not seeing any run-off where people understand. So it takes a little bit longer for us because we already had such a good funding base at lower yields. But we can work it down even further.

Okay. That's helpful. And then just last - oh, go ahead.

If we stayed in this environment and it might take quarters for us to get there, but I would look back to the low in our deposit costs in the last cycle, so - which we had a number of quarters where we were below 30 basis points in total deposit costs. I'm not saying we're not going to be there in the next quarter or two. But that's kind of the trajectory you could see us down pretty well.

Got it. Okay. That's helpful.

It might be lower than we did in the last cycle.

Yes. Well, with all this liquidity, I would - not just for you, but for the industry, I would hope so. I think so. Okay. And then just on the PPP. I know it's hard to determine and hard to guess. But just for modeling purposes and how you guys are thinking about it, what's your sort of - what are you assuming in terms of forgiveness in the next few quarters? So how that trajectory is going to look in terms of percentages like in each quarter?

I think it all depends on how effective the SBA is in terms of their portal. I think as we mentioned, we got the portal up and running. We got electronic documents from our customers. In theory, when they open that up and we can hit send, you should see some pretty rapid forgiveness. I will say that we have not been extending the maturity of our PPP loans. So, we're not in that camp of giving people five years because we don't think that was what was originally intended. And we don't think our customers need. You are either going to be okay or you're not going to be okay. So, my guess is you'll begin to see them in the third quarter, probably the bulk in the fourth quarter. And if the SBAs doing what they're supposed to, we should be able to clear a lot of it by the first quarter or in the first quarter of '21.

Right now, Collyn, almost every single, probably 99.5% of loans are two year loans. We didn't really do much of the five-year loan tranche. And the SBAs indicated to the banks, I think it came out yesterday, day before that they expect to open their portal, August 10. We've done 3,000 loans. I think I mentioned earlier, we set up an automated system to have customers start to provide their forgiveness applications to us in advance of the SBA portal opening. We've already got over 500 applications of the 3,000 loans and that's going to ramp up pretty quickly. So, I think Chris is right. I think we'll see the vast majority of the income that we would accrete if the loans stayed open over two years coming in the next couple of quarters.

Our next question comes from Matthew Breese with Stephens, Inc. Please go ahead.

First of all, just kudos for the presentation and particularly the pages - pages three and four. Those are really helpful. With that, we're starting to get a good sense for what the initial cure rate is on loans coming up on the - the end of the initial 90 days. 65 percentage for you on the commercial side. Is there any reason to believe that, that figure is a good or bad number to use for the cure rate on the second round? I mean, I can see both sides of this argument, but just wanted your thoughts.

We've had that discussion internally. And I want to be careful to tell you that we don't have a number that we're using, but that doesn't sound like a crazy assumption. And it really goes to the content of the conversations. And as Grace described them, there is a lot of liquidity out there and I think that's underappreciated. I mean, I know we know, you look at all the bank balance sheet and you say there's a ton of liquidity. Our businesses, as we talked to them, have more cash than you would think at this point of the crisis, right. And I think the races to the vaccine because many of the - the hardest parts we're going to have in this portfolio are going to be those that will benefit the most from the vaccine. And it's really a waiting game. If folks have liquidity and we've talked to a couple of restaurateurs, who say, look, if I can hang on until there is a true reopening and maybe that's early 2021, I'm going to be in great shape because a bunch of the restaurants aren't going to be here. And I'm going to have the seats and the staff and the ability and the margins to have a great year. So, I think if - it's going to depend a lot on how quickly the pandemic eases and whether we have these rolling things for a year or whether the vaccine comes out and you get a much faster recovery. But we did not expect the cure rate in round one that we are seeing. And it's been surprising to us. That said, on the consumer side, we're not concerned about it, but the cure rate is lower than we thought in the first round. And…

And to take the conversation one step further and let's just - I'm trying to get a sense for what the transfer rate at the end of the year from things on deferral to TDR or non-performing? Is it safe to say that if the cure rate is the same that the most is still - so if it was $500 million of commercial forbearance, you apply that cure rate, you're left with $200 million at the end of the year, that, that would be the balance you would transfer to TDR or NPA? There would be zero in deferral, right?

It would be very low levels in deferral. I mean the only situation where we might differ is, if there is a very unique and specific COVID issue. So if you think about it, I don't recall us having any of these loans. But if you think about it like a performing arts theater, right, there is no way that they will be able to operate until really there's a vaccine. So if they had a good business and they're going to remain closed for another 90 days, maybe you could make an exception. But I would expect that the majority of the credits we have in our book and people may have different books. But in our book, they're going to have to either come out of forbearance and return to normal or we will risk rate them. I do want to make another important point about the allowance though. So, let's just play that forward and forget about the percentage of loans that wind up being, say, non-accrual. If loans go non-accrual, you're going to do an impairment analysis and then we're right back in the real estate discussion because the vast majority of our book and this is a nuance to OceanFirst, but we're real estate secured in almost all of these loans. So, now we're going to do our best to estimate collateral values. And if it's something like a warehouse or a multifamily building, then it's probably going to be straightforward. Trying to figure out collateral values on a restaurant property or a hotel, it's going to be difficult even in the fourth quarter. So, I think, then you're going to get into these discussions about, okay, it's non-accrual, what is the appropriate reserve on that non-accrual loan? A reserve on one industry versus another might be quite different. We may have to haircut some of our valuations on things like hotels and restaurants until we know more about that.

And then lastly, Chris, you talked about measure you'll be taking to stabilize the NIM or even make up some ground in the back half of the year. Could you just give us a sense for where you see that NIM stabilization point? Is that here or better? Or is there a potentially another lockdown in 3Q?

So, I think what you saw in the big lockdown in Q2, a little bit of it was a self-inflicted gunshot wound, right. So, we put on that liquidity. I'm proud we did. And we did it for all the right reasons, but that was the single biggest cost to us, was carrying this $700 million in cash. So we can reverse that. So that's not going to happen again. We're not going to have another big liquidity build on top of that in the third quarter. So, that takes some of the headwind out. We're also not going to do PPP loans again. So, we're not going to have that pressure on the margin. So, you're really down to this kind of 7 basis points or so of ordinary course pressure, and then how much of that can we overcome in deposit costs and other measures. So, I think it will be relatively stable. I don't think we're going to be losing or making up a lot of ground in either direction. And I think this quarter, the drivers this quarter of the NIM issue, meaning the liquidity and the PPP program and the subordinated debt, those are not going to recur. So, they're not going to provide pressure on us going forward.

[Operator Instructions] Our next question comes from William Wallace with Raymond James. Please go ahead.

Couple of follow-up questions. Sticking to this concept of the second round deferrals rolling off and then being able to figure out what to do with what's left. How would you guide us to think about the cadence of charge-offs? Will you be charging these loans? If you move into non-accrual, but only building reserves, if you move into TDR or will charge-offs be really a first and second quarter of next year event? Just maybe help us think about that. And then on top of that, the way the CECL model worked, I'm not sure if you're using the Moody's forecast or Fed forecast or whatever. But over the forecast period, if the unemployment rate remains at that sort of high single-digit what-ish type level and the GDP forecast doesn't improve, would you assume that you would have to maintain your reserves at current levels? In other words, would you have to cover your charge-offs entirely or would you be able to use reserves to cover those charge-offs?

I'll take the first one because it's easier, and then I'll give Grace the second one. In terms of when you're going to see that charge-off activity, it's certainly possible that we'll have some charge-off activity in the fourth quarter. As we calibrate on a loan-by-loan basis what's non-accrual and then what is the real estate collateral on that non-accrual loan, then we think we've got a deficit, we've got a charge-off. So, there could be some in the fourth quarter. If that's the end of, kind of the forbearance wave, so to speak and we move into next year, then you might see charge-off activity when the loan is finally disposed off and you are truing up the actual, call it the auction value of the real estate. Or if you're doing incremental appraisals because property values, say, restaurants change a lot over the first half of 2021. But the charge-off activity would happen first when you initially assess the non-performing loan and determine the appraisal, that's a fourth quarter event. And then if the appraised value were to sink further, you could have additional write-offs or when you actually liquidate that piece of real estate finished foreclosure, whatever that may be, you would true it up. So, I think it's going to be a little bit over a few quarters, probably Q4. And then depending on how much of this asset type we have in Q4, you might go into beginning next year. I will say though that one option that we'll think carefully about is when we get to the end of what we perceive is the end of the forbearance pool and we're going to have to watch the public health crisis, the way the economy is going, the level of fiscal stimulus where the vaccine is. If we think that the worst is over in any given quarter and whether that's the fourth quarter or the first quarter of next year and we think we can exit these in bulk, we would not be averse to saying, look, here's a mark that we think we have, why don't we exit a bunch of the stuff so that we no longer have to have conversations like this with you guys. We can just say, look, it's gone and we resolved it. So, I couldn't even begin to handicap either a possibility of us doing that or a timing, but that is a door we will consider.

And then thoughts on how the economic forecasts will drive the ability to utilize the reserves?

I'll pass it to Grace.

So if I understand the correct - the question correctly, I guess you're asking is, say, the forecast continues to be fairly negative in the first quarter of '21. And so it would indicate more reserve build and we'll be able to - we have to replenish charge-offs at that time. And I would say, this is a general question. And there's a lot of - it depends to it. It would depend, I think, on at that time on how that economic forecast compares to our actual risk profile. If our non-forbearance portfolio continue to have the current credit metrics at that time and our second forbearance we had gotten through all of it like Chris just described and really kind of isolated or capped, figured out exactly or quantified the degree of loss and exposure, then there might be an argument for not having to maintain the reserve build despite the economic forecast. Then there might be a two-factor adjustment in the other direction, if it was justified. I'm not sure if I'm - hit on your question or not. So I'll pause there.

No, that's fair. I think the answer is, it depends. Fair enough. Okay. And then, Chris, you had mentioned the - you talked a little bit about collateral values and the improvement in the residential market and then the - not much visibility on the commercial real estate market just because of the lack of trades. But I'm curious as you guys underwrite new deals, maybe in sectors that are not directly impacted by COVID, what you're seeing in the appraisals of the properties? What are the appraisers doing with cap rates and what impact is that having on the collateral values?

So, there is two things and I want Joe to chime in as well, because he's a little closer on some of these appraisals. But we're getting general COVID disclosures, which are not very helpful. So the appraisers are kind of stamping every appraisal and going, well, this is what I think, but you know, this is COVID, so I could be wrong. So that's not very helpful, but it probably protects them. I would tell you that in some - like industrial and all that, it's a relatively straightforward. You're doing - NOIs, net present valuing up, it's very clear with good cap rates. It's - and Joe, maybe talk about a couple of deals we've done recently and how the appraisals and how you handled the LTVs.

Interestingly, for us, and I'll echo Chris' comments about the appraisers and making the COVID disclosure and some of that is just because there is no comps, right? There's not a lot of comps. The comps you are using are pre-COVID. We've seen some adjustment to cap rate, not meaningful adjustment to the cap rate. And I think our approach for new transactions has largely been stick to the credit appetite that we have, which is always tended to be a lower LTV perspective. And if we do and we have financed some properties where we have, for example, we financed a couple of great retail properties where there are tenants, in-line tenants that are on deferral. We take out all of their cash flows from the cash flow math and we discount the values and we tend to look at lower LTV loans. So, we're still doing loans. The value of the property may come in where we have a 50 LTV, our internal LTV after discounting. The retailers aren't paying because they are on deferral - rent deferral, maybe a little bit higher, might be 60. Might even be 65, but the appraisers coming in at a value, assuming that at a certain point in time, that property will be re-leased or where the people begin to pay. So, we take a fairly heavy hand to some of these properties and we've continued to win transactions. So it tells you that you could be in the market with a certain credit appetite and still do well. We just - we just want to a substantial Amazon distribution warehouse at a very low LTV, I think it was south of 40 - 40 LTV. So, we're still --

And you're saying that, that's an LTV on a - on a value that you're being pretty aggressive on cash flow assumptions or cap rates. So it's an LTV on a value that you're hitting hard or relatively hard. Is that - I'm hearing you correctly?

Okay. Yes.

Okay. All right. And then just one last question, just for a point of clarification. I believe it was maybe in Joe's prepared remarks. I believe you made a statement that he feels that OceanFirst is comfortable with the expense run rate. And so - and then there was a lot of commentary about cost save initiatives and also the cost saves out of the converted acquisitions. So, I'm just confused, I guess. What is - is $51.1 million after the - after the one time? Is that the run rate that you think we'll see in the back half of the year? Or will it be deal cost saves and other initiatives that are underway, drive that lower? And if so, can you maybe help us quantify that because the moving parts have all changed so much.

Yes. I'll take that. So the $51.1 million, first of all, includes $924,000 prepayment penalty on - for home loan bank borrowings. So the core rate is really about $51 million, pretty close to $51 million even. And we think that going forward, we have some costs that are coming out because of the Two River conversion in May and the 13 branches that are closed. So we expect that to be probably about $2 million or so coming out of the run rate in the third quarter and then maybe a little bit more in the fourth quarter with some of the voluntary retirement that Joe mentioned earlier.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Christopher Maher for any closing remarks.

Great. Thank you. With that, I'd like to thank, everyone, for their participation in the call this morning. As I said at the conclusion of the first quarter, our company has been around since 1902 for a reason. We take conservative credit risk positions. We're strongly profitable, and we maintain ample capital levels. We look forward to talking again after our third quarter results are posted in October. Thank you.

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