OceanFirst Financial Corp. (OCFC) Q3 2023 Earnings Report, Transcript and Summary

Hello, all and welcome to OceanFirst Financial Corp's Third Quarter 2023 Earnings Call. My name is Lidya and I'll be your operator today. [Operator Instructions] I'll now hand you over to your host, Alfred Goon, SVP of Corporate Development and Investor Relations to begin.

Thank you, Lydia. Good morning, and welcome to the OceanFirst third quarter 2023 earnings call. I'm Alfred Goon, SVP of Corporate Development and Investor Relations. Before we kick off the call, we'd like to remind everyone that our quarterly earnings release and related earnings supplement can be found on the company website, oceanfirst.com. Our remarks today may contain forward-looking statements and may refer to non-GAAP financial measures. All participants should refer to our SEC filings, including those found on forms 8-K, 10-Q and 10-K for a complete discussion of forward-looking statements and any factors that could cause actual results to differ from those statements. Thank you. And now, I will turn the call over to Christopher Maher, Chairman and Chief Executive Officer.

Thank you, Alfred. Good morning, and thank you to all, who've been able to join our third quarter 2023 earnings conference call. This morning, I'm joined by our President, Joe Lebel; and our Chief Financial Officer, Pat Barrett. We appreciate your interest in our performance in this opportunity to discuss our results with you. This morning, we'll provide brief remarks about the financial and operating performance for the quarter and some color regarding the outlook for our business. We may refer to the slides filed in connection with the earnings release throughout the call. After our discussion, we look forward to taking your questions. Our financial results for the third quarter included GAAP diluted earnings per share of $0.33. Our earnings reflect net interest income of $91 million, representing a modest decline compared to the prior linked quarter of $92 million. Our third quarter results were impacted by modest margin pressure linked to our efforts to improve the bank's liquidity position and the quality of our deposit funding. These efforts resulted in meaningful deposit growth, a substantial decrease in brokered CDs, and a measurable reduction in the loan-to-deposit ratio. The resulting mix shift in our deposits play some pressure on net interest margins, but that pressure is decreased significantly as compared to the past two quarters and appears to be reaching a point of equilibrium. Our deposit betas increased to 35% from 29% in the prior linked quarter. Advancing a more competitive pricing strategy through various channels has protected our deposit base, which increased 4% to $10.5 billion, while reducing brokered time deposits by $426 million and bringing our loan-to-deposit ratio to 96%. Capital remains strong as we ended the period with a tangible book value per share of $17.93 and a CET1 ratio of 10.36%, both measures improving modestly since last quarter. Turning to Capital Management. The Board approved the quarterly cash dividend of $0.20 per common share. This is the company's 107th consecutive quarterly cash dividend and represents 61% of GAAP earnings. The company did not repurchase any shares in the third quarter. While we continue to see the frequency and magnitude of external economic, geopolitical, and natural forces increase. I am reassured that over the past year, our quarterly net interest income is only declined in the range of 5% and we are highly confident that our quarterly expense run rates as we finish 2023 are reverting to mid-2022 levels. Whether or not this becomes a new normal for the industry remains to be seen, but I'm convinced that we will remain very competitive in whatever environment may evolve. At this point, I'll turn the call over to Joe to provide some more details regarding our progress during the quarter.

Thanks, Chris. Net deposit growth for the quarter of $375 million was concentrated in core growth of $343 million. For the month of September, a decrease of $305 million in non-core, primarily brokered CDs, resulted in a meaningful change in deposit composition for the first time this year. Year-to-date deposit growth of $859 million is a reflection of our thoughtful and concerted effort to win meaningful deposit relationships in today's competitive and higher cost deposit environment. Continuing on the deposit front, I wanted to mention our addition of a new branch opening in December in the town of New Brunswick, located in Middlesex County, New Jersey. On the loan origination side, we continue to see tempered growth as a result of reduced demand from customers and our pricing expectations given the cost of funding. Asset quality metrics remained strong with non-performing loans in criticized and classified assets, representing 1.3% and 0.2% of total loans, respectively. The quarter included an $8.4 million charge-off on a single commercial real estate relationship as previously announced, which so far continues to be an outlier in our portfolio. Additionally, this relationship was included in our non-performing loans at September 30. Absent this, non-performing loans would have decreased $1.4 million. Net charge-offs for the year are $8.3 million, representing only 11 basis points of total average loans on an annualized basis. With that, I'll turn the call over to Pat to review margin and expense outlook.

Thanks, Joe, and good morning. Net interest income and margin were $91 million and 2.91% respectively, reflecting higher funding costs associated with deposit growth. As Chris noted, funding costs reflect cycle-to-date deposit betas of 35% and we clearly saw margin compression begin to stabilize throughout the quarter. While we believe our fourth quarter margin may see further modest compression, we're hopeful that such compression will be ending as we finish the fourth quarter of 2023. We continued to maintain excess cash during the quarter, reflecting the stress liquidity environment and combined with continuing uncertainties around monetary policy and the risk of a government shutdown. As those risks ease and the banking sector continues to stabilize, we expect to normalize cash levels which will have a modest, but positive impact on net interest margins and capital ratios. Non-interest expense increased $1.5 million to $64.5 million compared to the prior quarter. The increase in expenses includes $2.4 million of one-time charges related to severance and other compensation linked to the company-wide strategic initiatives and investments we introduced earlier this year. As a reminder, we've been investing improving processes and longer-term strategic growth throughout this year focusing on expanding our C&I, deposit gathering, and residential businesses, as well as improving the revenue contribution of our branch network, increasing automation of internal processes, and improving infrastructure support across all lines of business. Progress on this project remains on track, and we've made meaningful strides to improve both internal processes and the customer experience. As a result of the work performed on this project, we believe quarterly operating expenses will decline to the $58 million to $59 million range next quarter, representing an annualized reduction of between $20 million and $25 million going forward, compared to the current expense run rate that we're tremendously pleased. We continue exploring additional opportunities to further improve our operating leverage in 2024. Our effective tax rate for the quarter, 24% remains in line with prior periods and guidance, and we expect to remain in this range going forward. Turning to the balance sheet, which we don't usually talk about on an earnings call, we just wanted to highlight one thing, the company completed its annual goodwill impairment test as of August 31 and we concluded that our goodwill is not impaired. However, given the depressed stock prices that many banks are experiencing combined with the volatility of those stock prices that we've seen over the last few months. We'll likely be reevaluating this conclusion at year end. Finally, we expect capital to remain strong through the remainder of the year with a CET ratio of about 10%. At this point, we'll begin the Q&A portion of the call.

Thank you. [Operator Instructions] Our first question today comes from Daniel Tamayo of Raymond James. Your line is open.

Thank you. Good morning, everyone. Maybe we can start just on -- good morning, on the margin and you talked a little bit about, Pat and Chris, the forecast for the fourth quarter being similar compression to the third and then stable, and the deposit mix shift that's happening. I'm just curious, if you can go in a little bit more detail about kind of what's driving the remainder of the compression in the fourth quarter and why you think that you can get stable margin in 2024?

I think we would start by just kind of gauging the pressure we've had on deposit costs throughout the course of the year, and we've seen it steadily decline kind of step by step since April of this year, and it really appears to be flattening out. So as we kind of look through our models, which are always imperfect, and we kind of think about the outside rate environment which is outside our control, it's challenging to come up with a forecast, but it does appear that NIM could trough in the fourth quarter, that's our best guess as of this point. And then in terms of what happens in 2024, it's really dependent upon the outside rate environment. There is the possibility for a tailwind and we're certainly working to improve the chances of that on our side, but we are going to be beholden to the market to a certain degree.

Okay. But in terms of, I guess, the mix shift that you're anticipating, is it fair to say that you're going to see or you expect the remainder of the broker deposit balances to come off in the fourth quarter or the FHLB? I'm just curious kind of how you expect the entire kind of funding side to work over the next few quarters.

Yeah. I think we had -- historically we've had a very low level of brokered CDs, so we took the opportunity when things got a little bit tight in the spring to build up excess liquidity and we used brokered as a quick way to do that effectively. I think over time, lower brokerage is always better, but we're going to be -- I think we're in a good place now. So we will take the opportunity depending on kind of how rates market -- rate markets work in the fourth quarter to maybe move that around a little bit. But I don't think you're going to see big changes. We've also seen that our non-interest bearing accounts seem to be behaving very steadily. So when we think about non-interest deposits compared to earlier this year, you're just not seeing customers behaving in the way they were back in April. So if deposits which may continue to increase in cost hold a little bit slower at the rate of increase, we do have a lot of loans repricing, we have new loans we make every day and then we have the opportunity to work on that side of the margin. So I think some additional deposit pressure, not a big mix shift. We think the mix is going to be largely similar to where you see it as of September 30 and we do have some opportunity on the loan side.

If I could add just one thing that, that isn't in the material, this is Pat, that might be helpful. We have repaid all of our short-term liabilities that we can. So everything we have left on the balance sheet is term. Our FHLB funding about $600 million matures $100 million every year starting next year or $200 million starting next year. And then our brokered CDs and our own house-issued promotional retail CDs have average remaining lives of about six months right now. So we'd have to actually break and penalize ourselves if we were going to reduce things further. So that's kind of what's driving the near-term compression. And then everything that Chris said kind of means next year is going to be -- probably bouncing along plus-minus range at fairly stable, unless there's higher levels of loan growth, which we should hopefully coincide with expansion.

Okay. All right. I appreciate all that color. And just lastly, maybe a little on the asset side. If you could provide any kind of color on what cash flows may look like in the next few quarters and on the cash side to the excess cash, just your thoughts on the pace of the reinvestment of that.

In 2024, we have a little bit more cash flow in terms of maturing loans than we had in 2023. Maybe, Joe, if you could just talk to the market for that and then, we can kind of swing back to give you a sense of the magnitude.

So, Dan, I think I'd start by saying that, I think we have opportunity to improve margin from the renewal of loan transactions. We're looking at this. As you know, we've done a variety of things on the asset quality side, stress testing, all the kind of things you need to do. But we're hearing from -- we're hearing from clients that as loans renew, their expectations are very similar to ours. They understand the market that we're in, their relationship clients, they understand that they're going to be repriced at certain levels. Those that are in the C&I bucket are already at floating rate levels, so they've repriced the market for the most part. And we don't have a significant amount of maturities in '24. You guys are aware from the 8-K supplement, but the stuff that we do will price and provide us with a little bit of extra NIM as we go forward.

Yeah. And maybe I just add on to that. On the asset side, we've got about $1.4 billion repricing maturing coming in next year. The loans are the bulk of that. So our securities cash flows remain relatively stable at about $40 million a quarter. Then we've got the liabilities that are repricing, and I just kind of outlined those. Those are actually a little bit more volatile with the remaining $0.5 billion, call it, of record CDs maturing fairly evenly over the next three quarters and our retail CDs have buckets and some volatility, Q1, Q2 being the bigger quarters of maturity. So that's kind of the general range of cash flows.

Terrific. I appreciate all the color. That's all for me.

All right. Thank you.

Thank you. Our next question today comes from Justin Crowley of Piper Sandler. Your line is open.

Hey. Good morning, guys.

Good morning, Justin.

Just want to hit on some of the expense measures. Good morning. That have taken place. You saw that run through the base this quarter, and I know you're maybe not necessarily in a position to get real specific about '24. But just wondering if you can comment on perhaps any smaller initiatives that could be additive to some of the efficiency gains that are already in the run rate?

Sure. So this is Pat. I would first caveat anything we see -- say about opportunities in 2024, still facing the headwinds of persistent inflation. So the bias for every cost is to go up, including people costs. And so, it's not an easy market without reducing vendors or reducing employees to do that, but we continue to have some opportunities. So we think -- we actually think our run rate of, call it, $58 million, $59 million that we're expecting in the fourth quarter is a pretty good run rate quarterly for the following year, it will be a little tough because we're going to have to manage through inflation and normal merit increases and all that, but we feel like we've got a decent shot at that. We still have initiatives that are in the early stages that are geared around some of our larger processes. We're looking at a couple of outsourcing opportunities and our vendor initiatives, we still have an unconscionably high number of vendors. And so, the continuation of building out a procurement function vendor consolidation that leads to better negotiating power, we think will also add a little bit of wind. But I guess I'd caution you against thinking that our $58 million to $59 million could be lower because of those initiatives. So I just -- I think that's probably our best estimate of what to use will be relatively flat.

And we think flat expenses in this environment.

Okay. Got it.

[Multiple Speakers] From this performance.

Okay. Appreciate that. And then, just quickly circling back just to the margin discussion. In the past, even holding to the side, what the loan securities still can make cash flow, you've talked about just the excess liquidity that you're running with just more broadly. Curious, if you could just detail how you see that trending if we think about -- we've talked about some stabilization heading into the end of the year and just curious how that filters through just to your broader thoughts on the margin dropping at the end of this year?

I would think about -- kind of two things that are structurally in our position at September 30. The first is, we have a little bit more cash than we would have been keeping around before events in the spring. So you may have a couple of $100 million there that you could choose to put to use. But at the same time, overnight funding is pretty efficient. So you're getting a yield on that. It's not hurting you to keep that much cash. The margin impact is more from shrinking the balance sheet a little bit. The other thing is our 96% loan-to-deposit ratio. If you followed us over a long period of time, we have an ability to lend that backup, when we think times are right. We're kind of watching how the markets evolve. We're watching pricing in the market. We do see, particularly 2024 as an opportunity to be a lender where terms and pricing may be on the side of the bank for a change. So we're watching that market. So those are the two levers. They're not big levers, either one of them, but they are an opportunity.

Okay. I appreciate it. And then just sort of following up -- following up on what you just mentioned, with some of the progress on the loan-to-deposit ratio and perhaps some opportunity heading into next year. Are you able to bifurcate perhaps maybe geographically and just on a loan category basis where your focal point might be in the event that, that incrementally more favorable environment plays out from a lending standpoint?

I think, our focus is going to be on margin and price and that will lead us and will grow our credit culture and our credit standards will remain the same regardless of where or what kinds of credits we put on, but we're going to be optimizing around those opportunities to get paid well for the use of our balance sheet. The balance sheet availability is scarce in the industry, so we want to make sure we get paid for it. And at this point, there's not a big price difference between our markets. It's relatively kind of level between Boston, New York, New Jersey, Baltimore, and Philadelphia. There is a little bit more differentiation by asset class. So we're just kind of watching and seeing how those things settle out. What we didn't want to do is to deploy all that cash in the short term before we have a good sense as to how well we could structure it on a longer-term basis.

Okay. I appreciate that. I'll leave it there, guys. I appreciate you taking my questions.

Thanks, Justin.

Our next question comes from Michael Perito of KBW. Please go ahead.

Hey, guys. Thanks for taking my questions.

Good morning, Mike.

Good morning. I wanted to drill down a little bit more on the margin. A lot of focus, obviously on the liability side. But Pat, I wonder, number one, can you just repeat, I think you -- I heard you correctly. I just want to make sure. I think you mentioned the amount of loans that you have maturing in 2024. If you could repeat that, that'd be great. But just second point on that, like, when we think about -- with funding cost stabilizing, right? I mean, does the focus for you guys to shift to the asset side? I mean, your blended loan yields, say are like 530 (ph), which is basically right on top of Fed funds. I imagine incremental production is coming on higher than that. If you can give some context around where that is, that would be great too. But I guess what's the outlook for kind of loan yields putting some proper distance to fund the incremental funding costs as we think about the NIM's ability to kind of approach 3% again and maybe exceed that longer term, which obviously is pretty critical for ROEs, et cetera.?

Sure. I'll repeat what I said, which was a little bit high level on loan maturities. It's a little over $1 billion next year, spread relatively evenly over the year. There are some ups and downs, but I don't think make a huge difference. And then, our originations -- the pricing of our originations this quarter were in the 7.5% to 8% range. But I'd probably defer to Joe a little bit to talk about kind of opportunities and how we're thinking about loan pricing.

Yeah, Mike. I think Chris aptly put it the right way earlier. There's opportunities now for us. The pricing has been going up quarter-over-quarter as you would expect for a variety of reasons. Not only the Fed increases, but also availability of credit. And I think there's an opportunity for us to continue that and continue it on a prudent basis, right? I think that it does matter a little bit based on asset class. So, for example, in the resi space our focus has been to build and you've seen it the last couple of quarters, we're starting to build the gain on sale business, so that's not a balance sheet item. That's an opportunity for us to originate good assets and then put the assets that we want to put on the balance sheet in C&I and create rates that make the most sense for us.

Mike, maybe to be in it. [Multiple Speakers]

So, as we think about. Sorry. No, go ahead.

The loans rolling off have a five -- mid-5s handle and the new lending coming in has a mid-7s handle. But before you get too excited, we do have to cover there will be an increase in deposit costs. So we think there's a possibility for margin expansion. But you can see that there's two levers there, right? I don't -- do not take the $1 billion and play it forward without increased deposit cost.

Yeah. No, 100%. I guess, what I'm trying to sort out is just -- the last 12 months have been challenging, right? Because the assets aren't repricing as fast as the liabilities have gone up. But I think part of the challenge too has been that incremental margin on new assets hasn't been probably as good as it needs to be and I'm just trying to get a better handle of. And it sounds like it's getting closer. The incremental margin in some cases is maybe 3%, maybe a smidge better. But I'm just trying to get a better handle of what the dynamics are driving that. Because if that incremental margin doesn't kind of get back to that level, it's probably going to be very hard for kind of the consolidated margin to pick up off of the kind of 2.80% trough level that you guys are guiding to in the fourth quarter.

We're not going to be interested in putting on net growth that doesn't carry at least a three handle in margin. So if we're going to be growing the loan book.

Yeah.

We need to fund it appropriately or get above that because we do think that earning our way back to an over 3% margin is an important strategic objective of ours. I can't give you a time frame on it, but that's the way we want the company to operate.

Mike, I'll also say that we've been really thoughtful about loan growth in the last two quarters, largely because we wanted to make sure that we positioned our deposits out of the balance sheet the way we wanted. We wanted the kind of deposits that we're used to having. And in an environment like this, you want to make sure that side of the balance sheet provides you with the stable funding for the loan side of the balance sheet.

Yeah. That makes sense, Joe. And Chris, just as you think about the loan portfolio, I mean, with -- especially with the gain on sale business now on the residential mortgage side, I mean, if you guys think about the bank two, three years from now, any thoughts on what you're kind of hoping the mix seems you're about? I think what, like almost 30% in mortgages today, about 53% CRE, maybe a little higher than that if you do the owner occupied as well. But just any updated thoughts there?

I think you're going to continue to see the mix shift in favor of commercial. I think about -- when I joined the company, we were inverted, so we were probably 70% resi at that time. We're going to keep chunking away at that. We still want to provide residential finance in our markets. We think we can do so, but more as a fee business. We don't mind putting it on the balance sheet in certain cases. If it's a 15-year self-liquidating and adjustable, a relationship customer, we'll make the right choices there. But I think you're going to see residential grow very slowly and commercial kind of pick up growth rates over the course of the next year or so. So you'll see the mix shift just kind of continue quarter-after-quarter with higher percentages of commercial and lower percentages of consumer and residential.

Helpful. And then just lastly for me, would love kind of a growth and credit comment on kind of each of your markets. I mean, I think the last time you guys spoke, it sounded like Boston and Baltimore had some decent trends. There were some more concerning stuff going on in Philly and New York. But we would love any updated thoughts you're willing to provide on kind of growth opportunities in those markets and then just credit outlook near term if there's kind of any deterioration or anything you're seeing that has you more cautious on one versus the other?

Yeah. I'll ask -- Joe will chime in a minute. I'll give you kind of the high level. One of the most important things I try and stress with folks is, virtually the entirety of our franchise is located in the Northeast, which is always slower growth, but is always remarkably stable as well when you get into weaker economic periods. So, I mean, who knows whether we have a soft landing or not. But if there is economic weakness, usually the Northeast perform -- outperforms and we've been careful to keep the franchise here. There's not a lot of differentiation between markets. Boston has a significant life sciences market that's kept it more stable even through COVID. New York had some of its early issues with public safety that they seem to have largely resolved. See some of the office sector there you're worried about, but we don't have any significant exposure there any longer. And then, Philadelphia is still dealing with a public safety issue, so we're a little more cautious there. And New Jersey has been doing remarkably well. I think there's kind of an afterglow that came after COVID with folks that have decided they could spend more time outside the urban centers and New Jersey is squarely positioned between two giant ones. But Joe, any customer comments you're hearing or anything that -- that you would share about geographies or industries?

So I'd summarize Chris's comments about geographies by saying that we stress test the portfolio. We're doing it almost every quarter. We're doing the kind of things you need to do to be proactive. And we're not seeing any real bumps from anywhere in terms of the geographies and client bases and asset classes. On the other end of the spectrum, clients are basically telling us, while many remain cautiously optimistic, they're telling us they're delaying on major opportunities to do things, whether it's M&A, large equipment purchases, new lines of business, until they see more clarity on a national economic scale. So it's not something we're surprised by, it's not something new we've heard it over the last couple of quarters. I think we'll continue to hear it. But on a positive front, I'll give you an example, we've seen a couple of our largest C&I clients pay lines off to zero and have multimillions in the bank. I think they're much better positioned today than they were in prior crisis easily over 2008-'09. So that's a real positive.

Great. Well, thank you, guys. I appreciate all the color on my questions. Thanks.

Thanks, Mike.

Thanks, Mike.

Our next question today comes from David Bishop of Hovde Group. Your line is open.

Yeah. Good morning, gentlemen.

Good morning, Dave.

Chris or Joe or Pat, a question for everyone. I know the slide deck mentioned in terms of some of the deposit growth, it looks like about $328 million from a stock high-yield savings account. Just curious maybe what the -- what the duration looks like that and what that might be indexed to? It sounds like that could come back in if rates starts up to decline next year.

Yeah. So what we decided to do is as we built those deposit flows, we wanted to make sure that we didn't over-concentrate a duration issue in the deposit base should conditions change over time. And we're not predicting rates do anything up or down or whatever, we don't -- we try and stay out of that game. But we felt that it was better to have a slug of deposits that we had the ability to reduce the rates when we felt it was appropriate at some point in the future. So what we didn't want to do is put on fixed-term funding. So all of those, there's no index to it. It's a rate that we maintain and we have the ability to change that rate over time if we think appropriate.

Got it. And then, in terms of, I appreciate the continued guidance in terms of the downdraft and expenses that are expected in the fourth quarter. Just curious where you see this coming out of? How should we expect that to look? Is it coming out of salaries and benefits, occupancy, data processing, or other, just curious what are sort of the main segments where you'll see expenses reduce?

It's coming out of all the above. So we had a couple of significant contracts we're able to renegotiate, hat was a big win. We've been able to fundamentally fix processes. And I don't want to, the expense part of this has been terrific. There's a real customer experience improvement as well. We were added -- were able to significantly reduce the amount of time it takes to open an account. We're able to pull some processes out of the branches that could have been distracting to building new relationships and either modernize them, automate them, or do away with them. So it was kind of a comprehensive look of -- at everything within the company. So there are equal parts in -- there are compensation impacts, there are IT impacts, there are vendor impacts. So it's a pretty full spectrum process and it's taken us about a year to get through to the bottom of all these. And even as Pat said, we have some things we know we'll be able to accomplish, but it'll take another quarter or two. So I think if you think quarter-over-quarter where we see the decrease coming, about 50% of that decrease would be in compensation-related lines and 50% would be in professional fees.

Got it. And then one last question in terms of the capital deployment, capital outlook. Appetite for buybacks at this point? Thanks.

Look, we have a strong capacity to buy back, but we have been favoring building capital and kind of watching the markets. I just want to make this point, that's not a comment about how we feel about us, it's about us watching the world. So external factors are holding us back as we watch what's going on in the markets and make sure we feel we've got a full understanding. So that's kind of what the issue is about why we're not buying back today. We have the capacity to do so. And certainly, we think it could be a financially attractive thing to do. We just want to make sure we understand the environment best.

Got it. Appreciate the color.

Thanks, Dave.

Thanks, Dave.

The next question today comes from Matthew Breese of Stephens, Inc. Please go ahead.

Hey. Good morning, everybody.

Good morning, Matt.

I wanted to go back to the office loan charge-offs. And good morning, everybody. Going back to the office loan charge off, was there anything idiosyncratic about that loan and charge-off or was it -- what we would expect at a New York office? Lower occupancy -- lower asking rents per square foot. It just strikes me as a pretty dramatic change in valuation there, and I appreciate a little bit more color.

I think, yeah, there's a couple factors there, Matt. First, I think it is exactly what you would expect from urban office in a place like New York. And as referenced, it was a block and a half off Times Square. So pretty vibrant area of New York City. Three things happened here. The first thing that happened is we had some vacancy, but not -- I want to be cautious about that. I mean, the building is more than half tenanted and its cash flowing, so -- but the vacancy comes down. The second thing you do is this was a B office and I want to go back to when the loan was made in 2019, B office would have been perceived as actually more stable because it had lower rents and pretty much divided kind of occupancies. So you have vacancy, you have a reduction in the asking price for any space you can rent. You have the cost of vacancy, which is kind of re-tenanting. And then the last one is probably the biggest impact, which is, you could express it as a cap rate, or you could just think of it as kind of catching a falling knife, trying to figure out who is going to value New York City office of that nature right now. So that sponsor had been supporting this credit for the last couple of years. Actually made a principal paydown a little more than a year ago. They liked the asset. They just kind of got to that point where they had to make a different decision. And I think, as we've covered before, there's nothing else in our portfolio that looks like this.

So as we think about the spectrum of office, and it's funny, we've kind of as an industry oscillated between what's safest, Class A, Park Ave, or suburban. After gone -- going through this experience, how would you kind of rank order the riskiest portions of office versus the safest? And maybe give us a flavor for what you have exposure to within that?

So, I think, I would start with -- at the end of the day, it's always location in real estate, any kind of real estate and micro markets matter. So you really want to look at the specific market, what the vacancy rates are, what the demand for space is. That's what drives it. In terms of what we like the most, there's a lot of office categories that require you to be in the office, so -- people will talk about medical that's because you have to actually go in, right? We've done a lot of medical lab work up in Boston. We like that a lot. Kind of classic case of the dentist can't work from home, right? So we like all that. Second thing we like is, uses where we have an exceptionally strong tenant. Some cases that could be government tenants, it could be credit tenants, but there's a structure to the cash flows that is highly reliable and where we can underwrite those, we think that that's a good bet. And then one of the things that's happened in our market, I think it's happened elsewhere, is that in the suburban markets that fall between New York and New Jersey, there had been very little office build-out for the last decade. So even a very small portion of the office demand shifting from Central Business District New York or Philly and out to suburban office filled up whatever vacancy was there. So we've seen -- when we look across our office portfolio, we just finished stress testing the whole thing. The occupancy rates in the office portfolio now are higher than they were on the day we originated that portfolio. So, I think that -- like anything this -- it depends, we have to really kind of peel back the layers of the onion. This was a central business district New York City high-rise Class B office. And that's going to be a tough sell these days. But fortunately, we didn't make a business of that.

Got it. And then, I know this was part of a, like, a syndicated loan. What is the overall size of your syndicated loan portfolio and how has credit in that portfolio performed?

So the vast majority of what we do, we originate. So we have 93% of what we've lent is us as the lead, actually a little more. So less than 7% is the syndicated book, less than half of that is shared national credits. 97% of that book is pass-rated or better, and we don't see any trends in the book that would be of any concern.

Okay. I'm sorry, I might have missed that in your comments. But how much of that is out of market? Meaning out of your Boston, Baltimore, New York City, New Jersey footprint?

I don't have the number in front of me, Matt. There's no particular trend that's not concentrated in one area or another.

Okay. I appreciate that. Last one from me. I noticed in your 10-Q that the CRA rating was downgraded to needs improvement or needs to improve. I was curious your thoughts around that and what does the remediation effort looks like and what should we expect in terms of impacts of the P&L or balance sheet as you go through that?

Yeah. So there was a single well-defined issue that arose in our last CRA exam that we've been working on for quite some time with our regulator. I would not classify it as something that's going to have a meaningful change in our financial commitments to remediate. And our CRA period that is under review will complete on December 31 of this year. So our next CRA exam would likely be sometime in early -- or at some point in 2024. I can't say when.

So we don't think it's a big cost to remediate. It was a very narrow issue, and we've been working on that remediation for some time with our regulator.

Great. Okay, I will leave it there. Thank you for taking my questions. Appreciate it.

Thanks, Matt.

Our next question today comes from Christopher Marinac of Janney Montgomery Scott. Your line is open.

Hey. Thanks for taking our questions. Mine here is just goes back to the loan marks that we see in the 10-Q each quarter. Will those get lower and better as next year plays out, particularly as you have some of this loan turnover that you referenced earlier in the call?

Yeah. They should over time, they're just going to kind of bleed themselves out. The only caution I would have on that is that it depends on what the Fed does, right? Actually, it depends less on what the Fed does. It depends on where the long end of the curve goes. So if we're in this rate environment higher for longer, you're going to see those kind of amortize themselves off as the loan book rolls through. If rates change meaningfully, that could be a different situation.

Got it. Thanks for that, Chris. And in the presentation, you mentioned about the long duration of your customer relationships. Do you see that advantage still playing out in terms of how -- as you repriced the book? I know everything has moved up as we've seen in the numbers, but just curious, if you can kind of pinpoint how that relationship pricing is benefiting you overall in the book?

I think there is a benefit. I think we've learned a lot this year about some of the backward-looking deposit tests. Maybe some segments of our customers responded more predictably than other segments did, so we're kind of learning a little bit about that. But overall, we're very pleased with the level of retention among -- across our customer base, and we think we still have the opportunity to grow. We have a tremendously large deposit market, so while -- it's a tough environment to grow in, we have a very small market share, so I think we can continue to grow those. Our customers do 43 million transactions a year with us. Largely the best customers we have are those that have chosen to do things with us to move money around. We're helping them with everything from ACH to Wire to Zelle (ph). That's why they're with us. And I think that's a pretty durable relationship. That said, look, in a higher rate environment, we've had to make sure that we've paid enough. Loyalty will carry you. It won't carry you all the way. It'll just carry you so far. So you want to make sure you're providing both quality of service, access, transaction capability, but you also have to provide some rate yield as well. We feel pretty good about it.

Got it. Thank you for that. Got it. And then just one quick question, might be for Pat. But I may have missed it earlier, but the FDIC, a special assessment, do you anticipate that being part of fourth quarter or would that possibly go into first quarter?

Wow. If I could predict that, then I probably wouldn't be doing this job. We don't know when that's going to hit and be effective. And frankly, we're not 100% sure what the impact will be. But best estimate based on what's out there.

Got it.

Now, which hasn't been finalized, is that it'll be around $2 million, kind of a one-time thing. And that's roughly a quarter's worth of our $8 million run rate of our current assessment that's built into this year's P&L. So we'll see. I don't see an outcome where we wouldn't be subject to it, although everybody lobbied, particularly those that are around the margin, the lower end. But there's been no progress that we've seen in changing what was proposed out there or further details as to when -- if and when that will become effective.

Okay. So it's told to be determined. Obviously, it may or may not happen in the near term. Okay. That's what I want to clarify. Thank you, Pat. I appreciate you taking [Multiple Speakers]

You should just pick a date and count on it, because I don't -- I can't see an outcome where that would not happen because it's already out there, and it doesn't require somebody in Congress or Senate to propose something new. It's just like out there. So we're not forecasting it at a specific time. It'll just be at some time during 2024.

Got it. Okay. Great. Thanks very much for all the insights today.

Thanks, Chris.

Our final question today comes from Manuel Navas of D.A. Davidson. Please go ahead.

Hey. Good morning.

Good morning.

I want to stay on the deposit growth. The high yield savings, what channel is that coming from? Is that coming from branches, from your commercial lenders? Where are those funds being sourced?

That's a direct marketing channel. So one of the things you have to do to optimize your pricing is manage pricing by each channel. So we have highly competitive offers that we have in the branch. We have highly competitive offers we bring direct out to customers, and obviously, we negotiate individual deals with our commercial folks. So, it's kind of trying to figure out, what do you have to pay to move the needle in each of those channels. And it's a different yield in each one. And you try and come up with the best mix you can, but that is a direct marketing channel.

Is that -- is the branch opening kind of related to that? Is it a shift in how you want to gather deposits, or is it unrelated?

Yes and no. It's not really a shift in the way we think about deposits, but there's a little bit of a shift in that. We spent years pruning our branch network. And I think very effectively we closed 77 branches over a series of years. So as we go forward now and the company grows, we're not going to grow through opening a pile of branches. We don't think that, that makes sense. There's a little bit of a hole in our geography here. It's a county seat. There's about $1.7 billion in deposits there, a lot of commercial activity. So from time-to-time, I think you may see us in 1s or 2s over time, open a branch here or there because we think the branch has relevance. But I would not view this as a shift where you see we're going to open any number of branches next year. We have no plans to open any branches beyond this at current. But as we work in markets and we think we're kind of resonating, we may from time-to-time open branches that are kind of geographically separated from the rest of our group.

I appreciate that. As you paid off most of the short-term kind of wholesale-ish really borrowings or broker deposits and you brought in some more deposits with the high yield channel, some other channels probably will pick up. Where is the trigger for kind of an increase to loan growth?

So I think we're thinking about that hard right now in this quarter and we just want to make sure that we've got the best-informed view about how those flows come in, what the marginal cost of deposit gathering is, what the marginal yields we're going to get in each of the loan segments. So we're going through that plans now. I'll tell you this, there is demand in the market. We just have to decide which products we want it in and what yield and structures are going to be best for us. So we're working through that now. I don't think you're going to see meaningful loan growth in Q4. It'll be around what you've seen in Q3, if that. But as we go into 2024, we're kind of gearing up to figure out what the right growth number is there and what the mix of growth will be.

With the operating leverage strategies you've been putting into place, at the beginning of that, a lot of it was contemplating lower rates. Has that plan shifted across the year now that were kind of the consensus is today it could change pretty quickly. Is it a higher for longer environment? Can you kind of talk about how that operating leverage strategies have incorporated that shift?

I think the main one would be not so much around operating leverage, but we have two different fee income lines that will be constrained as long as we're in this rate environment. The first is swaps and the second one is the gain on sale and residential. We're still focused on them because they're important businesses in the long run. But the outlook for them in the short run is going to be constrained in this rate environment. So I don't think the operating leverage initiatives would have changed much, but the gain on sale in particular and the work we've done around swaps are just going to be kind of not quite on pause, but they're going to be minimally contributing until we see some change in the rate environment.

So that was kind of like the fee side of the operating leverage. It's probably has a little bit longer tail just because of the rate environment.

Correct. And we're still -- look, we would still hire very good commercials [Multiple Speakers] Yeah, I was just going to say, Manuel, we will still hire good commercial bankers if we have the opportunity to, but our appetite is not what it was two years ago. So we're going to be pretty discriminating before we add a headcount, and you won't see that headcount change much.

Okay. I appreciate it. Thank you.

All right. Thank you.

We have no further questions, so I'll turn the call back over to the CEO, Chris Maher, for closing remarks.

All right. Thank you. We appreciate your time today and your support of OceanFirst Financial Corp. We offer our best wishes to all throughout the upcoming holiday seasons. We look forward to speaking with you after our fourth quarter results are published in January. Thank you very much.

This concludes today's call. Thank you for joining. You may now disconnect your line.