Valley National Bancorp (VLY) Q4 2018 Earnings Report, Transcript and Summary

Good day ladies and gentlemen, and thank you for standing by. We welcome you to the Valley National Bancorp's Fourth Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] I’d now like to turn the conference over to Rick Kraemer, Investor Relations Officer. Please go ahead, sir.

Thank you, George. Good morning and welcome to the Valley fourth quarter 2018 earnings conference call. Leading our call today will be Valley’s President and CEO, Ira Robbins; and Chief Financial Officer, Alan Eskow. Before we get started, I’d like to make everyone aware that you could find our fourth quarter earnings release and supporting documents on our company website valley.com. Additionally, I would like to direct you to slide two of our 4Q 2018 earnings presentation with a reminder that comments made during this call may contain forward-looking statements relating to Valley National Bancorp and the banking industry. Valley encourages all participants to refer to our SEC filings, including those found on Form 8-K, 10-Q and 10-K for a complete discussion of forward-looking statements. And now, it's my pleasure to turn the call over to Ira Robbins.

Thank you. Good morning and thank you for joining us today. 2018 was a remarkable year in the history of Valley. Not only have we begun the physical transformation of our branches and brand, but we’ve dramatically improved upon the longstanding foundation that Valley was built upon. I’m pleased with our progress to-date. You have eyes wide opened that execution and delivery of the initiatives we’ve established in 2018 must be implemented to migrate Valley’s financial performance towards the upper end of our peers. Resource demands were expensive in 2018, as we close our largest acquisition in our history and integrated with great success. Most importantly we retained the talented employees including key executives and customer facing staff at USAB. Loans within the new footprint grew nearly 20% while we simultaneously grew deposit household by over 5%. All of which occurred while undergoing a significant core platform system integration, commercial treasury solution migration, implementation of a brand new residential mortgage platform and delivery of a new mobile delivery services such as biometric authorization and mobile Valley. Our adjusted efficiency ratio improved to 103 basis points on a full year-over-year basis while we substantially reinvested into the bank during this timeframe. Our aggregate IT expense as a percent of total revenues was over 7.1% for the full year of 2018. To put this into monetary context, this represents a direct increase of over $20 million in IT expense from 2017 that hit our P&L. The mix of our tech expense has continued to shift towards growth and transformation with approximately half of the incremental expense increase allocated towards improving future efficiencies and revenues. To give an example, we spent about $1.5 million during 2018 on developing, establishing and introducing a data hub. A significant amount of severance costs recognized in this quarter’s period is attributable to new quantitative staffing models introduced within our branch network, a direct result of our data hub and shift towards the analytics. We anticipate salary expense will be positively impacted by over $3 million of loan in 2019 as a result of this expense in 2018. Further, positively impacting the future efficiency of Valley is the extensive efforts we’ve made in reshaping the workforce and altering the productivity of our employees. On a linked quarter basis total headcount is down approximately 70 employees. As a result our assets per employees have increased 7% for the year leaving us much close to the peer levels. However, a more telling change is that involuntary separations have increased by over 25% from 2017, as the bank’s expectations have shifted towards growth and accountability. A tangible result of the improving and streamlining of our workforce is that our reported net income per employee was up over 20% from the prior year. The culture change at Valley is real and I can think of no better example than the profound lift in focus on sales and revenue growth. Our loan growth over the course of 2018 was 13.4% far outpacing the industry in our stated goals. Approximately 65% of our total loan originations are repeat business with existing customers. Additionally, the growth we realized in 2018 via USAB was a result of existing customer growth even higher than the legacy 65% value rate. In addition to the efforts on the asset side of the balance sheet, we continue to be very focused on new account growth and deepening core deposit relationships. In 2018, we opened approximately 46,000 new core deposit accounts. This is an increase of 23% from the prior year. The average new core account balance opened in 2018 was approximately $55,000 versus $36,000 in 2017. Additionally, we’ve steadily increased our share at Valley. As an example, our residential mortgage business has opened over a thousand new core deposit account customers with balances totaling in excess of a $100 million just this year alone. Execution and accountability are two driving things within the bank and this starts from the top. In 2018 we effectively doubled the component of compensation tied to relative stock performance for every single executive. We also tied greater levels of incentive performance for all lending and deposit gathering employees and continued to make stock a greater portion of overall compensation ultimately driving increased ownership across a greater base. We’re making all the necessary changes to drive a culture that puts the customer first and encourages performance and accountability throughout the entire organization. Over the long term we believe this is in the best interest of every Valley stakeholder. With we will move onto earnings presentation to cover some additional highlights from the fourth quarter. If we focus on slide 3, for the fourth quarter of 2018 Valley posted reported diluted earnings per share of $0.22. After adjusting for several increased aligning during the quarter adjusted earnings per share was $0.21. On an adjusted basis, our quarterly earnings per share represent growth of approximately 31% over the same period just one year ago. We continue to make stride in lowering our efficiency ratio, in fact, included in 56.7% adjusted efficiency ratio for this quarter are several items that we anticipate will not be as meaningful as we move into 2019. Specifically we incurred a little over $1 million in quarterly expense directly related to the company we ran during the fourth quarter. We expect a little bit of it will remain in the first quarter of 2019 and then come down thereafter. Secondly, our residential mortgage conditions for the quarter of $4.2 million are meaningfully greater than our expectations for 2019 on an annual basis. Based on more recent pipeline and changes in compensation structure, we expect this cost to drop significantly in the first quarter, while residential gain on sales revenue are likely to remain relatively static. Lastly, as I previously mentioned we continue to reinvest in our core business having spent approximately $2.7 million during the quarter on future facing technologies. We expect a greater return on these investments in quarters and years to come. With that Alan Eskow will now cover few slides regarding some additional financial trends for the quarter.

Thank you, Ira. Please turn to slide 4. We grew net interest income by 9.7% on an annualized linked quarter basis. Our net interest margin showed moderate compression of two basis points from the prior quarter ending at 3.10% in line with our previous guidance. For the full year our net interest margin was flat compared to 2017 at 3.11. Our strong loan growth during the course of 2018 coupled with rising funding cost for Valley and the industry have placed additional pressures on the NIM. That said, we are constantly working to achieve a neutral balance sheet position and a defensive net interest margin. Turning to non-interest income we saw a large increase on a quarterly basis. That was driven primarily by a pre-tax gain of $6.5 million realized on the sale of our Visa Class B shares partially offset by a loss of $1.5 million on the sale of private label mortgage backed securities classified as available for sale. We experienced stronger swap income generation versus the prior quarter which was partially offset by our lower level of mortgage gain on sale income for the year. During the quarter we sold approximately $94 million of loans for a pre-tax gain of $2.4 million or a 2.5% margin, a modest pickup in spread from the previous quarter. While the market still remains unpredictable for jumbo secondary sales, we are hopeful we will begin to realize greater sales revenue again over the course of 2019. Slide 5 is next and if you move onto that and operating expense you will notice that we have achieved over 83% of the annualized benefit related to our LIFT initiative. We remain on pace to achieve the full annualized amount through the end of the second quarter of 2019. Our reported operating expenses of $153.7 million included in frequent items of approximately $2.7 million of severance related to branch transformation in accretive 600,000 due to merger related items. Our quarterly amortization of tax credit expense was $9 million. Excluding all of these items, our adjusted operating expense level was down to $142.6 million for the fourth quarter versus $143.3 million in the previous quarter. Importantly there were several items that were not considered infrequent in nature inflated the current quarter expenses. Mortgage commissions related to residential mortgage production was $4.2 million for the fourth quarter. The originations in the fourth quarter remained high as a result of a large pipeline at September 30, driving the large commission expense. Based on our current pipeline we expect mortgage commissions to drop in the first quarter of 2019. Also we have previously cited our advertising costs associated with the company's re-brand were elevated by approximately $1 million in the fourth quarter. We expect this number to be comparable in the first quarter and then abate. One last highlight to mention is that our reported quarterly salary and benefit expense was essentially flat from the previous quarter despite including the previously mentioned severance charge of $2.7 million. This is further affirmation that many of the changes we have made recently are starting to take hold. As you can see on slide 6, we posted impressive loan growth of 15.3% annualized for the quarter. The growth was diversified among all asset classes but we are especially pleased by the increases in C&I which is validating the initiatives we have implemented. Also included in the fourth quarter was the purchase of our $105 million in CRA qualifying residential loans. Additionally we sold approximately $94 million of residential mortgages during the quarter. Total gross originations for the quarter were approximately $1.5 billion down slightly from the previous quarter. Our new origination yields during the quarter were weighted average of 4.95% up significantly from the prior quarter. In 2018, net residential loans grew approximately $700 million while USAB added about $600 million in mostly commercial business lines. Both of those business lines should be smaller contributors throughout 2019. Resi should also be curtailed somewhat by our focus to drive the mix to more conforming loans while the first year growth out of USAB was primarily driven by giving existing customers access to a larger balance sheet. Additionally, as we continue to build out more niche programs with higher yielding assets we should continue to migrate the mix of loans away from lower yielding fixed-rate commercial real estate. Accordingly, we are anticipating overall net loan growth of 6% to 8% for the full year of 2019. Turning to slide 7, you'll notice our deposit balances experienced a linked quarter increase of approximately $1.9 billion. The largest contributor of growth during the quarter was the increase in brokerage deposits of approximately $1.4 billion followed by retail CD growth of almost $250 million. While these products do carry a higher level of costs versus some core deposits, they have enabled the bank to reduce the reliance on higher cost and shorter duration FHLB borrowings which were $924 million lower than the previous quarter. You will notice our total funding beta remains reasonably paired to our earning assets over the past 12 months. We will continue to act opportunistically in an effort to improve our wholesale costs and durations. However, we expect the growth of brokered CDs to diminish over the course of 2019. Our loan to deposit ratio was 102.4% down from 107% in the previous quarter. This level is back within our strategic operating range of 95% to 105%. Competition for core deposits remains stiff and our efforts to improve delivery channels and focus on core deposit generation are our first priority. Over the course of 2018, we organically grew no and low-cost core deposits of approximately 3.7%. We recognize the need to improve this growth rate regardless of the rate and competitive environment that exists. Turning to slide 8, during the quarter we recorded a loan loss provision of $7.9 million up about $1.3 million linked quarter, negatively impacting the third quarter provision was the continued valuation decline of taxi medallion loans which equaled about $2.5 million or 31% of the quarterly provision. Following this quarter’s provision our level of related reserves as a percentage of exposure continues to build that now equates to 24.7% of the entire taxi medallion loan portfolio. Our current model values the average New York City medallion on our books to a level of approximately 221,000. We continue to monitor the positions closely to reflect any meaningful changes to the market and will adjust our valuations accordingly. Overall our credit quality remains strong. We did see a modest uptick in the 30 to 59 days past due bucket primarily due to one C&I loan and a hire seasonal uptick in residential loans. This was offset in part by a decline in construction past dues that we highlighted during the last quarter's call. The approximate $10 million quarterly increase of non-accrual loans was driven mostly by the inclusion of additional taxi medallion loans. With the exception of taxi medallion loans, we continue to experience very favorable credit trends. Our legacy in New Jersey and New York commercial portfolios are sitting at or near all-time lows in terms of non-accrual loans and our acquired Florida markets are showing no signs of deterioration. I would also like to highlight some details giving concerns in the investment community regarding the participation and shared national credit markets. Similar to previous periods our syndicated participations portfolio equates to approximately 317 million committed and 119 million outstanding spread over approximately 19 different relationships for an average 10 million outstanding per relationship and 16.6 million committed. Currently all of these loans are performing and the majority are secured by real estate and within footprint. Further our leveraged loan portfolio is minimal with less than 40 million outstanding and 50 million in commitments all too well-known longtime customers of the bank. On slide 9, we have laid out some goals for 2019. In terms of loan growth we are expecting the full year to be in the range of 6% to 8% on a net basis. We also expect our net interest income to be up approximately 5% to 7% from 2018. We believe it's a reasonable expectation that loan growth will make up the majority of our running asset growth throughout the year. Finally, we anticipate achieving a full-year adjusted efficiency ratio of 55% or better. As a reminder, the adjusted efficiency ratio excludes amortization of tax credits and any other infrequent items. And with that I'd like to turn the call over to the operator for some question and answer.

Thank you. [Operator Instructions] And our first question comes from the line of Ken Zerbe with Morgan Stanley. Your line is now open.

Great, good morning guys.

Good morning.

I was hoping you could actually just address your net interest margin expectations a little more clearly and the reason I'm asking because loan growth looks like it is your guidance is outpacing your NII growth and if Alan was right the loan growth is the vast majority of running assets implies that you're shifting into sort of higher yielding assets presumably which kind of implies that the NIM itself would have to be down fairly noticeably to get the lower NII growth. Just wanted to pressure that. Thanks.

Well Ken, what I'd like to say is regarding the NII growth as we do expect that even in the environment we’re in relative to the Fed maybe not increasing rates that much going forward. We obviously have a curve that's extremely tight and/or partially inverted at times. So that being said, what we're seeing on the deposit and on the funding sides are higher costs. I mean even just recently I can tell you that we have seen the large banks come out with programs across the board that are raising rates that we did not see last year. So, where we thought we could reduce rates going into 2019, I'm now seeing pressure on that which is causing us some concern. So that being said, even though we are seeing higher originations and volume coming in, not volume, I'm sorry, rate coming in. I think it is going to be pressure on the NIM on a go-forward basis, there's no doubt about it.

Hey Ken, this is Rick. Just to go back to your comment. So, I'm not so sure that that's what this guidance implies. I mean, there is an overlap between the net interest income range and the target loan range.

Sure.

I think your estimate was around 9% net interest growth for the year. So, it's probably the high. So, this you personally may be down but I think this encompasses where the existing guidance was or the existing consensus was.

I was very optimistic for you guys.

Thank you. It doesn't imply absolute decline in margin. It does give -- it does leave some space for that though, in case there is.

Got it, okay. Well, I think Alan's answer was that there NIM compression does, it is reasonable to assume.

Yes.

Okay, got you, all right. And then, just one follow-up question. On the loan growth, obviously this quarter was fantastic in terms of your ability to grow loans. The guidance does imply a much more meaningful slow down versus what we have this quarter annualized. If you mind kind of go over why the slowdown or what is driving the slowdown in '19 versus fourth quarter? Thanks.

Hi Ken, this is Thomas Iadanza. Yes. I think what you saw in '18 was the benefit of USAB coming on board having a higher hold level, being able to do more with your existing customer base that in the past they weren’t. We expect that to slow down. USAB is 20% growth in 2018; we expect to be lower than that. Also, we're just seeing a natural slowdown based on some of the economic conditions, political conditions that are out there. People in our marketplace are still tentative on investing heavily into infrastructure. So, we're seeing it from there. We're seeing certainly a slowdown in the housing and what all pieces of our business. And as we report, our portfolio is a very granular portfolio or average one. On the real-estate side, it's still under $3 million, our average loan on the C&I side is still under a $1 million. And we're building that way and some of the what we're really noticing in the market is heavy competition, we're not going to compete at some of the cap levels that are happening in certain segments of our real-estate market. And we're not going to compete on terms that would compromise our traditional credit standards in the C&I market.

And Ken, this is Ira. Thinking addition to that, we saw about $700 million of growth in the residential portfolio during the course of the year. And our expectations are for that to come way down, it will. So, I think when you combine what Tom referenced with regard to the USAB portfolio combined with the contraction we're expecting in annual growth in resi. And we could down the numbers are much more palatable for the capital we have.

All right, that's great. Thank you, very much.

Thank you. And our next question comes from the line of Frank Schiraldi with Sandler O'Neill. Your line's now open.

Good morning.

Good morning, Frank.

I wonder if you guys could talk about the efficiency target for the fourth quarter or your expectations for the fourth quarter. I think you came in a little bit above there on an adjusted basis. And then sort of the primary reason for that and then you gave guidance for under 55% in 2019, given some of the elevated cost, you talked about on giving some of the branch closures early in '19. Are you thinking that can get is it reasonable thing I guess the 55% or below in 1Q and then maybe trails down from there. Thanks.

I think at the beginning of the year, if we go back one year ago, the guidance we gave for efficiency was at 56%, so we definitely came in a little bit higher. I think part of that was associated with the increase in residential mortgage commissions during the quarter as well as the rebrand. So, without those, we would have been right along with the guidance we provide in the beginning of the year. So, I think we're comfortable with what we've targeted for 2019. Specific to that, think the first quarter is going to be at the 55%. I think that's our estimate for from where we end up for the full-year. I think as I mentioned in my prepared remarks and we continue to invest in some technologies that we think we'll have positive impacts to us. The data of being one of them, if we look at what we've done on the consumer space, we've increased other decisions which had dried down some of the expense there. So, we do believe that there's going to be some significant positive reductions in not just expenses as a result to what the expenses were in 2018.

And then, just to follow-up on, you mentioned you talked about brokered and the growth in the quarter. Could you just remind us now where brokered stands as a percentage of total deposits and then how much more room you have this year to further increase those levels?

Yes. So, first of all I just think the most important thing is to think about brokered is just another wholesale place to go. We're comfortable with the level we're at. The percentage of brokered --.

I think close to 13%.

13%. So, again I think the important thing is that we have enabled to set some duration out there and I'm not just sitting there overnight. So, we as we told you before the average term on those previously it's been about seven months overall. So, instead of having overnight funding at a higher level, they will do a lower -- higher duration and not have so much volatility. And also, we have recently been out a little shorter. We were concerned about going out too long. So, and we have brought in some of those cost recently.

Okay.

Sorry, it's about -- let me just clarify. $1.9 billion on the $24.5 billion we have.

It seems like. I mean, and Alan spoke to, it's slowing growth there. It seems like you kind of you have role over there but it seems like we shouldn’t expect to see increases in that brokerage deposit.

Well, I think that was my point. You're not going to see that kind of growth you saw before.

Okay. All right, thank you.

Thank you. Now our next question comes from the line of Austin Nicholas with Stephens. Your line's now open.

Hey guys, good morning.

Good morning.

Good morning.

Just maybe hitting back on the expenses, can you maybe just help us understand the cadence of getting maybe down to that, that sub-51% by 2020 and how that should look as we trend through '19 and into '20 just on the bigger picture basis?

Well, I think what the issues are, you got branch transformation going on. We are spending a lot of money as Ira keeps pointing out on technology. But I think we have not yet seen all the benefit you're going to see out of the technology changes. So, I think that's where a lot of those efficiencies are going to come in that we really just haven’t seen here. We're spending the money, we're getting some benefit. I think we're going to get a lot more benefit. I mean, we just started to go into on the commercial side and see no treasury solutions. We've hired a number of people that's going to help us on treasury solutions. So, we've got a lot still going on and in order to get that efficiency ratio down, they have to either produce revenues or have to be less cost.

Austin, I don’t think we want to get into a quarter-by-quarter efficiency target. But look, if you look back over the last year, while reinvesting a pretty substantial amount of dollars, just efficiency ratio came down by over 100 basis points. So, that reinvestment is going too slow. And while we also alluded to just now on the call was we're taking a decent amount of severance which will also lower future salaries again. So, it's going to be gradual but to get to a 55% by the end of the year or for the year, we're starting at a place that's 57.7%. It's going to be chipping a way out of it. I think it should be a gradual adjustment lower but that's not to say there isn’t a quarter to here or there that its flat lines or even goes up.

Understood. And then, I guess I think maybe you addressed it partly before but your picture looking at capital, maybe just to remind us what the message is to investors on capital here with your TCA TCE kind of bumping around 6.5 level?

Yes. I think definitely message should be that we have flexibility. There's definitely internal levers that we have within the organization to look at raising capital without being deluded to shareholders. We're extremely sensitive to that component of that. I think if you just look at where we were from an EPS estimate, I think just based on the street estimate TCE or tangible equity is about to grow about a $175 million. If you layer that in with the midpoint of our loan growth targets, right there there's about 20 basis points of increase in the TCE ratio. That being said, I think a large piece of it's going to be of how we moderate the overall loan growth. What we experience in 2018 in regard to the residential increase in the USAB, not our expectation that that's going to be there as that continues to go down, then we should have enough capital to support the growth that we're looking at. But going out and doing a common way is something that that's not attractive to us at any means as being sensitive to the shareholder dilution is really where the focus is.

And don’t forget too. There was about $22 million of items that negatively affect net income that shouldn’t be there in 2019. So, that's you might be able to argue there were additional and frequent items that were not included in that.

Understood. I appreciate the message. Thanks, guys.

Thank you. And our next question comes from the line of Steven Alexopoulos with JP Morgan. Your line's not open.

Hey good morning, everybody.

Good morning.

Good morning.

So, given the outlook for 60% loan growth that you guys are looking for in 2019. Can you talk about how you plan to fund the loan growth is mostly going to be retail deposits and is there plan to keep the loan to deposit ratio relatively flat?

Yes. I think that you look at what we did just this quarter. We did time deposits plus core deposits that how would have funded, a loan growth number similar to what we've targeted for next year. So, the current initiative that we've already outlined probably support that. That being said I think there's a lot of things we're looking at doing. As Alan mentioned, we had additional treasury sales people during the year; I think we're probably an 11 year-over-year. There's going to be much more of a focus on going after not just Valley commercial customers but as well as noncommercial customers. Actually, tomorrow we're going to be introducing a brand new Valley authorizer which is automated callback. We're going to be first times in the entire country that have automated callbacks for our commercial customers. We think different investments like that are going to begin to have differentiations for us as to how we can attract commercial customers. We've been migrating to a brand new commercial treasury platform. We've seen significant growth in commercial deposits as a result to that. So, I think in 2018 was a lot of investments that we put forth to make sure that we have the ability to grow core deposits in 2019. We saw massive growth year-over-year and in units of the accounts and now we just need to make sure that is down to the come along with this.

And the other thing I'll just point out is that we also made some changes to our compensation programs for both the deposit people and the lending people in order to attempt to grow deposits at a greater level than we did in the past.

And for a follow-up, Alan, can you give us a sense of the cost of new money deposits, not equating broker because that's how you're going to grow them next year. If you look at the quarter and just a cost of customer new deposits, what was the incremental new deposit costs in 4Q?

Hold on, I'll give you that in one second because I don’t have that off the top of my head. The commercial customer came on at 72 basis points, Steve. And the consumer customer came out at 170.

170. Okay, that's helpful. Just a clarification and I was to ask two questions. But the loan growth, is that guidance based on period end or average?

That's based on average.

It's average, okay. Thanks for taking my questions.

Thanks, Steven.

Thank you. And our next question comes from the line of Collyn Gilbert with KBW. Your line's now open.

Thanks. Good morning, everyone.

Good morning, Collyn.

Just a question on the mortgage banking. I just want to make sure I understand your comments. Can you just clarify where you see that business going and the growth? I know it sounded like you and it may be flat from the fourth quarter end to the first quarter on a revenue basis but yet still expect robust opportunities in '19. Just kind of frame, I know you Alan you went through the commission component of it but just trying to think about on the revenue side what the expectations are there.

Look, I think we grew $700 million in loan growth during the year on residential largely from a jumbo perspective. I think what we've done is adjust pricing within the jumbo. We have introduced additional outlets for the jumbo to create some gain on sale. And I think what we've seen is the overall pipeline come down as a result to that but the pipeline support of the gain on to the number that we reflected in the current quarter. However, as a result of not port folioing the significant number of loans that we did in 2018, are going to have commissions come back dramatically. It's one of the challenges obviously in being in the mortgage business is the commissions get expensed to a large degree in the current period and the interest income both a loan that you put on your balance sheet on really recognized over a period of time. So, in 2019, that will be right sized a little bit better than what we did in 2018, with the balance sheet growth will be more in line with what we think is appropriate for us. Appropriate gain on sale and appropriate commissions to come along with it.

Hey Collyn, this is Rick. From an income perspective or a contributor revenue to in terms of the efficiency ratio, we would only be -- we're only expecting pretty much exactly what we got this quarter. So, no growth in that category.

For the full-year '19?

For the fourth quarter annualized number.

Okay.

Right gain on sale that $2.4 million annualized would be all that we're expecting. That's basically just, that's just income from conforming flow business.

Okay.

Which have been remarkably steady all year long.

So, that will be on, the number stays the same, the expectation is that the commission number comes down significantly.

Right, got it, okay. And I apologize I don’t have it in front of me. I think that's a low -- the mortgage revenue side of this is a lot lower in '19 than what you were anticipating perhaps in the second quarter or even third quarter, is that correct?

That's correct.

Okay. But your point of it is that you're right sizing the expense side of it so that it shouldn’t have a material impact to the efficiency goals that you've set for '19.

Correct.

Yes.

Okay. And then just and I know that limiting on the question. But I just want to understand two on the taxi side, the $8.6 million that you drew out in the press release indicating that you probably have to add to the reserve this year. What kind of assumptions went into that?

And basically it does not take any assumptions into place that we go below the current valuation level that we use but rather loans that are renewed or mature and go into TDR status and get impaired. They will have to be written down to the current valuation. Obviously, valuations go down further, that number goes up as it does for the rest as a portfolio but at this point that's all we factored in.

Okay. And then, Alan, what went into the 220 valuation estimate you are using?

That's just an analysis of the trend of sales that takes place.

Okay.

We tracked. It's Tom, Collyn. We track on a regular basis the sales in the market where the number of sales that are over the value that we have. We look at it on a constant basis. And yes, I just want to kind of point out on that portfolio. We have on impaired over about 70% of the portfolio. We have over 95% of the portfolio still paying even though we classified 56% 57% of the portfolio as nonaccrual.

Okay, that's helpful. And then, just one final thing on the just kind of taking into consideration some of your comments, Alan on the NIM and just obviously the competitor pricing pressures that are still there on the deposit side. How does all of this tie into maybe what your ROA target would be either near term or long term?

I don’t think it negatively -- we don’t expect it's going to change our long-term target. We're going to have to produce if not exactly on the NIM, then and again I think we're more worried about driving NII than the NIM. What we're trying to guard against the NIM going down, NII is important. So, because that really is what drives at the end of the day, the ROA. As well as the efficiency ratio.

Okay. All right, I will leave it there, thank you.

Thank you. And our next question comes from the line of Matthew Breese with Piper Jaffray. Your line's now open.

Good morning.

Good morning, Matt.

Good morning, Matt.

I wanted to focus in on the salary expense line. I know the $2.7 million of severance will come out and there's some positive commentary in terms of mortgage commissions that will come out. But to what extent might we see the mortgage commission drop off. So, maybe you could give us an idea what the total mortgage commission was in '18 and what's the expectations are in '19 at this point?

I think we gave about $4.2 million or whatever I think is the number for 4Q. That's probably a good estimate as to annualizing that. What we recognized in 2018. And the expectation is that number will be cut more than a half in 2019. That will be a contraction in that. Like I mentioned earlier, we didn’t convert USAB until about three or four months later than what we originally anticipated. So, a lot of the cost saves that we anticipated didn’t happen until later in the year. Now we're getting the benefit of being able to focus on some of the technology initiatives that we had outlined originally for 2018 and implement them for 2019. So, we made significant progress in reducing salary expense in 4Q. We think that's going to continue. There's additional branch that we have already outlined that are going to close that additional cost saves that are going to come from and been seeing the implementation on the back-end from the encompass implementation on the back-end. Those haven’t been recognized at all. But now the technology is pretty much in place. Those will be recognized in 2019. So, we definitely got a little bit behind ourselves based on some of the merger integration, the software there. The other pieces that I mentioned, we were linked on an annual basis up $20 million in technology. You're not going to have that increase in 2019 to the same level that you had in 2018. That's going to be positive when we look at the efficiency ratio when we move into 2019 as well. So, we're feeling pretty positive about what we've said as an objective in 2019.

So, as I think about that $4.2 million annualized and the severance coming out, it seems like and I know there are recent some noise from the first quarter. But it seems like the salary expense line could come down by perhaps $4 million or $5 million on a normalized basis in the first quarters. Is that accurate and then it feels like through the tax spend that there's going to be a push for less FTEs, not more. It's so perhaps that that line item has more to go in 2020. Is that the way you think about it?

I think on the salary side, there is obviously you're going to have first quarters going to have your payroll taxes and anything like that again. But outside of that on a seasonal basis, I think your estimate as to what we're looking at in contraction is an appropriate estimate.

Okay. And then, I know you touched on the branch initiatives. So, with the nine coming of in 1Q that leaves I think 54, they were essentially targeted for either improving or closure. And I wanted to get a sense for how many of those 54 are breaking the right way and improving and how many are not and which you gauge are more likely to be closed over the next 12 months.

It's I think there's still 11 left to close that we have referenced that will happen in 1Q as well. So, this can be a positive momentum based on just closing those 11 when it comes to operating expenses. For the 54, I think we really want to give it a year timeline to make sure that they have the opportunity to hit some of the objectives that we outlined. And we'll come back to at the end of the second quarter and give you an idea as to where they're at.

Understood, okay. The other thing was just, Alan, I think you talked about the composition of growth in 2019. I missed all the specifics, could you just repeat where you expect the 6% to 8% to be -- to come from?

Well, I think we would expect more to -- yes, Tom.

Hey Matt, it's Tom Iadanza. I think that the good news in '18 is it really was across the board, every region, every department, every product type. C&I and real-estate. We expect the same. We began as we referenced in previous calls, some niches in late '17, early '18 that small ticket type of lending programs that really took off during the course of '18. And we expect those to continue to grow. So, I fully expect the growth to come from all segments and all regions.

Okay. But a little less so on residential, that's the message.

Yes. I'm sorry, I'm referring to other commercial. Yes, I think you'll see a reduction of residential as we've talked about a reduction in the auto size, we are in expectations of where the market's going. Yes, and keeping in mind that our core C&I customer, our company's up to a $100 million in revenues. Those loans just take a little bit longer to grow. We had a strong 2018 in that path but the level's off. We hire a lot of teams, we brought people in, you get that splash early if everything starts leveling off. So, we're going to level off on much of what we did in '18 but we still expect that 6% to 8% to be reasonable.

Understood, okay. That's all I had. Thank you.

Thanks.

Thanks.

And our next question comes from the line of David Chiaverini with Wedbush Securities. Your line's now open.

Hey, thanks. Just one nitpicky one from remaining is on the expense line for net occupancy and equipment expense since you've closed 11 branches. I was curious as to why that expense went up 1.5 million from third quarter to fourth quarter, but yet you closed 11 branches and then a follow up to that is should we assume that that line item essentially comes down roughly 10% as we look forward once those 20 branches are exited?

There's a lot of reasons. Number one, even when you close a branch in some cases it takes time to get out of a lease or whatever else we may be doing with it, we have additional depreciation going on based on branding change and other kinds of equipment changes. We also I think that goes in that category is things like snowplow removal, the winter months for us are always a little stronger in terms of cost on that area. So there's lots of areas, I mean, over time you would expect that as a result that the branch closures will see some decline. But, we also have transformation going on, meeting the other branches are going to be renovated. We're going to spend money on them. So it's not just a one-way street.

Yes. You also have just a normal course of rent increases in that I think Alan referred equipment expense obviously upgrades a lot of machines within –

Real estate tax increases, I mean, all that stuff doesn't stop. I think on a net basis David, linked quarter expenses on this core number came down and we anticipate further contraction going into 2019 for each individual quarter.

Yes, and quite frankly a lot of those branches that we closed to-date were closed later in the quarter and then if you think about, so the reference to the branch transformation I think we had originally estimated around 9 million in annualized operating expense reduction from that and that's approximately half of that was related to property and premises.

Got it, that's all I had. Thanks very much.

Thank you.

Thank you and our next question comes from the line of Arren Cyganovich with Citi. Your line is now open.

Thanks. On the technology side and I know that's probably going to be an ongoing investment for a number of years. But I think, in the past we talked about it being a kind of a three year plan for the large pieces that you're looking to overhaul. Where are you in that timeline and what are the larger projects that still remain on the technology side?

So, we're about halfway there. We had talked about one of the big ones that just even, the data center migration which we think will happen in 2019. That will be significant telecom saves that come out of that piece of it. But I think overall when we look at it there's ups – stepping lot of efficiencies that we're going to begin to see in 2019 as a result of what we did in 2018. I think when you look at it just on the residential space, we're processing times down and by about a third from where we were just in the beginning of 2018 just by implementing the auto decisioning on the auto side we're probably able to do twice of that that we were able to do before without increasing staff overall. The problem is those things didn't implement until the end of 2018. So the efficiency expectations that we have are not going to come a little bit later into 2019, but they're going to be real we're already beginning to see a lot of them. But the incremental increase in technology expense is not going to be at the same level that we saw in 2018.

Thank you.

Thanks.

Thank you. [Operator Instructions] And our next question comes from the line of Collyn Gilbert with KBW. Your line is now open.

Hi guys, I'm really pushing my limits here but getting back into the queue with a question but I apologize, I lost power for a minute and it maybe it was covered but I just want to clarify. Rick you had said that the loan growth the 68% loan growth was average, but that would indicate that end period growth would be flat. I just want to make sure.

I'm sorry, it wasn’t average off of the year, off of the last quarter average number.

So, not the full year average for 18 just for the fourth quarter.

Right.

Got it, all right, thank you.

Thank you. And I show no further questions at this time. I would like to turn the call back to Rick Kraemer for any further remarks.

Thank you all for joining us today on our fourth quarter earnings call. If you have any additional questions you can reach out to Alan Eskow or myself. Have a good day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone have a great day.