OceanFirst Financial Corp (OCFC) 2017 Q4 法說會逐字稿

Good morning, and welcome to the OceanFirst Financial Corp. Earnings Conference Call. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Jill Hewitt. Please go ahead.

Thank you, Brandon. Good morning, and thank you all for joining us. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer at OceanFirst Financial Corp.

We will begin this morning's call with our forward-looking statement disclosure. Please remember that many of our remarks today contain forward-looking statements based on current expectations. Refer to our press release and other public filings, including the Risk Factors in our 10-K, where you will find factors that could cause actual results to differ materially from these forward-looking statements. Thank you.

And now I will turn the call over to our host, Chairman, President and Chief Executive Officer, Christopher Maher.

Thank you, Jill. Good morning to all who've been able to join our fourth quarter 2017 earnings conference call today. This morning, I'm joined by our Chief Financial Officer, Mike Fitzpatrick; Chief Administrative Officer, Joe Iantosca; and Chief Banking Officer, Joe Lebel. As always, we appreciate your interest in our performance and are pleased to be able to discuss our operating results with you. As has been our practice, we'll highlight a few key items and add some color to the results posted for the quarter, and then we look forward to taking your questions.

In terms of financial results for the fourth quarter, diluted earnings per share were $0.30. Quarterly reported earnings were impacted by the additional income tax expense related to the reduction in corporate tax rates, which totaled $3.6 million or $0.11 a share, and merger-related expenses and branch consolidation charges totaling $1.3 million or $0.04 per share. Excluding those amounts would result in core earnings per share of $0.45.

Regarding capital management for the quarter, the board declared a cash dividend of $0.15, the company's 84th consecutive quarterly cash dividend. The ex-dividend date is February 5, so our new shareholders from Sun will be eligible to receive this dividend, provided that Sun closing occurs, as anticipated, on January 31. The $0.15 dividend represents a 32% payout of core earnings, which is in the low end of our historical payout range. As mentioned in last quarter's earnings call, we expect to defer any consideration of a change in the dividend until the second half of 2018. At that point, we expect to be in a better position to assess overall economic conditions and for the earnings accretion from the Sun transaction to be well established. As we consider the dividend later in the year, our evaluation would include both the quarterly dividend rate and the opportunity for special dividends as appropriate. No share repurchases were made during the quarter, leaving 1.8 million shares available to repurchase.

I would note that despite the impact of merger-related charges during the year and the impact of tax reform on the company's deferred tax assets, strong core earnings and careful tax management have allowed tangible book value per share to increase by 5% over the last 12 months.

I would also draw attention to the developments regarding corporate governance and board constitution. We previously announced the additions of Sun directors, Anthony Coscia and Grace Torres, which will be effective at the Sun closing. In addition, we're pleased to welcome John Lloyd to the board effective immediately. All 3 of these additions strengthen the board, bringing board and management experience from large and complex organizations, including Amtrak, the Port Authority of New York & New Jersey, Prudential and Hackensack Meridian Health. The company is committed to ensuring that the board has the resources and experience to provide the appropriate governance for a bank that has increased its operating scale dramatically over a relatively short time period.

Finally, we noted that Director Dorothy McCrosson announced her decision to retire from the board at the end of her term at our Annual Shareholder Meeting in May. Dorothy has been a pleasure to work with and was particularly important as we integrated the Ocean City Home franchise in 2016 and 2017.

Operating results were generally in line with our expectations with strong loan growth, decreasing core operating expenses and stable deposits. Our progress against important benchmarks, including core ROA of 1.09%, return on tangible common equity of 13.27% and an efficiency ratio of 53.7% for the quarter, were generally in line with our targets. Loan growth came late in the quarter, muting net interest income and quarterly margins. Mr. Lebel will discuss lending conditions later in the call.

Of course, changes in the tax rate require the acceleration of certain income tax expenses to account for revaluation in our deferred tax assets. The company actively managed our response to the tax changes during the quarter. As a result, our finance and accounting team was able to realize the significant portion of the DTA in 2017, thereby preserving $0.30 of book value per share that would otherwise have been lost. Going forward, our normalized tax rate should approximate 19%. Of course, certain merger expenses are not fully tax-deductible, so that normalized tax rate might fluctuate during the Sun integration.

I'd also like to provide some additional color regarding the company's response to the tax reform. As previously announced, the company has implemented a $15 minimum wage policy in order to ensure that we retain and incent the employees that spend the most time with our customers, largely branch and call center staff. The change in competitive landscape has fundamentally altered what we are asking of this group of employees. In the past, much of their responsibility revolved around handling cash, conducting routine transactions and supplying basic information such as account balances or verification of transactions. While those tasks still exist, we now expect our customer contact staff to be digital experts, capable of helping a customer download our mobile app, training them on remote deposit transactions or even answering questions regarding PayPal, Apple Pay or Android Pay. Reflecting this new paradigm, the bank has graduated 65 staff through our certified digital banker curriculum in 2017. 80 more employees are currently working through that program, and additional 60 Sun employees begin training under the digital banker program in February. These folks are our competitive advantage. We're investing in them, and we want them with us for the long term.

In addition to the $15 minimum wage policy, we also wanted to address the broader pool of employees who contribute each day to our long-term success. We determined that the best way to reward our staff and to pass along a portion of the benefits of tax reform would be to increase the stock ownership levels of all our employees. The planned purchase of 300,000 additional shares to be added to our ESOP trust represents an $8.1 million investment in our workforce. The additional shares will increase annual share grants, beginning with the 2018 grant cycle through 2026.

Finally, to ensure the senior officers are highly focused on achieving the bank's long-term profitability targets, a portion of the equity grants provided to senior officers will now be performance qualified and will only vest upon achievement of certain ROA targets over the coming years.

Each of these decisions was made to ensure that we maintain the most competitive workforce in a highly competitive and relationship-centric business model. That investment, while material, was balanced against shareholders' interest as well. While these programs are significant, we estimate that approximately 90% of the benefits of tax reform will pass directly to our shareholders in the form of improved profitability. Of course, with our ESOP program, employees are a material constituency in our shareholder base.

Finally, the bank's increased profitability post tax reform provides a significant advantage to the OceanFirst foundation, which currently owns 1.3 million shares of OceanFirst common stock. OceanFirst pioneered the concept of creating a foundation in connection with our demutualization and initial public offering in 1996. Since then, total grants have exceeded $34 million. In response to the bank's decreased tax rate, the Foundation board has approved a 2018 grant budget of $2.4 million, almost double the grant budget of 2016. In this way, we're able to invest a portion of the tax reform proceeds directly with nonprofits throughout our market area.

Our approach preserves the majority of tax benefits for our owners, which was an easy decision when considering how many shares are currently owned by our employees, will be newly available to employees in the expanded ESOP program and the shares held by the OceanFirst Foundation. Our governance structure made these decisions relatively straightforward.

In terms of the Sun acquisition, the company is on track to close that transaction on January 31, at which time the company will convert to a bank holding company and the bank will convert to a national commercial bank charter. Estimated consolidated assets will be in the range of $7.6 billion, making OceanFirst the second largest commercially chartered bank headquartered in New Jersey. As previously announced, this transaction will be dilutive to earnings during the first half of 2018 until the efficiencies can be realized during the second quarter. We're pleased with the strong earnings improvements Sun has managed since the transaction was announced and remain confident of achieving earnings accretion -- the earnings accretion originally projected last June. Of course, the decreased federal tax rate will make the new earnings stream attributable to Sun even more valuable than originally anticipated, although much of that opportunity will come in the second half of 2018 and 2019.

At this point, I'll turn the call over to Joe Lebel for some perspective on conditions in our lending and deposit businesses and then on to Joe Iantosca for comments regarding our plans for the Sun integration and the consolidation of an additional 17 branches in the second quarter.

Thanks, Chris. Fourth quarter loan originations of $233 million represented the highest quarterly originations for the year, and annual loan production in excess of $825 million represented record loan activity for the company. Total loan originations for the quarter, including $141 million in commercial originations, also the best quarter in 2017. However, much of the growth came in December, which limited the impact on net interest income. As much of the loan growth was funded by cash, the incremental loans booked late in December will have a modestly positive impact on the net interest margin in the first quarter. The quarter also saw the largest loan growth for the year at $96 million, led by commercial growth of $71 million.

We have spent much of the last year reducing exposure to acquired commercial construction participations. We have slowly begun to build out the participation book by purchasing seasoned cash flow in commercial real estate loans, some of which carry lower coupons but demonstrate a lower risk profile. Our asset quality remains strong, the pipeline is solid, and economic conditions support consistent loan growth in the coming year. The addition of the Sun Bank commercial and CRE lending teams should also bolster 2018 originations.

Regarding deposit growth, we saw a flat fourth quarter but solid deposit growth for the year of $155 million. This growth is particularly important as it followed our efforts to retain and expand customer relationships subsequent to the consolidation of 15 branches and the Ocean City systems conversion in the second quarter.

Retention of deposits has exceeded expectations in all of our acquisitions to date. Additionally, our average branch size has improved from a respectable $68 million at the beginning of the year to a robust $94 million at year-end as we approach our goal of $100 million per branch in the second half of 2018.

Moving to the net interest margin. We saw a decrease from 3.50% to 3.42% quarter to quarter largely due to higher funding costs and lower loan yields. Loan growth was weighted late in the quarter, preventing the rotation from cash into loans from offsetting other NIM pressure. Purchase accounting contributed 2 basis points of contraction. We anticipate the NIM to remain at its current level into 2018, with anticipated loan growth offsetting modest reductions from purchase accounting.

The average cost of deposits for the year increased only 4 basis points over the prior year to 29 basis points from 25 basis points, one of the best funding profiles in our markets. We calculated deposit beta of roughly 4% since the December 2016 rate increase by Federal Reserve. Our loan-to-deposit ratio remains conservative at 91%, providing flexibility regarding how we react to deposit pricing pressure in 2018.

With that, I'll turn the call over to Joe Iantosca, who will provide an update regarding the integration of Sun.

Thanks, Joe. As Chris stated, the legal closing for the Sun transaction is scheduled to occur on January 31. Following the closing, all former Sun locations will remain open and will operate as Sun, a division of OceanFirst Bank NA until the systems integration is completed. Scheduled for June, the systems conversion and full integration progress is progressing on schedule and as planned. Concurrent with the systems conversion, all locations will be rebranded as OceanFirst Bank. Additionally, at that time, the branch consolidations anticipated in the merger model will be completed. Specifically, 17 branches will be closed and consolidated into neighboring branches in the second quarter. Of the 17 branches being closed, 8 are less than 1 mile from the nearest OceanFirst branch, 6 are between 1 and 3 miles away, and the remaining 3 are approximately 5 miles from the receiving branch. As we have in prior branch consolidation efforts, we convened the team, representing both OceanFirst and Sun officers, and coupled with customer analytics -- and coupled customer analytics with the observation and experience of those working in the various markets to determine a candidate for closure.

As you may recall, we've consolidated 17 branches in 3 groups over the past few years. We continue to gather data and analyze the results of each of those consolidations, measuring deposit retention levels in the combined branch from the date the closure was announced. To date, our experience is an overall deposit retention rate of 97.9%. We believe this was achieved because of the multiple initiatives we take to retain our customers. We employ a very high-touch communication protocol, with most impacted customers getting personal calls from their local bankers in addition to clear written communication. Additionally, our team, led by the certified digital bankers Chris mentioned earlier, worked diligently to encourage use of the bank's high-quality, self-service offerings, including our online, mobile and wearable apps and our interactive teller machines.

Also, we typically staff the consolidated branches with a mix of personnel from both the closing and receiving branches, providing our customers with a familiar face when they visit us. We will be able to staff in the same way for this round of consolidations as well since both OceanFirst and Sun have been carefully monitoring and managing open positions since the merger announcement. In fact, OceanFirst has offered continued employment to 100% of the Sun branch staff members.

Financial impacts of the consolidations planned in the second quarter will meet the expense reduction targets and the onetime cost estimates anticipated last June, when we modeled the Sun transaction. As a result of the above time line and actions, the bank will recognize a relatively lower level of the anticipated cost savings from the merger in the first and second quarter, with virtually full recognition occurring beginning in the second half of 2018 as the branches are closed and duplicate systems are eliminated. Additionally, by the end of the second quarter, we expect to have the Red Bank administrative building operational and occupied and the Toms River facility renovations largely completed, allowing the back-office consolidations to be well underway. This consolidation initially presents an expense headwind but will substantially reduce operating risk, establish a firm foundation for further growth, enhance professional recruitment opportunity and lead to longer-term efficiency improvements.

Turning now to a brief comment on asset quality. There was an increase of $5.7 million in nonperforming loans from the linked quarter. This was primarily attributable to one commercial relationship, which has been classified performing for several years. The bank subsequently received the payment of $3.7 million from this borrower in January, reducing the balance by over 50%. Charge-off for the quarter of $2.3 million, including $1.1 million attributable to a residential loan sale and $880,000 as the bank chose to choose -- to charge off those amounts that had been specifically reserved for in previous periods, was in the allowance.

I'd like to now turn the call back to Chris for questions and answers.

Okay. Thanks, Joe. At this point, we're happy to take your question.

(Operator Instructions) Our first question comes from Joe Gladue with Merion Capital Group.

I guess, first off, just based on the loan portfolio, just wondering, in third quarter, you had noted that payoffs were particularly high, unusually high. Just wondering how much they contributed to the loan balances and any net interest margin impact.

Joe, Joe Lebel. We did get a couple payoffs in the fourth quarter. I think they're largely neutral to the NIM because the returns are very similar where our NIM is today. And it did not obviously impact loan growth. We did -- we're pretty much, I'd say, 90% through the stuff that we wanted to exit, so I think there might be 1 or 2 popping up in the first quarter but nothing significant.

And just a little bit on the pipeline. It looks like it came down a little bit versus the third quarter, and you've mentioned that a lot of the originations were late in the quarter. Just -- is that just a, I guess, temporary decline because of the late closings or just...

Yes. Pipelines are always -- it's difficult when we do the pipelines for the reports because of the day and time. The pipeline is significantly higher today as we speak than it was at the end of the year. We did also see some closings at year-end for tax reasons that we felt would push into January. But either way, I think we're pretty bullish on where we are to start off '18.

And on the deposit side, there wasn't a whole lot of change in quarter-to-quarter balances, but there was some shift in the mix. It looks like, really, there was declines in almost all the deposit categories, with the one exception of interest-bearing check. What -- give us some color on what's going on with that shift.

So Joe, some of this is seasonal. It's not uncommon for us to see some runout in the core deposits in the fourth quarter based on what our market area is. And some of the mix shift had to do with some seasonal increases in government. And then we have seen several new accounts in government for the year, where we paid a little bit more to acquire those accounts but nothing significant.

And also, just one, I guess, small item. But there was a decline in one expense line, the FDIC and other insurance line, from quarter to quarter. Yes, it wasn't a huge amount, but just wondering what's going on there. Is that a sustainable level? Or is that something temporary?

Well, overall our FDIC insurance expense decreased for the year because our risk profile changed a little bit. So the calculation, we did have a benefit for this year, 2017 versus '16, with respect to the fourth quarter specifically. There was a little bit of an over-accrual in the third quarter that was adjusted in the fourth quarter. So if you took the third and fourth quarter and split the difference, that would be the run rate.

Our next question comes from Russell Gunther with D. A. Davidson.

I just want to follow up on the margin commentary earlier. I think the expectation you laid out was for a flattish margin going forward. Should we think about that off of the 3.42% result this quarter or the full year '17 margin?

Think about it [net of the] 3.42%.

And then what does that assume for purchase accounting for -- impact for 2018 as we layer on the Sun? Obviously, that will be still to be finalized, I would imagine, and volatile, but kind of what's embedded in that stable 3.42% from a purchase accounting? And if you could just comment on rate outlooks in there as well.

Sure. So a couple of questions there. I'll take a few. Mike may jump in as well. So the first thing is, obviously, we close Sun. We'll go through the purchase accounting exercise, which has to be done at the time of closing. We don't expect to see big changes from our merger model done last year. We think we were both -- both companies had a relatively balanced interest rate risk position, so accretively, yields are not going to be a giant number. And I would point out, if you looked at Sun's progress through their third quarter earnings release, they made significant progress in building their margin. So the margins of both companies are pretty close on top of each other. You're not going to see a dramatic change in margin. There'll be a little bit of a purchase accounting impact from Sun, and then we'll have -- obviously, the purchase accounting from the prior transactions rolls off a little bit each quarter. As we think about margin going forward, if you take that kind of 3.42% and say that, I don't think you can see that move dramatically in either direction, you may see it up a couple basis points or down a couple basis points. And there's a variety of headwinds and tailwinds, right? You've got the headwind from purchase accounting. Tailwind, prime went up in December, and we'll get some impact from that in the first quarter. So I think we're going to have a relatively stable margin, so hopefully, that helps. Mike, anything you'd add to that?

Yes. When we say the margin looks like it's going to be stable going into the first quarter, we're just talking about the OceanFirst margin, not necessarily rolling in Sun. The purchase accounting adjustments, we're working on those now, but they're as of the closing date. And we certainly -- they're as of the closing date, so those have to be impacted. As Chris said, there's a little bit of headwind with respect to purchase -- the core purchase accounting for OceanFirst. In the fourth quarter, there was 2 basis points of purchase accounting benefit from some loans that were sold, and we accelerated the accretion. So that was 2 basis points of benefit. Then the "kind of recurring purchase accounting" runs down modestly every quarter, so there's about 2 basis points of headwind there. So overall, 4 basis points of OceanFirst purchase accounting headwind. And of course, that will be offset by what was probably done with Sun. But to offset that on the core OceanFirst book, we have the rotation out of cash and into loans that happened at the end of the fourth quarter. That will probably add 4 or 5 basis points to the margin. We also have the increase in the prime rate in December. That's 25 basis points. We have $340 million of loans that repriced, so that benefit would be about 2 basis points in the first quarter. We also have cash and securities that will modestly reprice up -- that have already repriced up because the yields on those portfolios was higher at the end of the year than it was, on average, for the quarter. So that's another basis point of incremental yield. So when you put that all together, it looks like kind of an offset -- basically, the positives and negatives offset each other.

That's great color, guys. And then just last follow-up on that line of question, just what your assumption is for incremental rate hikes for '18.

Look, I mean, if we knew that for sure, we can probably make a lot more money than running the bank. But the assumption that we use is we take the forward curve. So we use the market assumption about where just rates are going. That's what we build into our budget. But I think from the philosophy standpoint, we've been trying to run the company in a very balanced interest rate risk position. So if the Fed were to increase a little faster or a little slower, I don't think that has a big impact on our margins or where the year looks. That said, depending on what the environment turns into, and I'd be more concerned about the slope of the curve than the number of Fed increases, there could certainly be more favorable and less favorable slopes going into the year. We have the additional capital. One of the reasons we're deferring the dividend decision is to look at what economic conditions are. When it looks like they're very good conditions to grow a little faster, we want to have the capital inside of the company to do that. But we're going to watch those conditions in the first and second quarter, understand what the slope of the curve looks like, what economic conditions look like, how much capital we want to reserve for organic growth and make that dividend decision in the second half of the year.

Got it. Okay, very helpful. And then you guys have done an excellent job managing that core expense number down. Obviously, we'll get a bunch of noise with the Sun integration beginning next quarter. But that $26.4 million for 4Q, how would you expect sort of the legacy OceanFirst expenses to trend?

They're certainly going to trend up and for a couple of reasons. I mean, the main reasons we've mentioned earlier in the call, we've got the $15 an hour wage, plus we've got the ESOP expenses and other equity expenses. So that's heading up but being offset by the lower tax rate, so there's going to be gave and a take there. So I think you're going to see that come up. It's going to be a significant number, but our overall profitability targets would be well in line. And I hesitate to give you a specific number. And then the other thing is that we're going to have, as you point out, the noise of adding the Sun expenses in. And then the Sun expenses coming in will only be in for 2 of the 3 months, so I'd rather give you a better run rate after we complete the first quarter.

Understood. And maybe perhaps just if you were to isolate for the minimum wage increase, right, how would you expect the OceanFirst to trend?

So the total expense for the minimum wage increase, which includes -- this is why it gets kind of [kooji]. It includes the Sun employees because they're going to come to $15 an hour when we close or minimum of $15 an hour, is about $613 on an annualized basis. And then there are some other costs that come into that. I think when you look at all of our initiatives, you're talking a little bit more than a couple of million dollars a year in incremental compensation expense for all 3 of the initiatives we talked about.

I guess the other way to look at it, as Chris has commented earlier, 90% of the tax benefit we expect to accrue to shareholders, but we did reserve 10% for other items that you could look at that as kind of a starting point in terms of building most of that 10% goes into compensation. That's the minimum wage that the ESOP increased. So you can kind of look at that as kind of a starting point.

Yes. Very good, Mike. And then lastly, guys, you mentioned as part of the stock-based comp, that they are going to be performance-based around certain profitability hurdles. I believe ROA was the target. Would you be able to share what your kind of ROA target is?

So we won't -- I won't get into the specific numbers because there's -- it's a full planning ahead, has a bunch of different targets on it for different situations over the next couple of years. We'll be disclosing those targets in our next proxy, so you'll be able to kind of look through the plans and all that. To give you comfort, though, I can say that in order to achieve full vesting on those, we've got to meet our strategic objectives that we've laid out. So it's ROA based. We've talked about where we target the company to be. And in order to get the best performance out of those grants, we're going to have to meet and actually exceed those ROA targets.

Our next question comes from Dave Bishop with FIG Partners.

Chris, I know heading into past mergers, you might have had a little bit more of liquidity on balance sheet. And then obviously you had good deposit retention here. Did any of that play into the fourth quarter excess liquidity that may have impacted the margin as well and any more cash or security sitting on balance sheet than might be usual on a sort of a fully leveraged basis?

Sure. So it's kind of a tale of 2 parts of the quarter. So earlier in the quarter, we had more cash than we felt we needed. And by the end of the quarter, we felt comfortable with where we were, but it didn't really have the chance. It was -- not only were they December closing. Some of it are the closings for even late in December. So you had very little impact on the net interest margin. To your broader comment, so OceanFirst got a low 90% loan-to-deposit ratio as head Sun at their last reporting. There's plenty of cash available to us. And depending on conditions, and this is we're getting a little -- we're being careful to watch what happens in the coming months, we might choose to maybe hold the line tougher on deposit pricing and allow some of that cash to help us preserve margins. Or if we think that the loan markets are favorable, we might choose to grow a little faster and deploy that cash out in loans. So we're weighing all that. And we're looking at what loan demand will be like post the tax changes. So we want to have the optionality to either lend a little faster or use the excess cash to protect the deposit cost and the margin.

In terms of deposit costs there, anything changing intra quarter from a competitive standpoint? Have you had to become more defensive, just sort of retain the deposits? Just curious what the -- what maybe is a current quarter-over-quarter in terms of interest-bearing deposit costs?

Yes. We do have a -- the portion of the deposits in interest-bearing checking relate to institutional deposits that are -- there's a bunch of municipal in there, and they could be school districts and things like that. They have a base rate, and we raised that base rate in the end of the third quarter. I think it was September. So it had a full quarter impact in the fourth quarter. We don't anticipate raising that base rate in the foreseeable future, but we're going to watch things, see what competitors do. We don't feel a lot of pricing pressure on deposits, but that can change in a moment's notice. So as of now, I wouldn't expect much movement between the fourth quarter and the first quarter, but we're going to react to market conditions.

Got it. And conversely, I think -- I don't know if it was last quarter or 2 quarters ago. You'd sort of noted that some of the larger banks, especially in the greater Philly, got more defensive. Is it something that's sort of a phenomena maintained in the -- into the fourth quarter in 2018?

So you're certainly seeing it in segments. So I think the early thing everyone saw, or I think most everyone, was that, obviously, CD pricing moved first. The second thing that moved pretty shortly was these promotionally priced money markets, and those appear to still be under a fair amount of pressure. We have not seen a lot of pressure beyond that. So kind of ordinary course savings and money market accounts, we're not seeing pressure today. That could change. But for now, it's limited to the CD portfolio, which is not a big segment for us, and the promotional money market rates, which has never been a big market for us. We're not very active in that.

How about on the loan side of the house?

Well, I think when we saw it, 2017 was a great year to be a borrower. And I think what we've seen late in the year, as rates -- longer-term rates have trickled up just a bit that we've not been able to pass a lot of that along to the borrowers due to competition. The good news is we're still getting the spread that we'd like, but that spread is not always optimum. That's just the nature of the beast at this stage of the economic cycle.

Got it. And I have one more housekeeping question in the narrative note, so the rental income from the former tenant on the headquarters there. Is there a thought that -- how to redeploy that? Will that be -- we'd be renting out some of that space just sort of offset once they leave?

Yes. We're assuming we're going to -- the space doesn't lend itself well to that, and we're going to use the majority of it anyway. So that will be foregone, and it won't to be replaced. Although over the next couple of quarters, we have other real estate moves we're making. There are other facilities we're consolidating. Other things we'll exit. So there would be an initial drag, and then I'll think you'll see that drag offset, first, by other real estate moves as we exit other facilities. And then second, once everything settles down, as Joe mentioned in the -- we have not projected any incremental operating efficiencies from having people under the same roofs. So intellectually, we know that that's -- there's going to be additional efficiency. And we don't have a number for it, so we want to get everybody kind of moved into the new places. And then when departments are just sitting next to each other instead of an hour away from each other, we can look at staffing levels again. So I think you're going to see this initial headwind. It will decrease the first time as we consolidate some of the other locations. And then as we go into 2019, that will be an opportunity for us to really benchmark processes, procedures, workloads and trying to get a little more efficiency on other things.

(Operator Instructions) Our next question comes from Matthew Breese with Piper Jaffray.

Just maybe to start. Obviously, there was good loan growth at the end of the year. It was softer getting up until the fourth quarter. I guess it's a long-winded way of asking just what is your growth outlook for 2018, just on an organic basis?

So I think a couple of times over the last few quarters, we've kind of reiterated that we think that we should be able to grow somewhere in the range of $50 million or more each quarter. But there's been noise in that, not because of originations, but more because of prepayment levels. So as we went through 2017, the originations, they were high in the fourth quarter, but they were pretty consistent all year long. It was the pace of prepays that dampened the growth. So I think we're, as Joe said earlier, we're largely through the credits that were coming up for renewal where we had less of an appetite. So I think we're feeling more comfortable that, that $50 million a quarter target should be achievable, and there may be quarters we do better than that.

And how would you break that down between your resi portfolio CRE and C&I?

So it's a bit opportunistic, right. Depends on what's in the market in that quarter, but we like a blend. So one of the reasons, I think, that we've been able to manage our -- say, our investor CRE percentage, which is obviously something everyone closely watches, is because we've got a balance sheet that has different parts to it. So our focus is commercial. We like the majority of the growth to be on commercial, but we like the risk management aspects of having a significant residential portfolio. Especially if you think about 2020 or 2021, is there a possibility of a credit event? You've got portfolios that would be non-correlated. So I think commercials are focused. We'd like to see that grow the fastest. But we're welcoming some growth in residential because I think it's an important leg of the stool. So -- and then in that, the best growth we can have is obviously C&I and owner-occupied CRE. And our owner-occupied CRE is underwritten in price just like C&I. So it's got the same performance attributes, bringing deposits with it. It's relationship priced and all that. So obviously, I'd like to see very strong growth in C&I and owner-occupied CRE. But we've got room in the balance sheet for more investor CRE, and we welcome the opportunity to do good residential when it comes up.

Got it. Okay. That's helpful. And then maybe a bigger-picture question. To date, your retention after closing these -- I think you said 17 branches is 97%. You're on your way to $100 million in deposits per branch. I have to imagine that retention number gives you enormous confidence in being able to do these kinds of strategic initiatives. And do you think that beyond this next slate of branch closures that we could see that $100 million become something higher? And then as you push to reform the dots on the map and work perhaps something to $125 million, I mean, could you frame that for us?

Sure. I think you're absolutely right. So there's the -- there's 2 things going on here. Obviously, the acquisitions gave us a lot of branches that are close to each other, so those are relatively low-hanging fruit. But beyond that, it's something, at least internally, we've been devoting the time and energy to because we want to be good at this. We want to understand how to make the right decisions about which branches are important to people and which branches are not so important. So each time we go through this, we've been -- we refine our model. We capture additional data points, and we look at the performance of a variety of factors. That's, I think, giving us the institutional confidence to continue to rightsize the branch network to match our customers' needs. So the -- so independent of our acquisitions, you've got this long-term issue of people needing access or less frequent access to their local branch. So essentially, the branch training area is getting larger. Joe shared with you some of the radius numbers. What we found is that the consolidations under 5 miles are very low risk as long, as you're careful to make sure you're engaging with your customers and your employees and handling the systems right. Our deposit market is largely suburban. So if you're going to go to the bank, that means you're getting in a car. So if your trip to the bank is an extra half a mile or 1.5 miles, that's no big deal. So it's a thing we're getting good at, I think we're honing our skills at, and I think it's something, as a sector in an industry, everyone's going to be faced with this. So I would not rule out additional consolidations going into 2019. I'd also say that we've thought about relocations. Because in some cases, you'd have branches which are open 20 years ago that were in the right location 20 years ago and are not in the right location today. So you might to do a combination of consolidation in moving a branch. So -- but it's a big process. There's disposal of properties. There is renegotiations of leases. There's -- and it's something that we want to be institutionally competent at. I think we're doing that, and I think we're showing that through the numbers. In terms of your target, is there a target north of $100 million? Probably. I don't know that I have enough information to put a number to it today. But I think over the next 5 and 10 years, if you're not making these changes, I don't know how you're going to be able to handle the operating expenses you need to cover things like cybersecurity and regulatory compliance and those kinds of things.

Got it. Okay. No, that's very helpful. Two other ones. One being discussed today is part of legislation proposal for like a New Jersey State Bank that would collect municipal deposits. And so I want to get your thoughts on that. And what is your percentage to deposit there tied to local municipalities?

So it is a very complicated issue because the state bank obviously is in discussion now, but it doesn't really have a full form. So I'll make some general comments, but I don't know what full form is actually going to come out of the legislature. And so you kind of need to see the end product before you have significant comments on it, but I'll make some broader comments. The premise that we need a state bank to fill lending needs in the state, I think, is a flawed premise. We have several hundred financial institutions operating in the state. There's a wide availability of credit for the people who need it and deserve it, so I don't know that there's a giant need that is unmet. So that's the first thing that I would say, but let's see what proposal comes out. In terms of competition for deposits, obviously we thought about this a lot. We do a good business in municipal deposit gathering, but we also bank school districts and utility authorities and all that. I think the risks to our municipal and institutional deposit business are going to be based on the complexion of our customers. So we do a lot of operationally centric cash management, so things like payroll accounts, things where school districts wants their teachers to be able to drive down the road and cash a check. In those cases, I think the services we're delivering are not going to be attractive -- the services of a state bank will not be as attractive because they're not underpinned with the ability to go down the street to a branch and cash a check. The other thing is that this is a widely diverse market today. I checked the other day. I think there are about 109 banks that are listed by the state of New Jersey that offer municipal deposit taking today. So we compete today with 108 other banks for these dollars. The state bank may be another competitor, but it will be the 110th competitor. It's not like we don't have competition today. So from that aspect, I don't know that it changes a lot. If our business was centric on high-yield CDs, those kinds of things, I would probably be more concerned. So we're not overly concerned at this point. I hope that kind of frames it. When we see the final proposal, I think we'll be able to put more details to our thoughts about it, but we're not overly concerned.

Okay. No, that's helpful. The last one is given the changes to the ESOP, should we expect any sort of change to shares outstanding, be it common or average diluted? And to what extent?

Matt, it's Mike. So when the 300,000 that goes -- 300,000 shares that would go into the ESOP, it's the same way as -- basically like a repurchase. So the ESOP trust will go out and buy that 300,000 shares and put them into trust on day 1, those shares are not considered outstanding, so it'll reduce the shares outstanding by a little bit. As they get allocated to employees each year and get allocated to the retirement count then they're considered outstanding, and the employees can vote their shares, et cetera. So the initial -- but the initial transaction would reduce shares outstanding.

Got it. And when do you expect that to occur? Is that like a first quarter event or already been done?

Has not already been done, first quarter event.

(Operator Instructions) Our next question comes from Collyn Gilbert with KBW.

If I could, Mike, just to clarify your comments on the NIM. If I heard you correctly, it sounded like in terms of NIM headwinds, there was going to be -- and this is from 4Q to 1Q, but 2 basis points it sounded like I think you said due to accretion. And then was it another 2 basis points of funding cost pressure?

Oh, it's on the purchase accounting. There -- it's a total of 4. There's 2 basis points that were included in the fourth quarter for where we sold some loans, and we accelerated the recognition of some credit marks. So that was a 2 basis point benefits in the fourth quarter that will go away in the first quarter, unless we have the same kind of activity. And then regarding kind of the core, the core purchase accounting trends down over time. So that's another 2 basis points going down. It's a little bit more -- it goes down a little but more from fourth quarter to first quarter as compared to the second, third and fourth quarter. So that would be the other 2 basis points. So in terms of purchase accounting altogether, there's 4 basis points of kind of headwind there.

Okay. And then in addition to the purchase accounting, what other -- what were other margin headwinds you were assuming?

Okay. So the other margin headwind would be deposits. We're not sure how that would reprice. But in the fourth quarter, there was a 3 basis points of increase in deposits. So if you add that as the headwind with the purchase accounting, that might -- that's about 7. But we think that's offset by the change in the asset mix, the prime rate increase and the cash securities repricing upward that I mentioned earlier.

Got it. Okay, okay. That's helpful. And then you got -- Chris, you've given some color on your sort of outlook for loan growth and what you're hoping to see there. What about just in terms of cash and securities? It sounded like you may have said that the liquidity position at the end of the fourth quarter, you were sort of comfortable with. But then as you fold in, obviously additional liquidity with Sun, how are you thinking about kind of the balance of securities and cash you want to hold?

Yes. Collyn, it's Mike. I think that our strategic objective is to make as many good loans as we can, and then whatever's left goes into the securities book. So ideally, we'd like to see the securities book run down and allocate more to loans. But as we know, for the -- we mentioned earlier, some of the loan growth was muted in 2017 because of payoffs. So we don't necessarily target a securities cash division. It's really kind of dependent on loan and deposit growth, and we would, obviously, prefer strong loan growth and a lower securities book.

Okay. All right. So tying that to, Chris, your comment about you guys are going to be thinking sort of a little bit more broadly, a little bit more strategically on what you do with the liquidity, maybe some loan purchasing or adjust your deposit pricing, is there a period in time? Is there a metric? Is there some sort of catalyst that will cause you to make that decision sooner rather than later on how you're thinking about the balance sheet overall?

Sure. So they're kind of the 2 factors we would be looking at, one external and one internal. The external factor would be watching the slope of the curve. Most of the commercial lending we do has got a high correlation to the 5 year. So looking at where that moves and whether those are translating into improved yields, is the external metric that we would look at most closely to, say, this is something where we think we should be a little more aggressive in terms of growing the loan book. The internal measure around cash and the whole liquidity question really relates to the Sun integration. So I'll start by saying we have a high degree of confidence about our ability to consolidate branches and retain deposits. We also have a high degree of confidence in the Sun deposit base because I think Sun has done a great job of managing that well over the last several years. So they've decreased the deposit base, got rid of the sensitive money. And if you look at their deposit costs, they've kind of created what I would say is a high-quality deposit base. So I don't think that the Sun deposit base is highly susceptible, and I think we're very good about integration. All that said, until the integration is complete and until the customers are getting OceanFirst statements and until we know how folks are reacting to things, we're going to be a little conservative. So we'll probably run with a little heavy -- we'll probably consider our liquidity with an extra dose of caution until the Sun integration is complete. So that will be done in June, and we'll be watching deposit balances in July and August, September. So in the -- I guess the best outcome, if we see some steepness to the curve, that 5-year moves up, it starts to translate into yield in the markets and we feel very good about our progress points in deposits, I think you'd see us grow more quickly in the second half of the year, push that loan-to-deposit ratio up and take advantage of that situation. And I guess the bare scenario would be that for whatever reason the 5 year does not move or moves in the wrong direction and we have any concern in the way deposits are falling as part of the Sun transaction, we would be more conservative.

Okay, okay. That's very helpful. Mike, just want to hop back to you. On the margin, just 2 things. Is there an FTE adjustment that we should be thinking about on the NIM for the first quarter?

No. We report -- we don't report it, the tax event, like that. So what you see in our press release, you don't have to adjust that.

Okay. And then any change on the day count? Does the day count in the first quarter affect your margin much?

We do, do day counts. So fourth quarter was 92 days. The first quarter would be a little less, so you have to adjust for the day count.

Okay. All right. And then just finally, back to you, Chris. So you'd mentioned, you guys are committed to your -- the profitability targets you've laid out in the past, your ROA targets. Can you just update us on those? And I guess I'm asking because, obviously, with a tailwind to the tax bill, right, it sort of -- I don't want to say artificially inflates your earnings, but whatever, inflate your earnings and it inflates your ROA. So are you adjusting your ROA targets accordingly? Or how should we think about those -- you achieving those targets? And what are those targets?

Absolutely. It's a great question. So the message I would send is that we had, what I thought, were strong ROA targets given the Sun acquisition. We expect it by the end of the year. Our target was to get to an ROA over 1.20%. And we said earlier that we want 90% of the benefit of the tax reform to go to our shareholders, so we would adjust our ROA targets up accordingly. And that's the way we're looking at it. We think that the majority of the benefit of tax reform should go to our shareholders. And we'll -- in the second half of the year, and that kind of ties into the question you had before about growth, conditions and the dividend, we don't want to be making long-term dividend decisions now. We want to see what the economic environment is. Look at what our -- the internal earnings generation is, and then we'll calibrate to that and make decisions about the dividend. But there's no question, we're moving our return targets up to reflect approximately 90% of the tax benefit going into the shareholders.

(Operator Instructions) Our next question comes from Brian Zabora with Hovde Group.

Yes. I have just one question. With the change in tax laws, the tax cut, does this impact how much DTA or the valuation recapture that could be with the Sun transaction? Is it any different than you initially thought?

Okay. So I guess it does affect it, although not directly. Obviously, Sun will have to write down their DTA as of 12/31, which they've done. And the impact you'll see is actually in purchase accounting, right. So it will affect the goodwill number that we wind up putting through purchase accounting. Now we anticipated a -- when we announced the Sun acquisition, we actually modeled a more advantageous interest rate -- I'm sorry, tax rate scenario, which could have gone down as low as 15% at the time. At that time, when we announced the merger, we explained that we thought the DTA write-down would be in the range of could be as high as $40 million. And that we would recapture that over about 4 years, and that really has -- those numbers will change a little bit, but the recapture rate is about the same, and the total numbers are about the same. So the way we look at it, we'd rather have the earnings stream than the book value. But it's working out as we thought it might when we modeled the Sun transaction last June.

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

All right. Thank you. With that, I'd like to thank everyone for their participation in the call this morning. We look forward to providing additional updates as the year progresses. Thank you. Goodbye.

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