Oceanfirst Financial Corp Q4 FY2022 Earnings Call

Hello everyone, and welcome to the OceanFirst Financial Corp. Earnings Conference Call. My name is Daisy, and I will be coordinating your call today. I would now like to hand over to your host, Jill Hewitt, Investor Relations Officer to begin. So Joe please come ahead.

Thank you, Daisy. Good morning, and thank you all for joining us today. 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. We 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 this morning, Chairman and Chief Executive Officer, Christopher Maher.

Thank you, Jill. Good morning and happy New Year to all who have been able to join our fourth quarter 2022 earnings conference call. This morning, I'm joined by our President, Joe Lebel; and our Chief Financial Officer, Pat Barrett. We appreciate your interest in our performance and this opportunity to discuss our results with you. This morning, we will provide brief remarks about the financial and operating performance for the quarter and some color regarding the outlook for our business. As a reminder, in addition to the earnings release issued last night, an investor presentation is also available on our company's website. We may refer to these slides during the call. After our discussion, we look forward to taking your questions. Our financial results for the fourth quarter included GAAP diluted earnings per share of $0.89. Our record earnings reflect expanding margins, disciplined expense management and strong loan growth with benign credit conditions. Core earnings were $0.67 per share and reflect noncore items primarily related to a $17.5 million unrealized mark-to-market valuation gain on our equity investment position and Auxiliary Capital Partners. The details related to the auxiliary investment were shared in an 8-K filed on November 30, 2022. While provision expense was $3.6 million for the quarter, an increase of $2.6 million from the prior linked quarter. We couldn't be more pleased with the credit experience in our loan portfolio. Nonperforming loans represent just 19 basis points of total loans and remain at pristine levels. With the potential for a recession ahead, the increase in provision for the quarter represents general macroeconomic factors and risks external to our portfolio's asset quality and loss experience. Turning to capital management. The Board approved a quarterly cash dividend of $0.20 per common share. This is the company's 104th consecutive quarterly cash dividend and represents 30% of core earnings. Tangible common equity per share increased to $17.08, reflecting earnings momentum and stable AOCI marks related to our investment portfolio. Over the past eight quarters, tangible common equity per share has increased 14%. The company did not repurchase any shares in the fourth quarter. At this point, I'll turn the call over to Joe to provide some more details regarding our progress during the quarter.

Thanks, Chris. Loan growth for the quarter totaled $199 million, capping off a record year of net loan growth of $1.3 billion. Loan originations of over $3 billion for the year were primarily driven by the commercial bank, with growth across the bank's footprint. Originations were also bolstered by our conservatively underwritten construction vertical, which we expect to drive additional loan growth in 2023. We remain unwavering on the preservation of asset quality, credit standards, and pricing disciplines. Regarding credit risk metrics, we ended the year with net credit recoveries, decreased delinquencies, sharply lower criticized and classified assets and improving portfolio risk ratings. At just 15 basis points, nonperforming assets, excluding PCD loans, are among the lowest level the bank has ever recorded. Our credit discipline will allow for responsible growth in certain segments. The softened pipeline provides relief from pressure on funding needs in the short term as we shift to managed credit risk and focus on continued margin improvements. That said, we expect loan growth to continue in the mid single-digit ranges with less noise from prepayments. Turning to deposits. We continue to emphasize effective management of deposit costs. Total deposit costs of 53 basis points for Q4 have increased 33 basis points over the past year for a deposit beta of just 8%. The deposits of $9.7 billion decreased just $57.6 million, less than 1% as compared to the prior year. The loan-to-deposit ratio ended the year at 102.5%, up from 97.6% in the prior quarter and slightly above our target of 95% to 100%. We expect modest deposit growth in the coming quarters, but we will exercise price discipline and pace deposit growth to approximate the growth in well-priced credit facilities. We will be methodically focused on deposit gathering through our seasoned relationship bankers, treasury management teams, and competitively priced consumer deposits. With that, I will turn the call over to Pat to review margin expansion, expenses, and tax rate expectations.

Thanks, Joe. Turning to net interest income and margin. Net loan growth of $199 million in our historically asset-sensitive balance sheet drove another quarter of margin improvement, which expanded by 28 basis points to 3.64%. Our strengthening margin benefited from 8 basis points of purchase accounting accretion and 5 basis points of accelerated loan payoff activity. While our margin was clearly impacted by higher funding costs, it's important to expand or reiterate Joe's remarks and highlight that our deposit betas to date have proven to be lower than we would have expected, and we believe will ultimately outperform others in this respect through the current rate cycle. Two factors should provide further modest tailwinds for our overall margin. First, the quarter-end loan portfolio of nearly $10 billion was $100 million higher than the fourth quarter average. Second, nearly a quarter of our earning assets are floating rate, providing further opportunity for margin expansion, although likely at a more modest rate. Also of note, although not material to the fourth quarter's performance is that we resumed securities purchases during the quarter as part of an overall effort to lock in longer-term investment yields and in conjunction with other efforts, move our asset sensitivity towards a more neutral position. Core noninterest expense remained relatively flat in the fourth quarter compared to the prior quarter, with almost equal and offsetting increases and decreases in professional fees and data processing expense, respectively. The elevated level of professional fees are expected to continue and through the first half of '23 should level up by year-end '23. It's also worth noting that our effective tax rate for the quarter was 24.6%, and we expect that to remain in the range through the rest of this year. Overall, we continue to remain very disciplined around expense management. This, combined with our steady growth puts us in a position to highlight that we've already outperformed both the 2022 and 2023 quarterly efficiency and profitability targets that we announced at our last Investor Day in the third quarter of 2021. We couldn't be more pleased with the company's financial performance. As a reminder, the 2023 core target metrics set at that time were to earn $0.65 per share, met or exceed 1.1% ROA, and achieve an efficiency ratio of around 50%. Having largely achieved that performance a year earlier than originally anticipated, we continue to work through how we should be thinking about financial targets going forward. Not only are we considering the external economic and interest rate environment, we're also reviewing how our efficiency and productivity across all of our operating businesses and processes compare to industry benchmarks. More to come on this topic during the second quarter, but expect that over the near to medium term, our targets may be framed more in terms of relative performance rather than absolute goals. At this point, I'll turn the call back to Chris.

Thanks, Pat. Now we will begin to the question-and-answer portion of the call.

Our first question today comes from Frank Schiraldi from Piper Sandler. Frank, please go ahead. Your line is open.

Good morning.

Hi, Frank.

I wanted to discuss the pipeline. Joe, you mentioned it, but I believe you talked about mid single-digit loan growth going forward. It seems like you're anticipating more modest deposit growth as well. I am curious about where you expect the loan-to-deposit ratio to move over time. Additionally, are there any specific niches you are focusing on to enhance the funding side of the balance sheet?

Sure, Frank, it's Chris. I will take that. In terms of the strategy over the loan-to-deposit ratio, we love being like 95% to 100%. That's a great operating range for us. So it was a little bit higher. I mean, frankly, the last couple of days of the year, we had just a couple of variations in deposits that were a timing thing. We'd like to try and manage to stay around 100, there's really no issue going to 102 or 103, but we are not going to become a bank that's going to go to 120. We don't think that's a highly valuable franchise strategy. So I would expect, as we go into this year, we think we're going to have mid single-digit loan growth based on as much as we can see now, right, which is really early in the year. We want to try and match fund that with deposits for the most part. So in terms of where we're going to get those deposits, we have a terrific group of commercial bankers that have had a little bit of a luxury in the last couple of years not to have to focus as much on that. Obviously, their goals and objectives this year will be heavily focused on deposits. We have a great treasury team. We have a very mature product set there. So you're going to see our commercial bankers and our treasury team are probably doing the heaviest lift. But we also have the opportunity in our consumer franchise to be able to drive some deposit growth in consumer. So I would think about deposit growth coming in as a blend, some of which may be noninterest-bearing, but a lot of it may be either less price-sensitive interest-bearing accounts and some of it will just be market-sensitive rates. I think it's a blend. So when we blend on that and we look at the loan opportunities in the pipeline, I think we can maintain margins. As Pat said, there's an opportunity potentially for additional margin improvement, as long as rates continue to increase and then maybe flattening out after the increase is top.

Okay, great. Pat mentioned the securities purchases. I'm curious if you could discuss the potential size of additional additions to the securities book. I assume that as you're reducing asset sensitivities, you're funding that with shorter-term FHLB borrowings, and I'm guessing you won’t see much spread there. I'm interested in understanding how to think about the progression as we move through the year.

Yes. Well, it's kind of the trade you make for future asset-sensitivity versus future returns. We bought roughly $250 million towards the middle and later part of the quarter of agency paper CMOs constructs. The yields on those were in the kind of low to mid 5s. So net-net, if you consider incrementally, we are funding it at wholesale costs, and we probably clear about 1% on those increases. Now the combination of that and some other efforts that we are looking at, we are hoping to get to where our downside sensitivity is reduced from what we had last year. And frankly, as we move through this year, we kind of like to try to position ourselves relatively neutral. So that we can hopefully lock in a margin at a higher level than certainly what we saw during the zero interest rate environment.

I want to emphasize that this is an opportunity for us to reduce the risk of future margin compression, especially if interest rates start to change in the latter half of the year and into 2024. During the period of zero interest rates, we were comfortable allowing the bank to become quite asset sensitive, which we have seen positively impact our margin over the last year. As we approach terminal rates, we need to ensure we lessen the volatility in spreads. This is very much about our outlook for 2024 and 2023.

Got you. Just thinking about possible additional purchases for modeling purposes, is there a securities to assets ratio we should consider? Or is it not expected to change much from what you did in the first quarter?

I don't think you're going to see a material change in that kind of outlook. And this is a very tailored approach. So we are dollar averaging into a few positions, we are going to watch the market, watch what rates do, watch what our own interest rate sensitivity evolves to be, and also look at the peer group and make sure that we kind of stay in the band of folks that we want to be in with. So I don't think you're going to see a very different structure to our balance sheet. It's just kind of around the margins.

Okay, great. Thanks for all the color.

Thanks, Frank.

Thank you. Our next question is from Daniel Tamayo from Raymond James. Daniel, please go ahead. Your line is open.

Thank you. Good morning, everyone.

Good morning.

I wanted to ask about the expense base. Does the fourth quarter align with your expectations, and is it still a good reference point? Also, with the upcoming increase in FDIC assessments, how do you think that will affect that line item?

Right. Hey, Danny, it's Pat. So, yes, I think the fourth quarter is a good starting point. The first quarter will be influenced by merit increases and related staff costs that come towards the end of that period. This could raise costs slightly. Given the current environment, this might lead to a more persistent inflation rate, so we may see a small increase due to merit raises. However, overall, our expenses are stable right now. We are evaluating our expense base and revenue efficiency, and this will take some time as we work towards optimizing our businesses. This will be a consistent focus for us throughout the year. Some professional fees and other costs will likely remain high for the short term. Additionally, the FDIC assessment will affect us similarly to others, amounting to about $2 million due to the new rate scale.

For the year?

Yes, for the year, sorry.

Okay, terrific. Thanks, Pat. And then maybe on the fee income side, a little bit below what we're all looking for. The swap fees certainly impacted that. So maybe your thoughts on the swap fees from here and how the rates play into that? And then on Trident as well, a little bit below the range, if there was some seasonality there? Or how are you thinking about that going forward?

Yes, I'd say a couple of things just on swaps and the outlook there, and then Joe may chime in on both loan volume and Trident. Look, our clients are smart. That's a good thing. So they are resistant to buying swaps in a market where they think that rates may be going down over the next couple of years. So it's a combination of the appetite for our customers to want to be in swaps as well as the aggregate amount of loan volume. So while loan growth has been pretty good, the origination volume has come down quite a bit. So we're seeing slower prepayments, and that's what's affecting growth. So if you looked at the swap income, that's going to vary with your new originations, not with your portfolio growth. So Joe, any comments on swaps or Trident or …

I think you hit right on the head. Relative to swaps, relative to Trident, I'd say that there's always a little seasonality in the fourth quarter, but I think there's also a mechanism that rates have gone up substantially in the residential market. While we're still doing the commercial business and we are doing more and more of penetration there of our own book into Trident, that we expect that run rate may be a little bit muted over the next year until we get a little bit more normalized, less volatile rate environment in the residential space.

Thank you. Lastly, regarding CRE loan growth, I'm interested in the interest cap renewals. There was a recent article in the Wall Street Journal discussing how these may affect real estate values and potentially loan demand in the industry. I'm curious about your thoughts on this dynamic in the current market.

So a couple of things I would just point out. We've always been very disciplined about stress testing every credit we put on. So at the very beginning, we are looking at how interest rate changes over time will affect that borrower's ability to kind of roll that loan. I think that the article you're referencing focused on central business district office and the ability for those kind of the cap rates and vacancies, how could you roll that? We have very low exposure in that segment. So we have less than 1% of our assets, in central business district office underwritten CRE. So we don't feel we've got a significant exposure to that. Most of the exposures we have been well stressed tested at the beginning and have enough room that we don't think rollover risk is going to be material, at least if rates top out where the market expects now. Any thoughts you have about other segments, Joe, you've seen outside the office segment and kind of continuing strength.

Yes. I mean if you look at the balance sheet and the way we've reported the credit metrics are very strong. We are not seeing any noise in any one segment. I think one of the things we do well is, and especially in the CRE book is we have diversified not only within asset classes. So office and industrial, retail, multifamily and a bunch of other stuff. We've also diversified by geographic region. So in the last few years, with the advent of our New York offices, which are now already 4 years old and more recently, Boston, Baltimore, we've really diversified the portfolio.

Okay. Thanks, guys. I appreciate all the color.

Thank you.

Thank you. Our next question is from Michael Perito from KBW. Michael, please go ahead. Your line is open.

Hey, guys. Thanks for taking my questions.

Good morning, Mike.

Good morning. I have a couple of things I want to address. First, on one of the opening slides, you mention the balance of efficiencies and technology investments. Pat, I want to ask about expenses a bit differently. You've achieved efficiency targets ahead of schedule. As we consider the pressures for next year and the minimum level of investment you want to maintain, is it reasonable to think about an efficiency ratio in the low 50% range, or do you believe there's still potential for leverage in this environment?

I think it's reasonable to estimate that for now. We believe we can improve our performance and definitely prepare better for future growth across our business areas over time. We've invested significantly in technology, but we still have a variety of different processes and personnel. In any environment, we would focus on optimizing this, but especially now, we recognize that our revenues are likely to decline over time. We aim to maintain the efficiency and operating leverage we've achieved, even as revenues decrease with falling rates. There will be more updates on this, but it's a key priority for us this year.

Got it. That's helpful. Chris, you mentioned something about the central business district office. Can you remind us what the total office exposure is in the loan book? Also, Joe, as a follow-up, could you provide a bit more detail on growth opportunities for next year on the commercial side, specifically regarding product types and geographic areas where the pipeline might rebound faster? I'm curious about the kind of activity you’re observing.

Sure. The figure I was referring to is our office exposure in central urban markets, which includes New York, Philadelphia, and Boston. To broaden the discussion, Joe, do you have anything to add?

Yes. As I mentioned earlier, we have approximately $1.1 billion in office properties in our portfolio. The central business district office represents only about $125 million, which is 2% of our commercial real estate book and 1% of our total loan book. If we exclude life sciences or credit tenants, that amount drops to $50 million in central business district exposure. Therefore, our exposure is quite limited, and we haven't been heavily involved in that area. We maintain a fairly narrow credit band, which has worked well for us. Regarding growth in commercial real estate and our overall portfolio, I previously mentioned that the end-of-period pipeline tends to change quickly. We are comfortable with mid-single-digit growth, though there may be some fluctuations in the market. We've seen some pullbacks in Q4 with certain clients, but already in Q1, we've had people seeking opportunities. There remains considerable liquidity in the investor market, and many want to invest their capital. We have been fortunate to work with several funds over the years that have money available for opportunities. Thus, I believe there will still be chances for us to grow rapidly, or more responsibly, as you might say.

I would just to kind of complement Joe and his team, we’ve assembled a group of commercial bankers that specialize in a lot of different things, which gives us the opportunity to really diversify not only the portfolio but the growth we're putting on in any one period and the geographic diversity. So we have the opportunity markets they come and go and they're hot and cold. And our opportunity to have seasoned bankers in some of the largest markets in the country is really proving to be an advantage. It allows us to be very selective about kind of how we choose to grow and which types of risks we take on.

It was encouraging to see the return on equity of the business. While you've mentioned that the inputs are ahead of schedule, maintaining a 15% level has been a consistent trend for you over the past few years. There is a growing narrative that banks may be experiencing peak earnings and facing pressures on operating expenses and net interest margin. Although I understand you may not be ready to provide specific targets, could you share any insights on how this return on equity aligns with your internal expectations? Are you anticipating the ability to maintain this level for most of next year, give or take?

I want to start with some humility and say that it has been a challenging year. It's difficult for any of us to have clear visibility on what’s next. However, there are a few observations from the past year that support our views on the business. First, regarding deposit rates, we will need to be more competitive on deposits in the first half of the year. Nevertheless, our current deposit base remains strong, which will work in our favor. While we may increase what we pay for deposits, we won't be doing the same with our loan portfolio. We’re looking to attract more deposits to support loan growth, which presents a solid opportunity. Concerning loan yields, we've seen an uptick this quarter, and that trend should continue as rates rise. As Pat pointed out, we have a significant amount of floating rate assets. I believe this will contribute to margin expansion, even without growth. We also need to keep in mind that our business operates daily, and we aim to attract new clients during both favorable and unfavorable times. Overall, we expect that margins will keep improving for the foreseeable future, and I don’t think we’ve reached peak margin yet. On the operational efficiency front, we’ve made good progress. However, as Pat noted, we are carefully considering long-term structural costs to enhance efficiency as we scale. Reflecting back, apart from the pandemic, which was a significant disruption, we transitioned past the $10 billion mark and navigated various adjustments. We believe those challenges are behind us, and our focus is on expanding the customer base. Realistically, given our pricing discipline and credit approach, we anticipate growth closer to single digits this year rather than double digits. I hope this gives you a clearer picture of our outlook.

Great. No, no, I appreciate all that context, Chris. Thanks guys for taking the question.

Thanks, Mike. Thank you.

Thank you. Our next question today comes from David Bishop from Hovde Group. David, please go ahead. Your line is open.

Hey, good morning, gentlemen.

Good morning, Dave.

Chris, or Joe, Slide 6, you break out the loan geographic distribution by region. As you look out in terms of the newer markets, the Boston and Baltimore, just curious maybe where you see that potentially growing as a percent of the pie over the next maybe 2 to 3 years or so? Do you think that gets to double digits here in the next 2 years?

I don't know where the end game is because of the cloudiness as Chris referred to it, at least for '23. But we are pretty happy with what they've done so far. I think Boston has got a little bit of a head start. They have a little bit of a larger team as we tend to do, we are always outlooking for seasoned successful bankers will continue to do that. And the Baltimore group is largely focused on the C&I space, whereas Boston has been largely focused in CRE. So it's not easy to compare them. But if you look at the trajectory of what we did in Philadelphia and New York, I do think we have an opportunity to grow those meaningfully down the road. Some of that will be incumbent upon us to continue to fund them appropriately in this environment. So I do see really, they call it blue skies ahead, David. But I don't know if it will be as rapid as the growth we've enjoyed infilling in New York in a really good environment.

Got it. Joe, during our discussion, you mentioned some opportunities in the construction segment. Can you elaborate on where you see potential for growth?

Sure. Well, you guys may recall that we started a construction vertical just a few years ago with the acquisition of a very talented banker who has been in the space for 30 years, and we built out that team a bit. We really saw some significant activity in 2022. We actually did about triple the volume that we did in 2021. A lot of that, as you would expect, is undrawn because these are projects that are being built out. And so we do see that even if we were to slow activity in that space because of the uncertainty, these projects are going to fund and help us support some loan growth in that segment regardless. So we are pretty bullish there. And we are reinvesting there. We are again, we are very thoughtful, but we know the markets that we serve pretty well. And as you all know, especially, we will use New Jersey as an example, it’s very difficult to get things approved. It takes 18 to 36 months to get things approved. When projects get approved, they get built and they get filled. So we are pretty bullish.

Also kind of talk a little bit about the risk characteristics of that. If you think about our construction book, a significant chunk of it, approximating 40%, is non-speculative; another 40% of that spec is apartment-based. So those are underwritten to a very modest rental expectation. So there really shouldn't be an issue as those kind of mature and only 20% of it would relate to a single-family home. And as Joe noted, in the Northeast, we tend to have a much more stable level of inventory and prices. In fact, the home prices in New Jersey despite all the slowdown in unit sales continue to be up about 6% year-over-year. So it's a very prudently underwritten, very conservative and very thoughtful portfolio that we feel very good about.

Got it. That's great color. And then I noticed in the slide deck, pretty substantial improvement in the substandard loan bucket. Maybe just some commentary on what drove that decline?

I think it's a combination of factors, David. We've had improving economic conditions post-COVID. And we were, as we tend to be typically very conservative in looking at the client base that was adversely affected by COVID during that period, we were quick to downgrade credit into classified or criticized because we had concerns, the vast majority of those folks were paying, but it made sense for us to do what was prudent for the company. As they've rebounded post-COVID, it's allowed us to upgrade those. And we've had some payoffs from that bucket as well and some recoveries, which we anticipated that we would. So I think it's just a foundational aspect of the way we approach things when we have uncertainty, we will downgrade when we need to. And when we see some more certainty, we are not afraid to upgrade. We made two important decisions during COVID, which may not have been super popular at the time. The first was in the third quarter of 2020, we derisked the portfolio by pushing out the stuff we thought would have a higher likelihood of having a post-COVID issue and sold that off. The second thing that we did is we did not care about long-term Cares Act deferrals in our commercial base. So we took a position that we gave a lot of short-term deferrals, worked with our borrowers, really made sure that we kind of got them through a difficult time, but we did not restructure the facilities and enter into these kind of longer-term IO periods or payment plans that would have allowed weakness to continue. So we were able to move through that, I think, pretty effectively. When you think about the last eight quarters, having two years in a row having net recoveries on a balance sheet our size, I think that kind of proves out our thesis back in the third quarter of '20, which was not very popular, I think, held true.

Got it. Appreciate the color, guys.

Thanks, David.

Thank you. Our next question is from Christopher Marinac from Janney Montgomery Scott. Christopher, please go ahead. Your line is open.

Hey, thanks. Good morning, Chris and team, you’ve all mentioned 2024 as part of your thought process for managing the bank now. As we possibly have a different rate then, are there any lessons learned from the 2019 era when rates kind of peaked the last time with the Fed that you can implement now? I know the portfolio is a lot different. But just curious kind of if loan floors and other tactics can work or if there's any particular way you think through the structure from the past?

I think it's a great point. We're trying to learn from the experience we had in 2020. Coming out of that COVID cycle, we had a highly asset-sensitive position, which led to our margins declining into the 270s. What we started in the fourth quarter and will continue over the next few quarters is doing what we can to achieve a more neutral interest rate risk position. We're not trying to manipulate the environment to make money in one way or another; instead, we aim to ensure stability around our margins. We are prepared to sacrifice some of our net interest income today to safeguard that margin for the long term. As Pat explained, we've made some securities purchases and established a modest hedge position starting in the fourth quarter as well. This is not intended to protect against further Fed increases, but rather to guard against potential decreases in the future, although we don't know when that might happen.

Great. That's helpful. And Pat, can you remind us two things, how far out are you going on the hedge position? And then what's the amount of cash flow that comes off the securities portfolio each quarter?

The effective durations we are applying to the hedge position are likely in the 7 to 8 year range for the cash balance sheet purchases that Chris mentioned regarding the swap. We only have one swap, which is a 3-year SOFR. This will significantly alter things, mainly resulting in a marginal improvement in the downside interest rate risk exposure reflected in our Qs and Ks. Overall, that's the general idea. Our securities book is fairly short-dated, averaging around 3.5 years. So every little improvement in duration helps. Regarding the cash flows from the book, it’s approximately $25 million per month.

Okay, $25 million a month. Great. Okay. That’s very helpful. Perfect. Thank you all. I appreciate the time this morning.

Thanks, Chris.

Thank you. Our next question is from Manuel Navas from D.A. Davidson. Manuel, please go ahead. Your line is open.

Hey, good morning.

Good morning.

Many of my questions have been addressed. Regarding the construction aspect that could contribute to growth moving forward, is it not reflected in the pipeline? Is that the correct way to consider it, given that the pipeline is slightly lower in this construction area?

These are undrawn facilities that have like a 2-year life as they're kind of drawing down and building and then kind of convert after that. So we can kind of project that there'll be some draws coming in the first half of the year that are expected in natural. And they would not be in the commitments. The loan pipeline has some really nice higher loan yields. What would be the construction lines coming in as well? And they kind of have a similar, like, I think, like 6.5% yield roughly?

Well, I think the average construction transactions are higher anywhere between half and 1 over prime. You want to get paid for the risk you take in the environment that you're in. I'm sure some of our borrowers are disappointed that the rates have continued to rise, but they look at it from the long-term. And it's a little disintermediation as you would expect. If you build a multifamily project today and it may cost you prime plus one to build it, you can still, at the end, when you fill it up and stabilize it to get an end loan at 200 over a 7 or 10-year treasury, which is 5.5 today. So they look at that as we do. It's a window to pay for the risk of the construction. And then when you get to the end game, you're going to stabilize it and get much better cash flows.

That's helpful. How much of your outlook on loan growth takes into account the likelihood of a slowdown? You mentioned some slower activity. If you were more optimistic about the economy, could you potentially see greater loan growth? Or are you intentionally being more selective, focusing on better yields, and being price conscious? How are you balancing this now compared to a year ago?

I believe the market currently presents fewer opportunities. For instance, in sectors that have been rapidly expanding in recent years, like warehouses, there are not many new large facilities being constructed. This indicates a decrease in economic activity, which in turn reduces opportunities for everyone involved. Additionally, as interest rates rise, borrowers become more selective about the projects they choose to finance. If they are facing higher borrowing costs, they are likely to be very careful in how they allocate their resources, especially if they are looking at substantial interest rates. This leads to lower demand overall. Our traditional discipline tends to filter out many of the available options in the market. However, given our presence in various markets and our strong banking relationships, we can seek deals based on the strengths of different regions, like New York, Philadelphia, Boston, or New Jersey. That said, the general sentiment is one of slowdown. Regarding the potential for a recession, it's difficult to predict its arrival or severity. One aspect often missed is how a recession can impact different regions differently. Historically, the Northeast has been less affected by economic cycles, and even during mild downturns, there tends to be plenty of activity in that area. We have not seen significant overcapacity or oversupply in our markets, although we are monitoring certain areas, like the central business district office market.

That's really helpful. If the probability of a recession increases, where do you think the loan loss reserve will go? I know you currently have about 57 basis points; it’s around 65 with marks. If you were to shift more towards the severely adverse scenario, where would that potentially rise to?

We've faced challenges with CECL, and when there are no charge-offs, it becomes difficult to establish a quantitative allowance. Most of our allowance is qualitative, reflecting some anticipated risk of a recession in the near future. If a recession occurs, we would need to assess its geographical impact, which product segments are affected, and our exposures in those areas. I can't predict a specific number, but I'm confident in the strength of our loan portfolio, underwriting, and credit risk management, which should position us better than our peers, resulting in a lower coverage ratio for our reserves. Our net charge-offs are approximately 80% lower than those of banks in the $10 billion to $50 billion range, leading to a smaller loss reserve. While it could increase, I can't specify which segments would be impacted or to what extent. However, as Pat mentioned earlier, I believe our credit discipline will remain strong. We utilize Moody's SQ as the basis for our quantitative models, supplemented with qualitative factors to achieve our current positioning.

Okay. I appreciate that color. I can step back into the queue.

Thank you.

Thank you. Our next question is from Matthew Breese from Stephens. Matthew, please go ahead. Your line is open.

Hey, good morning.

Hi, Matt.

I was hoping for more insight into the near-term NIM outlook. I understand there are questions regarding the Fed's actions, so I wanted to ask a common question: with a 25 basis point hike, what is the expectation for NIM expansion at this time?

The expectation is for expansion, not contraction. Last time we spoke, we anticipated single high single-digit NIM expansion, and deposits outperformed in the fourth quarter, exceeding those expectations. A lot will depend on the level of deposit pressure we experience; so far, we haven't seen much. We still anticipate some modest expansion as long as the Fed continues to raise rates, which we believe will last for about a quarter after they stop. After that, we expect to see a flattening out. It could be around 10 basis points, but I'd rather not give a specific number.

Okay. And maybe to get a little bit more specific on the components, could you just re-quantify for us how much of the loan portfolio, I think, is the majority is fixed rate? And then what is the roll-off yield versus the roll-on yields?

About 68% of the book is fixed rate, and the remainder is floating rate.

And then the roll-off yields will probably have like a high 3 to 4 handle the payoffs. And the new facilities coming on is a high 5s, 6 and change.

Okay. Can you provide the total cost of deposits at the end of the quarter?

I don't think we published that. So I would hesitate to introduce a new number, Matt. I appreciate where the question is coming from. But I think that when you consider deposit betas, we are likely to remain on the low end of the pack going forward.

Okay. If we do see a slowdown in loan growth, obviously, the balance sheet has been a bit more protected from AOCI, so your tangible equity ratio is pretty solid. I know there's some regulatory bank level capital ratios that are a little bit thinner, but I just wanted to get your thought on capital management and where the stock is thoughts around buyback?

It's a great question. We haven't been doing buybacks, so the question is about our appetite for them. It really begins with our fundamental view on the business. We're quite pleased not only with our financial performance this year but also with our customer relationships and the expansion of our commercial banking teams in our core markets, particularly with the addition of bankers in New Jersey. It's not solely about the growth in new markets. We feel positive about this. We do see some slowing in growth as we potentially face the beginning of a recession this year, but we share the belief with many others that it won't be severe or particularly disruptive for us, and we expect to emerge from it. We believe there are significant opportunities for continued growth in the next couple of years. Therefore, we are allowing our equity position to build. I am confident we will find a good opportunity to utilize it for our shareholders in the next year or two, and we're willing to be patient. Whether growth is a bit slower this year and faster next year, we are focusing on building our capital levels because I am sure we will find an effective use for it. Okay. Understood. My last question is a bit unusual, but I've noticed some fluctuations in unrealized gains from investments, specifically a $100 million equity portfolio. I'm curious about its details. Is there anything noteworthy outside of investments this quarter? I don't anticipate significant changes in the equity portfolio unless there is a major shift in interest rates. The $100 million you mentioned consists mainly of preferred instruments with good yields, primarily from banks. The portfolio is quite diverse with no major holdings, and we have limits on how much of any one investment we will acquire. It generates decent cash flow. If interest rates rise significantly, there might be slight adjustments, but I don't foresee much risk in either direction. This shouldn't be a significant factor for us. I appreciate your insight. We are pleased with the opportunities we've had in the second half of the year, though those were quite unique, and I wouldn't expect similar occurrences in the near term. Understood. Thank you very much. That’s all I had.

Thank you. This is all the questions we have today. So I will hand back over to Chris for any closing remarks.

All right. Thank you very much. Our fourth quarter results were consistent with our strong performance throughout 2022, and they leave us well-positioned for what may be an economically challenging year in 2023. As always, we appreciate your time and interest in OceanFirst, and we look forward to speaking with you after our first quarter results are published in April. Thank you very much.

Thank you everyone for joining today’s call. You may now disconnect your lines and have a lovely day.