OCEANFIRST FINANCIAL CORP. Overview
OceanFirst Financial Corp. has been the holding company forOceanFirst Bank since it acquired the stock of the Bank upon the Bank's Conversion. The Company conducts business primarily through its ownership of the Bank which, atDecember 31, 2019 , operated its branch office and headquarters inToms River , its branch and administrative office located inRed Bank , 54 additional branch offices and five deposit production facilities located throughout central and southernNew Jersey . The Bank also operates commercial loan production offices inNew York City , the greaterPhiladelphia area and inAtlantic andMercer Counties inNew Jersey . OnJanuary 1, 2020 , the Bank acquired an additional 14 branches and one loan office as part of theTwo River acquisition and five branches and one loan office as part of theCountry Bank acquisition. The Company's results of operations are primarily dependent on net interest income, which is the difference between the interest income earned on the Company's interest-earning assets, such as loans and investments, and the interest expense on its interest-bearing liabilities, such as deposits and borrowings. The Company also generates non-interest income such as income from bankcard services, trust and asset management, deposit account services, Bank Owned Life Insurance, derivative fee income and other fees. The Company's operating expenses primarily consist of compensation and employee benefits, occupancy and equipment, marketing, Federal deposit insurance and regulatory assessments, data processing, check card processing, professional fees and other general and administrative expenses. The Company's results of operations are also significantly affected by competition, general economic conditions including levels of unemployment and real estate values as well as changes in market interest rates, government policies and actions of regulatory agencies. Acquisitions OnJanuary 31, 2018 , the Company completed its acquisition ofSun Bancorp, Inc. ("Sun") which added$2.0 billion to assets,$1.5 billion to loans, and$1.6 billion to deposits. Sun's results of operations are included in the consolidated results for the period fromFebruary 1, 2018 toDecember 31, 2018 . OnJanuary 31, 2019 , the Company completed its acquisition ofCapital Bank of New Jersey ("Capital Bank ") which added$494.7 million to assets,$307.8 million to loans, and$449.0 million to deposits.Capital Bank's results of operations are included he consolidated results for the period fromFebruary 1, 2019 toDecember 31, 2019 . OnJanuary 1, 2020 , the Company completed its acquisition ofTwo River Bancorp ("Two River"). Based on the$25.54 per share closing price of the Company's common stock onDecember 31, 2019 , the total transaction value was$197.1 million . The acquisition added$1.1 billion to assets,$938 million to loans, and$942 million to deposits. Two River's results of operations are not included in any of the periods presented herein. OnJanuary 1, 2020 , the Company completed its acquisition ofCountry Bank Holding Company, Inc. ("Country Bank "). Based on the$25.54 per share closing price of the Company's common stock onDecember 31, 2019 , the total transaction value was$112.8 million . The acquisition added$798 million to assets,$616 million to loans, and$654 million to deposits.Country Bank's results of operations are not included in any of the periods presented herein. These transactions have enhanced the Bank's position as the premier community banking franchise in central and southernNew Jersey and have provided the Company with the opportunity to grow business lines, expand geographic footprint and improve financial performance. The Company will continue to evaluate potential acquisition opportunities for those that are expected to create stockholder value. Strategy The Company operates as a full-service community bank delivering commercial and consumer financing solutions, deposit services and wealth management throughoutNew Jersey and the metropolitan areas ofPhiladelphia andNew York City . The Bank is the largest and oldest community-based financial institution headquartered inOcean County, New Jersey . The Bank competes with larger, out-of-market financial service providers through its local and digital focus and the delivery of superior service. The Bank also competes with smaller in-market financial service providers by offering a broad array of products and by having an ability to extend larger credits. The Company's strategy has been to grow profitability while limiting exposure to credit, interest rate and operational risks. To accomplish these objectives, the Bank has sought to (1) grow commercial loans receivable through the offering of commercial lending services to local businesses; (2) grow core deposits (defined as all deposits other than time deposits) through product 35 -------------------------------------------------------------------------------- offerings appealing to a broadened customer base; and (3) increase non-interest income by expanding the menu of fee-based products and services and investing additional resources in these product lines. The growth in these areas has occurred both organically and through acquisitions. The Company will focus on prudent growth to create value for stockholders, which may include opportunistic acquisitions. The Company will also continue to build additional operational infrastructure and invest in key personnel in response to growth and changing business conditions. Growing Commercial Loans With industry consolidation eliminating most locally-headquartered competitors, the Company fills a void for locally-delivered commercial loan and deposit services. The Bank has strategically and steadily added experienced commercial lenders throughout its market area over the past few years. In 2015, a loan production office was opened inMercer County to better serve the centralNew Jersey market area. An additional loan production office in thePhiladelphia area was acquired onMay 2, 2016 as part of the Cape transaction. Subsequently in 2019, the Bank expanded its presence in the greaterPhiladelphia andNew York City markets. AtDecember 31, 2019 , commercial loans represented 66.9% of the loan pipeline and 56.1% of the Bank's total loans, as compared to 55.7% and 42.6% atDecember 31, 2014 , respectively. Commercial loan products entail a higher degree of credit risk than is involved in one-to-four family residential mortgage lending activity. As a consequence, management continues to employ a well-defined credit policy focusing on quality underwriting and close management and Board monitoring. See "Risk Factors - Increased emphasis on commercial lending may expose the Bank to increased lending risks." Increasing Core Deposits The Bank seeks to increase core deposit (all deposits excluding time deposits) market share in its primary market area by improving market penetration. Core account development has benefited from Bank efforts to attract business deposits in conjunction with its commercial lending operations and from an expanded mix of retail core account products. As a result of these efforts the Bank's core deposit ratio was 85.2% atDecember 31, 2019 , and the loan to deposit ratio was 98.1%. Enhancing Non-Interest Income Management continues to diversify the Bank's product line and expand related resources in order to enhance non-interest income. The Bank is focused on growth opportunities in areas such as derivative contracts, trust and asset management and digital product offerings. The Bank also offers investment products for sale through its retail branch network. In late 2018, the Bank replaced its third party broker/dealer investment sales program with a hybrid robo-advisor product offered by the Bank's partner, Nest Egg, a registered investment adviser. Nest Egg is an investment platform that helps define and reach financial goals by providing access to high quality and cost-effective investments. It includes web-based tools as well as access to personal financial advisors via phone, chat, or video. AtDecember 31, 2019 , the Company had an ownership interest of less than 20% in NestEgg and a seat on the Board of Directors.Branch Rationalization and Service Delivery Management continues to evaluate the Bank's branch network for consolidation opportunities. The Bank anticipates at least 13 branch consolidations in 2020, of which eight are a result of the Two River merger. This follows the consolidation of eight and 17 branches in 2019 and 2018, respectively. In addition to branch consolidation, the Bank is adapting to the industry wide trend of declining branch activity by transitioning to a universal banker staffing model, with a smaller branch staff handling sales and service transactions, as well as increasing the marketing of products that feature digital and mobile service. In certain locations, routine transactions are handled through "Video Teller Machines," an advanced technology with live team members in a remote location performing transactions for multiple Video Teller Machines. The Bank is also investing in multiple digital services to enhance the customer experience and improve security. AtDecember 31, 2019 , a majority of the branch staff were trained as Certified Digital Bankers to better support customers use and adoption of digital services. Capital Management In addition to the objectives described above, the Company actively manages its capital position to improve return on tangible equity. The Company has, over the past few years, implemented or announced, five stock repurchase programs. The most recent plan to repurchase up to 5% of outstanding common stock was announced onDecember 18, 2019 to repurchase up to an additional 2.5 million shares. This amount is in addition to the remaining 167,996 shares available under the 2017 Repurchase Program. For the year endedDecember 31, 2019 , the Company repurchased 1.1 million shares of its common stock under these repurchase programs. AtDecember 31, 2019 , 2.7 million shares remain available for repurchase. 36 --------------------------------------------------------------------------------
Summary
Highlights of the Company's financial results for the year endedDecember 31, 2019 were as follows: Total assets increased to$8.246 billion atDecember 31, 2019 , from$7.516 billion atDecember 31, 2018 . Loans receivable, net increased by$628.5 million atDecember 31, 2019 , as compared toDecember 31, 2018 , while deposits increased$514.2 million over the same period. The increases were primarily the result of theCapital Bank acquisition. Net income for the year endedDecember 31, 2019 was$88.6 million , or$1.75 per diluted share, as compared to net income of$71.9 million , or$1.51 per diluted share for the prior year. Net income for the year endedDecember 31, 2019 includes merger related expenses, branch consolidation expenses, non-recurring professional fees, compensation expense due to the retirement of an executive officer, and reduction in income tax expense from the revaluation of state deferred tax assets as a result of a change in theNew Jersey tax code. These items decreased net income, net of tax, for the year endedDecember 31, 2019 by$16.3 million . Net income for the year endedDecember 31, 2018 included merger related expenses, branch consolidation expenses, and reduction of income tax expense from the revaluation of deferred tax assets as a result of the Tax Cuts and Jobs Act ("Tax Reform") of$22.2 million , net of tax. These items reduced diluted earnings per share by$0.32 and$0.47 , respectively, for the years endedDecember 31, 2019 and 2018. Excluding these items, net income for the year endedDecember 31, 2019 increased over the prior year period. The Company remains well-capitalized with a tangible common equity ratio of 9.71% atDecember 31, 2019 . Critical Accounting Policies Note 1 Summary of Significant Accounting Policies, to the Company's Audited Consolidated Financial Statements for the year endedDecember 31, 2019 contains a summary of significant accounting policies. Various elements of these accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. Certain assets are carried in the consolidated statements of financial condition at estimated fair value or the lower of cost or estimated fair value. Policies with respect to the methodology used to determine the allowance for loan losses are the most critical accounting policies because it is important to the presentation of the Company's financial condition and results of operations, involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. The use of different judgments, assumptions and estimates could result in material differences in the results of operations or financial condition. Critical accounting policies and their application are reviewed periodically and, at least annually, with the Audit Committee of the Board of Directors. Allowance for Loan Losses The allowance for loan losses is a valuation account that reflects probable incurred losses in the loan portfolio. The adequacy of the allowance for loan losses is based on management's evaluation of the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, current economic and regulatory conditions, as well as organizational changes. Additions to the allowance arise from charges to operations through the provision for loan losses or from the recovery of amounts previously charged-off. The allowance is reduced by loan charge-offs. The allowance for loan losses is maintained at an amount management considers sufficient to provide for probable losses. Acquired loans are marked to fair value on the date of acquisition and are evaluated on a quarterly basis to ensure the necessary purchase accounting updates are made in parallel with the allowance for loan loss calculation. Acquired loans that have been renewed since acquisition are included in the allowance for loan loss calculation since these loans have been underwritten to the Bank's guidelines. Acquired loans that have not been renewed since acquisition, or that have a Purchased Credit Impaired ("PCI") mark, are excluded from the allowance for loan loss calculation. The Bank calculates a general valuation allowance for these excluded acquired loans without a PCI mark and compares that to the remaining general credit and interest rate marks. To the extent the remaining general credit and interest rate marks exceed the calculated general valuation allowance, no additional reserve is required. If the calculated general valuation allowance exceeds the remaining general credit and interest rate marks, the Bank would record an adjustment to the extent necessary. The Bank's allowance for loan losses includes specific allowances and a general allowance, each updated on a quarterly basis. A specific allowance is determined for all impaired loans (excluding PCI loans). The Bank defines an impaired loan as all non-accrual commercial real estate, multi-family, land, construction and commercial loans in excess of$250,000 for which it is probable, based on current information, that the Company will not collect all amounts due under the contractual terms of the loan agreement. Impaired loans also include all loans modified as troubled debt restructurings. For collateral dependent loans, the specific allowance represents the difference between the Bank's recorded investment in the loan, net of any interim charge-offs, and the estimated fair value of the collateral, less estimated selling costs. Impairment for all other impaired loans is calculated based on a combination of the estimated fair value of non-real estate collateral, personal guarantees, or the present value of the expected future cash flows. 37 -------------------------------------------------------------------------------- Generally, for collateral dependent real estate loans, the Bank obtains an updated collateral appraisal once the loan is impaired. For impaired residential real estate loans, the appraisal is generally updated annually if the loan remains delinquent for an extended period. For impaired commercial real estate loans, the Bank assesses whether there has likely been an adverse change in the collateral value supporting the loan. The Bank utilizes information based on its knowledge of changes in real estate conditions in its lending area to identify whether a possible deterioration of collateral value has occurred. Based on the severity of the changes in market conditions, management determines if an updated commercial real estate appraisal is warranted or if downward adjustments to the previous appraisal are warranted. If it is determined that the deterioration of the collateral value is significant enough to warrant ordering a new appraisal, an estimate of the downward adjustments to the existing appraised value is used in assessing if additional specific reserves are necessary until the updated appraisal is received. A general allowance is determined for all loans that are not individually evaluated for impairment (excluding acquired loans that have not been renewed under the Bank's underwriting criteria). In determining the level of the general allowance, the Bank segments the loan portfolio into the following portfolio segments: residential real estate; consumer; investor-owned commercial real estate; owner-occupied commercial real estate; construction and land; and commercial and industrial. The portfolio segments are further segmented by delinquency status or risk rating. An estimated loss factor is then applied to the outstanding principal loan balance of the delinquency status or risk rating category for each portfolio segment. To determine the loss factor, the Bank utilizes historical loss experience adjusted for certain qualitative factors and the loss emergence period. The Bank's historical loss experience is based on a rolling 36-month look-back period for each portfolio segment. The look-back period was selected based on (1) management's judgment that this period captures sufficient loss events (in both dollar terms and number of individual events) to be relevant; and (2) that the Bank's underwriting criteria and risk characteristics have remained relatively stable throughout this period. The historical loss experience is adjusted for certain qualitative factors including, but not limited to, (1) delinquency trends, (2) net charge-off trends, (3) nature and volume of the loan portfolio, (4) loan policies and underwriting standards, (5) experience and ability of lending personnel, (6) concentrations of credit, (7) loan review system, and external factors such as (8) changes in current economic conditions, (9) local competition and (10) regulation. Economic factors that the Bank considers in its estimate of the allowance for loan losses include: local and regional trends in economic growth, unemployment and real estate values. The Bank considers the applicability of each of these qualitative factors in estimating the general allowance for each portfolio segment. Each quarter, the Bank considers the current conditions for each of the qualitative factors, as well as a forward looking view on trends and events, to support an assessment unique to each portfolio segment. The Bank calculates and analyzes the loss emergence period on an annual basis or more frequently if conditions warrant. The Bank's methodology is to use loss events in the past 12 quarters to determine the loss emergence period for each loan segment. The loss emergence period is specific to each portfolio segment. It represents the amount of time that has elapsed between (1) the occurrence of a loss event, which resulted in a potential loss and (2) the confirmation of the potential loss, when the Bank records an initial charge-off or downgrades the risk-rating of the loan to substandard. The Bank also maintains an unallocated portion of the allowance for loan losses. The primary purpose of the unallocated component is to account for the inherent factors that cannot be practically assigned to individual loss categories, including the periodic update of appraisals, subjectivity of the Bank's credit review and risk rating process, and economic conditions that may not be fully captured in the Bank's loss history or qualitative factors. Upon completion of the aforementioned procedures, an overall management review is performed including ratio analyses to identify divergent trends compared with the Bank's own historical loss experience, the historical loss experience of the Bank's peer group, and management's understanding of general regulatory expectations. Based on that review, management may identify issues or factors that previously had not been considered in the estimation process, which may warrant further analysis or adjustments to estimated loss or qualitative factors applied in the calculation of the allowance for loan losses. Of the Bank's loan portfolio, 92.2% is secured by real estate, whether consumer or commercial. Additionally, most of the Bank's borrowers are located throughoutNew Jersey and the metropolitan areas ofPhiladelphia andNew York City . These concentrations may adversely affect the Bank's loan loss experience should local real estate values decline or should the markets served experience difficult economic conditions including increased unemployment or should the area be affected by a natural disaster such as a hurricane or flooding. Management believes the primary risk characteristics for each portfolio segment are a decline in the general economy, including elevated levels of unemployment, a decline in real estate market values and rising interest rates. Any one or a combination of these events may adversely affect the borrowers' ability to repay their loans, resulting in increased delinquencies, loan charge-offs and higher provisions for loan losses. 38 -------------------------------------------------------------------------------- Although management believes that the Bank has established and maintained the allowance for loan losses at adequate levels, additions may be necessary if future economic and other conditions differ substantially from the current operating environment. In addition, various regulatory agencies, as part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to make additional provisions for loan losses based upon information available to them at the time of their examination. Although management uses what it believes to be the best information available, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions beyond the Bank's control. Analysis of Net Interest Income Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income also depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them. The following table sets forth certain information relating to the Company for each of the years endedDecember 31, 2019 , 2018 and 2017. The yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown except where noted otherwise. Average balances are derived from average daily balances. The yields and costs include fees which are considered adjustments to yields. 39 -------------------------------------------------------------------------------- For the Year Ended December 31, 2019 2018 2017 Average Average Average Average Yield/ Average Yield/ Average Yield/ (dollars in thousands) Balance Interest Cost Balance Interest Cost Balance Interest Cost Assets: Interest-earning assets: Interest-earning deposits and short-term investments$ 57,742 $ 1,299 2.25 % $
49,683
1,048,779 27,564 2.63 1,073,454 26,209 2.44 796,392 16,792 2.11
Loans receivable, net
(2)
Commercial 3,329,396 168,507 5.06 3,012,521 149,965 4.98 1,858,842 87,706 4.72
Residential 2,204,931 87,729 3.98 1,965,395 79,805 4.06 1,726,020 69,784 4.04
Home Equity 339,896 18,284 5.38 357,137 17,991 5.04 282,128 13,003 4.61
Other 107,672 5,411 5.03 35,424 1,788 5.05 1,156 95 8.22
Allowance for loan loss
net of deferred loan
fees (8,880 ) - - (9,972 ) - - (12,251 ) - -
Loans receivable, net
(2) 5,973,015 279,931 4.69 5,360,505 249,549 4.66 3,855,895 170,588 4.42 Total interest-earning assets
7,079,536 308,794 4.36 6,483,642 276,654 4.27 4,790,244 188,829 3.94
Non-interest-earning
assets 964,920 880,836 501,929
Total assets $ 8,044,456 $ 7,364,478 $ 5,292,173
Liabilities and Equity:
Interest-bearing
liabilities:
Interest-bearing
checking $ 2,517,068 16,820 0.67 % $ 2,336,917 9,219 0.39 % $ 1,796,370 4,533 0.25 %
Money market 605,607 4,919 0.81 571,997 2,818 0.49 410,373 1,213 0.30
Savings 906,086 1,195 0.13 877,179 990 0.11 672,315 345 0.05
Time deposits 929,488 15,498 1.67 858,978 9,551 1.11 625,847 6,245 1.00
Total 4,958,249 38,432 0.78 4,645,071 22,578 0.49 3,504,905 12,336 0.35
FHLB advances 387,925 8,441 2.18 382,464 7,885 2.06 258,870 4,486 1.73 Securities sold under agreements to repurchase 64,525
276 0.43 66,340 168 0.25 74,712 121 0.16
Other borrowings 98,095 5,674 5.78 94,644 5,521 5.83 56,457 2,668 4.73 Total interest-bearing liabilities
5,508,794 52,823 0.96 5,188,519 36,152 0.70 3,894,944 19,611 0.50
Non-interest-bearing
deposits 1,325,836 1,135,602 776,344
Non-interest-bearing
liabilities 80,028 56,098 31,004
Total liabilities 6,914,658 6,380,219 4,702,292
Stockholders' equity 1,129,798 984,259 589,881
Total liabilities and
equity $ 8,044,456 $ 7,364,478 $ 5,292,173
Net interest income $ 255,971 $ 240,502 $ 169,218
Net interest rate spread
(3) 3.40 % 3.57 % 3.44 %
Net interest margin (4) 3.62 % 3.71 % 3.53 %
Total cost of deposits
(including
non-interest-bearing
deposits) 0.61 % 0.39 % 0.29 %
Ratio of
interest-earning assets
to interest-bearing
liabilities 128.51 % 124.96 % 122.99 %
(1) Amounts represent debt and equity securities, including FHLB and Federal
Reserve Bank stock, and are recorded at average amortized cost. (2) Amount is net of deferred loan fees, undisbursed loan funds, discounts and
premiums and estimated loss allowances and includes loans held-for-sale and
non-performing loans.
(3) Net interest rate spread represents the difference between the yield on
interest-earning assets and the cost of interest-bearing liabilities.
(4) Net interest margin represents net interest income divided by average
interest-earning assets.
40
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Rate Volume Analysis
The following table presents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest-bearing
liabilities have affected the Company's interest income and interest expense
during the periods indicated. Information is provided in each category with
respect to: (i) changes attributable to changes in volume (changes in volume
multiplied by prior rate); (ii) changes attributable to changes in rate (changes
in rate multiplied by prior volume); and (iii) the net change. The changes
attributable to the combined impact of volume and rate have been allocated
proportionately to the changes due to volume and the changes due to rate.
Year Ended December 31, 2019 Year Ended December 31, 2018
Compared to Compared to
Year Ended December 31, 2018 Year Ended December 31, 2017
Increase (Decrease) Due to Increase (Decrease) Due to
(in thousands) Volume Rate Net Volume Rate Net
Interest-earning
assets:
Interest-earning
deposits and
short-term
investments $ 159 $ 244 $ 403 $ (1,239 ) $ 686 $ (553 )
Securities (621 ) 1,976 1,355 6,496 2,921 9,417
Loans receivable, net
Commercial 16,085 2,457 18,542 57,184 5,075 62,259
Residential 9,528 (1,604 ) 7,924 9,676 345 10,021
Home Equity (891 ) 1,184 293 3,693 1,295 4,988
Other 3,630 (7 ) 3,623 1,744 (51 ) 1,693
Loans receivable, net 28,352 2,030 30,382 72,297 6,664 78,961
Total
interest-earning
assets 27,890 4,250 32,140 77,554 10,271 87,825
Interest-bearing
liabilities:
Interest-bearing
checking 737 6,864 7,601 1,638 3,048 4,686
Money market 173 1,928 2,101 615 990 1,605
Savings 31 174 205 131 514 645
Time deposits 832 5,115 5,947 2,552 754 3,306
Total 1,773 14,081 15,854 4,936 5,306 10,242
FHLB advances 109 447 556 2,429 970 3,399
Securities sold under
agreements to
repurchase (5 ) 113 108 (15 ) 62 47
Other borrowings 200 (47 ) 153 2,123 730 2,853
Total
interest-bearing
liabilities 2,077 14,594 16,671 9,473 7,068 16,541 Net change in net interest income$ 25,813 $ (10,344 ) $ 15,469 $ 68,081 $ 3,203 $ 71,284 Comparison of Financial Condition atDecember 31, 2019 andDecember 31, 2018 Total assets increased by$730.0 million to$8.246 billion atDecember 31, 2019 , from$7.516 billion atDecember 31, 2018 , primarily as a result of the acquisition ofCapital Bank , which added$494.7 million to total assets. Loans receivable, net, increased by$628.5 million , to$6.208 billion atDecember 31, 2019 , from$5.579 billion atDecember 31, 2018 , primarily due to acquired loans of$307.8 million . As part of the acquisition ofCapital Bank , the Company's goodwill balance increased to$374.6 million atDecember 31, 2019 , from$338.4 million atDecember 31, 2018 . Other assets increased by$95.4 million to$119.5 million atDecember 31, 2019 , from$24.1 million atDecember 31, 2018 , primarily due to consideration held in escrow in advance of the acquisition closings onJanuary 1, 2020 , of$47.0 million and the right of use assets recorded related to the adoption of Accounting Standards Update ("ASU") 2016-02, Leases (Topic 842), of$18.7 million . The core deposit intangible decreased to$15.6 million atDecember 31, 2019 , from$17.0 million atDecember 31, 2018 due to amortization of core deposit intangible, partially offset by the increase from the acquisition ofCapital Bank . Deposits increased by$514.2 million , to$6.329 billion atDecember 31, 2019 , from$5.815 billion atDecember 31, 2018 , primarily due to acquired deposits of$449.0 million . The loan-to-deposit ratio atDecember 31, 2019 was 98.1%, as compared to 96.0% atDecember 31, 2018 . Other liabilities increased by$25.1 million to$62.6 million atDecember 31, 2019 , from$37.5 million at 41 --------------------------------------------------------------------------------December 31, 2018 , primarily due to the right of use liability recorded related to the adoption of ASU 2016-02, Leases (Topic 842), of$18.9 million . Stockholders' equity increased to$1.153 billion atDecember 31, 2019 , as compared to$1.039 billion atDecember 31, 2018 . The acquisition ofCapital Bank added$76.4 million to stockholders' equity. OnDecember 18, 2019 , the Company announced the authorization of the Board of Directors of the 2019 Stock Repurchase Program to repurchase approximately 5% of the Company's outstanding common stock up to an additional 2.5 million shares. This amount is in addition to the remaining 167,996 shares available under the existing 2017 Repurchase Program. During the year endedDecember 31, 2019 , the Company repurchased 1.1 million shares under these repurchase programs at a weighted average cost of$23.12 . Tangible stockholders' equity per common share increased to$15.13 atDecember 31, 2019 , as compared to$14.26 atDecember 31, 2018 . Comparison of Operating Results for the Years EndedDecember 31, 2019 andDecember 31, 2018 General Net income for the year endedDecember 31, 2019 was$88.6 million , or$1.75 per diluted share, as compared to$71.9 million , or$1.51 per diluted share, for the corresponding prior year period. Net income for the year endedDecember 31, 2019 included merger related expenses, branch consolidation expenses, non-recurring professional fees, compensation expense due to the retirement of an executive officer, and reduction in income tax expense from the revaluation of state deferred tax assets as a result of a change in theNew Jersey tax code, which decreased net income, net of tax benefit, by$16.3 million . Net income for the year endedDecember 31, 2018 included merger related expenses, branch consolidation expenses, and reduction of income tax expense from the revaluation of deferred tax assets as a result of the Tax Reform, which decreased net income, net of tax benefit, by$22.2 million for the year. Excluding these items, net income for the year endedDecember 31, 2019 increased over the prior year period. Interest Income Interest income for the year endedDecember 31, 2019 , increased to$308.8 million , as compared to$276.7 million , in the prior year. Average interest-earning assets increased$595.9 million for the year endedDecember 31, 2019 , as compared to the prior year. The average for the year endedDecember 31, 2019 , was favorably impacted by$341.9 million of interest-earning assets acquired fromCapital Bank . Average loans receivable, net, increased by$612.5 million for the year endedDecember 31, 2019 , as compared to the prior year. The increase was primarily due to organic loan growth, as well as the acquisition ofCapital Bank , which contributed$250.3 million to average loans receivable, net. The yield on average interest-earning assets increased to 4.36% for the year endedDecember 31, 2019 , as compared to 4.27% for the prior year. Interest Expense Interest expense for the year endedDecember 31, 2019 , was$52.8 million , as compared to$36.2 million in the prior year, due to an increase in average-interest bearing liabilities of$320.3 million , primarily related to the acquisition ofCapital Bank . For the year endedDecember 31, 2019 , the cost of average interest-bearing liabilities increased to 0.96% from 0.70% in the prior year. The total cost of deposits (including non-interest bearing deposits) was 0.61% for the year endedDecember 31, 2019 , as compared to 0.39% in the prior year. Net Interest Income Net interest income for the year endedDecember 31, 2019 increased to$256.0 million , as compared to$240.5 million for the prior year, reflecting an increase in interest-earning assets. The net interest margin decreased to 3.62% for the year endedDecember 31, 2019 , from 3.71% for the prior year. The decrease in net interest margin was primarily due to the increase in the cost of average interest bearing liabilities, partially offset by the increase in the yield on interest-earning assets. Provision for Loan Losses For the year endedDecember 31, 2019 , the provision for loan losses was$1.6 million , as compared to$3.5 million for the prior year. Net loan charge-offs were$1.4 million for the year endedDecember 31, 2019 , as compared to net loan charge-offs of$2.6 million in the prior year. Non-performing loans totaled$17.8 million atDecember 31, 2019 , as compared to$17.4 million atDecember 31, 2018 . AtDecember 31, 2019 , the Company's allowance for loan losses was 0.27% of total loans, as compared to 0.30% atDecember 31, 2018 . These ratios exclude existing fair value credit marks of$30.3 million atDecember 31, 2019 and$31.6 million atDecember 31, 2018 on loans acquired fromCapital Bank , Sun,Ocean Shore Holding Co. ("Ocean Shore"),Cape Bancorp, Inc. ("Cape"), andColonial American Bank ("Colonial American"). These loans were acquired at fair value with no related allowance for loan losses. The allowance for loan losses as a percent of total non-performing loans was 94.4% atDecember 31, 2019 , as compared to 95.2% atDecember 31, 2018 . 42 -------------------------------------------------------------------------------- Other Income For the year endedDecember 31, 2019 , other income increased to$42.2 million , as compared to$34.8 million in the prior year. The increase from the prior year was primarily due to an increase in derivative fee income of$4.6 million , a decrease in the loss from real estate operations of$3.5 million and the impact of theCapital Bank acquisition, which added$1.5 million to other income for the year endedDecember 31, 2019 . These increases to other income were partially offset by decreases in fees and service charges of$1.3 million , rental income of$810,000 received primarily for January andFebruary 2018 on the Company's executive office, and decrease in the gain on sales of loans of$653,000 , mostly related to the sale of one non-performing commercial loan relationship during the first quarter of 2018. Operating Expenses Operating expenses increased to$189.1 million for the year endedDecember 31, 2019 , as compared to$186.3 million in the prior year. Operating expenses for the year endedDecember 31, 2019 included$22.8 million of merger related expenses, branch consolidation expenses, non-recurring professional fees, and compensation expense due to the retirement of an executive officer as compared to$30.1 million of merger related and branch consolidation expenses in the prior year. Excluding the impact of merger related expenses, branch consolidation expenses, non-recurring professional fees, and compensation expense due to the retirement of an executive officer, the change in operating expenses over the prior year was primarily due to theCapital Bank acquisition, which added$6.3 million for the year endedDecember 31, 2019 . Excluding theCapital Bank acquisition, the remaining increase in operating expenses, for the year endedDecember 31, 2019 from the prior year period, was primarily due to increases in professional fees of$2.3 million , check card processing of$1.6 million , compensation and employee benefits expense of$1.3 million , and data processing of$1.0 million , partially offset by decreases inFDIC expense of$1.6 million , and occupancy of$1.1 million . Provision for Income Taxes The provision for income taxes for the year endedDecember 31, 2019 was$18.8 million , as compared to$13.6 million for the prior year. The effective tax was 17.5% for the year endedDecember 31, 2019 , as compared to 15.9% for the prior year. The current year period includes the reduction in income tax expense of$2.2 million from the revaluation of state deferred tax assets as a result of a change in theNew Jersey tax code. Excluding the impact of theNew Jersey tax code change, the effective tax rate for the year endedDecember 31, 2019 was 19.6%. The lower effective tax rate in the prior year period was primarily due to Tax Reform which required the Company to revalue its deferred tax asset, resulting in a tax benefit of$1.9 million , for the year endedDecember 31, 2018 . The remaining variance is due to larger tax benefits from employee stock option exercises in the prior year period. Comparison of Operating Results for the Years EndedDecember 31, 2018 andDecember 31, 2017 General Net income for the year endedDecember 31, 2018 was$71.9 million , or$1.51 per diluted share, as compared to net income of$42.5 million , or$1.28 per diluted share, for the prior year. Net income for the year endedDecember 31, 2018 included merger related expenses, branch consolidation expenses, and a reduction of income tax expense from the revaluation of deferred tax assets as a result of Tax Reform. These items decreased net income, net of tax benefit, for the year endedDecember 31, 2018 , by$22.2 million . Net income for the year endedDecember 31, 2017 included merger related expenses, branch consolidation expenses, and additional income tax expense related to Tax Reform, which decreased net income, net of tax, by$13.5 million . Excluding these items, net income for the year endedDecember 31, 2018 increased over the prior year primarily due to the acquisition of Sun and the expense savings from the successful integration during 2017 of Ocean Shore which was acquired onNovember 30, 2016 . Interest Income Interest income for the year endedDecember 31, 2018 , increased to$276.7 million , as compared to$188.8 million , in the prior year. Average interest-earning assets increased$1.693 billion for the year endedDecember 31, 2018 , as compared to the prior year. The average for the year endedDecember 31, 2018 , was favorably impacted by$1.511 billion of interest-earning assets acquired from Sun. Average loans receivable, net, increased by$1.505 billion for the year endedDecember 31, 2018 , as compared to the prior year. The increase attributable to the acquisition of Sun was$1.290 billion . The yield on average interest-earning assets increased to 4.27% for the year endedDecember 31, 2018 , as compared to 3.94% for the prior year. The asset yield benefited from the accretion of purchase accounting adjustments on the Sun acquisition and, to a lesser extent, from the impact ofFederal Reserve interest rate increases. 43 -------------------------------------------------------------------------------- Interest Expense Interest expense for the year endedDecember 31, 2018 , was$36.2 million , as compared to$19.6 million in the prior year, due to an increase in average-interest bearing liabilities of$1.294 billion , primarily related to the acquisition of Sun. For the year endedDecember 31, 2018 , the cost of average interest-bearing liabilities increased to 0.70% from 0.50% in the prior year. The total cost of deposits (including non-interest bearing deposits) was 0.39% for the year endedDecember 31, 2018 , as compared to 0.29% in the prior year. Net Interest Income Net interest income for the year endedDecember 31, 2018 increased to$240.5 million , as compared to$169.2 million for the prior year, reflecting an increase in interest-earning assets and a higher net interest margin. The net interest margin increased to 3.71% for the year endedDecember 31, 2018 , from 3.53% for the prior year. The net interest margin for the year endedDecember 31, 2018 , benefited by 16 basis points due to$10.7 million of purchase accounting accretion on the Sun acquisition. Provision for Loan Losses For the year endedDecember 31, 2018 , the provision for loan losses was$3.5 million , as compared to$4.4 million for the prior year. Net loan charge-offs were$2.6 million for the year endedDecember 31, 2018 , as compared to net loan charge-offs of$3.9 million in the prior year. Non-performing loans totaled$17.4 million atDecember 31, 2018 , as compared to$20.9 million atDecember 31, 2017 . AtDecember 31, 2018 , the Company's allowance for loan losses was 0.30% of total loans as compared to 0.40% atDecember 31, 2017 . These ratios exclude existing fair value credit marks of$31.6 million atDecember 31, 2018 and$17.5 million atDecember 31, 2017 on the Sun, Ocean Shore, Cape, and Colonial American loans. These loans were acquired at fair value with no related allowance for loan losses. The allowance for loan losses as a percent of total non-performing loans was 95.2% atDecember 31, 2018 , as compared to 75.4% atDecember 31, 2017 . Other Income For the year endedDecember 31, 2018 , other income increased to$34.8 million , as compared to$27.1 million in the prior year. The increase from the prior year was primarily due to the impact of the Sun acquisition, which added$8.0 million to other income for the year endedDecember 31, 2018 . Excluding the Sun acquisition, the slight decrease in other income was primarily due to an increase in the loss from real estate operations of$2.9 million , of which$1.7 million related to the year-to-date write-down and sale of a hotel, golf and banquet facility, offset by increases in Bankcard fees of$852,000 and service charges of$700,000 , mostly related to deposit fees, an increase in the gain on sales of loans of$568,000 , mostly related to the sale of one non-performing commercial loan relationship and an increase in other income of$653,000 . Operating Expenses Operating expenses increased to$186.3 million for the year endedDecember 31, 2018 , as compared to$126.5 million in the prior year. Operating expenses for the year endedDecember 31, 2018 included$30.1 million in merger related and branch consolidation expenses, as compared to$14.5 million in the prior year. Excluding the impact of merger and branch consolidation expenses, the increase in operating expenses over the prior year was primarily due to the Sun acquisition, which added$35.2 million for the year endedDecember 31, 2018 . Excluding the Sun acquisition, the remaining increase in operating expense for the year endedDecember 31, 2018 over the prior year period was primarily due to increases in compensation and employee benefits expense of$4.0 million as a result of higher incentive and stock plan expenses, occupancy expenses of$1.6 million , service bureau expense of$1.5 million , equipment expense of$657,000 , and marketing expenses of$589,000 . Provision for Income Taxes The provision for income taxes for the year endedDecember 31, 2018 was$13.6 million , as compared to$22.9 million for the prior year. The effective tax was 15.9% for the year endedDecember 31, 2018 , as compared to 35.0% for the prior year. The lower effective tax rate for the year endedDecember 31, 2018 was due to Tax Reform which lowered the Company's statutory tax rate to 21%, from 35%. Additionally, Tax Reform required the Company to revalue its deferred tax asset, resulting in a tax benefit of$1.9 million , for the year endedDecember 31, 2018 , and a tax expense of$3.6 million for the year endedDecember 31, 2017 . Excluding the impact relating to the revaluation of deferred tax assets, the effective tax rate for the year endedDecember 31, 2018 was 18.0%, as compared to 29.4% for the prior year. Liquidity and Capital Resources The Company's primary sources of funds are deposits, principal and interest payments on loans and mortgage-backed securities, FHLB advances and other borrowings and, to a lesser extent, investment maturities and proceeds from the sale of loans. While scheduled amortization of loans is a predictable source of funds, deposit flows and loan prepayments are greatly influenced by 44 -------------------------------------------------------------------------------- interest rates, economic conditions and competition. The Company has other sources of liquidity if a need for additional funds arises, including various lines of credit. AtDecember 31, 2019 , the Bank had$270.0 million of outstanding overnight borrowings from the FHLB, compared to$174.0 million of outstanding overnight borrowings atDecember 31, 2018 . The Bank utilizes overnight borrowings from time-to-time to fund short-term liquidity needs. FHLB advances, including overnight borrowings, totaled$519.3 million atDecember 31, 2019 , an increase from$449.4 million atDecember 31, 2018 . The Company's cash needs for the year endedDecember 31, 2019 were primarily satisfied by principal repayments on loans and mortgage-backed securities, increased borrowings, proceeds from maturities and calls of debt securities, increased deposit inflows and acquired cash fromCapital Bank . The cash was principally utilized for loan originations, the purchase of loans receivable, the purchase of debt securities, and cash held in escrow to fund the Two River acquisition. The Company's cash needs for the year endedDecember 31, 2018 were primarily satisfied by principal payments on loans and mortgage-backed securities, proceeds from maturities and calls of investment securities, and increased borrowings. The cash was principally utilized for the purchase of loans receivable, loan originations, the purchase of investment securities and to fund deposit outflows. In the normal course of business, the Bank routinely enters into various off-balance-sheet commitments, primarily relating to the origination and sale of loans. AtDecember 31, 2019 , outstanding commitments to originate loans totaled$327.7 million ; outstanding unused lines of credit totaled$784.6 million , of which$451.5 million were commitments to commercial borrowers and$333.1 million were commitments to consumer borrowers and residential construction borrowers. The Bank expects to have sufficient funds available to meet current commitments in the normal course of business. Time deposits scheduled to mature in one year or less totaled$522.2 million atDecember 31, 2019 . Based upon historical experience, management is opportunistic about renewing time deposits on an as needed basis. The Company has a detailed contingency funding plan and comprehensive reporting of trends on a monthly and quarterly basis which is reviewed by management. Management also monitors cash on a daily basis to determine the liquidity needs of the Bank. Additionally, management performs multiple liquidity stress test scenarios on a quarterly basis. The Bank continues to maintain significant liquidity under all stress scenarios. Under the Company's stock repurchase programs, shares ofOceanFirst Financial Corp. common stock may be purchased in the open market and through other privately-negotiated transactions, from time-to-time, depending on market conditions. The repurchased shares are held as treasury stock for general corporate purposes. For the year endedDecember 31, 2019 , the Company repurchased 1.1 million shares of common stock at a total cost of$26.1 million . For the year endedDecember 31, 2018 , the Company repurchased 459,251 shares of common stock at a total cost of$10.8 million . AtDecember 31, 2019 , there were 2.7 million shares available to be repurchased under the stock repurchase programs. Cash dividends on common stock declared and paid during the year endedDecember 31, 2019 were$34.2 million , as compared to$29.6 million for the prior year. The increase in dividends was a result of an increase in the dividend rate and the additional shares issued in theCapital Bank acquisition. OnJanuary 27, 2020 , the Company's Board of Directors declared a quarterly cash dividend ofseventeen cents ($0.17 ) per common share. The dividend was payable onFebruary 19, 2020 to common stockholders of record at the close of business onFebruary 5, 2020 . The primary sources of liquidity specifically available to theOceanFirst Financial Corp. , the holding company ofOceanFirst Bank , are capital distributions from the bank subsidiary and the issuance of preferred and common stock and debt. For the year endedDecember 31, 2019 , the Company received dividend payments of$79.0 million from the Bank. The Company's ability to continue to pay dividends will be largely dependent upon capital distributions from the Bank, which may be adversely affected by capital restraints imposed by the applicable regulations. The Company cannot predict whether the Bank will be permitted under applicable regulations to pay a dividend to the Company. If applicable regulations or regulatory bodies prevent the Bank from paying a dividend to the Company, the Company may not have the liquidity necessary to pay a dividend in the future or pay a dividend at the same rate as historically paid, or be able to meet current debt obligations. AtDecember 31, 2019 ,OceanFirst Financial Corp. held$33.3 million in cash. The Company and the Bank satisfy the criteria to be "well-capitalized" under the Prompt Corrective Action Regulations. See Regulation and Supervision-Bank Regulation - Capital Requirements. AtDecember 31, 2019 , the Company maintained tangible common equity of$762.9 million for a tangible common equity to tangible assets ratio of 9.71%. 45 -------------------------------------------------------------------------------- Off-Balance-Sheet Arrangements and Contractual Obligations In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in the financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used for general corporate purposes or for customer needs. Corporate purpose transactions are used to help manage credit, interest rate, and liquidity risk or to optimize capital. Customer transactions are used to manage customers' requests for funding. These financial instruments and commitments include unused consumer lines of credit and commitments to extend credit and are discussed in Note 13 Commitments, Contingencies and Concentrations of Credit Risk, to the Consolidated Financial Statements. The Company enters into loan sale agreements with investors in the normal course of business. The loan sale agreements generally require the Company to repurchase loans previously sold in the event of a violation of various representations and warranties customary to the mortgage banking industry. The Company is also obligated under a loss sharing arrangement with the FHLB relating to loans sold into the Mortgage Partnership Finance program. In the opinion of management, the potential exposure related to the loan sale agreements and loans sold to the FHLB is adequately provided for in the reserve for repurchased loans and loss sharing obligations included in other liabilities. AtDecember 31, 2019 and 2018, the reserve for repurchased loans and loss sharing obligations amounted to$1.1 million and$1.3 million , respectively. The following table shows the contractual obligations of the Company by expected payment period as ofDecember 31, 2019 (in thousands). Refer to Note 17 Leases, to the Consolidated Financial Statements for lease obligations. Further discussion of these commitments is included in Note 9 Borrowed Funds, and Note 13 Commitments, Contingencies, and Concentrations of Credit Risk, to the Consolidated Financial Statements. Less than More than Contractual Obligation Total one year 1-3 years 3-5 years 5 years Debt Obligations$ 687,800 $ 431,178 $ 116,925 $ 41,330 $ 98,367 Commitments to Originate Loans 327,714 327,714 - - - Commitments to Fund Unused Lines of Credit: Commercial 451,535 451,535 - - - Consumer and Residential Construction 333,074 333,074 - - - Purchase Obligations 60,386 13,063 23,392 23,931 - Debt obligations include advances from the FHLB and other borrowings and have defined terms. Commitments to fund undrawn lines of credit and commitments to originate loans are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company's exposure to credit risk is represented by the contractual amount of the instruments. Purchase obligations represent legally binding and enforceable agreements to purchase goods and services from third parties and consist primarily of contractual obligations under data processing servicing agreements. Actual amounts expended vary based on transaction volumes, number of users and other factors. Impact of New Accounting Pronouncements Accounting Pronouncements Adopted in 2019 InFebruary 2016 , the FASB issued ASU 2016-02, "Leases (Topic 842)." This ASU requires all lessees to recognize a lease liability and a right-of-use asset, measured at the present value of the future minimum lease payments, at the lease commencement date. Lessor accounting remains largely unchanged under the new guidance. The guidance is effective for fiscal years beginning afterDecember 15, 2018 , including interim reporting periods within that reporting period, with early adoption permitted. A modified retrospective approach may be applied for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements OnJuly 30, 2018 , the FASB issued ASU 2018-11, "Leases (Topic 842) Targeted Improvements", which provided an option to apply the transition provisions of the new standard at the adoption date rather than the earliest comparative period presented. Additionally, the ASU provides a practical expedient permitting lessors to not separate non-lease components from the associated lease component if certain conditions are met. The Company adopted this ASU in its entirety onJanuary 1, 2019 , and has appropriately reflected the changes throughout the Company's consolidated financial statements. The Company elected to apply the new standard as of the adoption date and will not restate comparative prior periods. Additionally, the Company elected to apply the package of practical expedients standard under which the Company need not 46 -------------------------------------------------------------------------------- reassess whether any expired or existing contracts are leases or contain leases, the Company need not reassess the lease classification for any expired or existing lease, and the Company need not reassess initial direct costs for any existing leases. The adoption of this ASU resulted in the recognition of a right-of-use asset of$20.6 million in other assets and a lease liability of$20.7 million in other liabilities. Refer to Note 17 Leases, for additional information. InMarch 2017 , the FASB issued ASU 2017-08, "Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20) - Premium Amortization onPurchased Callable Debt Securities ." This ASU requires the amortization of premiums to the earliest call date on debt securities with call features that are explicit, noncontingent and callable at fixed prices and on preset dates. This ASU does not impact securities held as a discount, as the discount continues to be amortized to the contractual maturity. The guidance is effective for fiscal years beginning afterDecember 15, 2018 , with early adoption permitted, including adoption in an interim period. The amendments in this ASU should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The adoption of this update did not have an impact on the Company's consolidated financial statements. InAugust 2017 , the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815) - Targeted Improvements to Accounting for Hedging Activities." The amendments in this ASU was issued to better align an entity's risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. As a result, the amendments expand and refine hedge accounting for both nonfinancial and financial risk components and align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. Current GAAP contains limitations on how an entity can designate the hedged risk in certain cash flow and fair value hedging relationships. To address those current limitations, the amendments in this ASU permit hedge accounting for risk components in hedging relationships involving nonfinancial risk and interest rate risk. In addition, the amendments in this ASU change the guidance for designating fair value hedges of interest rate risk and for measuring the change in fair value of the hedged item in fair value hedges of interest rate risk. The amendments in this ASU are effective for fiscal years beginning afterDecember 15, 2018 , and interim periods within those fiscal years. Early adoption was permitted. The Company does not enter into derivatives that are designated as hedging instruments and as such, the adoption of this ASU did not have an impact on the Company's consolidated financial statements. InFebruary 2018 , the FASB issued ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." This ASU was issued to address a narrow-scope financial reporting issue that arose as a result of the enactment of the Tax Cuts and Jobs Act ("Tax Reform") onDecember 22, 2017 . The objective of ASU 2018-02 is to address the tax effects of items within accumulated other comprehensive income (referred to as "stranded tax effects") that do not reflect the appropriate tax rate enacted in the Tax Reform. As a result, the ASU 2018-02 allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the newly enacted federal corporate income tax rate. The amount of the reclassification would be the difference between the historical corporate income tax rate of 35 percent and the newly enacted corporate income tax rate of 21 percent. ASU 2018-02 is effective for fiscal years beginning afterDecember 15, 2018 , with early adoption permitted, including adoption in an interim period. The amendments in this ASU may be applied retrospectively to each period in which the effect of the change in theU.S. Federal corporate income tax rate in the Tax Reform is recognized. The Company has early adopted ASU 2018-02 for the year endedDecember 31, 2017 , and has elected not to reclassify the income tax effects of the Tax Reform from accumulated other comprehensive loss to retained earnings. Accounting Pronouncements Not Yet Adopted InJune 2016 , the FASB issued ASU 2016-13, "Measurement of Credit Losses on Financial Instruments." This ASU significantly changed how entities will measure credit losses for financial assets and certain other instruments that are measured at amortized cost. The standard replaced today's "incurred loss" approach with an "expected loss" model, which necessitates a forecast of lifetime losses. The new model, referred to as the current expected credit loss ("CECL") model, applies to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. The CECL model does not apply to available-for-sale ("AFS") debt securities. The ASU simplifies the accounting model for purchased credit-impaired debt securities and loans. ASU No. 2016-13 is effective for interim and annual reporting periods beginning afterDecember 15, 2019 ; early adoption is permitted for interim and annual reporting periods beginning afterDecember 15, 2018 . Entities will apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). The Company will utilize the modified retrospective approach. The Company's CECL implementation efforts are in process and continue to focus on model validation, developing new disclosures, establishing formal policies and procedures and other governance and control documentation. Certain elements of the calculation are pending finalization, including refinement of the model assumptions, the qualitative framework, internal control design, model validation, and the operational control framework to support the new process. Furthermore, changes to the 47 -------------------------------------------------------------------------------- economic forecasts within the model could positively or negatively impact the actual results. Due to these items, the quantitative impact to the consolidated financial statements cannot yet be reasonably estimated. InJanuary 2017 , the FASB issued ASU 2017-04, "Intangibles -Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment." This ASU intends to simplify the subsequent measurement of goodwill, eliminating Step 2 from the goodwill impairment test. Instead, an entity should perform its annual goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge by which the carrying amount exceeds the reporting unit's fair value; however the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The ASU also eliminates the requirement for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment. ASU No. 2017-04 is effective for fiscal years beginning afterDecember 15, 2019 ; early adoption is permitted for annual goodwill impairment tests performed on testing dates afterJanuary 1, 2017 . The adoption of this update will not have a material impact on the Company's consolidated financial statements. InAugust 2018 , the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820) - Changes to the Disclosure Requirements for Fair Value Measurement." This ASU updates the disclosure requirements on Fair Value measurements by 1) removing: the disclosures for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels, and the valuation processes for Level 3 fair value measurements; 2) modifying: disclosures for timing of liquidation of an investee's assets and disclosures for uncertainty in measurement as of reporting date; and 3) adding: disclosures for changes in unrealized gains and losses included in other comprehensive income for recurring level 3 fair value measurements and disclosures for the range and weighted average of the significant unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 is effective for fiscal years beginning afterDecember 15, 2019 , with early adoption permitted to any removed or modified disclosures and delay adoption of additional disclosures until the effective date. With the exception of the following, which should be applied prospectively, disclosures relating to changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the disclosures for uncertainty measurement, all other changes should be applied retrospectively to all periods presented upon the effective date. The adoption of this update will not have a material impact on the Company's consolidated financial statements. Impact of Inflation and Changing Prices The consolidated financial statements and notes thereto presented herein have been prepared in accordance withU.S. GAAP, which require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations. Unlike industrial companies, nearly all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Management of Interest Rate Risk ("IRR") Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises primarily from IRR inherent in its lending, investment and deposit-taking activities. The Company's profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact the Company's earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent or on the same basis. To that end, management actively monitors and manages IRR. The principal objectives of the Company's IRR management function are to evaluate the IRR inherent in certain balance sheet accounts; determine the level of risk appropriate given the Company's business focus, operating environment, capital and liquidity requirements and performance objectives; and manage the risk consistent with Board approved guidelines. Through such management, the Company seeks to reduce the exposure of its operations to changes in interest rates. The Company monitors its IRR as such risk relates to its operating strategies. The Bank's Board has established an Asset Liability Committee ("ALCO") consisting of members of the Bank's management, responsible for reviewing the asset liability policies and IRR position. ALCO meets monthly and reports trends and the Company's IRR position to the Board on a quarterly basis. The extent of the movement of interest rates, higher or lower, is an uncertainty that could have a substantial impact on the earnings of the Company. The Bank utilizes the following strategies to manage IRR: (1) emphasizing the origination for portfolio of fixed-rate consumer mortgage loans generally having terms to maturity of not more than fifteen years, adjustable-rate loans, floating-rate and balloon maturity commercial loans, and consumer loans consisting primarily of home equity loans and lines of credit; (2) attempting to reduce the overall interest rate sensitivity of liabilities by emphasizing core and longer-term deposits; and (3) managing the maturities of wholesale borrowings. The Bank may also sell fixed-rate mortgage loans into the secondary market. In determining 48 -------------------------------------------------------------------------------- whether to retain fixed-rate mortgages or to purchase fixed-rate MBS, management considers the Bank's overall IRR position, the volume of such loans originated or the amount of MBS to be purchased, the loan or MBS yield and the types and amount of funding sources. The Bank may retain fixed-rate mortgage loan production or purchase fixed-rate MBS in order to improve yields and increase balance sheet leverage. During periods when fixed-rate mortgage loan production is retained, the Bank generally attempts to extend the maturity on part of its wholesale borrowings. Prior to 2017, the Bank generally sold much of its 30 year fixed-rate one-to-four family mortgage loan originations in the secondary market primarily to manage interest rate risk. However, since the beginning of 2017 and through 2019, the Bank generally retained newly originated mortgage loans in its portfolio. Given the recent decline in the interest rate environment, the Company will evaluate the portfolio for potential sales in the future. The Company currently does not participate in financial futures contracts, interest rate swaps or other activities involving the use of off-balance-sheet derivative financial instruments, but may do so in the future to manage IRR. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. Accordingly, during a period of rising interest rates, an institution with a negative gap position theoretically would not be in as favorable a position, compared to an institution with a positive gap, to invest in higher-yielding assets. This may result in the yield on the institution's assets increasing at a slower rate than the increase in its cost of interest-bearing liabilities. Conversely, during a period of falling interest rates, an institution with a negative gap might experience a repricing of its assets at a slower rate than its interest-bearing liabilities, which, consequently, may result in its net interest income growing at a faster rate than an institution with a positive gap position. The Company's interest rate sensitivity is monitored through the use of an IRR model. The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding atDecember 31, 2019 , which were anticipated by the Company, based upon certain assumptions, to reprice or mature in each of the future time periods shown. AtDecember 31, 2019 , the Company's one-year gap was positive 4.31% as compared to positive 4.89% atDecember 31, 2018 . Except as stated below, the amount of assets and liabilities which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual maturity of the asset or liability. The table is intended to provide an approximation of the projected repricing of assets and liabilities atDecember 31, 2019 , on the basis of contractual maturities, anticipated prepayments, scheduled rate adjustments and the rate sensitivity of non-maturity deposits within a three month period and subsequent selected time intervals. Loans receivable reflect principal balances expected to be redeployed and/or repriced as a result of contractual amortization and anticipated prepayments of adjustable-rate loans and fixed-rate loans, and as a result of contractual rate adjustments on adjustable-rate loans. Loans were projected to prepay at rates between 8% and 19% annually. Mortgage-backed securities were projected to prepay at rates between 8% and 20% annually. Money market deposit accounts, savings accounts and interest-bearing checking accounts are assumed to have average lives of 7.3 years, 6.2 years and 8.2 years, respectively. Prepayment and average life assumptions can have a significant impact on the Company's estimated gap. There can be no assurance that projected prepayment rates for loans and mortgage-backed securities will be achieved or that projected average lives for deposits will be realized. 49 -------------------------------------------------------------------------------- More than More than
More than
3 Months 3 Months 1 Year to 3 Years to More than
At December 31, 2019 or Less to 1 Year 3 Years 5 Years 5 Years Total
(dollars in thousands)
Interest-earning assets
(1):
Interest-earning
deposits and short-term
investments $ 25,534 $ 980 $ 2,695 $ - $ - $ 29,209
Investment securities 58,210 69,136 131,434 71,647 27,679 358,106
Mortgage-backed
securities 64,790 87,004 176,115 120,149 116,451 564,509
Equity investments - - - - 10,136 10,136
Restricted equity
investments - - - - 62,356 62,356
Loans receivable (2) 1,227,176 1,015,411 1,592,049 992,073 1,387,943 6,214,652
Total interest-earning
assets 1,375,710 1,172,531 1,902,293 1,183,869 1,604,565 7,238,968
Interest-bearing
liabilities:
Interest-bearing
checking accounts 910,956 130,404 294,704 232,500 970,864 2,539,428
Money market deposit
accounts 15,141 43,199 100,429 82,092 337,286 578,147
Savings accounts 37,267 75,331 171,576 133,293 480,707 898,174
Time deposits 140,804 381,442 361,281 51,243 862 935,632
FHLB advances 295,000 64,724 117,536 42,000 - 519,260
Securities sold under
agreements to repurchase
and other borrowings 141,600 191 416 466 25,867 168,540
Total interest-bearing
liabilities 1,540,768 695,291 1,045,942 541,594 1,815,586 5,639,181
Interest sensitivity gap
(3) $ (165,058 ) $ 477,240 $ 856,351 $ 642,275 $ (211,021 ) $ 1,599,787
Cumulative interest
sensitivity gap $ (165,058 ) $ 312,182 $ 1,168,533 $ 1,810,808 $ 1,599,787 $ 1,599,787
Cumulative interest
sensitivity gap as a
percent of total
interest-earning assets (2.28 )% 4.31 % 16.14 % 25.01 % 22.10 % 22.10 %
(1) Interest-earning assets are included in the period in which the balances are
expected to be redeployed and/or repriced as a result of anticipated
prepayments, scheduled rate adjustments and contractual maturities.
(2) For purposes of the gap analysis, loans receivable includes loans
held-for-sale and non-performing loans gross of the allowance for loan
losses, unamortized discounts and deferred loan fees.
(3) Interest sensitivity gap represents the difference between interest-earning
assets and interest-bearing liabilities.
Certain shortcomings are inherent in gap analysis. For example, although certain
assets and liabilities may have similar maturities or periods to repricing, they
may react in different degrees to changes in market interest rates. Also, the
interest rates on certain types of assets and liabilities may fluctuate in
advance of changes in market interest rates, while interest rates on other types
may lag behind changes in market interest rates. Additionally, certain assets,
such as adjustable-rate loans, have features which restrict changes in interest
rates both on a short-term basis and over the life of the asset. Further, in the
event of a change in interest rates, loan prepayment rates and average lives of
deposits would likely deviate significantly from those assumed in the
calculation. Finally, the ability of many borrowers to service their
adjustable-rate loans may be impaired in the event of an interest rate increase.
Another method of analyzing an institution's exposure to IRR is by measuring the
change in the institution's economic value of equity ("EVE") and net interest
income under various interest rate scenarios. EVE is the difference between the
net present value of assets, liabilities and off-balance-sheet contracts. The
EVE ratio, in any interest rate scenario, is defined as the EVE in that scenario
divided by the fair value of assets in the same scenario. The Company's interest
rate sensitivity is monitored by management through the use of an IRR model
which measures IRR by modeling the change in EVE and net interest income over a
range of interest rate scenarios.
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The following table sets forth the Company's EVE and net interest income
projections as of
December 31, 2019 December 31, 2018
Change in
Interest Rates
in Basis Points Economic Value of Equity Net Interest Income Economic Value of Equity Net Interest Income
% EVE % % EVE %
(Rate Shock) Amount Change Ratio Amount Change Amount Change Ratio Amount Change
300 $ 1,242,674 5.1 % 16.4 % $ 253,184 (0.6 )% $ 1,325,144 2.7 % 19.4 % $ 254,556 (0.6 )%
200 1,246,011 5.4 16.0 254,424 (0.1 ) 1,337,463 3.6 19.0 255,979 (0.1 )
100 1,227,428 3.8 15.3 254,996 0.1 1,326,352 2.8 18.4 256,474 0.1
Static 1,182,696 - 14.4 254,721 - 1,290,369 - 17.4 256,181 -
(100) 1,090,184 (7.8 ) 12.9 252,662 (0.8 ) 1,220,289 (5.4 ) 16.1 253,979 (0.9 )
The sensitivity of the economic value of equity increased in the rising interest
rate scenarios from December 31, 2018 to December 31, 2019 due to increased
holdings in longer-term fixed-rate commercial and residential loan products.
There was no change to the sensitivity of net interest income in the rising
interest rate scenarios year-over-year.
As is the case with the gap calculation, certain shortcomings are inherent in
the methodology used in the EVE and net interest income IRR measurements. The
model requires the making of certain assumptions which may tend to oversimplify
the manner in which actual yields and costs respond to changes in market
interest rates. First, the model assumes that the composition of the Company's
interest sensitive assets and liabilities existing at the beginning of a period
remains constant over the period being measured. Second, the model assumes that
a particular change in interest rates is reflected uniformly across the yield
curve regardless of the duration to maturity or repricing of specific assets and
liabilities. Third, the model does not take into account the Company's business
or strategic plans. Accordingly, although the above measurements do provide an
indication of the Company's IRR exposure at a particular point in time, such
measurements are not intended to provide a precise forecast of the effect of
changes in market interest rates on the Company's EVE and net interest income
and can be expected to differ from actual results.
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