Call Start: 11:00 January 1, 0000 12:13 PM ET
Opus Bank (NASDAQ:OPB)
Q4 2015 Earnings Conference Call
January 25, 2016, 11:00 ET
Brett Villaume - Director, IR
Stephen Gordon - Founding Chairman, CEO & President
Nicole Carrillo - CFO
Michael Allison - Co-President & President of Commercial Bank
Preeti Dixit - JPMorgan
Julianna Balicka - KBW
Matthew Clark - Piper Jaffray
Good morning. My name is Connor and I'll be your conference operator today. At this time, I would like to welcome everyone to the Opus Bank Fourth Quarter Earnings Conference Call. [Operator Instructions]. Brett Villaume, Director of Investor Relations, you may begin your conference.
Thank you, Connor. Good morning and welcome to Opus Bank's investor webcast and conference call. Today I'm joined by Stephen Gordon, Opus Bank's Founding Chairman, CEO and President, Michael Allison, Co-President and President of the Commercial Bank, and Nicole Carrillo, Chief Financial Officer. Our discussion today will cover the Company's performance during the fourth quarter and year ended December 31, 2015 and information contained in the earnings press release issued earlier this morning, as well as the acquisition of PENSCO Trust Company which we also announced earlier this morning. A slide show presentation that accompanies today's call is available on the Opus Bank Investor Relations web page at www.opusbank.com.
Today's discussion may entail forward-looking statements which are intended to be covered by the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. You'll find a discussion of these forward-looking statements in our recent FDIC filings and on page 8 of this morning's release. [Call Instructions]. Now, I'll turn the call over to Stephen Gordon, Chairman and CEO.
Thank you, Brett. I will now provide an overview of our results for the fourth quarter and full year 2015 and then hand it over to Michael Allison, Co-President and President of the Commercial Bank and Nicole Carrillo, Chief Financial Officer, to go into more detail on our financial performance. After our discussion of Opus' financial performance, we will provide an overview of our acquisition of PENSCO Trust Company which we announced earlier this morning.
We will address questions related to either our financial performance or the acquisition at the end of our prepared remarks. 2015 was an exemplary year for Opus Bank. We achieved record loan and deposit growth during the year, including meaningfully higher record new loan fundings and commitments in the fourth quarter, surpassing our West Coast regional and high growth national peer growth rate, while at the same time continuously evaluating how we do what we do and looking for opportunities to improve upon our already highly scalable platform for growth which has resulted in a 45% efficiency ratio that is expected to decline into the 30%s during 2016.
During 2015, Opus' sources of revenue became more diverse with the addition of our escrow and exchange divisions, the continued maturation of our young merchant banking division, including the formation of Opus Financial Partners, our broker dealer subsidiary and the continued growth of our correspondent banking, fiduciary banking and specialty banking division, such as healthcare banking, technology banking, corporate finance, institutional syndications and structured finance, all while maintaining our leading position in multifamily banking.
Our fourth quarter and full-year 2015 financial results demonstrated Opus' strong performance as we continue to execute on our mission of building a highly profitable, high growth, sophisticated super-regional bank that is entrepreneurial, solution-based and client-centric in major metro markets up and down the West Coast.
For the fourth quarter we recorded net income of $16.7 million or $0.50 per diluted share, compared to net income of $14.7 million or $0.44 per diluted share for the third quarter of 2015. For the full year of 2015 we recorded net income of $59.9 million or $1.79 per diluted share, compared to net income of $43.7 million or $1.38 per diluted share for the full year of 2014.
This quarter's earnings included approximately $1.2 million of acquisition and strategic initiative-related expenses, including costs associated with a secondary stock offering by selling shareholders completed on November 23, costs associated with the acquisition of PENSCO which we announced earlier this morning and initial costs associated with our expense reduction and efficiency improvement strategy announced earlier in January. Also the provision for loan losses increased slightly from the prior quarter to $8 million, of which $3.7 million was related to our record loan fundings and growth during the fourth quarter compared to $2.3 million of provision expense for growth in the third quarter.
Return on average assets also improved to 1.03% for the fourth quarter and full year 2015 and return on average tangible equity increased to 11.2% for the quarter and 10.5% for the full year. Opus achieved record new loan fundings of $763 million during the fourth quarter, surpassing our previous all-time high during the prior quarter by 20%.
We also achieved new loan fundings of $2.4 billion for the full year 2015, outpacing our previously guided projections for 2015 loan funding of $2.2 billion. New loan commitments were also a record high at $820 million in the fourth quarter, up from $807 million in the prior quarter and were $2.8 billion for the full year of 2015 compared to $2.1 billion in the prior year.
Organic loan growth was a record $494 million or 10% from the prior linked quarter. And deposits increased by $359 million or 7%, year over year, loans increased by $1.4 billion or 35% during 2015. And deposits outpaced that growth, increasing by $1.5 billion or 40%. Our record new loan fundings during the fourth quarter and full year 2015 contributed to 12% growth for the quarter and 44% annual growth in our originated loan portfolio. These growth rates continue to be significantly higher than the organic growth of our West Coast regional and high growth national peers.
Strong performance from our Commercial and Specialty banking divisions which represented 54% of our new loan fundings during the quarter, contributed to 149% annual growth in our originated commercial business loan portfolio and helped drive 46% growth in interest income from our originated loan portfolio compared to the fourth quarter of last year and 51% annual growth in interest income compared to the prior year.
Over the past 12 months the concentration of commercial business or C&I, loan commitments has increased from 19% of our total loan commitments to 31% as of the end of the fourth quarter. Unfunded commitments on originated loans totaled $554 million as of December 31, 2015, an increase of 13% from $491.8 million at September 30, 2015 and an increase of 74% from $218 million at December 31, 2014, creating additional opportunities for future new loan fundings.
Our industry-leading income property banking division also continues to provide strong loan origination growth and overall performance metrics to support our overall growth. In addition to new loan fundings, we continue to work the acquired loan portfolio to generate accelerated outsized returns. Our current loan pipeline remains robust entering the first quarter, with 57% contributed from our Commercial and Specialty banking divisions as of January 1.
Total deposits grew to over $5.3 billion, increasing $359 million or 7% during the fourth quarter of 2015 and increased $1.5 billion or 40% from year-end 2014. Our Commercial and Specialty banking divisions contributed strongly to overall growth in deposits during the fourth quarter and in 2015, adding over $300 million and $1.5 billion, respectively.
Commercial banking added $54 million of low cost deposits during the quarter and our Escrow and Exchange divisions grew deposits by an additional $135 million, bringing the total for Escrow and Exchange deposits to $690 million, with a weighted average rate of 6 basis points at the end of the quarter. Our Fiduciary banking division added $64 million in deposits in the fourth quarter, while our Correspondent banking division added $23 million.
During the fourth quarter we established our Municipal banking division which was the formalization of a business line that Opus has been in since 2011, serving local municipalities within our West Coast footprint. Municipal banking division deposits grew to $281 million at year end, increasing $21 million from the prior quarter and $58 million during 2015. We're very enthusiastic about the future growth prospects for this division. Total assets reached a record $6.6 billion at the end of the year which is an 8% increase from the prior linked quarter and 31% growth from the year-ago period.
During the fourth quarter net interest margin improved by 6 basis points to 3.86% which included higher accretion income from our acquired loan portfolio. Contractual net interest margin which excludes accretion income, decreased by 7 basis points from the prior quarter to 3.42% due primarily to lower benefit from prepayments, but on an annual basis our contractual net interest margin increased 4 basis points to 3.44% compared to the prior year.
The continuing shift in the mix of loans to a greater percentage of higher yielding Commercial and Specialty banking division loans and the continued improvement in the quality and mix, as well as decline in rate on our deposit base, continues to have a positive impact on our net interest income and spread, offsetting the reduction in yield due to the continued runoff of our acquired loan portfolio.
Our cost of deposits continued to decline during the fourth quarter to 47 basis points, aided by the continuing improvement in the mix of deposits with a greater percentage of low- and no-cost core transaction accounts and DDAs. Total demand deposits, including non-interest-bearing and interest-bearing DDA, improved to 40% of total deposits at the end of the fourth quarter compared to 37% of total deposits at September 30. Also the level of business deposits grew to 52% of total deposits this quarter, up from 50% last quarter and 37% one year ago.
Opus further benefited during 2015 from the investments made in our early years to build an infrastructure capable of supporting a much larger, more efficient organization. Our efficiency ratio improved to 44.7% for the fourth quarter of 2015 compared to 57.1% in the fourth quarter of 2014 and excluding the non-core items during the fourth quarter our normalized efficiency ratio was 43.1%.
Additionally, the ratio of non-interest expense to average assets continued to improve, decreasing to 1.7% in the fourth quarter from 1.8% in the third quarter and from 2.1% in the fourth quarter of 2014. While our efficiency ratio continues to be lower than the average of our West Coast regional peers, this does not mean we get comfortable, as evidenced by our recently announced data- and technology-driven efficiency improvement strategy.
We as an entire industry are doing a brilliant job of discouraging clients from needing to walk into a branch. We provide online banking, mobile banking, remote deposit capture, mobile capture and tech-driven ATMs that receive cash and scan checks. Therefore we will continue to always look to rationalize expenses associated with our retail branch system and always evaluate leases, square footage, FTE count and other related expenses.
Additionally, last week we announced that we entered into a referral marketing partnership with OnDeck which we look forward to driving additional fee income and further leveraging our retail distribution without using our capital or balance sheet. We think these efforts demonstrate our commitment to achieving the best possible operating leverage for Opus which will contribute to improved profitability and ultimately result in greater returns to our shareholders.
In addition to contributing strong loan and deposit growth, our Commercial and Specialty banking divisions also continue to contribute meaningfully to non-interest income, including $1.8 million during the fourth quarter from our Escrow and Exchange divisions and $561,000 in advisory fee income from our Merchant Banking division which includes our broker dealer subsidiary, Opus Financial Partners.
While we're proud of Opus' industry-leading growth, we remain focused on profitability and maintaining our strong credit culture. While our ratio of non-performing assets to total assets increased this quarter to 37 basis points, it still remains below the average levels of our West Coast regional peers. Michael will go into further detail regarding the performance of our loan portfolio.
The asset liability interest rate risk simulation modeling of our balance sheet continues to show asset sensitivity due to the mix, duration, repricing characteristics, amortization schedules and cash flows generated from our strong core deposit base and loan portfolio. We look forward to continuing to redeploy the higher cash flows we've been receiving into a mix of higher earning loan assets as we continue to financially back our clients' growth. While we began to realize the benefits of the Fed rate increase on December 16, 2015, we look forward to realizing the full benefits of the increase in 2016.
I'm proud of our fourth quarter and annual performance including the successes we're seeing from our Commercial and Specialty banking divisions due to the client demand for our dynamic solutions-based advisory approach. Our record quarterly new loan fundings, better than expected annual new loan fundings, growth and improving mix of high quality deposits, continued conservative approach to credit, strong capital ratios and scalable business give us confidence as we head into 2016.
As we continue to successfully grow and improve efficiency, we're pleased to announce that the Board of Directors of Opus has approved increasing the quarterly cash dividend payable in the first quarter by 25% to $0.15 per share which reflects the strength and maturation of our business and strong capital position and liquidity and brings us a little bit closer in line with our peer groups. At this point, I'll turn it over to Nicole Carrillo to go into more detail on the financial results.
Thank you, Stephen. Our fourth quarter performance resulted in net income of $16.7 million or $0.50 per diluted share, compared to $14.7 million or $0.44 per diluted share for the third quarter of 2015 and $12.5 million or $0.38 per diluted share for the fourth quarter of 2014, earnings per share increased by 14% from the third quarter and 32% from the fourth quarter of 2014. Interest income from originated loans was $52.3 million for the fourth quarter of 2015, an increase of 8% from the third quarter, driven by higher average balances from quarterly new loan fundings of $763 million and an increased yield on acquired loans due to higher accretion income.
The yield on originated loans decreased by 7 basis points to 4.26% during the fourth quarter due to lower benefit from prepayments and higher amortization of deferred costs from paydowns. The originated loan yield expanded by 6 basis points to 4.30% for the full year of 2015 compared to the prior year due predominantly to higher prepayment fees and higher weighted average interest rates on the originated portfolio.
Interest income from the acquired loan portfolio which includes accretion income, increased to $10.2 million for the fourth quarter of 2015 from $8.3 million in the prior quarter, primarily due to higher accretion income from loan sales. During the fourth quarter we sold $8.4 million of acquired loans which accelerated $4.6 million of accretion income.
This is compared to $14.5 million of acquired loans sold during the third quarter that accelerated $1.4 million of accretion income. We currently have a remaining discount of $15.4 million on the acquired loan portfolio and we will continue to opportunistically work the acquired loans to maximize returns and expect continued, but volatile, income contribution to our total revenue. Accretion income increased our net interest margin by 44 basis points during the fourth quarter compared to 31 basis points in the prior quarter.
Interest expense on deposits was $6.1 million during the fourth quarter of 2015 compared to $5.7 million in the prior quarter due to a 9% increase in the average balance of total interest-bearing deposits from the third quarter. While we experienced quarterly growth of $336 million in average interest-bearing deposits, our total cost of deposits actually decreased by 1 basis point to 47 basis points due to the growth being in lower cost deposits from multiple sources within Opus, such as our Escrow and Exchange, Fiduciary banking, Correspondent banking, as well as our newly formed Municipal banking division. These trends in interest income and interest expense resulted in net income of $56.7 million for the fourth quarter of 2015 compared to $51.4 million in the third quarter.
Our GAAP net interest margin for the fourth quarter increased 6 basis points to 3.86% from the third quarter, primarily due to accelerated accretion income from the sale of those acquired loans offset by lower net benefit from prepayments during the quarter. Our contractual net interest margin which excludes accretion income, decreased by 7 basis points to 3.42% during the fourth quarter due to lower average balances of acquired loans and lower benefits from prepaid -- prepays offset by a higher average balance of our originated loan portfolio.
Our quarterly GAAP and contractual NIM both increased on a year-over-year basis by 1 basis point and 5 basis points respectively, due to higher rates and volume contribution from our originated loan portfolios offsetting the decline in contribution from the acquired loan portfolio which we expect to see as the portfolio continues to run off and become a smaller component of our balance sheet. Additionally, the quarterly cost of deposits decreased by 10 basis points year over year, further benefiting our net interest margin.
I'll now turn to non-interest income and non-interest expense. During the fourth quarter non-interest income totaled $6 million. As Stephen mentioned earlier, our Specialty banking divisions continued to mature and contribute meaningful fee income, including $1.8 million from Escrow and Exchange and $561,000 from our Merchant banking division. As discussed on previous earnings calls, quarterly income from Opus Financial Partners, our broker dealer subsidiary and the Merchant bank will be lumpy as they mature. But we will see more stability from these revenue sources as the pipeline of engaged transactions becomes more robust.
Non-interest income during the fourth quarter also included a net write-down of $515,000 on equity warrant valuation changes compared to a gain of $1.1 million last quarter and a $399,000 gain on the sale of Opus-originated loans during the quarter. Changes in the valuation of our growing warrant portfolio will also be lumpy due to market conditions and timing of realized gains. Strong growth within our increasingly diverse sources of revenue was evidenced by the annual increase in non-interest income of $11.6 million or 88%, to $24.7 million, much of which was provided by Escrow and Exchange divisions and our Opus Financial Partners.
Non-interest expense for the fourth quarter totaled $28 million compared to $26.9 million in the prior quarter. The quarterly increase was primarily due to $1.2 million of additional expenses related to our secondary stock offering in November, acquisition costs and other strategic initiative-related expenses.
Both our efficiency ratio and ratio of G&A to average assets for the fourth quarter and full year 2015 improved, decreasing to 44.7% and 1.7% for the fourth quarter and decreasing to 47.3% and 1.9% for the full year 2015. We're continuing to benefit from the investments we made early on in Opus' history to build the infrastructure and we expect our operating leverage will continue to improve, leading to further improvements in the efficiency ratio going forward.
Finally, our tangible book value per as-converted share increased to $18.28 at quarter end which is up $0.39 from $17.89 at September 30 and increased by $1.02 from $17.26 as of the end of 2014. Our return on average assets improved to 1.03% for the fourth quarter and the full year of 2015. And return on average tangible equity was 11.2% for the fourth quarter and 10.5% for the full year 2015, demonstrating strong trends in our returns and growth for our shareholder base. Our capital ratios also continue to remain well in excess of regulatory requirements under the Basel III requirements at quarter end.
I would now like to turn the call over to Michael Allison for a discussion of our origination trends and credit metrics.
Thank you, Nicole. As Stephen discussed, we accomplished record total originations of $820 million in new loan commitments during the fourth quarter, reflecting a continuation of the trend of increasing contributions from our Commercial and Specialty banking divisions, further augmenting the continuing strong results from our multifamily and commercial real estate efforts.
We accomplished $763 million in new loan fundings during the quarter, setting a record for Opus' loan origination volume and surpassing our previous record by 20%. This result continues to demonstrate that our strategy to compete across all sectors, not on price but on a value proposition based on solutions is proving to be successful.
We continue to be pleased with the successes in all of our divisions. For the full year 2015, we originated $2.8 billion of new loan commitments which also surpass our previous record high for annual new loan commitments and was above our previously forecasted goal. As we expected origination levels ramped over the course of the year, culminating in a strong fourth quarter, as we have experienced in years past and as we previously guided was likely to occur.
Our new loan fundings during the quarter were driven by all of our banking division, with $350 million from income property banking, $85 million from corporate finance, $74 million from technology banking, $69 million from structured finance, $64 million from healthcare banking, $60 million from commercial banking and $57 million from institutional syndications. We continue to focus on our strategy to shift the mix within our loan portfolio towards a greater percentage of higher yielding, non-multifamily loans and our efforts have been impactful.
Our total portfolio has transitioned to 47% originated multifamily from 54% between the end of the fourth quarter 2015 and 2014 respectively and importantly this shift over the last 12 months has helped to drive 3 basis points of expansion in the quarterly yield on our originated loan portfolio. We continue to enjoy that multifamily lending on the West Coast remains a more favorable market environment than comparable East Coast ultra-competitive markets that have experienced compressed pricing.
During the fourth quarter of 2015 we continue to witness stable to improving loan pricing on new multifamily loan originations which has resulted in a 5-basis point increase in the weighted average interest rate on new multifamily loan fundings versus the prior quarter and a 6-basis point increase since the fourth quarter of 2014.
As we continue to find success growing originations, we also continue to maintain our focus on a disciplined credit culture, including active portfolio management. Non-portfolio -- non-performing assets measured 37 basis points at total assets at the end of the fourth quarter as compared to 27 basis points last quarter and 21 basis points seen in the fourth quarter of last year.
The increase in non-performing assets during the fourth quarter was driven by one loan relationship, for which Opus has confirmed there is sufficient collateral to cover expected future inherent loss. This NPA ratio continues to compare favorably to the average of our West Coast peers. Additionally, our level of total criticized assets as a percentage of our portfolio decreased from the prior quarter.
While we remain dedicated to maintaining our stringent disciplined underwriting standards on our entire portfolio as we have guided, we continue to expect risk rating migration to occur in our entire -- as our entire portfolio seasons. It is important to note that while our Commercial and Specialty banking portfolios are likely to experience some risk rating migration, our multifamily portfolio which now constitutes just under one-half of our entire portfolio, continues to reflect stellar credit metrics and in fact there are zero delinquencies in our entire multifamily portfolio.
Our provision for loan losses on the originated portfolio during the fourth quarter included $3.7 million for quarterly loan growth and $4.7 million for changes in specific reserves, our continuing success in shifting the mix of our loan portfolio, individual risk rating changes identified through our credit management process and loss factors.
This compares to a provision expense of $2.3 million for growth and $6 million for specific reserves, risk ratings and loss factors during the third quarter. The provision for changes in specific reserves and risk ratings during the fourth quarter were predominantly additional amounts on existing problem assets for activity in the fourth quarter of 2015 and not related to newly identified problem assets during the quarter.
Our ratio of the allowance to total loans increased to 80 basis points at year end and is consistent with our allowance expectations, given we have experienced great success growing our C&I portfolio more quickly than originally guided relative to our multifamily portfolio. We expect this ratio will increase over time as our portfolio seasons and the mix of our loan portfolio continues to shift towards more commercial business concentration.
We recorded a provision recapture of $359,000 on the acquired loan portfolio, with the corresponding allowance for loan losses on the acquired loan portfolio decreasing to $1.1 million at the end of the current quarter. The remaining discount on the acquired loan portfolio was $15.4 million as of December 31. Our total coverage ratio at the end of the fourth quarter was 1.08%, a decline from 1.16% last quarter, as the acquired loan portfolio continues to comprise a smaller percentage of our total portfolio.
True to our effort to deliver the entire bank to our clients, along with the loan growth from our specialty banking divisions, we continue to experience great contribution of deposits from these divisions, including our deposit-focused Fiduciary and Correspondent banking groups and our newly formed Municipal banking group. Our total deposit base has grown by $1.5 billion over the last year, of which $690 million of the growth was contributed by our Escrow and Exchange divisions and $784 million from our Commercial and Specialty banking divisions. In addition, our retail banking office network increased deposits by $58 million during the fourth quarter in support of our overall business plan.
I'll now turn the discussion back over to Stephen.
Thank you, Michael. In summary, I'm pleased with the success we've seen from all divisions of Opus during the fourth quarter and full year 2015 and I look forward to continuing this throughout 2016. Additionally, I'm excited to share with you the news that Opus has entered into a definitive agreement to acquire PENSCO Trust Company, a leading fintech custodian of self-directed IRA and alternative investments. I would now like to walk you through an overview of the transaction.
So Opus is the premier regional bank in the Western U.S. We provide high-value relationship-based banking through, really, four core focuses. Our commercial bank, our merchant bank, our retail bank and our correspondent bank. We're the fastest growing bank in the Western U.S. and among the fastest growing in the country. Now at $6.6 billion in total assets, $5.5 billion in loans, $5.3 billion in deposits and 58 offices and roughly 600 bankers.
We have strong growth prospects with 39% two-year loan compounded annual growth rate, 41% two-year deposit compounded annual growth rate, 30% 2014 to 2015 EPS growth rate and 2015 to 2016 projected 65% Street consensus, 2016 to 2017 28% and we have an industry-leading efficiency ratio and a highly scalable operating structure.
PENSCO, as a leading alternative asset IRA custodian, now brings Opus into the alternative, tech-enabled alternative asset wealth services business. They've got diverse asset allocation across private equity, real estate, notes, cash and other non-exchanged-traded assets and approximately $11 billion of assets under custody in 45,000 accounts. Of that, approximately just north of 17,000 clients are located in Opus' footprint, representing over 50% of PENSCO's custodial assets. And they've got a competitive advantage over the peers, basically driven by their technology platform.
The IRA market is very significant and alternative assets are expected to grow. There are strong demographic tailwinds. They've got specialized knowledge and need for technology which create barriers to entry. And their organic growth, including wirehouse bulk transfers of accounts, creates a tremendous opportunity for growth for Opus going forward and for the combined entity.
And there are also opportunity for sector consolidation. Combined, this gives us a diversified revenue stream with greater fee income and spread income. It enhances and augments the deposit base by approximately 20% and total demand deposit by approximately 50% and it creates a superior profitability profile once the merger is closed. And it creates a comprehensive end-to-end alternative asset wealth services business that does not exist at Opus at this point.
We've got complementary management teams committed to growing the specialty business lines. We've been working very closely together over the course of the last couple of months. And it's very clear that we have a shared vision between the two companies and the management teams. The fact that it's not a bank acquisition, it's an alternative, it's a bank-like -- non-bank bank-like business, we view this as a very low integration risk and PENSCO's going to continue to run as a subsidiary, as a company, with the approximately $11 billion in custodial assets off-balance sheet with the approximate $1 billion in deposits coming on balance sheet over a very short period, a transition period.
PENSCO works with financial institutions, financial advisors and self-directed investors to put tax advantage retirement dollars to work in alternative investments. They are responsible for facilitating the initial investment and administering the assets over their lifetime. They do not approve or endorse the actual investments. That's made by the custodian, the custodial client. The company has existed for over 25 years, established in 1989. They are headquartered in San Francisco. They have three locations across the U.S. They've got 45,000 clients, approximately $11 billion in custodial assets, 40,000 unique asset types and about 186 employees.
The custodial pool, the custodial investments are broken out between predominantly private equity, at almost 52% of the assets, real estate, at approximately 10.7% of the assets, the $1.1 billion of cash represents about 10% of the asset pool, and then notes represent about 10.6%. And the locations across the country are San Francisco, Denver and in the Northeast, in New Hampshire.
Getting into the highlights, the economic highlights of the transaction, based on Friday's closing price, that represented roughly $103.7 million at the announcement, but it's structured as a fixed number of shares and it has a cash component. It works out to approximately 1.699 or 1.7 million shares, a fixed amount of shares and $47.25 million of cash. That breaks down to 95% Opus ownership and 5% pro forma of PENSCO ownership and we expect the close to be in the very beginning of the second quarter, 2016 earnings per share accretion, being that we're expecting it to close at the beginning of the second quarter.
So for the nine months we're expecting low to mid-teen operating accretion annualized. 2017 for the full year, low to mid-teen operating accretion. We're expecting less than a three-year tangible book value earnback. As we've always indicated to the market, we would be very, very disciplined on any acquisitions that we do. And that we would see earnbacks from our standpoint wanting to be in three years and under. And this very much fits into that from a earnback perspective.
We're expecting to bring over $1 billion of PENSCO balances onto Opus' balance sheet over a very, very short transition period, over the course of a couple of few months. And those are going to come over as additional near-zero cost deposits. And we expect to earn a significantly higher amount of spread income coming off of those balances than PENSCO was able to earn, given that PENSCO was not a bank and simply had those balances sitting in a number of banks across the country and they would earn whatever the bank was paying them in terms of that interest rate that the bank would pay.
The transaction is subject to regulatory and PENSCO shareholder approval. PENSCO's board represents a majority of the shareholders and has already voted in favor of the transaction. The management team of the subsidiary of PENSCO will be led by Kelly Rodriques, the current president and CEO. He's going to remain as president and CEO. And we're very excited and proud that he's going to also be joining our executive team. He's going to be joining as Executive Vice President and heading up Wealth Services. And key members of the senior executive team of PENSCO have been retained.
As far as pro forma operating performance, Opus' stand-alone Q4 2015 fee income ratio stood at 9.6%. Opus and PENSCO combined, we're projecting that number to nearly double to between 16% and 18% and compared to West Coast peers of roughly 17.6%. Cost of deposits of Opus is currently 47 basis points. Pro forma, we're expecting that to drop to 41. Return on average assets, 1.03% for the fourth quarter of 2015.
We're projecting that to move up meaningfully to 1.30% to 1.40% and return on average common equity, that was 11.2% for Opus during the fourth quarter. We're anticipating that Opus and PENSCO combined would drive between 15% to 18% return on average tangible equity. Opus' earnings per share growth in the fourth quarter was 30%. And we're anticipating that for 2016 to increase meaningfully to 70% to 80%.
And in capital ratio, our Tier 1 leverage ratio was 9.6% and we're anticipating at the close to be approximately 8%. And as far as capital going forward, we will evaluate as we always do, but we have plenty of capital as far as Opus at this time. And we're very comfortable with where our capital ratio will be at the close.
The transaction represents a combination of two very complementary client-centric business models and operating platforms and it's going to create a more diversified and sophisticated bank and alternative asset IRA custodial platform. It's a financially attractive acquisition. It's immediately low to mid-teen accretive to 2016 and 2017 operating EPS. It's below -- less than a three-year tangible book value earnback and the internal rates of return are greater than 25%.
The combined entity is going to have an enhanced pro forma funding profile, given that it's going to provide approximately $1 billion of incremental, on top of what we're already projecting in growth, incremental near-zero cost deposits, as client funds transition onto Opus' balance sheet. I want to be clear that this acquisition is incremental growth on top of what we've already guided the Street that we anticipate as far as growth in 2016.
It's going to reduce Opus' already low standalone cost of deposits. It's highly complementary to Opus' existing Commercial and Specialty banking divisions. We anticipate that we're going to earn a higher spread on current PENSCO cash balances.
And in the future, Opus' merchant bank through Opus Financial Partners, Opus' broker dealer subsidiary, will be able to present custodial clients and capital sources with additional deal flow, meaning that Opus' merchant bank always has engagements to raise equity, etcetera and that comes from private equity, managed funds, etcetera and we now will have a meaningful distribution with approximately $11 billion of custodial assets that constantly is looking for investment opportunity in alternative investments outside of exchange listed assets. And we have deal flow.
We're looking at that as very, very synergistic. We're viewing that as something that will occur over time and we did not model in much in the way of any synergies. So the transaction is not dependent on that occurring. But we feel very strongly that we're going to be able to do that in the future.
It further diversifies Opus' business model by creating a leading commercial and alternative asset custodial wealth platform. And it provides an additional source of recurring non-interest income. And we view this is a significant -- it has a significant amount of growth potential with immediate economic benefits. And the complementary management teams are both committed to a very shared vision.
So from strategic opportunities' standpoint, large wirehouses have already begun shifting over clients in bulk over to PENSCO, being that they have leading technology and a leading platform and are well known brand amongst the large wirehouses. And it's very complicated and cumbersome for the large wirehouses to handle retirement accounts that have privately held non-listed alternative assets.
There is potential for further consolidation. The M&A opportunity remains robust, as the alternative asset custodial sector continues to consolidate. There's an opportunity to accelerate the growth with the integration of Opus Bank and PENSCO and their complementary business models. We believe that this is going to unlock mutual value between the two companies and future potential upside. Opus Financial Partners will facilitate the execution of capital raising initiatives through managing multiple sources of deal flow and building relationships with custodial clients and capital providers.
And we also feel very, very strongly that there's a tremendous opportunity now to bank these north of 17,000 clients of the 45,000 accounts that fit in Opus' footprint up and down the entire West Coast. If you consider what IRA -- retirement assets, especially in this alternative asset-based account for, they represent generally roughly 10% of the net worth of that client base. And we feel that that represents a tremendous opportunity for Opus to bank that client up and down the entire West Coast.
So I believe the combination of Opus Bank and PENSCO creates tremendous value for shareholders of both companies. And I look forward to working with the PENSCO team and their clients in the years to come.
Thank you again for joining our conference call. And we'll now take questions. Operator, would you please open the call for Q&A?
[Operator Instructions]. Your first question comes from the line of Preeti Dixit with JPMorgan. Your line is open.
Lots of ground to cover, but maybe Stephen, I'll start with the period on loan growth was ahead of the average this quarter. Can you give us a sense of the timing of the growth and if you think this carries into the first quarter average? And then broadly speaking, obviously --
Let me deal with -- I'm really tired from a lot of work over the last 72 hours. So let me just answer one at a time and then I'll come to your second question. Because trust me, I will not remember the second question at this stage.
So we were, again, in the quarter back-end weighted. We had a tremendous December and that came off of also a strong back-end weighted November. See, I even had trouble counting back one month from December.
Now, where that puts us and I think is very, very interesting, is we were north of $100 million higher in new loan fundings for the -- versus what everybody expected for the fourth quarter and obviously $200 million higher than we had guided as recently as even at the end of the third quarter. We were very comfortable that the $2.2 billion number that we had guided was going to be the number for the year. We actually came in at $2.4 billion.
Now, remember that also during the year the piece that we don't control, we had a significant amount of loan payoffs, paydowns, prepays that were driven by all of us living with this low and sustained low interest rate environment that drove higher prepays through the industry over the course of the year. But what we feel really, really good about is that now we're at a higher starting point going into 2016. So like a start-off point than originally forecasted internally and higher than obviously you all had at heading into the first quarter of 2016.
Now, as we have always guided also, Preeti, is that our originations, our fundings build over the course of the year. They trend over the course of the year. We've seen historically over the five years of Opus and if we go back to our former companies that we built, the first quarter of the year is always lighter than the second quarter and then it trends up more to the third quarter and it kind of crescendos with the fourth quarter. So I would look at where we finished the fourth quarter, as that's now going to drive stronger earnings or stronger net interest income and interest income off of the loan portfolio, as we now head into January.
And then do you still see that $2.5 billion in fundings as a good target for the year or potentially some upside to that?
Okay. So the $2.5 billion number is the number that we're using for 2016 and that's pre-acquisition of PENSCO. So our modeling assumes that this $1 billion will come on over the course of a couple of months. And remember, we already bank PENSCO. So we already have, I'm going to say that number is somewhere around $90 million of balance for PENSCO that we're paying market interest on. Those balances at the close, we're going to lower that rate down to being consistent with what the rate is that PENSCO pays.
And then from there -- there's another, per the agreement, there's $50 million of additional balances that now will come on within five business days of the signing. And then in addition to that and I'll show you where I'm going in a second. In addition to that, then the rest of the balances will come on over the course of a couple of months.
That we're viewing as incremental growth on top of the guidance that we have already given for the year in terms of total growth for the year. So we were assuming in our modeling that roughly one-half of that additional balances is going to be going into generating higher spread income from Opus.
In in other words, you view it as adding capacity for fundings?
Yes. Preeti, also when you say, adding capacity for funding, we weren't feeling like we were struggling for capacity to begin with. So I just want to make that point clear.
Okay, fair enough. And then, Nicole, what were the dollars of the prepayment fees in the quarter versus last? And then outside of this volatility, could you give us your latest thoughts on the direction of the core margin? I know in the past we've talked about that 3.6% to 3.7% range as the year progresses.
Yes. So prepays were down about 20% -- prepay fees were down about 20% quarter over quarter. But prepayments in general were up 10%. So we saw that prepay fees for third quarter was $1.5 million and the fees we got in Q4 was $1.2 million. But it was on an increasing amount of payoffs which is why we saw that contractual NIM coming down a little bit. We're still comfortable with that contractual NIM coming in between that 3.6% and 3.7% with the addition of PENSCO.
And then as we see what that incremental funding that Stephen talked about, what loan types that will be going into, we'll probably provide more guidance after the first quarter to true that up as we see where that incremental funding is going to be targeted at.
And then maybe if I could switch to credit, Michael, the $4.7 million of provision this quarter that wasn't tied to loan growth, can you help us understand how much of that is in fact specific reserves for credits as opposed to just changing general loss factor? Trying to get a feel for how much individual credits are influencing the quarterly provision at this point. And then maybe a targeted reserve ratio, if I could sneak that in, for 2016?
So of that $4.7 million, a little over $3 million of that were SVA changes. And then the balance is loss factor contribution. So I think it's important to note that when we put on a C&I loan, that loss factor is probably close to 3 times what it is for the multifamily loans. So you can see the meaningful contribution, if you will, to the provisioning as we're shifting this mix.
So the 80 basis points that we have is really a pretty true reflection of where we expect the percentage breakdown of the portfolio to drive that provision. Into next year, I think Nicole and I are a little hesitant to put a tab on it, but I would expect we'll be closer to 90-ish basis points as we continue to see this mix move the progressive way we think it will.
Meaning mix of C&I to multifamily.
Your next question comes from the line of Julianna Balicka with KBW. Your line is open.
I have several questions. One, maybe we can talk about commercial real estate and the outlook in the market that you're seeing on several fronts. One, maybe give some comments about how that influences the loan growth in terms of your core CRE product, but also some of your specialty lending that relate to CRE. And what are the drivers that you're seeing by market or by geography or whatever answer makes most sense?
And two, what does the -- some of the headwinds [Technical Difficulty] imply for some of your specialty deposit growth verticals, some of which are related to real estate, such as title and escrow? And three -- yes, let's leave it at that.
The questions become challenging already. So let's be mindful that when we talk about commercial real estate for our portfolio, the vast majority of that is multifamily. And the vast majority of our multifamily efforts are in urban infill, workforce housing kinds of assets. And cycle over cycle, those have been relatively stable, despite the noise that we're hearing now about CRE in general.
I think it's also good to note that we're fairly aggressive in trying to understand the markets that we serve, those markets all being large metropolitan areas with micro markets within them. And so our outreach is to understand occupancy trends, rental levels, NOI results in those micro markets to help us adjust to where our appetite should be directed. So we really do have guidance at a fairly granular level around where we think it is prudent to deploy our real estate assets.
I think that gets a little bit to what you're saying. I know there's a fair amount of noise around hyperactivity in the CRE space, people once again underwriting to future state NOI levels. We don't do that.
We remain disciplined around lending against income in place against stress scenarios, around taxes, expense levels, vacancy, movements, etcetera, against always an underwriting rate, not an actual rate that is anywhere from 40 to 75 basis points above actual. So that discipline has allowed us to continue to originate at the pace that you're seeing, but hopefully avoid some of the noise that you're hearing around commercial real estate.
And Julianna, let me add to that also. I think there was an article in the last handful of days talking about some sort of projected decline in rent, rental rates. And we've actually not been seeing that in market at all. Maybe Michael, you want to speak to what we're seeing happening as far as rent rates in -- whether it's in Seattle, Bellevue, whether it was in San Francisco.
We really, to Stephen's point, we haven't seen deterioration in rental levels. We have seen in certain markets a slight uptick in vacancies. But again, not to any level that is in fact hitting where we underwrite in the first place.
So we always take a cycled view of where vacancies may raise to and that's what we underwrite against. So while admittedly there are a couple of markets that we serve that are seeing higher vacancy rates, we're not underwriting to those rates anyway. We're more conservative, if you will, than what we're seeing.
And then to answer your second question where you were asking about the impact that this could have on real estate-related deposits, I'm not sure the this that we're referring to, the this that might impact real estate-related deposits. If you're referring to all this noise and volatility that's going on out there, we're not seeing that impacting our businesses.
What we're doing is strategically and I want everyone to really appreciate the thought process around everything that we're doing both on the loan side and on the deposit side, is we're making sure coming out of the previous decade, the previous cycle, that what we have here is a very diversified, but very well thought-through structured institution that has multiple sources of income, multiple counter-cyclical business lines on the balance sheet, that is not a one-directional focused institution.
You might remember my former company, Commercial Capital Bank and Commercial Capital Bancorp, that was a mono-line institution entirely real estate-focused, almost entirely multifamily. And the liability side of the balance sheet had some of the same risk or one-directional bed as the asset side did. That is not Opus.
Opus is a very well structured, very diversified institution that should be able to stand the test of time. And that is the thought process, even behind the PENSCO acquisition, that completely diversifies our sources of income and diversifies our types of deposits on the balance sheet.
So we've got commercial business-related-driven deposit balances through our commercial depository services and through all of our specialty banking divisions. We do have Escrow and Exchange, but we even have diversification -- some diversification inside of Fiduciary banking where we've got financial services-related companies that we bank. Now we have this custodial platform that is alternative investments comprised and roughly $1 billion of balances that will be on Opus' balance sheet that have nothing to do with Fiduciary banking, Escrow and Exchange, etcetera. So we're feeling increasingly even better about the structure of the institution.
That makes sense. And in terms of the custodial platform, in thinking about the $1 billion of deposits that you're bringing on and the fee income that that will contribute from the platform, what are some of the macro drivers we should be thinking about that will help drive bigger growth out of that segment going forward in the future?
So it's really threefold. One is the pure organic-related growth that occurs through just natural evolution of the business. I'm going to say it's fourfold. Two is the pure organic referral activity that comes in through the wealth advisors, through investment advisors, through wirehouses, through other financial advisors and self-directed investors coming to PENSCO, etcetera.
And then you've also got the, what I'll call the bulk transfers, that are coming from the large wirehouses that find that PENSCO's platform is that much more scalable and has technology to be able to enable the ease of use by the client and also addresses the regulatory and fiduciary cumbersome responsibilities that the wirehouses have.
So that flows over to PENSCO. And then add on to that consolidation opportunity in terms of the peers within the sector. There are a couple of handsful of these types of companies. We view that PENSCO is the leader amongst all of those peers. And there's opportunity to look at consolidating within that set of peers as well.
Okay. That makes sense. And then in terms of thinking about a potential slowdown in the velocity of commercial real estate transactions excluding multifamily, is that something that worries you? Is that something you're seeing or thinking about or is that simply more noise from the newspapers?
Well, when you said excluding--
And how does that affect your business?
Julianna, when you said excluding multifamily, I appreciate that. There's a lot of talk out there right now and rumor-milling around the concept that because the regulators put out an additional guidance memo related to commercial real estate lending that that's going to trigger some sort of slowdown or that if there's some sort of global slowdown that there's going to be a slowdown.
I think you got to remember underneath all of this noise and I'm not ignoring that there's noise in the world, could filter into slowdown. But remember what's also going on. We're just simply back in the exact same interest rate environment that we've been in for the last five years. Nothing has changed around the world in which we're operating.
So real estate investors are seeing that rates are back to where they were. And real estate investors are seeing that cap rates are still where they are. And real estate investors are now seeing that if they borrow money from a bank, it's costing them what it has over the course of the last five years.
I think we got about five minutes of increased rate across the entire curve when the Fed increased rates by 25 basis points on December 16. And then subsequent to that, all that's happened is the rest of the yield curve has come down and flattened against the increase in rates. We're not seeing -- back to the rates they were at. So we're back to making multifamily loans at exactly the same rates that we have been over the course of the last five years. Nothing has changed.
So we're not seeing a slowdown in that at this point. And I think everyone kind of took a breath for a second when the Fed did what they did and rates started moving up. And we've seen this happen cycle over cycle after cycle and people breathe for a second. They look, they evaluate. Then they go, cap rates haven't changed. Price of building hasn't changed. I can still borrow the exact same rate from a bank. Then they get back to business.
And then from a regulatory standpoint, we're just as disciplined around that commercial multifamily real estate portfolio as we always have been. And the regulators have said to us through multiple safety soundness exams year over year that our discipline has not changed. If anything we continue to tighten it even more, in spite of the fact that it seems like financial institutions around us are scratching their heads going, multifamily looks like an interesting asset class. I think we'll try one of those.
Julianna, I might make two more points, too, is if you look at the expectation for our growth, this year as in years ahead the growth pace is more aligned to our C&I effort than it is around our real estate effort. So we're not quite as sensitive, if you will, to the growth, even though we will grow.
Secondarily, again while we may be as successful as we're, our market share is just barely over 1% now in LA county. So we have a ton of opportunity to capture growth in market share capture, not from the growth of the overall industry, if you will. So I think, again, we're not hesitant to expect that we'll capture the growth we need in CRE without undue risk.
And then, if I may, just to switch over real quick to the provision expense from this quarter and the charge-offs in the increased -- excuse me, increased reserve related to the loan that you pointed out in the press release. Could you tell us a little bit more about what happened? Maybe this is a naive question. But why was the specific reserve buildup split up over a couple of quarters, since you said this is the previously identified loan versus getting it out of the way upfront or you could maybe give us a little bit more discussion around that point?
Yes. I think as a general comment, what we experienced was identified troubled assets, if you will, that migrated through an earlier stage of our risk-rating matrix have migrated to a more distressed level. Although we still don't expect the loss content to necessarily have increased, our provisioning does require because of the risk grade change, that we increase that allowance number, if you will. So again, we didn't recognize any new credits but we recognized progression in a couple. And that's the majority of the dollar impact that you see. I would suggest, though, also that overall we had more loans upgrade than downgrade during the quarter. So the seasoning of our portfolio is going to show you both of those sides.
Then what were those loans specifically? Can you give us a little color as to what kind of property, what kind of industry, whatever? Or what happened to that [indiscernible]?
It was actually pretty uniform across the portfolio, so. Other than multifamily which never seems to move. So healthcare, technology and C&I all had a part of that movement.
[Operator Instructions]. Your next question comes from the line of Matthew Clark from Piper Jaffray. Your line is now open.
Can you just update us on the criticized loan ratio at the end of the fourth quarter?
So the criticized assets level actually stayed very flat. And it went from 1.9% of the total loan portfolio at the end of the third quarter down to 1.7% of the total loan portfolio at the fourth quarter. So flat, but with the growth the percentage came down.
Then in terms of the incremental provision this quarter tied to the -- those previously identified credits that you assigned more reserves to, can you just help us ring-fence the credits that we're talking about, the credits that are deteriorating? Help us get our arms around the size, maybe the average size or just a total size and the related reserve against that exposure?
I'm trying to think of the best way--
Yes, I know. Let me see.
I guess a general comment, Matt, that I would make and it's probably worthy. We tend to win credit opportunities that are between, let's say, $5 million and $15 million. And so unlike our multifamily portfolio where there's a ton of granularity in a $2 million to $2.5 million loan, when you talk about C&I or healthcare or technology, it is a $10 million credit, it's an $8 million credit. And when those migrate through the risk rate, given the size of our book, if you will, it has an impact. And you see that impact. The NPAs are the best example. This was a single loan relationship that moved the basis points of our NPA to the degree that you saw. It's one loan.
It's actually, it's two loans to one relationship and it's totally, completely collateralized. And so the loss content isn't something that we're worried about. But you're seeing it in and reflected by our allowance, our NPAs, our criticized, our classifieds, because they are large loans relative to the size of our book.
I think to put a fence around the number of loans, the number of loans that we're currently driving SVAs or looking at SVAs, that range in various size from under $1 million to -- the larger ones that Michael talking about are under 10 loans. So it's under 10 loans.
Loans also, as Michael said, resolve out of that each quarter which we did have this quarter, as well as join in a quarter. We may have one join in a quarter. We're looking at the loans that are driving this SVA content, it's under 10 loans.
Out of -- do you know how many loans we've made at Opus?
We have like 1600 relationships. So there's more loans--
Which is over 3000 loans -- yes.
Okay and then the incremental non-performer that you recognized this quarter, can you just give us some additional color as to the type of credit and I guess the situation that occurred?
Well, sure, because it's an extraordinary situation. It happens to be a healthcare loan. It happens to be an assisted living facility. It happens to be a loan made to a partnership that had been a partnership for longer than 20 years and a partnership that decided they can't tolerate one another.
So they actually just informed the bank, they informed us that they no longer want to pay on this loan while they resolve their dispute. We have basically a 62% advance against an appraisal that we just had done. So we would love to take this property back and avoid this nasty relationship that our borrower partnership is engaging in.
Okay, good. And then thinking about the incremental -- or the core margin outlook, I think you talked about feeling good about the 3.6% to 3.7% range, again on a core basis. I mean incrementally here, if you think about the yield on your new loans at 4.34% and the pro forma costs of your deposits at 41 basis points and you're talking about a 3.93% incremental margin, at least on loans. Obviously you have a [indiscernible] portfolio too, but it's relatively small. I guess thinking about that timing and getting to that 3.6%, 3.7%, I would assume this acquisition would just make that range that much more doable now.
Yes, yes, exactly.
Okay. And then sorry, one more, maybe two. In terms of the -- we can back into obviously the fee contribution from PENSCO. But just wanted to get a better sense for the pretax margin that PENSCO has done in the past on their AUA, what that was historically and I guess what it could be -- you all.
We're not giving that. What you can do is back into what you think the spread will be off of balances that will cost us roughly under 5 basis points. We will give color over a short period of time. We'll give you color as to obviously the same way we did with Commerce and RPM. We'll give you color as these balances move over onto our balance sheet.
And then last one for me. Just on capital, your Tier 1 leverage ratio gone 8% from 9.6% on a pro forma basis. You talked about 9% being the threshold where you would look -- talk through capital once again. I guess--
No, what I've always been saying, Matt, is that we would -- I think we were guiding towards 9% Tier 1 leverage and that at 9% Tier 1 leverage we would evaluate how we're feeling about our balance sheet, how we're feeling about local economies that we bank in, how we feel about the overall economy, etcetera and determine where we were going to go from there in terms of Tier 1 leverage. And based on all of that, we've determined that with the acquisition of PENSCO, we're going to be at roughly 8% Tier 1 leverage, around there at the close. And we'll continue evaluating and determining and giving color to the market as we determine what we want to do from there.
There are no further questions at this time. I will turn the call back over to Stephen Gordon.
Great. Thank you, everyone, for calling in. And we look forward to having further communications as the Company continues to grow. Thank you.
This concludes today's conference call. You may now disconnect.
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