OceanFirst Financial: Trading At 1.25x TBV, Offers A 3.8% Yield

Introduction

OceanFirst Financial (NASDAQ:OCFC) (hereafter ‘Ocean’ for simplicity sake) is a New Jersey-based bank with a balance sheet total of approximately $12.7B and an equity value of $1.54B. The main focus of the bank is on issuing commercial real estate loans, and that likely is the main reason why OCFC is trading at attractive multiples. The bank originally planned to acquire Partners Bancorp (PTRS) but that deal was terminated in November.

The net interest income is increasing

The increased size of the balance sheet and the higher interest rates on the financial markets provided a nice boost to OceanFirst’s net interest income. Compared to the third quarter of last year, the interest income increased by $25M while the interest expenses increased by just over $6M. This resulted in a net interest income increase from $77M to just under $96M.

The total non-interest income generated during the quarter was $15.2M while the total non-interest expenses remained pretty stable at just under $59M. This resulted in a lower net non-interest loss of $43.2M versus almost $49M in the third quarter of last year. The bank’s pre-tax and pre-loan loss provision income for the quarter was approximately $52.1M and after deducting the $1M in loan loss provisions the taxable income was $51.1M resulting in a net income of $38.6M. OCFC also has a series of preferred shares outstanding (OCFCP) and those preferred dividends are costing the bank approximately $1M per quarter. This means the net income attributable to the common shareholders of Ocean was approximately $37.6M for an EPS of $0.64. The total net income in the first nine months of the year was $90.3M for an EPS of $1.54 and that includes a total loan loss provision of $4.1M.

The bank currently pays a quarterly dividend of $0.20 per share, resulting in a total dividend of $0.80 per year for a dividend yield of 3.8%. And as this year’s EPS will very likely exceed $2.00 per share (even if the loan loss provisions increase on a QoQ basis) that dividend is very well covered.

The status of the loan book

OceanFirst is clearly focusing on commercial real estate loans as the weight of CRE in the total loan book has increased from 49% to 68% in the past few years. Most of the loans are based on New Jersey assets, but the combination of Philadelphia and New York assets recently surpassed the 50% range, so the NJ-based bank is definitely expanding beyond its ‘own’ region.

While the bank mainly focuses on commercial real estate loans, let’s not forget that approximately $3B of the loan book also consists of residential real estate and home equity loans.

Unfortunately, OCFC did not disclose the LTV ratios of its CRE or residential loans. A quick look at the annual report for FY 2021 tells us the average LTV ratio in the residential mortgage portfolio was 59% as of the end of 2021, and I think it’s safe to assume the LTV ratio will not have changed too much. However, as the bank clearly focuses on commercial real estate, I would feel more comfortable if I’d also know the average LTV ratio for the commercial real estate portfolio.

Fortunately, OceanFirst appears to have a good understanding of the CRE market in the three states it is very active in. As of the end of September, less than $18M of the loans in the $9.7B loan book were past due, and only $11M of those loans were related to the CRE and commercial loan portfolio.

While that is an increase compared to the $5.2M in loans past due in the Commercial and CRE segment as of the end of 2021, the situation appears to be very manageable. The total provision for loan losses has now increased to in excess of $53M, providing a coverage ratio of almost 300% (assuming the bank doesn’t recover a single dollar from any of the loans that have gone sour).

Investment thesis

While I’m usually not too keen on investing in banks that are focusing on commercial real estate, the very low amount of loans past due is very interesting as this bank clearly focuses on credit quality rather than pursuing high yield/high risk loans. Even at the end of 2020 the total amount of NPLs as a percentage of the total loan book remained below 0.5% and as the bank continues to increase its loan loss provisions, the cushion becomes increasingly comfortable. While I would expect the bank will have to increase its quarterly loan loss provisions, those increases may very well be fully compensated by the increasing net interest income as increasing interest rates should have a positive impact on the net interest margins.

As of the end of September, the bank had $1.54B in equity and after deducting the $521M in goodwill and intangibles, the net equity value was $1.02B. We also need to deduct the $57M in preferred capital, which results in about $970M in tangible equity attributable to the common shareholders. Divided over 59.1M shares outstanding, the TBV per share is approximately $16.41. After deducting a few other (small) intangible items, the TBVPS was $16.30 which means the stock is currently trading at about 1.25 times its TBV.

However, as the bank will retain in excess of $1 per share in earnings, that gap could be closed pretty fast, and I would not be surprised to see a TBVPS of $20 by the end of 2024.

I have no position in OceanFirst, but I will keep an eye on the common shares as well as the preferred shares as the latter could be a good addition to my income-oriented portfolio.