OceanFirst will disrupt large new loan markets and generate significant operating leverage

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Banking is a business where the Goliaths don’t always have decisive advantages over the Davids. With regard to commercial lending, in particular, smaller banks can often succeed by hiring productive loan officers unhappy to work for less entrepreneurial banks and exploiting them with high interaction service models.

OceanFirst (OCFC) has had strong success using this approach to grow lending in the New York and Philly metro areas, and is now targeting Baltimore, Boston and Washington, DC, while continuing to be an acquisition bank – his latest acquisition building the company’s presence in Delaware, Maryland, Virginia and Washington, D.C.

In the three years since my last article on OceanFirst, the bank hasn’t performed particularly well, underperforming smaller regional banks by about 30% or so. In addition to being impacted by the pandemic, OceanFirst has suffered from a shift in sentiment against acquirer banks. With a credible plan to deliver above-average growth, these stocks may be worth another look now.

Wait for the light to turn green

The pandemic has definitely impacted OceanFirst’s business, with lower rates, weaker loan growth and excess cash on the balance sheet impacting results. OceanFirst did not meet Street’s targets for operating profit before provisioning in the four quarters of 2021, largely due to lower spread income (a common problem in the banking industry) and more challenges on the operating expense/leverage side.

Coming out of 2021, however, I think OceanFirst is in better shape.

Net interest margin improved quarter-over-quarter on a reported (6 bps) and basis (7 bps) basis, and the bank continues to have substantial funds that it can redeploy into loans as rates improve. To that end, loans grew 5% q/q on an adjusted basis (excluding PPP and purchased loans), with C&I loans growing 5% and CRE loans growing over 11%. Even better, loan originations were up 28% QoQ and despite this strength in new loans, the loan pipeline was still up about 3% QoQ in the fourth quarter.

Sensitivity, however, is one area where my expectations are more modest. The majority of OceanFirst’s loans are fixed rate, giving it less leverage for higher rates, and the loan-to-deposit ratio isn’t particularly low at just under 90%. Although OceanFirst had a significantly above average deposit beta during the last tightening cycle, and I think there is a risk that betas will be higher than expected during this next cycle, OceanFirst has below-average overall asset sensitivity compared to its peers. .

Loan growth will need to drive most of the growth on the income spread side, but I see other positive leverage contributors. Management is in the midst of another branch consolidation, and while I expect continued investment in hiring and IT to continue to grow the business, I expect growth to double-digit revenue growth and single-digit growth in core OpEx to support an annualized pre-provision of more than 30% earnings growth over the next two years.

Growth – organic and acquired

In that last article I wrote, I said I expected OceanFirst to remain a very long-winded bank, and indeed they did – announcing four more deals in the meantime. The last purchase, Bancorp Partners (PTRS), expands bank’s footprint in Delaware, Maryland, Virginia and Washington, D.C.

The market hasn’t been particularly receptive to this deal, and I can understand why. While geographic expansion makes sense, the multiple (1.45x tangible pound) is high for a bank with a single-digit ROTCE, and the three-year ROI on tangible pound dilution isn’t great . On top of that, the market has generally taken a dim view of whole bank acquisitions in recent years, with organic growth stories getting significantly better multiples.

To that end, OceanFirst still has a credible organic growth history. The growth story now focuses on the bank essentially replicating its successful loan growth approach in New York and Philly in Boston, Baltimore and Washington, DC. All three of these markets have been disrupted by mergers and acquisitions, and Boston and Baltimore are highly concentrated markets. , with large super-regionals holding a large share in each – a circumstance that often allows smaller, more nimble, service-oriented banks to secure a share of commercial lending.

At the same time, OceanFirst has grown other parts of the business, and I think those efforts can help with the loan growth plan. Cash management has roughly doubled in size in recent years, and the bank’s minority stake in NestEgg gives it access to a growing third-party robo-advisor that should help the wealth management business grow assets under management. With treasury and wealth management services supporting the growth of commercial loans (for the typically family-owned small businesses that are the core of OCFC’s market), this should help the company increase its share of loans in the years to come. to come.

The prospects of OCFC Action

While I understand the allure of Boston, Baltimore, and Washington, DC, I would also like to see the bank “double up” and reinvigorate its lending efforts in its backyard; I think there has also been significant disruption in the New York and New Jersey markets, and I think a further push here could be well rewarded. I don’t mean the bank has moved away from these markets, but that doesn’t seem to figure prominently in the strategy discussions.

The pandemic has definitely impacted OceanFirst, but the bank had been on target against my model before and will be back in line with my model in 2023. Beyond that, I actually raised my expectations to reflect the success seen in NYC/Philly and the opportunity in Boston, Baltimore and Washington, D.C. I expect low double-digit core earnings growth over the next five years and high single-digit growth core earnings figure over the next 10 years, and I continue to expect mergers and acquisitions to be a part of that process, although perhaps not at the same rate as before.

The essential

Between discounted core earnings, ROTCE-based P/TBV (a near 1.6x multiple) and a 12x multiple of my 2023 EPS estimate ($2.53), I think OceanFirst shares should negotiate between $25 and $30. That’s a reasonable return for the risk, I believe, but there’s certainly no shortage of other banks to consider. While OceanFirst’s acquisitive nature is a sentiment risk and recent execution leaves something to be desired, I believe improving loan demand and operating leverage opportunities can drive better performance.