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OceanFirst Financial Corp. (NASDAQ:OCFC) is a regional bank headquartered in New Jersey with exposure to residential and commercial real estate markets in New Jersey, New York, and Pennsylvania. This name offers income, but the loan book is a bit concerning, with about one-third of loans to residential real estate-related loans and nearly two-thirds of the loan book in commercial real estate.
For nearly a year, we have been hearing the warnings on commercial real estate. Now, not all commercial real estate is created equal, but it is riskier than traditional residential real estate, particularly if the economy worsens from here. Retail and office comprise nearly half of the commercial book here. Despite the Fed’s actions to hike rates, the economy has largely held up, but it is possible the effects are just starting to be felt. Overall, the valuation is somewhat attractive, and the income here offered is a near 5% yield to hold shares, but asset quality is pretty mixed as evidenced in the just-reported fourth quarter earnings. Let us discuss.
Headline performance
In the just-reported Q4, the bank saw decreases in the deposit base but increases in the loan base versus Q3. Loan loss provisions have been a concern in this environment, but OceanFirst saw a big decline in provision expenses in Q4 to $3.2 million, down from $10.3 million in the sequential Q3, and down from $3.6 million a year ago.
Net income hit $26.7 million, or $0.46, down sizably from $52.3 million, or $0.89 per share a year ago. However, it rose $19.7 million, or $0.33 per share, from Q3. Annual income was down for the year. Core earnings (adjusted earnings) for the quarter were $26.3 million or $0.45, a decrease from $39.5 million or $0.67 from a year ago. However, it was an increase from $18.6 million, or $0.32 per share, in the sequential Q3.
Growth in loans, but deposits dip
We always monitor total deposits as one measure of liquidity. Deposits were $10.4 billion at the recent quarter-end, down from $10.5 billion to start the quarter, but up from $9.7 billion to start 2023. Over on the loan front, unlike deposits, we saw increases. Total loans receivable, net of allowance for credit losses, were $10.1 billion compared with $10.0 billion in Q3, and up from $9.9 billion to start the year.
What about the income from those loans? Well, the net interest margin actually dipped here in the quarter. Net interest margin was 2.82%, dipping from 2.91% in Q3. It was also down substantially from 3.64% in the year-ago quarter. This year, we have seen margins hit a bottom in this rate environment for many in the sector, but OceanFirst is still seeing pressure here. While yields on loans were up, the cost of deposits continued to weigh. Moreover, the asset quality was severely mixed.
Asset quality severely mixed
Charge-offs and non-performing loans
Loans are up, but we need to have a sense of asset quality. While provision expenses were down, we saw $35 million in net charge-offs. This is not comparable to Q3, which saw a sizable markdown, but was an improvement from Q2’s $123 million in charge-offs. However, there were recoveries in Q1 and in Q4 of 2022. Mixed result overall. On the one hand, it improved from Q2 (and what we consider non-comparable in Q3), on the other, it was worse than a year ago.
What about non-performing loans? Well, this was mixed, too. Non-performing loans in total were $29.5 million, a slight improvement from Q3’s $30.1 million, but up sizably from H1 2023 and up from $23.6 million last year. Moreover, non-performing loans continue to increase in commercial real estate, both investor and owner-occupied. The total allowance for credit losses also spiked to $67.1 million from $63.8 million in Q3 and was up from $56.8 million a year ago.
Efficiency ratio and return metrics
One positive is that despite mixed asset quality, OceanFirst Financial is a relatively efficient bank. We still like to target a textbook 50% efficiency ratio for ideal regional bank performance, but the efficiency ratio did improve to 60.38% compared to 63.37% in the sequential quarter, but worsened from 44.56% a year ago. That said, it was the best efficiency ratio of the 2023 quarters.
The return on average assets and equity are down substantially from last year, and from H1 2023, but did show improvement from the tough Q3. The return on average assets was 0.78% vs. 1.68% in the year-ago quarter but improved from 0.57% in Q3. The return on average equity is also trending lower over time, down to 6.41% vs. 13.25% last year, only better than Q3’s 4.25%. Other than that, it has moved lower.
Final thoughts
We do like the OceanFirst Financial Corporation dividend yield, but with the commercial real estate exposure and increasing nonperforming loans here, we think you pass on this bank stock. The quality metrics are very mixed, and the margins are still narrowing here. Lower provision expense is a positive and there was a rebound from a very tough Q3. However, there are many regional banks to choose from, so we pass on this one.
