Significant merger activity has had a positive effect on our community bank investments this year (see below). The following table updates our holdings in community banks. OceanFirst (OCFC) is shown in the third row, adjusted to include our estimate of the pro-forma impacts of the CBNJ acquisition that closed May 2nd.
Price data as of 6/30/2016. Sources: SEC filings, Call Reports, Bloomberg, FactSet, Anabatic estimates. Figures adjusted/estimated as applicable to reflect current annualized levels.
1 Market price divided by tangible book value, as reported
2 Non-performing assets (non-performing loans + foreclosures / other real estate owned) divided by total assets, as reported
3 Tangible common equity divided by tangible assets, as reported
4 Estimated percentage of the company’s current shares outstanding likely to be repurchased under existing buyback authorization
5 Net interest margin, adjusted and annualized
6 Return on assets, adjusted and annualized
7 Return on common equity, adjusted and annualized
8 Market price divided by earnings per share, adjusted and annualized
9 Efficiency Ratio = non-interest expenses divided by the sum of net interest income and non-interest income, as reported
10 Mutual holding company conversion — the year in which the company converted to public ownership
The early May closing of OceanFirst’s acquisition of Cape Bancorp was several months ahead of schedule. OceanFirst is proving to be an adept acquirer, an opinion shared by the regulators who approved the deal more quickly than expected. As noted previously, we received approximately 15% of the proceeds in cash and the rest in shares of OceanFirst. I remain impressed by OceanFirst’s operations and management and I find the valuation compelling.
[On July 13, 2016] OceanFirst announced the acquisition of Ocean Shore Holding (OSHC), a smaller peer in southern New Jersey and another of our holdings (shown in the second row of the table above). This deal was a logical and somewhat expected outcome for both banks. (It also explains OceanFirst’s timing of its prior acquisition.) When we made our investment in Ocean Shore in 2015 I thought it was a likely acquisition target, particularly after its long-standing CEO suffered a health scare just over a year ago.
The announced purchase price of $22.47 per share, consisting of $4.35 in cash and 0.9667 shares of Ocean First, represents 132% of tangible book value, 20x trailing earnings, and a 4.9% core deposit premium.
There is substantial geographical overlap between the two companies and OceanFirst expects significant cost savings that I believe are attainable. If realized, OceanFirst is paying less than 10 times its estimate of Ocean Shore’s 2017 earnings. Despite issuing equity for roughly 80% of the purchase price, OCFC’s tangible book per share will be diluted by a modest 3.1% with a projected earn-back period of 3-4 years. OSCH’s deposits will add to OCFC’s already substantial low-cost funding base, and OSHS will add high-quality residential loans to OCFC’s asset mix.
I also want to mention that Ocean Shore may have lacked efficient scale but it was always a well-managed bank. Ocean Shore’s net charge-offs never exceeded 16 basis points of average loans at any point in the past decade, despite being a mostly residential mortgage lender in southern New Jersey faced with the housing crisis and the Great Recession, the collapse of many Atlantic City casinos, and Superstorm Sandy, among other problems. That is exceptional credit quality and exactly what I hope to find in a bank. Sound underwriting combined with a stable base of low-cost deposits is a recipe for success.
Another of our banks, the first on the chart shown above, is also under increasing pressure from shareholders to find a merger partner. Stay tuned for further updates.
The Brexit vote and the decline in interest rates sent shockwaves through many markets, and many large financial stocks were notable for their declines. WFC fell but the market didn’t assign a negative time value to the warrants as it did briefly in the first quarter.
In Wells Fargo’s case, I believe the impact of the recent macro shakeup will be manageable. Wells Fargo is primarily a domestic operation with little business directly exposed to the worst of the turmoil. There could be spillover effects in the U.S. economy but Wells is in excellent shape to navigate the problems as they arise. The company has plenty of capital, in excess of $30 billion of pre-tax earnings power per year, and it remains one of the world’s best managed banks with a preeminent deposit gathering franchise. To that point, WFC’s deposits grew at 7-9% per year each of the past three years, and as of 1Q16 they cost 10 basis points per year. Asset yields may decline marginally, and loan growth is far from booming, but this doesn’t change the overall picture very much.
From a broader perspective, the past decade has clearly been a difficult one for any bank, yet Wells Fargo has been profitable in each and every year, posting an ROE lower than 10% only in 2008 (4.8%) and 2009 (9.9%). More of the same seems likely. The problems are real, but so is the progress. Interest rates have continued to fall – the 10-year U.S. Treasury recently hit an all-time record low – and the yield curve has flattened. That is certainly not helpful to most banks, although as the nation’s largest mortgage lender some of WFC’s pain might be offset by an increase in refinancings. Non-interest (fee) income is also nearly as large as net interest income.
I expect Wells Fargo’s earnings to be roughly flat compared to the past year or two. Compared to 2012 – the last time interest rates were in this ballpark – pre-tax earnings are about 15% higher. (The improvement is even greater on a per-share basis due to buybacks, and book value per share has grown roughly 22% in the three years ended December 31, 2015.) So despite low interest rates, despite the energy/commodity price declines, despite fintech, despite Brexit, and despite ongoing regulatory and capital pressure, Wells Fargo is still likely to produce a return on assets well above 1% and a low-double digit return on equity. At just less than eight times my estimate of pre-tax earnings, I think it remains a sound investment.
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