Description

Ocean Shore Holding Company (OSHCD) recently completed a second-step conversion offering, and is trading at 69% price to tangible book, 12 times earnings, and has only negligible asset impairment-NPA's are a scant 0.36%.  Year-to-date, they have had just $101,000 in net charge-offs against over $740 million in assets.

Given its strong asset quality and steady growth (its current management team has expanded the bank from two branches to ten branches over the last fifteen years), Ocean Shore should trade at least near the median of its peer group.  Both the median and average price to tangible book value ratio of its peers is close to 93%, representing a 35% premium to Ocean Shore.

OSHC is the parent company of Ocean City Home Bank, a one-hundred and twenty year old, ten branch, $750 million community bank headquartered in Ocean City, New Jersey.  Core deposits represent 59.5% of its total deposits, including 9.7% that are non-interest bearing.  These deposits represent a 7.0% market share, with four of their largest competitors being national or super-regional banks.  Insiders own 11%.  The stock pays a 2.2% dividend ($0.05 per quarter).

There is a lot to like in recent performance, as ROA, ROE, earnings and net interest margin are all showing improvement.  For Q3, ROA = 0.71%, ROE = 7.7%, NIM = 3.40%, and efficiency ratio = 60.16.  Given the rigorous standards of an underwriting, these improving metrics on an already decent performance suggest that this bank has ridden out the recessionary storm quite satisfactorily.

This shows up in Ocean Shore's excellent asset quality.  At September 30, 2009, non-performing loans totaled $2.5 million, or 0.41% of total loans.  As mentioned above, YTD they have just $101,000 in net charge-offs.  This is not unusual performance for this bank.  They have had terrific historical asset quality, and net charge-offs have been negligible, while non-performing loans have been scarce:

79% of their loan portfolio is in one-to-four family residential.  9.5% home equity loans, and no subprime loans.  Approximately 40% of the residential loans are secured by second homes and approximately 10% are secured by investment properties.

76% of their investment portfolio is pass-through agency mortgage-backed securities, with corporate debt securities an additional 17%.  Their two TRUP CDO's were written down to zero.

Ocean Shore has a strong capital position, with tangible common equity / tangible assets at 11.2%, and total risk-based capital ratio of 19.7%.

Its growth characteristics are attractive, but not worrisome.  For the 4.75 year period from 2004 through Q3 of 2009, Ocean Shore has grown steadily.  Assets, gross loans, and deposits have grown at a compound annual growth rate of 7.4%, 14.8%, and 5.4% respectively.

The bank provided an interesting rationale for doing their second-step conversion in the current market.  They stated that "current market conditions provide the opportunity to transition the Company for the future without raising excessive capital."  They also cited regulatory risk, which could impair the ability of the holding company to waive dividends and pass those dividends on to minority shareholders. 

It is refreshing to see a bank focused on the big picture and avoiding being overcapitalized.  In my opinion, a 120 year old bank does not need to saddle itself with more money than it can deploy successfully.  However, it is the nature of these conversions that a bank is often left terribly overcapitalized, simply due to the excesses of a bull market and the formulaic way in which these conversions proceed.

Following the offering, pro forma tangible book value per share is $12.91.  Versus the recent close of $8.95, the stock is trading at 69.3% price / tangible book, and 12.6x P/E.

In the appraisal for its recent offering, OSHCD's peer group consisted of eight publicly traded comparables:

With one exception, these are exceptionally clean banks, and yet OSHCD still stands out as unusually cheap on a price-to-tangible book ratio, not to mention its positively trending metrics.

Why is Ocean Shore so cheap?  I believe it is because their offering closed shortly before year-end, and very few people were paying attention to this sleepy situation.  Ocean Shore had filed to come at a valuation of anywhere between 63% and 77% of tangible book value.  This was their second attempt to complete this offering, and while the appraisal was lower this time around, the uncertainty of where the stock would price probably kept investors away.

There are only two significant outside shareholders-Hovde Capital and Tyndall Capital.  Both are well-respected, long-term bank investors.  I don't see any cause for activist investors to get involved.

At some point, the market will recognize that there is a shifting dynamic for these attractive thrifts.  As regulators require more tangible common equity to assets, margins will necessary expand to meet the required cost of capital.  As regulatory pressures reduce leverage in the banking system, and capital costs increase, ROE's will have to compensate by shifting higher.  In other words, banks need higher margins to compensate for their reduced leverage.

This should be a significant advantage to community banks, particularly for those with low cost deposits.  Banks typically can only get into trouble on the asset side, as was proven once again during this banking crisis.  Banks with terrific asset quality and a strong capital position will thrive going forward. 

I believe that if an investor focuses on those banks with growth potential that are simultaneously inexpensive to tangible book value, while also currently producing earnings yields of 8% or better, investment IRR's of 15% to 20% can be achieved over a three to five year horizon.  That is solely based on earnings of 8%, growth of several percent, and a steady convergence to current peer valuations.  Any upside valuation of the industry group as a whole would provide even further appreciation.

Catalyst

Convergence to peers.

Improving quarterly results.