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OceanFirst Financial Corp.: A 7.00% Fixed-To-Floating Preferred Stock IPO Linked To The SOFR

8 min read
https://seekingalpha.com/article/4349059-oceanfirst-financial-corp-7_00-fixed-to-floating-preferred-stock-ipo-linked-to-sofr

Introduction

During the last few months, everything has revolved around the new coronavirus (COVID-19) as some very strict measures have been taken around the world. All exchanged-traded securities have experienced a very difficult time where panic selling was almost everywhere and the issuance of new fixed-income securities was the last concern of the companies. Now, when things seem to have already calmed down, we start again to observe activity in the issuance of new preferred stocks. Exactly two months from the last IPO (FCNCP issued on 03/04/2020), OceanFirst Financial Corp. (OCFC) becomes the first company to issue its exchange-traded fixed-income security. In this article, we want to acquaint market participants with the newest preferred stock that shows up on the exchange, to see how it holds up against its peer group, and to determine whether it will find its place in our portfolio or if there is a better alternative.

The New Issue

Before we submerge into our brief analysis, here is a link to the 424B2 Filing by OceanFirst Financial Corp – the prospectus.

Source: SEC.gov

For a total of 2.2M shares issued, the total gross proceeds to the company are $55M. You can find some relevant information about the new preferred stock in the table below:

Source: Author’s spreadsheet

OceanFirst Financial Corp 7.00% Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock, Series A (NASDAQ: OCFCP) pays a qualified fixed dividend at a rate of 7.00% before 05/15/2025 and then switches to paying a floating rate dividend at a rate of the three-month SOFR plus a spread of 6.845%. For reference, the current three-month Secured Overnight Financing Rate is at the rate of 0.05% translating into a hypothetical post-call date nominal yield at 6.895%. The new issue has no Standard & Poor’s rating, pays quarterly dividends, and is callable as of 05/15/2025. Currently, OCFCP trades at its par value at a price of $25.05 and has a Current Yield of 6.99% and a YTC of 6.95%.

Here is the product’s Yield-to-Call curve:

Source: Author’s spreadsheet

The Company

OceanFirst Financial Corp. is a holding company for OceanFirst Bank (the Bank). The Company is a savings and loan holding company. The Bank’s principal business is attracting retail and business deposits in the communities surrounding its branch offices and investing those deposits primarily in loans, consisting of single-family, owner-occupied residential mortgage loans, and commercial real estate and other commercial loans. The Bank also invests in other types of loans, including residential construction and consumer loans. In addition, the Bank invests in mortgage-backed securities (MBS), securities issued by the United States Government and agencies thereof, corporate securities and other investments. The Bank originates home equity loans typically as fixed-rate loans with terms ranging from 5 to 20 years. The Bank also offers variable-rate home equity lines of credit.

Source: Reuters.com | OceanFirst Financial Corp

Below, you can see a price chart of the common stock, OCFC:

Source: Tradingview.com

The quarterly dividend the company pays for the common stock is constant from the last quarter of 2018 until the present second quarter of 2020 and is a $0.17 (turning into an annualized payout of $0.68). With a market price of $13.74, the current yield of OCFC is at 4.95%. As an absolute value, this means it pays $34.24M in dividends yearly. For comparison, the yearly dividend expenses for the newly issued Series A preferred stock is around $3.85M.

In addition, the market capitalization of OCFC is around $814M.

Capital Structure

Below, you can see a snapshot of OceanFirst Financial Corp.’s capital structure as of its Quarterly Report in March 2020. You can also see how the capital structure evolved historically.

Source: Marketwatch.com | Company’s Balance Sheet

As of Q1 2020, OCFC had a total debt of $1.06B ranking senior to the newly issued preferred stock. The new Series A preferred stock rank is junior to all outstanding debt and equal to the other future preferred stocks of the company. At this point, OCFCP is the only outstanding preferred stock.

The Ratios Which We Should Care About

Our purpose today is not to make an investment decision regarding the common stock of OCFC but to find out if its new preferred stock has the needed quality to be part of our portfolio. Here is the moment where I want to remind you of two important aspects of the preferred stocks compared to the common stocks.

  • Preferred shareholders have priority over a company’s income, meaning they are paid dividends before common shareholders.
  • Common stockholders are last in line when it comes to company assets, which means they will be paid out after creditors, bondholders, and preferred shareholders.

Based on our research and experience, these are the most important metrics we use when comparing preferred stocks:

  • Market Cap/(Long term debt + Preferreds). This is our main criterion when determining credit risk. The bigger the ratio, the safer the preferred. Based on the latest annual report and taking into consideration the latest preferred issue, we have a ratio of 814/(1,060 + 55) = 0.73, indicating the company is slightly high leveraged as the company market capitalization reaches to cover only 75% of the debt.
  • Earnings/(Debt and Preferred Payments). This is also quite easy to understand approach. One can use EBITDA instead of earnings, but we prefer to have our buffer in what is left to the common stockholder. The higher this ratio, the better. The ratio with the TTM financial results from the Income Statement data is 83.93/(15.31 + 3.85) = 4.38, which an excellent coverage of the preferred stockholders’ and the bondholders’ payments. Furthermore, in the following table, we can also see a steady performance of the company with respect to its debt payments coverage for the last 5 financial years.

Source: Marketwatch.com | Company’s Income Statement

Sector Comparison

In this section, I’ll compare the newly issued preferred stock with all other fixed-to-floating preferred stocks issued by a northeast bank. Except for OCFCP which is tied to the three-month SOFR, there are a total of 8 issues, all related to the three-month LIBOR. However, SOFR which is published by the New York Federal Reserve will be the LIBOR replacement for the dollar-denominated loans and securities. Thus, there is practically no difference in the floating element of the 9 fixed-to-floating preferred stocks in the sector. Note that all of these preferred stocks are eligible for the 15% to 20% federal tax rate.

  • By Years-to-Call and Yield-to-Call

Source: Author’s database

Except for the new IPO and VLYPP, all other issues are trading above their PAR and the YTC is actually their Yield-to-Best. Even OCFCP and VLYPP are not that much above $25. The two are currently trading a few cents above that, so we can feel free to summarize that the Yield-to-Worst of all issues is their Current Yield.

  • By % of PAR and Current Yield

Source: Author’s database

Viewed from this angle, MBINP is supposed to be the higher-yielding issue in the group. But we must take into account that their current yield is calculated based on their current nominal yield that is fixed. Besides, after their call date, all preferred stocks will start paying a floating dividend which will be significantly lower than the current one whether we will look at the LIBOR or the SOFR. Only OCFCP currently does not have much difference in its current fixed rate and the subsequent hypothetical floating rate.

Source: Author’s database

The Banking Preferreds

This section contains all preferred stocks, issued by a bank company, that pay a fixed-to-floating dividend and has a par value of $25. Again, all of these preferred stocks are eligible for the preferential federal tax rate.

  • By Years-to-Call and Yield-to-Call

Source: Author’s database

As will be seen in the following graph, the stocks are equally distributed between those that trade above their par value and such that trade below PAR. This also makes a difference in regards to their Yield-to-Worst. Those issues that are trading below $25 have their YTW equal to their Current yield (available below). The preferred stocks that have their last price above $25 also have their YTW equal to their Yield-to-Call.

  • By % of PAR and Current Yield

Source: Author’s database

In the second chart, the logic is the same. We are adding the Current Yields, in case the preferred stock doesn’t get called, but after their call date, all preferred stocks will be paying a floating dividend that is significantly lower than their current nominal yield.

Redemption Following a Regulatory Capital Treatment Event

Subject to the approval of the Federal Reserve (if then required), at our option, we may redeem the Series A Preferred Stock at any time, either in whole or in part, for cash, on May 15, 2025 or on any dividend payment date on or after May 15, 2025. We may also redeem the Series A Preferred Stock at our option, subject to the approval of the Federal Reserve (if then required), at any time, in whole, but not in part, within 90 days following the occurrence of a regulatory capital treatment event, such as a proposed change in law or regulation after the initial issuance date with respect to whether the Series A Preferred Stock qualifies as an “additional Tier 1 capital” instrument.

Source: 424B2 Filing by OceanFirst Financial Corp

Use of Proceeds

We estimate that the net proceeds from this offering will be approximately $53,189,900 (or approximately $61,316,150 if the underwriters exercise in full their over-allotment option), after deducting underwriting discounts and commissions and our estimated offering expenses. We intend to use these proceeds for general corporate purposes, which may include providing capital to support our organic growth or growth through strategic acquisitions, repaying indebtedness, financing investments, capital expenditures, repurchasing shares of our common stock and for investments in the Bank as regulatory capital.

Source: 424B2 Filing by OceanFirst Financial Corp

Addition to the iShares Preferred and Income Securities ETF

With the current market capitalization of only $55M, OCFCP cannot be an addition to the ICE Exchange-Listed Preferred & Hybrid Securities Index, thus it will not be included in the holdings of the main benchmark, the iShares Preferred and Income Securities ETF (PFF), which is important to us due to its influence on the behavior of all fixed-income securities.

Conclusion

The new IPO is the second fixed-to-floating preferred stock, after MBNKP, to be bound with the new alternative to the LIBOR, the Secured Overnight Financing Rate (SOFR). Since SOFR will take the place of the LIBOR after its termination, practically any difference between the newly issued preferred stock and all other fixed-to-floaters disappears. In terms of yield, OCFCP is trading at its PAR (while there are quite a number of securities that trade well below their par value) and has a Yield-to-Worst very close to its nominal yield of 7.00%. It also has one of the smallest difference between its current nominal yield and the subsequent floating one, unlike the rest f2f issues that their “LIBOR spread” is significantly below their current dividend rate. As for the company, its metrics are satisfying as, despite the slightly higher leverage, the company has a pretty good history of its debt payments coverage.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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