CPKF: Asset Quality Is Stellar, but Rising Deposit Costs Pressure Results
OTC:CPKF
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CPKF’s (OTC:CPKF) second quarter net earnings decreased $1.0 million, or 25%, year over year to $3.0 million, while 2023’s second quarter diluted EPS fell by $0.21, or 25%, to $0.65 from $0.86 posted a year ago.
This was worse than our estimate, which had called for a $0.3 million decrease in net earnings to $3.8 million and a $0.06 fall in diluted EPS to $0.80.
We note that this year’s second quarter included a one-time $1.9 million gain from the sale of VISA B stock (included in other miscellaneous income), which was offset by a $1.5 million loss on sales of securities and several one-time expenses totaling $0.4 million (included in other miscellaneous expense).
The main factors behind the difference between actual results and our estimate were: (1) net interest income was $0.5 million less than our estimate due to a lower-than-expected net interest margin of 3.45% (versus our 3.50% estimate); (2) there was a $1.5 million net loss on sales of securities (versus no securities gain or loss in our estimate); (3) other miscellaneous expense was $0.6 million worse than our estimate due to several one-time expenses totaling $0.4 million; (4) compensation expense was $0.2 million more than our estimate and (5) income tax expense was $0.1 million higher than our estimate, the result of a greater effective tax rate of 18.3% compared to our 14.2% estimate. Partially offsetting these negatives were: (1) cash management fee income was $0.4 million better than our $1.0 million estimate, due to the acquisition of a factoring company on May 1 and (2) other miscellaneous income was $1.7 million more than our estimate, reflecting a one-time $1.9 million gain from the sale of VISA B stock.
The major reasons for the second quarter’s $1.0 million, or 25%, decrease in net earnings versus the prior-year quarter were a $0.3 million, or 2%, rise in net revenues, due to a $0.9 million, or 17%, gain in other noninterest income partly offset by a $0.6 million, or 6%, decline in net interest income. In addition, total noninterest expense was $1.4 million more than last year’s second quarter as a $0.3 million, or 5%, increase in compensation costs added to a $1.1 million, or 33%, rise in other miscellaneous expense. Moreover, earnings benefitted from reduced income tax expense of $0.1 million, reflecting lower pretax earnings.
We are decreasing our diluted EPS estimate for 2023 by $0.10, from $3.10 to $3.00, an 11% fall from 2022’s actual diluted EPS of $3.37, which excludes a third quarter one-time gain on the sale of a partial interest in a brokerage firm of $1.7 million aftertax, or $0.36 per diluted share.
The main reasons for the reduction in our 2023 diluted EPS estimate are declines in net interest income and mortgage banking income. As to net interest income, we have cut our net interest margin estimate to 3.43% from 3.48% in 2023 (and 3.72% actual in 2022), primarily due to a larger-than-expected increase in deposit funding costs, reflecting rising interest rate levels at the Fed. Positively, CPKF’s deposit base held steady following the industry turmoil caused by the failures of several banks earlier in the year. The contribution from mortgage banking is estimated to decline by about $0.9 million, or 51%, in 2023 due to the impact of rising interest rates on mortgage activity.
We are also lowering our diluted EPS estimate for 2024 from $3.25 to $3.10, a 3% gain over our revised 2023 EPS estimate of $3.00. We expect most operations to post improvement in 2024 except mortgage banking, which should be flat year over year.
Loan demand appears solid and was stronger than expected in the first and second quarters. Therefore, we are increasing our estimates of loan growth to 10% from 6% in 2023 and to 8% from 6% in 2024, as well. Our initial net interest margin estimate for 2024 is now 3.30% (down from 3.40%), 13 basis points below our 2023 estimate of 3.43%.
We are maintaining our estimates of merchant services income, as well as trust and wealth management income for 2023 and estimating moderate increases for 2024.
As to cash management, we have significantly increased our estimates for both 2023 and 2024, following the acquisition of a factoring company in the Flexent division, which is expected to increase Flexent revenues by about 35% going forward. This acquisition will also improve industry concentration risk making it especially attractive. Valuation accounting adjustments are expected to be minimal.
On the expense side, we are increasing our estimates for 2023 for occupancy expense and other miscellaneous expense and projecting moderate expense growth in 2024.
For 2023 and 2024, our estimate for the loan loss provision remains $0.7 million, the same as the loss provision in 2022. Importantly, the Financial Accounting Standards Board’s Current Expected Credit Loss (CECL) impairment standard, which requires “life-of-loan” estimates of losses to be recorded for unimpaired loans, has not had a material impact on loss provisions in 2023. We note, however, there were some minor retroactive changes to CPKF’s capital account ($400,000) and the allowance for credit losses ($37,000) as a result of its adoption.
The provision for cash management losses, a separate line item listed under other noninterest expense, is expected to be stable at about $240,000 in both 2023 and 2024, the same as it was in 2022.
During the second quarter, CPKF opened another branch, this time in a retirement community in Richmond, Virginia. It is CPKF’s sixth branch in a retirement community, which is attractive due to its low cost of entry, as well as being a feeder for the Company’s investment management and deposit-gathering activities. In addition, in August CPKF opened a loan production office in Newport News, Virginia.
At the July 15, 2022 Chesapeake Financial Shares Board of Directors meeting, the Board raised the quarterly dividend to $0.15 per share from $0.14 per share (a 7% increase), paid on or before September 15, 2022. This follows two dividend increases in 2021. Notably, CPKF has increased the annual dividend payment every year for the past thirty years since 1991.
In 2023 for the sixteenth consecutive year, Chesapeake Financial Shares, Inc. has been included in the American Banker magazine listing of the “Top 200 Community Banks” in the United States. The bank ranked at #58 in the nation out of approximately 6,000 community banks in the study, up from #130 last year and #148 when CPKF first broke into the rankings in 2008. The ranking is based on a three-year average of return on average equity (ROAE), which for CPKF was 14.34%.
Chesapeake Financial Shares, Inc. (CPKF or the Company) is a financial holding company headquartered in Kilmarnock, Virginia, with $1,355 million in total assets at June 30, 2023. CPKF is predominantly a small business lender with 17 branch offices and one loan production office that serve customers in the eastern region of Virginia between the Potomac and James Rivers. CPKF, which began as Lancaster National Bank on April 13, 1900, has a long history and strong ties with the communities it serves.
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