CPKF: Reducing Diluted EPS Estimates by $0.50 in 2023 and 2024 due to Higher Deposit and Compensation Costs
OTC:CPKF
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Chesapeake Financial’s (OTC:CPKF) third quarter net earnings decreased $1.8 million, or 42%, year over year to $2.5 million, while 2023’s third quarter diluted EPS fell by $0.37, or 42%, to $0.53 from $0.90 posted a year ago. Results in 2022 exclude a one-time gain on the sale of a partial interest in a brokerage firm of $2.2 million pretax and $1.7 million aftertax, or $0.36 per diluted share. Reported net earnings were considerably higher at $5.9 million, or $1.26 per diluted share.
This was worse than our estimate, which had called for a $0.6 million decrease in net earnings to $3.6 million and a $0.12 fall in diluted EPS to $0.78.
The main factors behind the difference between actual results and our estimate were: (1) compensation expense was $0.9 million more than our estimate as full-time equivalent employees have grown to 287 at the end of the third quarter from 258 (an 11% increase) at the end of the first quarter, reflecting the acquisition of a small factoring company on May 1 and the hiring of several employees to fill vacant positions; (2) other miscellaneous expense was $0.7 million worse than our estimate due to larger FDIC premiums and higher customer check fraud losses, as is common in the industry currently; (3) net interest income was $0.6 million less than our estimate due to a lower-than-expected net interest margin of 3.37% (versus our 3.40% estimate) and reduced interest-earning assets; (4) cash management fee income was $0.2 million less than our $1.6 million estimate; (5) the loan loss provision was $0.1 million more than expected; and (6) there was a $0.1 million net loss on sales of securities (versus no securities gain or loss in our estimate). Partially offsetting these negatives were: (1) other miscellaneous income was $1.0 million more than our estimate, reflecting several one-time gains; (2) occupancy expense was $0.3 million better than our estimate; and (3) income tax expense was $0.2 million lower than our estimate, the result of reduced pretax earnings.
The major reasons for the third quarter’s $1.8 million, or 42%, decrease in net earnings versus the prior-year quarter were a $0.3 million, or 2%, drop in net revenues due to a $1.2 million, or 11%, decline in net interest income partly offset by a $0.9 million, or 17%, gain in other noninterest income. In addition, total noninterest expense was $1.6 million more than last year’s third quarter as a $1.1 million, or 16%, increase in compensation costs added to a $0.5 million, or 15%, rise in other miscellaneous expense. In addition, the provision for loan losses was $0.1 million more in 2023’s third quarter than a year ago. Finally, earnings benefitted from reduced income tax expense of $0.2 million, reflecting lower pretax earnings.
We are decreasing our diluted EPS estimate for 2023 by $0.50, from $3.00 to $2.50, a 26% 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.
We are also lowering our diluted EPS estimate for 2024 by $0.50 from $3.10 to $2.60, a 4% gain over our revised 2023 EPS estimate of $2.50. We expect most operations to post improvement in 2024 except mortgage banking, which should be flat year over year.
The main reasons for the reductions in our 2023 and 2024 diluted EPS estimates are declines in net interest income, as well as higher compensation costs due to the increases in full-time equivalent employees from the factoring acquisition and replacement staffing. Although top-line interest income is growing nicely, CPKF has experienced accelerating increases in deposit costs, similar to the rest of the banking industry. Moreover, CPKF is strategically increasing its use of brokered deposits and large time deposits (greater than $250,000) to invest in its available-for-sale securities portfolio to earn money on the spread and supplement interest income.
Loan demand appears solid, and we are maintaining our estimates of loan growth at 10% in 2023 and at 8% in 2024. Our net interest margin estimate for 2024 is 3.30%, 13 basis points below our 2023 estimate of 3.43%.
As to cash management, we are tweaking our estimate in 2023 while retaining our estimate in 2024. CPKF acquired a small factoring company in the Flexent division in May, which is expected to increase Flexent revenues by about 35% going forward. This acquisition also improves industry concentration risk making it especially attractive. Valuation accounting adjustments include the addition of $7.4 million in goodwill to the balance sheet and about $0.2 million in annual amortization charges to the income statement.
For 2023 and 2024, we are increasing our estimate for the loan loss provision to $0.9 million from $0.7 million in 2023 and to $0.8 million from $0.7 million in 2024, with the increases reflecting general economic conditions rather than specific concerns about asset quality, which remains exceptionally strong. As a comparison, the loan loss provision was $0.7 million 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 October 27, 2023 Chesapeake Financial Shares Board of Directors meeting, the Board raised the quarterly dividend to $0.155 per share from $0.15 per share (a 3% increase), to be paid on or before December 15, 2023. Notably, CPKF has increased the annual dividend payment every year for the past thirty-one 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 $1,382 million in total assets at September 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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