CADE - Cadence Bank: A Respectful Downgrade After A Remarkable Run

2023-12-23 23:08:01 ET

Summary

• Cadence Bank's shares have skyrocketed by 57.5% despite a decline in deposits, making the stock pricey.
• The bank has seen a decline in deposits, dropping by $1.06 billion in two quarters.
• The value of loans has flatlined, while the value of securities and cash has dropped, impacting the bank's profitability.

Every so often, you will find an investment opportunity that makes sense to hold on to for many years. This will be the case even if the investment in question achieves attractive upside. But for most investments, once an initial amount of upside is captured, it makes sense to sell out and look for opportunities elsewhere. One particular firm that is more typical in this regard is Cadence Bank ( CADE ). Back in July of this year, after the company had experienced some meaningful downside because of the banking crisis that began in March, I wrote a bullish article detailing why the stock made for an appealing prospect. Shares were cheap and management had achieved some good growth in the company over time. This led me to rate the business a ’buy’.

Since then, the institution has outperformed my expectations. Even though deposits of the institution have declined, shares have skyrocketed by 57.5% at a time when the S&P 500 is up only 7.9%. This significant move higher makes the stock actually quite pricey, especially relative to many of the other banks that are out there. I wouldn't go so far as to say that I am now bearish on the business. Although I will say that I am getting awfully close to that point. In all, I believe that it makes for a better ‘hold’ than it does anything else, so in the spirit of that feeling, I am downgrading the company accordingly.

In need of a downgrade

One of the biggest issues in the banking sector over the past year has been a decline in deposits. Although many banks have bucked the trend, others have not. In addition to concerns about the stability of the sector, there's also the fact that high interest rates have pushed depositors to look for attractive yields elsewhere. And one of the banks that has seen some weakness on this front is Cadence Bank. At the end of 2022, the institution had $38.96 billion worth of deposits on its books. By the end of the first quarter, deposits had grown to $39.41 billion. But ever since then, we have started seeing declines. By the end of the third quarter of this year, which is the most recent quarter for which data is available, Cadence Bank had seen its deposits drop to $38.34 billion. That's a decline of $1.06 billion in the span of two quarters.

The only good news on the deposit front is that the amount of uninsured deposit exposure the bank has is lower now than it was at the end of the first quarter. Back then, 28.9% of deposits were uninsured. For clarity, these figures refer to uninsured deposit exposure where we exclude from the equation those with collateralized protection. By the end of the most recent quarter, uninsured deposit exposure had dipped more to 25.7%. This isn't great, but it could definitely be worse.

There are some other important ways in which the institution has changed. For starters, the value of loans on its books has finely flatlined. At the end of 2022, the institution had $30.35 billion in loans. This ultimately continued to grow, peaking at $32.56 billion in the second quarter of this year. We have seen a slight decline since then to $32.52 billion. But that's not a material change in my view. Speaking of loans, only about $9.54 billion worth of the company’s loan portfolio is in the form of commercial real estate. I understand that many investors are worried at this time about exposure to office properties. But the great news is that only $748 million, or 2.3%, of the company’s overall loan portfolio falls under this category. To be clear, this does exclude some office space under the healthcare category such as doctor offices. With healthcare offices as a whole accounting for another $217.1 million, we are not talking about anything material here.

Seeing loans flatline for a quarter or two is not all that problematic. However, what is unpleasant is that the value of both securities and cash continues to drop. In 2022, the institution had $11.99 billion worth of securities on its books. This has fallen every quarter since then, hitting $9.64 billion during the most recent quarter. The value of cash did spike from $2 billion at the end of last year to $5.11 billion in the first quarter. But by the end of the third quarter, it was down to approximately $2 billion. The only positive when it comes to these declines is that it looks as though the money was used to reduce debt. The firm had $6.16 billion worth of debt on its books by the end of last year. Fast forward to today, and it has around $3.95 billion in debt.

These changes, especially the drop in the value of securities and the weakness on the deposit side of things, have resulted in some rather material changes in the company's profitability. In the first nine months of this year, for instance, Cadence Bank generated net interest income of $974.8 million. This is down only slightly from the $990.9 million reported one year earlier. Similarly, non-interest income dropped from $328.2 million to $325.4 million. However, net profits took a hit, declining from $358.2 million to $296.1 million. Certain rising costs, such as those associated with salaries and benefits, were responsible for much of this bottom line pain.

As for valuing the company, if we annualize results experienced so far for 2023, we would get net profits of $349.7 million compared to the $453.7 million reported for 2022. This would imply a price to earnings multiple of 15.9, which is amongst the highest that I have seen in the banking sector. Even if we use last year's results, the price to earnings multiple would be 12.3. There are also three different measures of book value for the institution. And these result in a price to book ratio of between 1.30 and 2.07. At the low end, that's not horrible. But it's not great either.

Takeaway

As far as banks go, Cadence Bank could be doing better. Frankly, I'm surprised that shares have seen so much upside at a time when deposits have continued to drop. The good news is that debt has come down, though that has come at the expense of larger cash and securities balances. If the stock were still cheap, I would probably remain bullish on it. But between fundamental changes that I already discussed and how much the stock has risen, I would argue that a downgrade to a soft ‘hold’ is most logical right now.

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