CATC - Cambridge Bancorp: Bright Earnings Outlook With A Low-Risk Level

2023-03-26 21:23:23 ET

Summary

• Due to the balance sheet positioning, loan re-pricing will outweigh deposit re-pricing in the second year of rate hikes. Therefore, this year’s margin will benefit from last year's rate hikes.
• High mortgage rates will hurt the residential mortgage loan segment, which is a big focus area for CATC.
• The December 2023 target price suggests a substantial upside from the current market price. Further, CATC is offering a high dividend yield for a bank-holding company.
• The risk level appears relatively subdued due to a low balance of unrealized losses.

Earnings of Cambridge Bancorp (CATC) will likely increase this year on the back of a lagged effect of last year's rate hikes on the net interest margin. Further, subdued loan growth will support the bottom line. Overall, I'm expecting Cambridge Bancorp to report earnings of $8.29 per share for 2023, up 14% year-over-year. Compared to my last report on the company, I've only slightly decreased my earnings estimate for this year. The year-end target price suggests a high upside from the current market price. Therefore, I’m maintaining a buy rating on Cambridge Bancorp.

Loan Growth Likely to Drop to Low-to-Mid-Single-Digit Range

The loan portfolio grew by 12% in the fourth quarter thanks to the acquisition of Northmark Bank as well as strong organic growth. Loan growth will slow down this year as borrowing costs are much higher now. Residential mortgage loans are highly dependent on mortgage rates; therefore, this segment will likely remain lackluster in 2023. Residential loans make up 41% of total loans; hence, the slowdown in this segment will have a large effect on the total loan growth. On the plus side, the house price index for Massachusetts has flattened recently, which is good news for housing affordability in Cambridge Bancorp’s main market.

Further, the outlook for commercial loans remains positive as the unemployment rate is persistently at a low level. Cambridge Bancorp mostly operates in Massachusetts with some presence in New Hampshire. As seen below, both states currently have very low unemployment rates when compared to their respective histories.

The management mentioned in the conference call that it is expecting loan growth to be between 0% to 5% this year. Considering the factors given above and management’s guidance, I'm expecting the loan portfolio to grow by 4% in 2023. The following table shows my balance sheet estimates.

In my last report on Cambridge Bancorp, I estimated earnings of $8.49 per share for 2023. I've tweaked almost all line items following the fourth quarter’s results, which were mostly in line with my expectations. As I haven't made any big changes, my updated estimate is close to my previous estimate.

Risks Appear Relatively Low

Cambridge Bancorp's risk level appears low despite the ongoing banking sector crisis due to the following reasons.

1. The gross unrealized loss on the available-for-sale securities portfolio was only $28.6 million at the end of December 2022, as mentioned in the 10-K filing. To put this number in perspective, $28.6 million is just 6% of the equity outstanding at the end of last year and around half of the net income reported for 2022. In case there is a deposit run à la SVB Financial Group’s ( SIVB ) case, and Cambridge sells its securities portfolio, then the unrealized losses will turn into realized losses. However, this extreme case doesn't worry me because the hit will be only half of earnings and just 6% of equity.
2. Cambridge doesn't have exposure to risky asset classes, including crypto assets, digital tokens, or venture capital, unlike the U.S. banks that have failed so far (Signature Bank ((SBNY)), Silvergate Capital ( SI ), and SVB Financial Group).
3. The company appears more than just well-capitalized. It reported a total capital ratio of 13.52% for the end of December 2022, which is much higher than the minimum regulatory requirement of 10.50%.

High Total Expected Return Justifies a Buy Rating

Cambridge Bancorp is offering a dividend yield of 4.0% at the current quarterly dividend rate of $0.67 per share. The earnings and dividend estimates suggest a payout ratio of 32% for 2023, which is below the five-year average of 39%. Therefore, the dividend appears secure.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Cambridge Bancorp. The stock has traded at an average P/TB ratio of 1.38x in the past, as shown below.

The stock has traded at an average P/E ratio of around 11.5x in the past, as shown below.

Equally weighting the target prices from the two valuation methods gives a combined target price of $90.9 , which implies a 36.4% upside from the current market price. Adding the forward dividend yield gives a total expected return of 40.4%. Hence, I’m maintaining a buy rating on Cambridge Bancorp.

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