CAC - Camden National: Both Expected Return And Risk Are High

2023-03-29 21:40:13 ET

Summary

• The margin will likely stop declining after the interest rate plateaus by the mid of this year.
• Commercial loan growth will likely partially compensate for the slowdown in the residential mortgage segment.
• The December 2023 target price suggests a high upside from the current market price. Further, CAC is offering a high dividend yield.
• CAC’s unrealized losses on the debt securities portfolio are quite high, which makes the stock risky.

Earnings of Camden National Corporation ( CAC ) will likely remain flattish this year. Loan growth will likely remain subdued at a level that’s below normal. Further, the margin will likely continue to contract in the first half of the year before reversing its trend in the second half. Overall, I’m expecting Camden National to report earnings of $4.11 per share for 2023, down by just 1% year-over-year. The year-end target price suggests a high upside from the current market price; therefore, I’m upgrading CAC stock to a buy rating. However, the company’s risk level is high which makes it unsuitable for low-risk tolerant investors.

Margin to Bottom-Out by the Mid of 2023

Camden National’s net interest margin declined by 12 basis points in the fourth quarter of 2022 as the surge in deposit costs outweighed the growth in average asset yields. Part of the surge in deposit costs was attributable to a significant worsening of the deposit mix as depositors tried to chase rates and shifted their funds to higher-yielding accounts, as can be seen below.

Another reason behind last quarter’s margin decline was that Camden’s deposits re-price faster than loans. This is because the deposit book is heavy on interest-checking, money market, and savings accounts that reprice frequently, while the loan book is heavy on fixed-rate mortgage loans. As a result, the margin stands to benefit from rate hikes once the up-rate cycle is over. The results of the management’s rate sensitivity analysis given in the 10-K Filing show that a 200 basis points hike in interest rates could reduce the net interest income by 3.93% in the first year and increase the net interest income by 8.78% in the second year of the rate hike.

As a result, the margin is likely to continue to contract in the first half of 2023, and then start expanding later this year. For the full year, I’m expecting the margin to grow by 10 basis points.

Loan Growth Momentum to Finally Weaken This year

Camden National’s loan growth remained strong in the fourth quarter of 2022 and beat my expectations. The portfolio grew by 3.9% during the quarter, which took the full-year growth to an above-average 16.9%. I’d previously been expecting the high-interest rate environment to take its toll on loan growth, especially residential mortgage loan growth, in the latter part of 2022. However, the effect is taking longer than expected to materialize.

I’m expecting the up-rate cycle to have finally hit loan growth in the first quarter of 2023. The management mentioned in the latest earnings release that pipelines had slowed by December 31, 2022, in comparison to earlier periods. Residential mortgage loans will likely get hurt the most because they depend heavily on mortgage rates. The residential segment is a key focus area for Camden National as it made up 48% of total loans at the end of 2022. Therefore, the slowdown in this segment will have a significant effect on total loan growth.

Meanwhile, commercial loan growth will likely remain at a normal level. High-interest rates will drag the commercial loan segment, while economic activity, as indicated by the unemployment rate, will boost the segment. Camden National mainly operates in Maine with some presence in New Hampshire and Massachusetts. As shown below, the unemployment rates of all three states are quite low when compared to their respective histories.

Considering these factors, I’m expecting the loan portfolio to grow by 4% in 2023. Further, I’m expecting deposits to grow in line with loans. The following table shows my balance sheet estimates.

In my last report on Camden National, I estimated earnings of $4.24 per share for 2023. Although I haven’t made any big changes to any line item, my updated earnings estimate are lower than my previous estimate. The tweaks I’ve made in all line items combine to give a material variance between my updated estimate and the previous estimate.

Unrealized Loss is Large Even After Last Year’s Reclassification

Camden National’s balance sheet was poorly positioned at the beginning of last year, just before the rate hikes started. It had a very large balance of fixed-rate available-for-sale (“AFS”) securities, whose market values started to decline as the interest rates increased. AFS securities made up a whopping 30% of total earning assets at the end of December 2021. As a result, the company racked up large unrealized losses.

During last year, Camden incurred a large part of its previous unrealized losses when it transferred AFS securities to the held-to-maturity classification. The company will amortize the cost over some time, as mentioned in the 10-K Filing. At the end of 2022, the remaining unrealized losses amounted to $101.2 million. To put this number in perspective, $101 million is a sizable 22% of total equity and 1.7 times the net income reported for 2022.

The remaining unrealized losses show that the earnings at risk are high. However, the possibility of further conversion of unrealized losses into realized losses is low. Firstly, the up-rate cycle may end soon and rates may start declining from next year, as can be gleaned from the Federal Reserve’s latest projections . It’s now easier to ride out the up-rate cycle because the end is near. Secondly, the chances of a deposit run à la SVB Financial’s ( OTC:SIVBQ ) case, which could force the sale of securities, are low because Camden National is quite different from the failed bank. Camden doesn’t have material exposure to start-ups and venture capital assets, and it operates far from SVB Financial’s Californian markets.

Overall, I believe Camden's risk level is high which makes it unsuitable for low-risk tolerant investors.

Upgrading to a Buy Rating

Camden National is offering a dividend yield of 4.6% at the current quarterly dividend rate of $0.42 per share. The earnings and dividend estimates suggest a payout ratio of 41% for 2023, which is above the five-year average of 35%, but easily manageable. 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 Camden National. The stock has traded at an average P/TB ratio of 1.61x in the past, as shown below.

The stock has traded at an average P/E ratio of around 10.4x in the past, as shown below.

Equally weighting the target prices from the two valuation methods gives a combined target price of $42.9 , which implies a 16.3% upside from the current market price. Adding the forward dividend yield gives a total expected return of 20.8%.

In my last report on Camden National, I adopted a hold rating with a December 2023 target price of $44.3. Since then, the stock price has plunged partly due to the banking sector crisis and the resultant increase in the risk level. Considering my updated total expected return, I’m adopting a buy rating on Camden National Corporation. However, as discussed above, Camden’s risk level is high due to its unrealized losses. Therefore, I believe this stock is not suitable for low-risk tolerant investors.

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