CBNK - Capital Bancorp: Attractively Valued But Earnings Likely To Dip

2023-04-01 05:16:52 ET

Summary

• Higher expenses will likely undermine the effect of moderate loan growth and slight margin expansion.
• The December 2023 target price suggests a very high upside from the current market price. However, CBNK is offering a low and unattractive dividend yield.
• The risk level appears moderate. Unrealized losses aren’t too high. However, the loan portfolio’s credit risk appears moderately high.

Earnings of Capital Bancorp, Inc. ( CBNK ) will most probably dip slightly this year on the back of high provision and operating expenses. On the other hand, single-digit loan growth and slight margin expansion will support earnings. Overall, I’m expecting Capital Bancorp to report earnings of $2.84 per share for 2023, down 2.5% year-over-year. The year-end target price suggests a high upside from the current market price; hence, I’m adopting a buy rating on CBNK stock.

Limited Yield Upside Foreseen

Capital Bancorp’s net interest margin dipped by 60 basis points in the fourth quarter, after rising by 18 basis points in the third quarter of 2022. Despite the dip, the margin is still very high compared to a year-ago period and peer banks. In fact, the margin is so high that it’s a cause for concern. Yields on loans were a whopping 9.15% in the fourth of 2022, which makes me concerned about the asset quality. Further, I’m worried the high yields will chase away potential borrowers to competitors; thereby hurting loan growth. The average loan rates were much lower for competitors during the fourth quarter, as given below. (The companies below are those that Capital Bancorp has identified as competitors in the Washington DC market in an old presentation ).

Credit Risk is High, but Credit Costs Likely to be Only Slightly Above Normal

The credit risk of Capital Bancorp’s loan portfolio is high due to the following factors.

1. The average portfolio yield is too high. As discussed above, the portfolio’s average yield was a whopping 9.15% in the last quarter of 2022. With rates so high, even the slightest financial stress can push borrowers into default.
2. The credit card book is a sizable component of the loan portfolio. As of the end of December 2022, credit card loans made up 7% of total loans.

Fortunately, the coverage of credit risk appears comfortable. Allowances were 2.7 times the non-performing loans at the end of December 2022. Moreover, as I’m expecting loan additions to be below average this year, the pressure on provisioning for loan losses will not be too high.

Overall, I’m expecting the net provision expense to make up 0.43% of total loans in 2023, which is slightly above the five-year average of 0.39%.

Expecting Earnings to Slightly Dip This Year

The anticipated loan growth and margin expansion will likely support earnings this year. On the other hand, higher provision expenses for loan losses will drag earnings. Further, inflation-driven growth in non-interest expenses will lead to a decline in earnings. Overall, I’m expecting Capital Bancorp to report earnings of $2.84 per share for 2023, down 2.5% year-over-year. The following table shows my income statement estimates.

Multiplying the average P/TB multiple with the forecast tangible book value per share of $18.2 gives a target price of $24.5 for the end of 2023. This price target implies a 47.1% upside from the March 31 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

Multiplying the average P/E multiple with the forecast earnings per share of $2.84 gives a target price of $25.2 for the end of 2023. This price target implies a 51.6% upside from the March 31 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

Equally weighting the target prices from the two valuation methods gives a combined target price of $24.8 , which implies a 49.3% upside from the current market price. Adding the forward dividend yield gives a total expected return of 50.7%. The high total expected return calls for a Strong Buy rating. Nevertheless, I’m adopting a Buy rating on Capital Bancorp because of the moderate risk level. Readers should consider their risk-tolerance ability and willingness before considering investing in Capital Bancorp.

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