CBU - Community Bank: Jump In Margin Subdued Loan Growth To Help Earnings

2023-04-22 07:13:30 ET

Summary

• The recent sale of treasuries and subsequent paydown of wholesale borrowing will lift the margin.
• The outlook for commercial loan growth is better than the outlook for the residential mortgage segment.
• The year-end target price suggests a high upside from the current market price. Further, CBU is offering a decent dividend yield.
• The risk level is moderately high mostly because of the large balance of unrealized losses.

Earnings of Community Bank System, Inc. (CBU) will most probably increase this year thanks to subdued loan growth. Further, the margin will receive a boost from the recent sale of treasuries and the paydown of expensive borrowing. Overall, I'm expecting Community Bank System to report earnings of $3.63 per share for 2023, up 5% year-over-year. The year-end target price suggests a high upside from the current market price. Based on the total expected return and the moderately-high risk level, I'm maintaining a hold rating on Community Bank System.

Recent Payoff of Wholesale Borrowing to Give One-Time Boost to the Margin

Community Bank's margin remained almost unchanged in the last quarter of 2022 from the third quarter of the year. The margin's movement is likely to have been better in the first quarter of 2023 because Community Bank sold off some of its low-yielding U.S. Treasuries in February and used the proceeds to pay off high-cost wholesale borrowing. The spread between the rates of treasuries and borrowings was 320 basis points, as mentioned in the earnings presentation . As per my calculations, this transaction would've improved the net interest margin by 17 basis points in the first quarter of the year.

After the jump in the first quarter, I'm expecting the margin to remain stable in the remainder of 2023 because the net interest income is barely sensitive to interest rate changes. The results of the management's rate sensitivity simulation given in the 10-K filing show that a 200-basis points hike in rates could reduce the net interest income by 0.4% over twelve months.

Commercial Segment to Offset Weakness in the Consumer Mortgage Segment

Community Bank System's loan growth slowed down to 3.1% in the fourth quarter, which is still a very high rate considering the company's history of organic growth. Community Bank has historically relied on acquisitions for growth, and the company has performed very poorly when it comes to organic growth. As can be seen in the table below, excluding 2020, Community Bank's organic growth has been lackluster in the past.

Earnings Likely to Grow by 5%

Earnings of Community Bank System will most probably grow this year on the back of mid-single-digit loan growth and the one-time jump in net interest margin. I'm expecting the company to report earnings of $3.63 per share for 2023, up 5% year-over-year. In my last report, I estimated earnings of $3.83 per share for 2023. I've reduced my earnings estimate because of the loss on the sale of treasury securities in February.

The company is scheduled to announce its first-quarter results on April 25, 2023. I'm expecting Community Bank to report earnings of $0.46 per share for the quarter, including the impact of the loss on the sale of treasury securities. Adjusting for this loss, I'm expecting earnings of $1.04 per share.

The following table shows my annual income statement estimates.

Multiplying the average P/TB multiple with the forecast tangible book value per share of $10.1 gives a target price of $35.7 for the end of 2023. This price target implies a 24.6% downside from the April 21 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 $3.63 gives a target price of $71.3 for the end of 2023. This price target implies a 50.6% upside from the April 21 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 $53.5 , which implies a 13.0% upside from the current market price. Adding the forward dividend yield gives a total expected return of 16.7%.

Although the total expected return is high, I don't want to give the stock a buy rating because of the moderately-high risks. Therefore, I've decided to maintain a hold rating on Community Bank System.

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