CHESAPEAKE FINL SHARES INC CPKF
February 24, 2014 - 1:01pm EST by
ochre
2014 2015
Price: 17.10 EPS $2.21 $0.00
Shares Out. (in M): 3 P/E 7.7x 0.0x
Market Cap (in $M): 56 P/FCF NA 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT NA 0.0x

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  • Community Bank
 

Description

CPKF is a thinly traded OTC security, making this investment suitable for PAs and tiny funds only. 

Chesapeake Financial is a very high quality community bank trading for 7.7x trailing earnings and 0.9x tangible book value. Chesapeake has earned a double-digit ROE every year for the past decade, with the actual figure usually landing between 13% and 15%. The company’s return on assets fluctuates around 1%, and the bank is only modestly levered, operating at 10.7x assets/equity presently. In addition, management, which owns approximately 35% of the company (the ESOP owns another 7%), is relatively shareholder friendly, paying out 20-25% of net income as dividends (3.2% yield currently), and occasionally buying back shares (the company completed a $1.5 million tender offer in 2012). 

That is the overview. I think you can learn 90% of what you need to know about this investment from the following table: 

 

  2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Interest Income 16,340 17,629 20,634 24,630 28,017 29,708 30,543 30,138 29,779 28,866 27,415
Interest Expense 4,668 4,332 6,414 10,365 13,471 13,245 11,615 8,349 6,962 5,811 4,121
Net Interest Income 11,672 13,297 14,220 14,265 14,546 16,463 18,928 21,789 22,817 23,055 23,294
Provision for loan losses 810 1,095 990 833 160 400 895 2,487 1,190 600 1,133
                       
Income after loan losses 10,862 12,202 13,230 13,432 14,386 16,063 18,033 19,302 21,627 22,455 22,161
Noninterest income 7,815 8,030 9,866 11,613 13,484 15,017 14,066 13,841 13,697 15,417 16,059
Noninterest expenses 14,359 15,478 18,168 19,643 21,808 24,958 25,860 26,164 26,445 28,172 29,029
Income before tax 4,318 4,754 4,927 5,402 6,062 6,122 6,239 6,979 8,879 9,700 9,149
Income tax expense 1,034 1,206 1,254 1,451 1,717 1,521 1,404 1,533 1,898 2,024 1,796
Net Income 3,284 3,548 3,673 3,951 4,345 4,601 4,835 5,446 6,981 7,676 7,353
                       
EPS  $1.11  $1.20  $1.23  $1.34  $1.49  $1.33  $1.48  $1.69  $2.16  $2.32  $2.21
Book Value per Share  $8.47  $9.24  $9.88  $10.81  $11.91  $9.11  $10.73  $12.58  $15.67  $18.80  $18.96
Shares        2,959        2,957        2,986        2,949        2,916        3,452        3,278        3,219        3,232      3,309      3,261
                       
Total Assets 332,424 363,548 382,694 418,091 443,002 537,952 586,680 607,733 637,953 667,718 661,771
Total Deposits 289,892 309,367 328,535 358,777 383,214 427,741 486,610 517,743 543,579 564,234 572,405
Net loans 214,951 261,231 277,401 297,202 329,332 358,917 360,607 356,505 349,798 366,878 374,275
LT Debt 1,632 6,541 6,445 11,346 24,243 55,135 42,023 24,682 24,235 23,709 10,000
TRUPs 10,310 10,310 10,310 10,310 25,775 15,465 15,465 15,465 15,465 15,465 15,465
Shareholder Equity 24,210 26,766 28,570 30,963 33,663 30,552 35,270 41,113 51,225 60,909 61,824
Average Assets 313,106 346,568 376,126 403,833 447,886 516,018 573,048 602,473 619,905 643,079 664,745
Average Equity 21,833 23,977 26,829 29,090 31,768 34,062 36,788 40,179 45,602 51,612 61,367
                       
ROA 1.05% 1.02% 0.98% 0.98% 0.97% 0.89% 0.84% 0.90% 1.13% 1.19% 1.11%
ROE 15.0% 14.8% 13.7% 13.6% 13.7% 13.5% 13.1% 13.6% 15.3% 14.9% 12.0%
Leverage 13.7x 13.6x 13.4x 13.5x 13.2x 17.6x 16.6x 14.8x 12.5x 11.0x 10.7x
                       
Interest Yield 5.2% 5.1% 5.5% 6.1% 6.3% 5.8% 5.3% 5.0% 4.8% 4.5% 4.1%
Interest Expense 1.5% 1.4% 1.9% 2.9% 3.3% 2.8% 2.2% 1.5% 1.2% 1.0% 0.7%
Spread 3.7% 3.7% 3.6% 3.2% 2.9% 2.9% 3.1% 3.5% 3.6% 3.5% 3.4%
Provision as % of loans   0.46% 0.37% 0.29% 0.05% 0.12% 0.25% 0.69% 0.34% 0.17% 0.31%
                       
Dividends per Share  $0.24  $0.28  $0.30  $0.32  $0.35  $0.34  $0.35  $0.36  $0.40  $0.45  $0.51
Div payout ratio 20.60% 23.00% 24.00% 23.50% 24.80% 24.90% 24.10% 21.60% 18.50% 19.33% 23.08%

Chesapeake is primarily a small business lender. Long ago the company began an effort to diversify its revenue stream so that it would not be overly dependent on net interest margin alone. This effort resulted in, among other things, a wealth management office, a trust office, a mortgage servicing division, and a payments processing division. As a result, Chesapeake now has a much less NIM-dependent revenue mix than its competitors. Non-interest income is roughly one third of total gross revenue for Chesapeake, compared to a 19% average for small Virginia bank peers (CFFI, UBSH, ESXB, OPOF, BAYK, EVBS). What’s more, the only two banks on the list with similar revenue mixes to Chesapeake (BAYK and CFFI) earn a higher portion of their non-interest revenue from mortgage origination activities, which is likely to decline significantly going forward.

Chesapeake has spent many years establishing these non-margin businesses, and to the extent that they are “relationship businesses”, I believe they represent a competitive advantage. 

Once upon a time the company filed SEC financials, but the board decided after a cost-benefit analysis that the expense associated with being listed was not worth incurring. This seems fair given that shareholders’ equity at the time was just $29 million. Today equity is $60 million, but I don’t think the company is planning to re-list in the near future, as the trading float still remains very small. 

Non-accrual loans ticked up noticeably in the most recent quarter due to one large problem loan going past 30 days overdue. The company stated publicly in its earnings release that it expects this loan eventually to be paid in full. I don’t have any special insight into the loan—based on past performance I trust the company’s judgment. In my discussions with officers of the company I have gotten the impression that management and the board are quite risk-averse. 

Now is probably a good time to point out that, as you can see in the table above, ROE has been trending down recently. NIM is compressing and the company is undertaking a bit of precautionary de-levering ahead of new capital requirements for banks in general. As a result it seems possible, perhaps likely, that EPS growth won’t be great over the next little while. This doesn’t concern me terribly given the ~15% earnings yield at present, but it is worth mentioning. 

What is Chesapeake worth? 

I ran a screen of all the small community banks in the U.S. that have similarly high ROEs, returns on assets, and minimal problem assets. The median P/TBV for the group was 1.46x.

Pre-crisis, CPKF traded for 1.5-2.0x book value. 

I also think American Business Bank, which was ably written up on VIC under the ticker 3AMBZ, is an interesting comp. AMBZ is a different kind of bank—it is located in Los Angeles and has built a business based on high-value, high-touch client relationships with mid-sized private businesses. But AMBZ and CPKF are similar in that they are both tiny, OTC-traded, and have extremely attractive financial profiles. AMBZ currently trades for 1.5x book value and 18x earnings. 

Using an estimated 12% future ROE as a proxy for growth in BVPS, and a 1.5x book value multiple on exit, I think a 30%-ish IRR over three years is reasonable:

    CPKF 3yr IRR Sensitivity    
         
      P/B  
    1.3x 1.5x 1.7x
  10% 24% 30% 36%
ROE 12% 26% 32% 38%
  14% 28% 35% 40%
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

This write-up?
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    Description

    CPKF is a thinly traded OTC security, making this investment suitable for PAs and tiny funds only. 

    Chesapeake Financial is a very high quality community bank trading for 7.7x trailing earnings and 0.9x tangible book value. Chesapeake has earned a double-digit ROE every year for the past decade, with the actual figure usually landing between 13% and 15%. The company’s return on assets fluctuates around 1%, and the bank is only modestly levered, operating at 10.7x assets/equity presently. In addition, management, which owns approximately 35% of the company (the ESOP owns another 7%), is relatively shareholder friendly, paying out 20-25% of net income as dividends (3.2% yield currently), and occasionally buying back shares (the company completed a $1.5 million tender offer in 2012). 

    That is the overview. I think you can learn 90% of what you need to know about this investment from the following table: 

     

      2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
    Interest Income 16,340 17,629 20,634 24,630 28,017 29,708 30,543 30,138 29,779 28,866 27,415
    Interest Expense 4,668 4,332 6,414 10,365 13,471 13,245 11,615 8,349 6,962 5,811 4,121
    Net Interest Income 11,672 13,297 14,220 14,265 14,546 16,463 18,928 21,789 22,817 23,055 23,294
    Provision for loan losses 810 1,095 990 833 160 400 895 2,487 1,190 600 1,133
                           
    Income after loan losses 10,862 12,202 13,230 13,432 14,386 16,063 18,033 19,302 21,627 22,455 22,161
    Noninterest income 7,815 8,030 9,866 11,613 13,484 15,017 14,066 13,841 13,697 15,417 16,059
    Noninterest expenses 14,359 15,478 18,168 19,643 21,808 24,958 25,860 26,164 26,445 28,172 29,029
    Income before tax 4,318 4,754 4,927 5,402 6,062 6,122 6,239 6,979 8,879 9,700 9,149
    Income tax expense 1,034 1,206 1,254 1,451 1,717 1,521 1,404 1,533 1,898 2,024 1,796
    Net Income 3,284 3,548 3,673 3,951 4,345 4,601 4,835 5,446 6,981 7,676 7,353
                           
    EPS  $1.11  $1.20  $1.23  $1.34  $1.49  $1.33  $1.48  $1.69  $2.16  $2.32  $2.21
    Book Value per Share  $8.47  $9.24  $9.88  $10.81  $11.91  $9.11  $10.73  $12.58  $15.67  $18.80  $18.96
    Shares        2,959        2,957        2,986        2,949        2,916        3,452        3,278        3,219        3,232      3,309      3,261
                           
    Total Assets 332,424 363,548 382,694 418,091 443,002 537,952 586,680 607,733 637,953 667,718 661,771
    Total Deposits 289,892 309,367 328,535 358,777 383,214 427,741 486,610 517,743 543,579 564,234 572,405
    Net loans 214,951 261,231 277,401 297,202 329,332 358,917 360,607 356,505 349,798 366,878 374,275
    LT Debt 1,632 6,541 6,445 11,346 24,243 55,135 42,023 24,682 24,235 23,709 10,000
    TRUPs 10,310 10,310 10,310 10,310 25,775 15,465 15,465 15,465 15,465 15,465 15,465
    Shareholder Equity 24,210 26,766 28,570 30,963 33,663 30,552 35,270 41,113 51,225 60,909 61,824
    Average Assets 313,106 346,568 376,126 403,833 447,886 516,018 573,048 602,473 619,905 643,079 664,745
    Average Equity 21,833 23,977 26,829 29,090 31,768 34,062 36,788 40,179 45,602 51,612 61,367
                           
    ROA 1.05% 1.02% 0.98% 0.98% 0.97% 0.89% 0.84% 0.90% 1.13% 1.19% 1.11%
    ROE 15.0% 14.8% 13.7% 13.6% 13.7% 13.5% 13.1% 13.6% 15.3% 14.9% 12.0%
    Leverage 13.7x 13.6x 13.4x 13.5x 13.2x 17.6x 16.6x 14.8x 12.5x 11.0x 10.7x
                           
    Interest Yield 5.2% 5.1% 5.5% 6.1% 6.3% 5.8% 5.3% 5.0% 4.8% 4.5% 4.1%
    Interest Expense 1.5% 1.4% 1.9% 2.9% 3.3% 2.8% 2.2% 1.5% 1.2% 1.0% 0.7%
    Spread 3.7% 3.7% 3.6% 3.2% 2.9% 2.9% 3.1% 3.5% 3.6% 3.5% 3.4%
    Provision as % of loans   0.46% 0.37% 0.29% 0.05% 0.12% 0.25% 0.69% 0.34% 0.17% 0.31%
                           
    Dividends per Share  $0.24  $0.28  $0.30  $0.32  $0.35  $0.34  $0.35  $0.36  $0.40  $0.45  $0.51
    Div payout ratio 20.60% 23.00% 24.00% 23.50% 24.80% 24.90% 24.10% 21.60% 18.50% 19.33% 23.08%

    Chesapeake is primarily a small business lender. Long ago the company began an effort to diversify its revenue stream so that it would not be overly dependent on net interest margin alone. This effort resulted in, among other things, a wealth management office, a trust office, a mortgage servicing division, and a payments processing division. As a result, Chesapeake now has a much less NIM-dependent revenue mix than its competitors. Non-interest income is roughly one third of total gross revenue for Chesapeake, compared to a 19% average for small Virginia bank peers (CFFI, UBSH, ESXB, OPOF, BAYK, EVBS). What’s more, the only two banks on the list with similar revenue mixes to Chesapeake (BAYK and CFFI) earn a higher portion of their non-interest revenue from mortgage origination activities, which is likely to decline significantly going forward.

    Chesapeake has spent many years establishing these non-margin businesses, and to the extent that they are “relationship businesses”, I believe they represent a competitive advantage. 

    Once upon a time the company filed SEC financials, but the board decided after a cost-benefit analysis that the expense associated with being listed was not worth incurring. This seems fair given that shareholders’ equity at the time was just $29 million. Today equity is $60 million, but I don’t think the company is planning to re-list in the near future, as the trading float still remains very small. 

    Non-accrual loans ticked up noticeably in the most recent quarter due to one large problem loan going past 30 days overdue. The company stated publicly in its earnings release that it expects this loan eventually to be paid in full. I don’t have any special insight into the loan—based on past performance I trust the company’s judgment. In my discussions with officers of the company I have gotten the impression that management and the board are quite risk-averse. 

    Now is probably a good time to point out that, as you can see in the table above, ROE has been trending down recently. NIM is compressing and the company is undertaking a bit of precautionary de-levering ahead of new capital requirements for banks in general. As a result it seems possible, perhaps likely, that EPS growth won’t be great over the next little while. This doesn’t concern me terribly given the ~15% earnings yield at present, but it is worth mentioning. 

    What is Chesapeake worth? 

    I ran a screen of all the small community banks in the U.S. that have similarly high ROEs, returns on assets, and minimal problem assets. The median P/TBV for the group was 1.46x.

    Pre-crisis, CPKF traded for 1.5-2.0x book value. 

    I also think American Business Bank, which was ably written up on VIC under the ticker 3AMBZ, is an interesting comp. AMBZ is a different kind of bank—it is located in Los Angeles and has built a business based on high-value, high-touch client relationships with mid-sized private businesses. But AMBZ and CPKF are similar in that they are both tiny, OTC-traded, and have extremely attractive financial profiles. AMBZ currently trades for 1.5x book value and 18x earnings. 

    Using an estimated 12% future ROE as a proxy for growth in BVPS, and a 1.5x book value multiple on exit, I think a 30%-ish IRR over three years is reasonable:

        CPKF 3yr IRR Sensitivity    
             
          P/B  
        1.3x 1.5x 1.7x
      10% 24% 30% 36%
    ROE 12% 26% 32% 38%
      14% 28% 35% 40%
    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    This write-up?

    Messages


    Subjectquestions
    Entry03/03/2014 11:49 AM
    Memberspike945
    thanks for the idea.  seems like a nice stable bank.
     
    however, can you explain the very poor results the past 2 quarters?  i see 45 cents for the 3rd quarter (down from 74 cents i think last year) and 35 cents for the 4th quarter (down from 39 cents i think last year).
     
    is $1.60-$1.80 a fair run rate for earnings?  or do you believe earnings will bounce back?
     
    thanks. 

    SubjectRE: RE: questions
    Entry03/18/2014 02:33 PM
    Memberspike945
    thanks very much for the detail response (and sorry for the delay).
     
    i will continue to watch the bank and see how it does. given the liquidity i'd prefer to make sure this 2 quarter trend is not going to remain for a while.  (although at 18 dollars it's probably cheap even if it does 1.80 a year - just hard to purchase many shares.
     
    i do think eventually this is worth at least 1.4x book when they decide to sell.
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