By Ann Heffron, CFA, CPA
OTC:CPKF
READ THE FULL CPKF RESEARCH REPORT
Chesapeake Financial’s (OTC:CPKF) third quarter net earnings increased $0.5 million, or 13%, year over year to $4.2 million, while 2022’s third quarter diluted EPS rose by $0.12, or 15%, to $0.90 from $0.78 posted a year ago. Results exclude a one-time gain on the sale of a partial interest in a brokerage firm of $2.2 million pretax and $1.7 million aftertax, or $0.36 per diluted share. Reported net earnings were considerably higher at $5.9 million, or $1.26 per diluted share.
This was better than our estimate, which had called for a $0.5 million decrease in net earnings to $3.3 million and a $0.09 decline in diluted EPS to $0.69.
We note that last year’s third quarter benefitted from the inclusion of $1,178,000 of Paycheck Protection Program fees, which this quarter did not.
The main factors behind the difference between actual results and our estimate were: (1) net interest income was $0.9 million higher than our estimate due to a larger-than-expected net interest margin of 3.79% (versus our 3.40% estimate); (2) merchant services income was $0.3 million higher than expected; (3) there was a $0.2 million net gain on securities sales (our estimate was $0.0) and (4) other miscellaneous income was $0.5 million more than projected. These positives were partly offset by: (1) compensation expense that was $0.4 million more than our estimate; (2) other miscellaneous expense that was $0.4 million more than projected; and (3) income tax expense that was $0.1 million larger than our estimate due to greater pretax earnings and a slightly higher effective tax rate of 15.2% versus our 15.0% estimate.
The major reasons for the third quarter’s $0.5 million, or 13%, increase in net earnings versus the prior-year quarter were a $1.3 million, or 9%, rise in net revenues, as a $0.5 million, or 5%, gain in net interest income combined with a $0.8 million, or 17%, increase in other noninterest income. In addition, total noninterest expense was $0.5 million less than last year’s third quarter as a $1.0 million decline in the provision for cash management losses more than offset growth in compensation costs (up $0.5 million). Partly offsetting were a $0.7 million swing in the provision for loan losses to $175,000 from a reversal of $525,000 the prior year as well as higher income taxes. Income tax payments were $0.6 million more than those a year ago due to larger pretax earnings and a much higher effective tax rate that was 12.5 points above last year’s 2.7%.
We are raising our diluted EPS estimate for 2022 by $0.20, from $3.01 to $3.21 (excluding the one-time gain on the sale of a brokerage firm interest), primarily reflecting better-than-expected results in the third quarter. We note our 2022 diluted EPS estimate is now 3% above 2021’s diluted EPS of $3.11. The main drivers of 2022 earnings include a strong turnaround in the cash management business, including a $0.8 million gain in fee income (up 41%) and a $1.6 million decrease in the cash management loss provision partly offset by the winding down of the PPP (and related decrease in recognition of deferred processing fees of an estimated $4.13 million in 2021), a loss provision of $0.7 million (compared to a credit of $0.4 million in 2021), and a $1.1 million drop in mortgage banking income.
We are increasing our diluted EPS estimate for 2023 by $0.20 from $3.11 to $3.31, a 3% gain over our revised 2022 EPS estimate of $3.21. We expect most operations to post solid improvement in 2023, with the exception of mortgage banking, which should experience some pressure due to rising interest rates. We are not projecting any one-time gains or losses from sales of securities or interest-rate caps, as occurred in 2022’s first quarter.
Loan demand was stronger than expected in the third quarter, and we are raising our estimate of loan growth in 2022 from 6% to 8%, while maintaining our estimate of 5% growth in 2023. The net interest margin will decline in 2022 due to the loss of PPP fee income (to 3.65%from 3.80% in 2021) and experience lesser erosion in 2023 (to 3.52% from 3.65%).
We are increasing our estimate of merchant services income by $0.8 million to $4.8 million in 2022 and by $0.4 million to $5.2 million in 2023, though a recently added ISO relationship may provide higher growth going forward. We are sharply increasing our estimate of cash management income by $0.8 million (up 41%) in 2022 and by $0.2 million (up 5%) in 2023, as we expect solid receivables growth. This reflects the addition of new clients, as well as growth in existing client credit lines, following the stoppage of the PPP program.
For the first time in 2021, CPKF showed a separate line item for its mortgage banking operations (previously included in other income), while at the same time folding the ATM income line item into other income. Our stand-alone estimates for mortgage banking income, reduced by $1.2 million in 2022 and another $0.4 million in 2023, are $1.6 million in 2022 and $1.2 million in 2023, down from $2.8 million actual in 2021, reflecting reduced activity due to the impact of higher mortgage rates.
For 2022, our estimate for the loan loss provision remains $0.7 million, up from 2021’s loan loss reversal (credit) of $0.4 million in 2021, but down from 2020’s $1.95 million loss provision, which reflected the bulking up of loan loss reserves in preparation for the possibility of asset quality deterioration due to economic distress caused by COVID-19 (which failed to materialize, as asset quality remains strong). Our estimate for 2023’s loss provision continues at $0.7 million, the same as in 2022. Signally, the Financial Accounting Standards Board’s Current Expected Credit Loss (CECL) impairment standard, which requires “life-of-loan” estimates of losses to be recorded for unimpaired loans will be adopted in 2023. Adoption of CECL is not expected to have a material impact on loss provisions in 2023.
The provision for cash management losses, a separate line item listed under other noninterest expense, is expected to decline to about $240,000 in 2022, down $1.6 million from 2021’s $1.8 million, which reflected strong growth in receivables during the first quarter, as well as the charge-off of one $2.3 million credit. We are projecting that losses will remain stable and estimate the cash management provision at $240,000 again in 2023.
There are other factors adding to CPKF’s expense burden going forward. CPKF expects several new hires to increase compensation costs. CPKF’s digital strategy for its new on-line banking platform requires investing in new technology, leading to higher IT expense. CPKF recently opened a new tech center, which houses IT operations, marketing, and merchant card processing, and will add to depreciation expense beginning in 2021’s third quarter.
At the July 15, 2022 Chesapeake Financial Shares Board of Directors meeting, the Board raised the quarterly dividend to $0.15 per share from $0.14 per share (a 7% increase), paid on or before September 15, 2022. This follows two dividend increases in 2021. Notably, CPKF has increased the annual dividend payment every year for the past thirty years since 1991.
In 2022 for the fifteenth consecutive year, Chesapeake Financial Shares, Inc. has been included in the American Banker magazine listing of the “Top 200 Community Banks” in the United States. The bank ranked at #130 in the nation out of approximately 6,000 community banks in the study, up from #148 when CPKF first broke into the rankings in 2008. The ranking is based on a three-year average of return on average equity (ROAE), which for CPKF was 11.07%.
Chesapeake Financial Shares, Inc. (CPKF or the Company) is a financial holding company headquartered in Kilmarnock, Virginia, with $1,334 million in total assets at September 30, 2022. CPKF is predominantly a small business lender with 16 branch offices that serve customers in the eastern region of Virginia between the Potomac and James Rivers. CPKF, which began as Lancaster National Bank on April 13, 1900, has a long history and strong ties with the communities it serves.
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