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CPKF: Maintaining 2020 EPS Estimate, but Reducing 2021 Estimate by $0.25


By Ann Heffron, CFA, CPA



Chesapeake Financial’s (OTC:CPKF) second quarter net earnings fell $1.2 million, or 37%, year over year to $2.1 million, while 2020’s second quarter diluted EPS decreased by $0.24, or 37%, to $0.42 from $0.66 posted a year ago. All data in this report have been adjusted for a 6-for-5 stock dividend, paid on October 15, 2019.

This was slightly worse than our estimate, which had called for a $0.9 million decline in net earnings to $2.4 million and $0.18 drop in diluted EPS to $0.48 (off by $0.06).

The main factors behind the difference between actual results and our estimate were: (1) net interest income was $0.3 million more than we had estimated as both the net interest margin and average interest-earning assets were stronger than we expected and (2) income tax expense was $0.2 million less due to lower-than-estimated pretax earnings and a tax rate of 11.8% versus our 15.0% estimate. These were offset by: (1) noninterest income that was $0.6 million lower than anticipated as service charges on deposit accounts, ATM income, and merchant card income were each $0.1 million weaker than our estimates, while cash flow income was $0.3 million below our expectations and (2) noninterest expense that was $0.2 million more than estimated due primarily to higher other miscellaneous expense.

The major reasons for the second quarter’s 37% decrease in net earnings versus the prior-year quarter were a $0.8 million, or 6%, drop in net revenues, as growth in net interest income (up $0.8 million) was more than offset by a $1.6 million, or 29%, slump in noninterest income, primarily due to the absence of securities gains ($0.8 million in 2019’s second quarter), a $0.3 million fall in merchant card income, and $0.4 million decline in cash flow income. Other contributing factors included a $0.2 million, or 2%, rise in total noninterest expense, primarily from greater compensation costs (up $0.3 million) offset by reduced other miscellaneous expense (down by $0.1 million), as well as $0.4 million more in the loan loss provision and $0.2 less income taxes due to lower pretax earnings and a lower effective tax rate of 11.8% versus 13.3% a year ago.

We are maintaining our 2020 diluted EPS estimate at $2.45, a $0.16, or 7%, increase over 2019’s $2.29. However, we are reducing our 2021 diluted EPS estimate by $0.25 to $2.25, 8% below our 2020 estimate. There are many uncertainties in our estimates, stemming from the effects of COVID-19. We discuss these below.

First, CPKF has participated in the Paycheck Protection Program (PPP), designed to provide a direct incentive for small businesses to keep their workers on the payroll. Through the end of June, CPKF had generated about $78 million of PPP loans. The Small Business Administration (SBA) will forgive loans if all employees are kept on the payroll for eight weeks and the money is used for payroll (60% of the forgiven amount must have been used for payroll), rent, mortgage interest, or utilities. PPP loans are guaranteed by the SBA for 100% of amount of the PPP loan not forgiven. Loans issued prior to June 5 have a maturity of 2 years and 5 years after that. All loans have an interest rate of 1%. In addition, lenders receive fees for processing the PPP loans: 5% for loans of $350,000 or less, 3% for loans between $350,000 and $2 million, and 1% for loans of $2 million or more. PPP loans provide for the deferral of payments for a period of 6 months, including payment of principal, interest and fees. Interest will accrue, but payments will not be required during the first 6 months. Processing fees will be amortized over the contract life and adjusted based on actual prepayments. Upon notification from the SBA of the amount of the PPP loan to be forgiven, acceleration of recognition of deferred processing fees will occur for the percentage of the loan forgiven. 

The PPP loans will have countervailing impacts on the CPKF’s net interest margin. First, the 1% annual interest rate is lower than is typical for CPKF loans, which will tend to reduce the NIM. However, PPP processing fees, amortized over the life of the loan, will add to the NIM. Moreover, when a PPP loan is forgiven, any deferred processing fee will also be added to the NIM. We have estimated a net interest margin of 3.75% for the third quarter of 2020, and a 5% net interest margin for the fourth quarter, assuming the majority of the deferred processing fee (estimated at $2.96 million) is recognized at this time. For full-year 2020, our NIM estimate is now 4.13% (up from 4.08% previously), which compares to an actual NIM of 3.98% in 2019. Our NIM estimate for 2021 remains 3.70%.

Secondly, our estimate of the provision for loan losses in 2020 is $2.35 million, about 4.5 times higher than in 2019, to allow for any asset quality deterioration that may occur as a result of the pandemic. Though asset quality remained strong in the second quarter, CPKF has wisely chosen to beef up its loan loss reserves in preparation for the possibility of asset quality deterioration due to economic distress caused by COVID-19. Positively, certain loans, which had previously been on deferral though still accruing interest (with deferred payments added onto the back end of the loan), are no longer in deferral. This means these loans are paying full principal and interest unless granted an interest only period.

For 2021, our initial estimate for the loan loss provision is $1.2 million, about half the level of 2020. We assume some economic improvement from 2020, though note the $1.2 million level is still much higher than the loss provision had been in each of the past six years prior to the pandemic.

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. Finally, the Company added a full-service branch to its network in the third quarter, which will also increase expenses.

Loan demand, other than for PPP loans, has softened, and we have reduced our loan growth estimate for 2020 by one-half, to 4% from 8%. Our initial estimate for loan growth in 2021 is 5%.

Our estimate of net merchant card income has been cut back again, this time to $3.2 million from $3.4 million in 2020 (previously reduced from $4.9 million last quarter) and to $3.4 million from $3.6 million in 2021. This primarily reflects the termination of one independent sales organization (ISO) in the first quarter, as well as lower card volumes due to reduced consumer spending during the pandemic.

Finally, our estimate of cash flow income has been slashed by almost 30% in 2020 to $2.5 million from $3.6 million and by 50% in 2021 to $2.0 million from $4.0 million, reflecting a 42% reduction in receivables outstanding (through June 30, 2020), as customers opted for PPP loans, rather than cash flow financing.

On October 18, 2019, Chesapeake Financial Shares, Inc. approved a 3% quarterly dividend increase to $0.125 per share from $0.121 per share, payable on or about December 15, 2019 to shareholders of record on December 1, 2019. Notably, CPKF has increased the annual dividend payment every year for the past twenty-nine years since 1991. This follows on the heels of a 6-for-5 stock dividend, paid October 15, 2019.

In 2020 for the thirteenth 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 #75 in the nation out of approximately 511 publicly traded banks and thrifts with less than $2 billion in assets 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 11.48%. Chesapeake Bank again garnered a top ranking in the American Banker’s list of “Best Banks to Work for”, moving up to a #19 spot in 2019, out of the 85 banks listed, from a #25 place in 2018.

In other news, Chesapeake Financial Shares, Inc. graduated in 2019 from the OTCQB Venture Market to the OTCQX Best Market, trading on OTCQX under the symbol CPKF.

Chesapeake Financial Shares, Inc. (CPKF or the Company) is a financial holding company headquartered in Kilmarnock, Virginia, with $1,115 million in total assets at June 30, 2020. CPKF is predominantly a small business lender with 16 branch offices and one loan production office 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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