We are initiating coverage on Chesapeake Financial Shares, Inc. (CPKF) with a Neutral rating. CPKF has done an exceptional job navigating the treacherous financial landscape that has characterized the past few years, with EPS growing throughout this period. While asset quality has weakened this year, it still remains satisfactory. The balance sheet continues strong. Going forward, we estimate that diluted EPS will increase 3% to $1.82 in 2010 and an additional 5% to $1.92 in 2011.
Turning to valuation, CPKF is valued at 0.9X versus the industry median of 0.6X, based upon price/tangible book value. This represents a 67% premium versus an average historical premium of about 19% for CPKF since the end of 2005. We believe this premium is justified given CPKF’s strong performance throughout the financial crisis, as well as our expectations for continued growth in EPS over 2010-2011, its strong profitability measures, and its solid dividend yield. With these positives already incorporated into the share price, we expect the stock to perform in line with the overall market over the next six months; hence our Neutral rating on CPKF shares.
Chesapeake Financial Shares, Inc. (CPKF, or the Company) is a bank holding company headquartered in Kilmarnock, Virginia, with $604 million in total assets at June 30, 2010. CPKF is predominantly a small business lender with 11 branch offices that serve customers in the eastern region of Virginia between the Potomac and James Rivers. These offices are located in Kilmarnock, Lively, Irvington, Mathews, Hayes, and Gloucester, with four branches in Williamsburg. CPKF, which began as Lancaster National Bank on April 13, 1900, has a long history and strong ties with the communities it serves.
Operations are carried on through Chesapeake Bank, a state-chartered bank as well as Federal Reserve and FDIC member bank, and Chesapeake Investment Group, Inc. (CIG), an independent wealth management firm that manages about $285 million in assets through its subsidiaries involved in asset management (CIG is a registered investment adviser), brokerage, and trust services. Other activities of the Company include Chesapeake Payment Systems, Cash Flow program, Clear Sky accounts, and its secondary market mortgage banking operation.
Chesapeake Payment Systems offers merchant processing services such as credit card and debit card processing, electronic benefits transfers, and loyalty and gift card processing to companies involved in travel, entertainment, restaurant, hospitality, retail, mail order, and e-commerce. At yearend 2009, Chesapeake Payment Systems had over 700 merchants in its system and processed over $115 million in merchant card transactions.
The Cash Flow program, which provides an attractive financing option to growing businesses, involves the purchase of the client company’s accounts receivables. The Cash Flow program is currently offered in the Eastern half of the United States and has approximately 80 customers.
Clear Sky accounts, which offer internet-based retail deposit services for checking and saving accounts and certificates of deposit (CDs), expands CPKF’s retail deposit base geographically.
Through Chesapeake’s secondary market mortgage banking operation, the Company services a $155 million loan portfolio of residential mortgage loans for Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac), for which it earns a 25 basis-point fee (approximately $375,000 annually) on the outstanding loan portfolio balance. Additionally, CPKF earns a pare-off fee for residential mortgage loans that are originated and closed with FHLMC, which added $620,000 to revenues in 2009 ( both types of fees are included in other noninterest income in the Company’s financial statements).
The lending portfolio is dominated by real estate loans, as shown in the chart at the left. At June 30, 2010, the lending book consisted of construction and land development (accounting for 35% of total gross outstandings), 1-4 family (26%), commercial real estate (17%), commercial and industrial (13%), cash management (5%), and consumer (4%). A majority of loans are secured, usually by real estate, inventory, accounts receivable, equipment, machinery, or corporate assets.
The liquidity portfolio, consisting of cash, short-term investments, federal funds sold, resale agreements, trading account assets, US Treasuries, and US agency mortgage obligations, has declined on a relative basis, and is now about 12% of total assets. This was due to CPKF’s shift in the available-for-sale securities portfolio into higher yielding municipal and private label mortgage securities, which currently account for approximately 11% and 7% of total assets, respectively (versus 7% and 0%, respectively, in 2005). Core deposits represented 77% of total deposits at June 30, 2010, with certificates of deposit larger than $100,000 at 23%.
In 2009, net interest income contributed 57% of net revenue, with a large 43% coming from noninterest income sources. Significant contributors to noninterest income include cash flow income (13% of net revenues), merchant card income (10%), income from fiduciary activities (6%), service charges on deposit accounts (5%) and ATM income (3%).
CHESAPEAKE FINC (CPKF): Free Stock Analysis Report
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