Description

I was pleasantly surprised by the total absence of U.S. bank pitches last quarter. The KRE regional bank index is down 40% in 18 months and flat since the SVB death spiral trough. 

The industry:

As you have all read, the risk for most U.S. banks is no longer deposit panics materializing fake HTM AOCI losses like SVB/FRC, but rather significant net interest margin and earnings compression caused by continuing core deposit outflows and negative liability mix shifts.

Previously lazy retail and commercial depositors are finally waking up and taking the 5 minutes to swap 0-1% checking/saving accounts into >5% CDs and nonbank money-markets. Avg SOFR went up 50 bps in Q2 and will go up at least another 25-50 later this year. Funding to cover industry-wide deposit outflows come from the FHLBs and wholesale deposits at >4-5% rates. 

On the asset side, new loan originations and security purchases are now rare due to the funding squeeze. Most loan yields reprice more slowly than deposit costs, and most banks with trustworthy underwriting discipline are overweight fixed-rate five-year multifamily loans written at <4% yields in 2020 and ’21.

The industry’s Q2 earnings are not going great in absolute terms and H2 will not get any better for most banks.

Further Fed hikes will likely flow through at >100% incremental deposit betas while causing further core deposit outflows and eventually larger credit losses. A universally expected CRE credit downturn for banks hasn’t even started yet despite recently accelerating charge-offs in class B/C metro office books.

Sell-siders were asleep on realistic NIM modeling until recently, and estimate revisions are only beginning to reflect the new reality. Most generalist shops are correctly staying away or already blew up their slivers on FRC, “but that customer service moat bro.”

The bank we would actually want to buy at this point should be largely immune to the industry’s problems:

-Stable core deposit balances sufficient to fund new loans without excessive deposit cost increases, low loan/deposit ratio 

-Locally dominant deposit franchise in footprint with strong demographic growth and sustainably low unemployment

- Loan books steadily repricing towards 7-8% and securities books repricing to >5%, expanding net interest margin

-No dumb mortgage securities losses weighing down earnings growth for >5 years

-Earnings growing and ROTCE stable at mid-teens % or better

-Proven credit discipline, management owns lots of stock, improving efficiency ratio, and so forth

-Likely beneficiary of an eventual industry M&A surge (once some AOCI losses accrete back to par), either as an intelligent serial acquirer with integration/synergies track record or as a likely seller with an associated medium-term valuation floor

-And of course a cheap multiple on predictable NTM earnings, this is a cyclical commodity industry in crisis after all

The bank:

Capital City Bank is based in Tallahassee FL. ADV is around $1m. Last quarter’s return on tangible equity was 18%, last year’s 13%. They report Q2 next week. 

I submit that CCBG deposits are likely to start growing again sustainably by Q3 or Q4, and the net interest margin is likely to increase sequentially every quarter for several years. 

Rural plumbers and dentists need local banks like CCBG for C&I, owner-occupied CRE, and mortgage loans since there are few full-service alternatives interested in underwriting them. These kinds of customers don’t pull their operating deposit accounts to find higher rates elsewhere due to rational and country-club social reasons. Every bank says it, but CCBG performance is actually driven by sticky customer relationships. 

The avg CCBG deposit account balance is $28k at a .46% rate in Q1. The uninsured deposits primarily come from municipal agencies, and these are also stable old (avg 20 year) relationships transcending the normal capitalist sensitivity to maximizing risk-free yields. Non-interest checking accounts are 42% of total deposits, which is top 3 nationally. The NIB mix will decline, but NIB outflows will primarily go to CCBG NOW accounts at 1.25% rates to remain on-balance sheet.

CCBG’s total deposit beta was 9% last cycle, vs. a 5% cumulative beta since Q1’22. Almost every other bank was >30% last cycle and will be >40% this cycle. CCBG will likely remain <20%, meaning total deposit costs peaking under 1-1.25%. Unless this is 1980.

The loan book yielded 5.39% in Q1, with new production rates >7% providing a multi-year earnings tailwind. The securities book duration is three years, and yields there will also grow consistently from the current 1.86%. Loans/deposits is 69% and loans grew 19% annualized in Q1, after 31% in ’22.

Adding it all up, the net interest margin was 4.04% in Q1 and 3.13% in FY22. First-level thinking posits “all banks are over-earning and under pressure, 4% is too fat with deposit costs going up.” 

Yet the CCBG NIM was >5% for 22/last 30 years. I think NIM will be >4.5% within 12 months, resulting in 20% ROTCE and double-digit earnings growth. This is one of the most asset sensitive banks out there anywhere due to high loan yields, bare minimum deposit costs, and high liquidity/conservative leverage.   

At <10x ntm P/E and 1.7x TBV, the CCBG valuation is too cheap. I think the stock is worth 15x ’24 EPS or $55. Larger FL comp SBCF with a lower mid-teens ROTCE has historically traded >2x TBV, while culty compounder FFIN remains >3x TBV and 19-20x P/E. 

If you’re patient, good regional banks can compound >15% for decades. Glacier (First Federal) in Kalispell MT did 19%/year for 30, and Bob Wilmers did a little better than that at former Buffett investmee MTB. If you’re into Buffett, his entire bank investment philosophy was always about lowest cost of funds, and there is no better example during this acid test year than CCBG. Go back and reread the 1990 BRK letter, though he and Joel were paying 3x pretax for WFC while we’re unfortunately paying 6x for CCBG. 

On credit, FL home and CRE prices are still increasing despite tough comps since 2020. FL leads the nation in population and wealth growth. Unlike western states, migration has continued into 2023. Underwriters tell me it is more young families moving in, as opposed to only retirees like pre-Covid. CCBG is neither the best nor the worst bank for historical credit performance, but it’s good enough. Hurricanes have historically been opportunities for growth during rebuilding as opposed to credit risks.

CEO Bill Smith owns $100m of stock (17% o/s) and has worked there 45 years, including 28 as CEO. His great-grandfather, lumberman William Henry Smith, first joined the bank’s board 104 years ago.    

If you think there’s a credit crisis next year, or industry deposit rates are all about to increase 200 bps, then don’t buy this and just short everything. If you think Jerome cuts to zero again near-term, almost every other bank’s PPNR growth will outperform this one’s.

Geography (57 branches):

• >40% of deposits in Tallahassee (since 1895)

  • Population up 10% since 2010

  • 2.8% unemployment

  • FL state capital (44k employees) and FSU (60k) out of 200k population

  • CCBG is #3 bank /w >15% deposit share

  • CCBG founder George Washington Saxon donated the land for the original FL governor’s mansion

• >30% of deposits in rural markets

  • Ie >80% share in Gadsden county (44k population)

  • Best situation for sticky low-cost checking accounts

• 13% of deposits in Gainesville and 12% in GA (Macon)

• Adding new branches in panhandle (Destin/Panama City), Tampa and Atlanta burbs

• St. Joe’s land company is within their footprint, for all you JOE heads and Fairholme believers 

Deposits:

• Core deposits down 3% QoQ in Q1 (up YoY) and likely flattish in Q2 

  • I think outflows stabilize in Q3 then return to historical MSD organic growth rate 

  • The majority of Q1 runoff was attributed to seasonal municipal outflows and tax payments rather than competitive rate-seeking

• No wholesale deposits or FHLB borrowings, small CD mix

Loans:

• 17 bps nonperforming, 24 bps net charge-off

  • <30 bps NPA in 2019, no real problems since 2013

  • 9% peak NPL in 2011 due to FL real estate concentration

  • Learned their lesson, much stricter LTV/DSRC criteria now

  • Only public FL bank who didn’t take TARP, and they did big repurchase in 2009

• >50% resi and auto, 30% CRE, 10% construction, 9% C&I mix

  • 60% of loans variable rate

  • CRE is primarily retail, hotel, multi-family

  • Office is <4% of total loans and low-rise owner-occupied

Opex:

• 64% efficiency ratio, improving every year

• Opex +3% YoY growth

M&A:

• 20 acquisitions since 1985, most recently a suburban Atlanta mortgage underwriter in 2020

• “Don’t need to acquire right now when we’re growing this fast organically”

• I think SBCF eventually buys this when Smith retires, they’re rolling up the state and both CEOs speak very highly of each other

  • I think Seacoast is the only other multi-generational Florida bank to survive both the state’s great depression real estate bust and great financial crisis real estate bust

Here's the IR deck if you're lazy: https://d1io3yog0oux5.cloudfront.net/_c812e3331f6586e845e1b584abc0a917/ccbg/db/1086/10156/pdf/1Q23+Investor+Presentation_FINAL.pdf

Catalyst

NIM expansion, deposit stability, mild deposit cost increases, loan yield increases, loan growth, earnings growth, sale