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: 

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:

Catalyst