Cascade: Great Bank, Overvalued Price (CACB)

May.25.06 | About: Cascade Bancorp (CACB)

Cascade Bancorp (NASDAQ:CACB) operates branches under the Bank of the Cascades name in Oregon and the Farmers and Merchants name in Idaho. The company has 21 branches in Oregon and 11 branches in Idaho.

Cascade Bancorp has total assets of $1.35 billion and deposits of $1.16 billion. Over the last ten years, the company has averaged a 2.08% return on assets and a 22.89% return on equity.

Location

Over a third of Cascade Bancorp’s total deposits are in the company’s six Bend, Oregon branches. Cascade has a 31% market share in Bend. Several larger banks have much smaller positions within the town. No other bank has a share of the market equal to more than half of Cascade’s share.

Cascade’s CFO, Gregory Newton, explained the attraction of Bend in an October 10th, 2005 interview with The Wall Street Transcript:

The economy in Central Oregon has been quite strong, mainly because of in-migration of baby boomers and active retirees. Central Oregon has better weather than most of the Northwest and has an abundance of recreational opportunities that draw quality of life seekers from large metros along the West Coast and increasingly from other parts of the country.

Cascade has a strong position both in the city of Bend itself (population 50,000) and Deschutes County as a whole. Over half of Cascade’s deposits come from the company’s ten branches in Deschutes County. Cascade has a 33% market share within the county. The two nearest competitors each have a market share that is well under half of Cascade’s.

Despite Cascade’s strong penetration in Deschutes County, the company has a less than 2.5% share of the statewide market. The company earns above-average returns on both assets and equity by dominating a very small (and very lucrative) geographic niche.

People

Cascade’s limited geographic reach (and strong penetration within its territory) allows the company to focus on attracting the best employees. The company recently completed a large acquisition relative to its small size. However, Cascade has usually focused on de novo expansion within its chosen geographic niche (central Oregon).

In the same interview with The Wall Street Transcript, Mr. Newton explained the importance of Cascade’s staff:

People are our biggest asset and differentiating factor. Quality bankers are hard to come by these days and their prices are being bid up. So we are investing in developing skill levels of existing staff. In addition, we believe we are an attractive alternative to bankers who are with big banks where they have less ownership interest.

Executives at some local banks, including Cascade, have expressed concern that there are not enough good loan officers in Central Oregon. Part of the problem seems to be demographics. An increase in retirees does nothing to improve the quality of the labor pool these banks draw from. At the same time, the growing retiree population greatly increases the demand for loan officers.

As a result, some local banks have had to extensively train people from within the organization or look outside the local market to fill these positions. For this reason, Mr. Newton’s comment about people being Cascade’s “biggest asset” may have more truth to it than similar sentiments expressed by other executives. Staffing is a real issue in Central Oregon.

Growth

Cascade is poised for strong earnings growth over the next decade due to favorable demographic trends. The company’s branches are located in areas where near-term population growth is expected to be very rapid. In fact, all of the markets Cascade serves rank well above average in terms of expected future population growth. Such growth is a boon for a bank with Cascade’s strong penetration. A strong local market position tends to be self-perpetuating.

Valuation

Shares of Cascade Bancorp currently trade at a rather lofty 21 times earnings. That’s almost 4.5 times book! Generally speaking, you aren’t going to make much money buying a bank at a price of more than 400% of book. However, Cascade does have a recent record of earning extraordinary returns on both assets and equity while also achieving a peer leading efficiency ratio.

Conclusion

Shares of Cascade Bancorp yield a paltry 1.3%. There is no margin of safety in paying more than four times book for any bank – even a great one. While Cascade’s past record is promising, the current price already assumes a very sunny future. At these lofty levels, any surprises are likely to be unpleasant. Investors should pass over these shares, despite the excellent underlying business. The price is simply too high.

CACB 5-yr chart:

Cascade Bank 5 year

This post is the third in a week long series of five posts on specific banks earning above average returns. The idea is to look at the bank’s business and ask why it is capable of earning above average returns. For a discussion of why banks, on average, earn returns above those of many other public companies, see my earlier post: “On Banks”. The fact that any particular bank is profiled this week should not be viewed as an indication that the bank’s shares are attractive at the current price.