- A stronger than peer earnings profile should warrant a valuation premium.
- Credit continues to look very healthy and is unlikely to derail positive earnings momentum.
- The Federal Reserve recently terminated its consent order which opens the door to future additional capital usage.
While most community and regional bank stocks have experienced a tremendous increase from the price depths of the 2020 market lows, Pikeville, Kentucky based Community Trust Bancorp, Inc. (NASDAQ:CTBI) has underwhelmed in terms of its relative move higher. When thinking in terms of totality, its move higher has only been about half that of regional peers - which provides fodder for continued strength while peers take a breather.
When looking at the structure of the bank itself, Community Trust is a $5.1 billion asset bank holding company and parent to Community Trust Bank. It operates 80 branches located throughout the eastern half of Kentucky, and a handful of additional branches in both Tennessee and West Virginia. Internally it is broken into four regions: Central ($740 million in loans), Eastern ($1.0 billion), Northeastern ($427 million) and South Central ($759 million). Outside of its core loan and deposit banking operations, the bank also has a pretty sizable asset management division (relative to its overall asset size), which oversees about $2.8 billion in assets under management.
Upon further analysis of the loan portfolio, one can see that there is a clear dependency to real estate. Commercial real estate was more than 36% of the portfolio at year end, while C&I made up another 18%. Residential mortgage comprised 25%, which compares to the national average of about 10%. Finally, Consumer Direct made up 4%, and the remaining 17% was associated with Consumer Indirect lending.
In my mind, its positive earnings outlook, juxtaposed against the relatively cheap valuation, should be more than enough of a bullish investment thesis to add to most portfolios. While not nearly as appealing as it was a few months ago, the current dividend yield of 3.4% is higher than both the banking average and S&P 500. In my mind, the credit profile looks to be fairly healthy, with just a slight uptick in criticized loans at the end of last year.
My bullish stance is driven by the positive earnings outlook, which should easily outpace bank peers, and the mispricing of the bank in terms of relative valuation. CTBI currently trades at 1.35x price to tangible book value per share, while national peers are closer to 1.65x. In more simple terms, its more profitable and cheaper than the average regional bank. Finally, it should also be noted that the Federal Reserve Board terminated its consent order in December of 2020, meaning CTBI is free to use capital as management sees fit (via M&A, higher dividends, or larger buybacks).
Revenue Analysis and Outlook
When looking back at the end of last year, in the fourth quarter CTBI increased its spread revenue by more than 2.5% from 3Q20 levels. This increase was almost entirely driven by margin improvement than anything else. While average earning assets grew $35 million from third quarter levels, the yield on that sub-category fell by more than 8 basis points.
When digging a little deeper into the puts and take of the balance sheet, one can see that not only was loan growth driven from indirect consumer, but most other loan categories were actually down quarter over quarter. While I am under the assumption that lending should pick up throughout the year, most of the near-term headwinds are likely to be driven from the PPP related loan forgiveness. For comparison purposes, PPP loans made up more than 7% of the total loan balances at the end of the year. As those are forgiven, CTBI needs to work through that headwind in order to report "loan growth".
Like most other mid-sized community banks, fee income comprises about 25% of the overall revenue. While it was only up a minimal amount quarter over quarter, I think it should be viewed as rather impressive since it was driven by loan related fees rather than the industry norm of strong mortgage, which is likely to fade throughout FY21.
Source: SEC Filings and Author's Estimates
When looking at the balance sheet relative to the lending categories and PPP originated loans, I believe that overall balances are likely to be a little softer over the next few quarters as PPP loans are forgiven. However, with this loan forgiveness come the accelerated fees embedded in net interest income. This acceleration is also likely to drive an optical margin improvement (see chart above). Once PPP related income works itself off the income statement, I think the overall margin compresses a little - but based on my assessment of the balance sheet, the recession low should already be accounted for last quarter.
Also, I believe fee income should hold up well quarter over quarter in 1H21. While most of the banking industry is likely to start to see mortgage related headwinds (when compared to year over year results in 2Q21), CTBI should see continued strength from its loan-related fee income.
As I have written about in previous articles, I think most investors should be expecting credit improving over the next few quarter. Each bank has a different starting point, and its relative improvement should help justify more peer-like valuations if improvements are made.
However, when it comes to CTBI, as one can see from the chart below – CTBI has a much better track record than peers when it comes to net charge offs.
Source: SEC Filings
In my mind, the biggest headwind to valuation came at the least opportune time. CTBI showed a sizeable, but also understandable, increase in criticized loans just as the market was turning the page into FY21.
Source: SEC Filings
While criticized loans are nothing to completely brush under the rug, I think CTBI has a better than average underwriting process and has clearly proven itself in terms of credit migration off the balance sheet (via net charge offs).
While the provision is unlikely to run negative (and boost earnings), like some other banks might see in 1Q21 – I do think that CTBI is likely to have lower year over year loan loss provision expenses. When looking at the overall profitability of the bank relative to the last couple quarters, I think a slightly higher provisioning expense is likely to put a bit of a lid on ROA improvement, but annual results should be better than FY20.
In my mind, CTBI is flashing an unjustified cheap valuation signal. While some investors might look to credit as being a near-term problem, as one can see from the chart above, CTBI has proven itself to better than average throughout an economic cycle. Also, in terms of both the margin and future ROA, CTBI is likely to produce a better profitability profile and show an improving ROA over the next few months – while most bank peers grasp at straws in order to stop the recent profitability downshift.
To top things off, I fully believe that CTBI’s recent reprieve of its Fed related consent order should open the door to more shareholder friendly capital actions. While I don’t believe CTBI will use its capital (and its fairly cheap stock price) to be a buyer in this recent wave of M&A, I do believe that investors should expect something in the next few quarters. In my mind, additional M&A carries the possibility of helping improve an already above-average profitability profile.
Source: SEC Filings and Author's Estimates
This article was written by
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