The merger between Cadence Bancorp and BancorpSouth, which now operates as Cadence Bank (NYSE:CADE), is a good example of the trade-off of short-term pain for longer-term gains. There will be a couple of messy quarters as analysts dial in their models and as the operational combination progresses, but the long-term advantages of a strong commercial loan operation in growth markets of the South and solid core deposit franchises from more sedate, less competitive, markets are compelling.
Shares are up more than 65% since my last write-up and have handily beat even the solid performance of smaller regional banks over that time. Although the return potential isn't as compelling as it was there, I think there's an argument for a mid-to-high-$30's share price, and this is still a bank worth a closer look.
Talking about Cadence's fourth quarter earnings is complicated not only by the fact that prior-year and prior-quarter comparisons aren't worth much because of the completion of the merger, but because there are typically significant deviations from sell-side expectations in the first quarter or two after a deal like this closes.
On balance, though, I'd say this was no worse than an "okay" quarter.
Revenue basically came in as expected, as net interest income (up 49% QoQ as reported) beat by about 1% (or $3M) and fee-based income (which declined 21% as reported) missed by about 3% (or $3M). Net interest margin, which improved 4bp QoQ to 2.90% was actually a bit better than expected. While core net interest margin (netting out PPP and other items) was a little low on a lower average security balance, management put more capital to work in securities before quarter-end.
Expenses declined 14% on a core basis, and this is another area where comparisons to the sell-side average are problematic, as not every analyst included/excluded the same items. So, while the reported beat looks large (13% or $37M), I don't think the beat was really that large on an "apples to apples" basis. It wasn't a bad quarter at all, it just wasn't as good as the "versus consensus estimates" may appear.
Likewise with pre-provision profits. Because of the problematic comparison of reported core expenses to published sell-side estimates, I can't really gauge how well Cadence did this quarter. I don't think the $37M (37%) beat was the "real" number, but I do think this was a better-than-expected quarter on balance.
I'd also note that tangible book value per share came in better than expected (more than 2%), as the bank took lower marks on the Cadence portfolio than previously expected. The bank also ended the quarter with a CET1 ratio of 10.8% - a robust capital position on a post-deal basis.
Relative to many other banks that I follow, and despite the fact that about two-thirds of the loan book is variable rate (37% floating), Cadence doesn't have much asset sensitivity. A 100bp shock move in rates (the "standard candle" for bank asset sensitivity) would only translate into about 3% of net interest income growth, well below the current average of around 6% for similarly-sized banks that I follow.
Given that about a quarter of the loan book is at rate floors, it will take a couple of hikes for Cadence to start responding to rates. That said, this is a bank with a strong, sticky core deposit franchise based in a lot of smaller Southern communities where there isn't a lot of deposit competition. With that, Cadence could well see better asset sensitivity than its peers if sector-wide deposit betas prove to be higher than many are currently modeling - deposit betas measure how quickly deposits flow out in response to higher rates, and I have a concern that much of the deposit growth seen during the pandemic (sector-wide) could move on faster than some banks expect as rates go higher.
Looking at loans, Cadence saw around 2% to 3% core organic loan growth this quarter (depending on what you call "core"). That's not exceptional, but it's certainly not bad either. Management's guidance for mid-single-digit growth in 2022 seems credible, and it's worth remembering that old Cadence brought a dynamic commercial lending franchise to the table, including specialty verticals like healthcare, hospitality, tech, and energy. This loan franchise (and old Cadence's presence in growth markets like Houston and Atlanta) gives the new bank attractive options for leveraging those core deposits, though I am curious to see if the new Cadence will take a more conservative approach to lending than old Cadence did.
As is typically the case with mergers, there is also a synergy / operating leverage angle to this story. Management reiterated its target of almost $80M in cost savings, and that should start to appear later in the year (the operation conversion should take place in Q4'22). Costs weren't the primary driver of the deal, but it should still provide a tailwind going into 2023.
Cadence is an interesting bank now, with a mix of high-growth loan markets like Houston, Memphis, and Atlanta and smaller, profitable markets scattered across the South. I like the prospects for better utilizing the low-cost deposit base to fund higher-growth commercial lending, and I don't think Cadence is going to see quite as much deposit competition as some of its peers. That said, Cadence's growth markets are intensely competitive, and Cadence will need to execute on its "high-touch" service model, as well as its cross-selling capabilities (offering treasury and cash management services to commercial clients).
I'm looking for long-term core earnings growth in the neighborhood of 7% with growing capital returns to shareholders as time goes on; management recently authorized another 10M shares of repurchases. I also think further M&A is likely; it will take time to "digest" Cadence, but the capital situation is strong, and I could see the bank looking to enhance its exposure to markets like Texas, Florida, and Tennessee with further deals.
Between long-term discounted core earnings, ROTCE-driven P/TBV, and P/E, I get a fair value range of $34 to $37 for Cadence and a long-term total annualized prospective returns in the low double-digits. That's enough to make this name worth a closer look. Though I would say that the bank's relatively lower sensitivity and loan growth outlook make it a less immediately compelling name for the next 12 months, the longer-term potential of the merger is pretty compelling.
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