Community Bank System: The Cost Of Total Deposits Remains Incredibly Low (NYSE:CBU)

Community Bank System (NYSE:CBU) is a bank with a market capitalization of only $2.55 billion and is headquartered in DeWitt, New York. It recently came out with Q4 2023 and overall I think the results were positive:

• Q4 Non-GAAP EPS of $0.76 misses by $0.08.
• Revenue of $177M (+0.6% Y/Y) beats by $1.33M.

EPS had some difficulties but nothing of concern. Bank funding remains the strength, as does a low-risk loan portfolio but with a NIM above 3%. As we will see, this bank remains very solid and also has sound growth prospects.

Loans and investment portfolio

Total loans reached $9.70 billion, up 2.64% from the previous quarter and 10.22% YoY. This is overall a great growth considering the current macroeconomic environment. After all, with rising rates, demand for credit has decreased, yet CBU has found new opportunities even in a complex situation. In particular, the bank has gained exposure to some of the larger metropolitan areas, where it has found a favorable competitive dynamic.

The majority of our growth has really come from our expansion in some of the larger metro areas, which we’ve talked about previously. In fact, every one of our regions had a growth year in ’23. So, it’s been strong across the board. We’re active, engaged in the markets a lot more than we were historically. There is a very favorable competitive dynamic for us as well, where a lot of the other participants, frankly, don’t have the liquidity or the regulatory capacity to service clients. So, we came into this cycle with a highly liquid balance sheet and no concentrations of any sort with plenty of runway. So, we’ve taken advantage of that.

CEO Dimitar Karaivanov

Basically, since many competitors are unable to lend due to lack of liquidity or structural limitations, CBU is taking advantage of this situation as much as possible. Probably, this trend will continue in the coming quarters, after all CBU has a very low LTD ratio compared to the average, only 75.10%.

So, as the weeks go by, it will be able to lend at quite high rates, which will lead it to increase the NII in 2024. Currently, new loans originated are around 7.50%, which is very positive compared to the low cost of deposits. In addition, given the momentary advantage in the market in which it operates, CBU can keep the rate at which it lends high even if the Fed reduces the Fed Funds Rate by a small amount. Commercial loans of $170 million were made in the last quarter alone, and the granularity of these loans was good.

According to management’s expectations, the revenue growth rate is expected to be between 5% – 10%. However, some optimism seems to be leaking out for high-single-digit growth, especially considering the recent results of the insurance segment. The latter has grown by 18% in the past year and by double digits over the past 3 years. Double-digit growth is also expected in 2024.

As for the securities portfolio, the situation remains at a standstill. CBU over the past few years has experienced significant unrealized losses due to its low fixed-rate securities. To date, this portfolio is worth $4.16 billion, about 26% of total assets. The problem is that the average yield is only 2.03%, while money market yields are well above that. As a result, AOCI has taken on some relevance and has been the cause of the collapse in TBV per share. Wanting to find a silver lining in all this, Treasury rates are falling and this is providing relief to CBU equity: in Q3 2023 the AOCI was ($684.90 million); in Q4 2023 it fell to ($559.50 million). It still remains a very high figure, about 25% of equity without counting HTM securities.

Since the yield on this portfolio is very low, the cash flows it will generate are quite limited, especially in 2024 and 2025: they are estimated to be less than $100 million each. From 2026 to 2029 there will be many maturities, and cash inflows of about $1 billion are expected for each year.

Deposits and NIM

Deposits are the strength of this bank, in fact it is really hard to find a better one in this aspect. Total deposits are $12.92 billion, roughly unchanged from the previous quarter and from last year.

However, their cost is minimal, only 0.98%. This figure is incredible considering that the Fed Funds Rate is at 5.25 to 5.50%. It probably was not that low for some banks, even when rates were at 0%. Consequently, it is quite easy for this bank to maintain a NIM above 3%: as of today it is 3.05%. It could be even higher, but I would like to mention that CBU’s loan portfolio is quite risk-averse and 58% of them belong to the consumer category and only 42% to the commercial category. By the way, deposits largely cover loans, as we noticed from the low LTD ratio.

According to management’s expectations, the cost of deposits will remain very low throughout 2024, but may increase slightly in the coming quarters. Be that as it may, NIM is expected to remain stable given the significant lending opportunities in markets where competitors are limited.

Shareholder remuneration

However, CBU is not only a bank with a low cost of deposits, it is also a bank that has been issuing a growing dividend for 26 years in a row. This is an amazing achievement considering that the great financial crisis was in the midst of it. Even during that time, CBU increased its dividend thanks to a strong balance sheet and below-average NPLs.

The current dividend yield is 3.75%, so it is quite attractive. Finally, in addition to dividends, CBU is also remunerating its shareholders by buying back its own shares. Starting January 1, 2024, until the end of the year, the Board approved the purchase of 2.70 million treasury shares, about 5% reduction of the total outstanding shares.

Conclusion

Community Bank System is a sound bank due to the low cost of its deposits. Its loan portfolio is relatively low-risk, and its NIM is stably above 3%. The low LTD ratio will allow the bank to operate in markets where competition is limited, and this will drive up the NII in 2024. The main problem concerns unrealized losses, still a burden despite the fact that Treasury rates fell in the last quarter. Finally, missing EPS expectations is not a red flag: there were some expenses in the last quarter beyond expectations, but that will no longer affect the core business going forward. For now, shareholders can enjoy their growing dividends and buyback.