CNND - Canandaigua National Corporation

[Guest Schwab711]

This one is a bit of a lay-up, imo.

 

CNND's primary customers are upper-middle class folks on the east side of Rochester. Not surprisingly, they have a few trust company branches in FL for the snowbirds. Considering the level of assets and customer demographics, it is a nice surprise that CNND is somewhat advanced, technologically, relative to peers. CNND has a fairly large asset management business for its size (~$3b AUM). The trust business generates approximately 14.7% of PPNR and ~50% EBT. Overall, the level of non-interest income, given the bank's traditional/conservative business model, is the secret to the high-level of ROTCE.

 

Historically, the bank has primarily grown organically. Over the last 5 years, loans have grown at ~8% CAGR while deposits have grown at ~5.5% CAGR. Non-interest bearing deposits have grown at > 12% CAGR over nearly any prolonged period,  up to 10 years (as far as I've checked). This will be useful as interest rates (thus, mortgage rates) rise because NIM margins will likely expand. Most of CNND's deposits are not competitively priced and are not very rate sensitive.

 

CNND's loan portfolio breakout is shown below. The book is fairly average for a traditional bank in the Rust Belt. A lot of mortgages. Rochester (and WNY) has a lot of car dealers situated in Rochester (including Auction Direct in CNND's backyard), which has led to the relatively high auto lending balance. For the mortgage portfolio, loan performance has improved from 2015 -> 2016. Auto lending is roughly unchanged. NPL and ALLL %'s are nearly equal at ~1%. Considering the bank almost exclusively lends in the Rochester area, this is pretty solid performance. Things really don't get much better or worse here.

 

That brings me to the last important thought on CNND. I'm certainly biased, but Rochester (or WNY in general) is perhaps one of the best markets to operate in for a bank. There is a lot of old money that is well-dispersed, employment/labor conditions are generally stable (if we can survive Kodak, we can survive anything), and the housing market is one of the most stable that I'm aware of (purely from a volatility perspective). I believe during the GFC, overall Rochester housing prices declined ~-5%. During 'hot' years, housing might increase 10% y/y. The stability of the market certainly makes the treasury/liquidity function of the bank much easier. Looking at CNND's income statement between 2007-2010, you would have no idea that the world was falling apart. Rochester barely noticed (on paper, at least).

 

Attached are a few other cuts of CNND that I think are useful.

 

For a peer group, I looked at all banks with:

1. less than $10b in assets

2. pre-tax ROTA (%) > 1.1%

3. pre-tax ROTCE (%) > 11%

4. No reliance/history of selling mortgages (since we are in good times, this will likely revert in the wrong direction for a long investor)

 

NOTE: Not a criteria per-se, but I also tried to find banks that had a trust business to keep comparisons apples-to-apples (and to weed out the high returns due to risky lending).

 

The top portion of the peer comparison is local banks meeting the criteria. WNY banks in general seem to earn higher returns than similarly sized banks elsewhere in the country. I'm not sure if my thesis fits this data or if the data fits my thesis. Either way, it's interesting.

 

I don't want to share my DCF but I used a discount rate of 9.5% and a future effective tax rate of 23%.

 

I think CNND is worth between $250 - $300/share, right now.

[Guest Schwab711]

CNND posted pre-tax income of $40.7m, up 18% y/y.

 

https://cdr.ffiec.gov/Public/ViewFacsimileDirect.aspx?ds=call&idType=fdiccert&id=6985&data-ipsquote-timestamp=12312017

 

Edit:

DCF Update:

 

1. Raising discount rate to 9.6%, primarily due to increase in 20y UST. I suspect 9.6% is ultimately a little high for a bank of this quality (actual WACC is in the neighborhood of 5.5%-6.0% iirc) but I'll keep rolling with it.

2. Updated financials from LTM -> FY2017

3. Raised projected effective tax rate to 25% from 23%

 

DCF Value with above assumptions = $327/share

 

With 30% tax rate = $305

With 30% tax rate, 8.5% discount rate = $381

With 25% tax rate, 8.5% discount rate = $408

 

It's worth pointing out that the tax rate doesn't have a huge impact on value. It's probably +/- 7% or so.

If the discount rate is supposed to represent the stability and quality of a cash flow, I'd guess somewhere around $350 is the proper price for these cash flows (+/- 15% or so).

 

I'll update the other slides eventually but I think they are going to come out to around $275 in aggregate.

[Libs]

Schwab,

 

Interesting - thanks.

 

The 2017 tax rate was so high: 17MM tax on 40MM pre-tax income ( 42% rate):

 

 

40,730 8. 8. Income (loss) before applicable income taxes and discontinued operations (item 3 plus or minus items 4, 5.m, 6.a, ...

17,167 9. Applicable income taxes (on item 8)...

 

 

It will drop all the way to 25%?

[Guest Schwab711]

My guess is based off 21% federal + state (~4% blend between FL/NY [currently <2%, pre-2017 tax act]). I included 30% this time around because I have less confidence in my ability to predict tax rates going forward then I originally thought (based on the difference between my guesses of future tax rates vs company guidance with some of my other holdings).

 

We'll have to see what they say about taxes in the annual report but I think the jump is almost solely due to the effect of the 2017 tax act on CNND's DTAs.

 

$17m DTAs * (35% - 21%) = $2.4m, which is roughly the amount the taxes exceed standard tax rates.

[Guest Schwab711]

https://www.cnbank.com/uploadedFiles/CNB_Site_Home/Your_Bank/About_Us/CNC%20Annual%20Report%20-2017.pdf

 

10-K is out. Note that their audited pre-tax income is less than the Fed Call Report.

 

The DTAs were written down by $3.7m. Effective tax rate would have been 33.5%

 

"Thus late in 2017, for the first time since I joined CNC in 2011, our net interest margin has moved upward. This is like a warm breeze after an unusually long and intensely cold winter. We are cautiously optimistic that the economy will continue to improve moderately over the coming years"

 

Looks like my DCF assumptions of rev growth outpacing expense growth in the near-term may actually be reasonable.

 

 

Why CNND is especially well-positioned, post-tax plan:

Credit unions have never been subject to income taxation. Consequentially, they have structured themselves to compete

directly with community banks without having one third of their earnings eliminated by taxation. Thus, this reduction of the

corporate tax rate for banks provides us with an immediate and reoccurring benefit not shared by credit unions. In markets

where one or more large credit unions exist, there could be a meaningful opportunity to recover market share. We share our

marketplace with several large credit unions with significant market share, so it is foreseeable that opportunities could arise.

 

Last interesting thing I probably should have noticed earlier, they opened a new branch in an up-and-coming part of downtown Rochester. Seems like a great location choice considering how few bank branches are in the area and proximity to millennial loan growth.

[Guest Schwab711]

CNND released their 1H 2018 update:

 

Deposits up 5.4%

Non-interest bearing deposits up 11.0%

 

NII up 12.5%

non-II up 11.5%

EBT up 19.7%

 

EPS up 41.2% to $9.01 through 1H 2018

 

ROA (%): 1.26%

ROE (%): 16.11%

 

@ $180/share (+20% from original post share price):

P/E: 10.0x

P/B: 1.54x

 

They are incredibly cheap on every metric and the bank is firing on all cylinders. The CEO is young and very bright. The financial results are even more impressive considering they've been hiring, giving raises, and increasing their investment in their technology. It's probably one of the best-run banks I know of and yet they trade at half the valuation of similarly performing banks.

 

https://www.cnbank.com/uploadedFiles/CNB_Site_Home/About_CNB_(Your_Bank)/SOC%202018_FINAL.pdf