Cambridge Bancorp: A Decent Play In These Uncertain Times

From my experience, some of the greatest opportunities when it comes to investing involves the companies or industries there have been underperforming the most recently. For the most part, 2023 is turning out to be a really fantastic year for the investment community. But there has been some weakness in some parts of the market. One great example of this is the banking sector. A crisis that began in March of this year caused the collapse of multiple financial institutions. That carnage, though now passed, has left an ominous cloud of pessimism over the industry, with shares of many of the banks out there it's still trading significantly lower than they were previously.

Although not a prime prospect in my opinion, one firm that does warrant some optimism is Cambridge Bancorp (NASDAQ:CATC), a fairly small bank with a market capitalization of only $431 million. At one point following the end of February, shares of the company were down as much as 43.1%. They have recovered some since then. But even today, they remain down about 32% compared to where they were previously. When you dig into the numbers, it becomes easy to understand why there was some pessimism regarding the business. But the worst for it seems to have passed. Given this, I would argue that the company does offer some upside from here and that a 'buy' rating is appropriate at this time.

A decent prospect

When it comes to banks in the US, Cambridge Bancorp is about as old as they get. The company can trace its roots back to 1890 when Cambridge Trust Company was founded in Cambridge, Massachusetts. Over more than a century, the company has grown into a bank holding business that boasts 22 banking offices throughout eastern Massachusetts and New Hampshire. Through these locations, the company provides customers a wide array of commercial and consumer banking services such as various loans, deposit services, and more. It also provides a variety of other services. For instance, its wealth management operations provide customers with investment management solutions through the five offices that it has open today.

To start with, we should touch on the company's loan portfolio. The total value of loans on its books grew from $3.15 billion in 2020 to $4.06 billion by the end of 2022. At the end of the most recent quarter, which would be the first quarter of 2023, the company had about $4.02 billion in loans outstanding. By value, an impressive 44% of its loan portfolio is in the form of commercial real estate. I understand that investors are very concerned about the exposure that any bank might have to the office space market. This is an area that I worry about as well. About 15% of the company's commercial real estate loan portfolio, or 6.6% of its overall loan portfolio as a whole, involves office properties. This could definitely be worse. Its greatest exposure on the commercial real estate side is actually to the multifamily category. 39% of its commercial real estate loan portfolio, or 17.2% of its overall loan portfolio, is dedicated to this market segment. Other major categories include retail, industrial and warehouse properties, and construction and land activities.

Outside of the commercial real estate category, Cambridge Bancorp's loan portfolio is largely centered on residential real estate. 23% of the value of its loan portfolio is dedicated to fixed rate residential properties. Another 17% involves adjustable rate residential assets. That leaves 3% for home equity activities. The commercial and industrial space accounts for only 9% of its loan portfolio, while construction and consumer loans account for 3% and 1%, respectively, of what the company has. It is worth noting that a rather sizable amount of its loan exposure is fixed rate. That number comes out to 44% in all. The rest is comprised largely of adjustable rate mortgages, with only 25% floating. While having a large degree of exposure to fixed rate mortgages likely means that borrowers are less likely to default during times of rising interest rates, it does also mean that the company should see the value of those assets worsen compared to if they were floating rate. The adjustable rate mortgages also bring with them certain risks. Sometimes, borrowers can handle fixed rate loans. But as interest rates rise, the adjustment higher can cause a great deal of pain.

The good news is that the management team at Cambridge Bancorp has provided some guidance for the impact that changes in interest rates would have on net interest income. As the image below illustrates, a sudden rise in interest rates could negatively impact net interest income for the company. But a gradual increase would not have a significant impact on the company. In fact, both a gradual decrease and a sudden decrease would help pop net interest income up rather nicely. But the picture really becomes interesting when you look out to a second year following a year in which these movements occur. In this case, the company should benefit rather significantly from an interest rate increases, irrespective of whether they are gradual or sudden.

The loan data for the company is definitely important. But it pales in comparison at this point in time to the deposit picture. After all, it was concern regarding uninsured deposits that sent the banking sector into a downward spiral earlier this year. From 2020 through 2022, the value of deposits for the company grew from $3.40 billion to $4.82 billion. This number did decrease some to $4.66 billion by the end of the first quarter. Much of this pain seems to have been concentrated in the uninsured deposit category. At the end of last year, 51.8% of the company's deposits by value were uninsured. That number has become a much more reasonable 33.1%. While I would like to see this number come in lower, it is definitely better than it could be.

The value of uninsured deposits is about $1.55 billion. That compares to the $2.50 billion that they stood at only one quarter earlier. It's worth noting that the company does currently have $2.69 billion worth of liquidity at its disposal should it need it. Even though borrowings more than doubled from the end of 2022 to the end of the first quarter of this year, borrowings were still a very modest $241 million. So absent anything unexpected, the company's overall financial position seems solid.

Another positive about the firm is that its stock is trading lower than its tangible book value per share. At the end of the most recent quarter, this number came in at $57.98 per share. By comparison, shares today are trading at $53.36. The total book value per share for the company, meanwhile, is even higher at $67.14. Both this and the tangible book value per share have increased over the years. For instance, one year ago, the tangible book value per share was $54.52, while the overall book value per share was $62.30.

Over the past few years, management has done a solid job growing the company's top and bottom lines. The growth in deposits and loans have allowed net interest income to climb from $101.9 million in 2020 to $139.3 million in 2022. Non-interest income grew more modestly from $39.5 million to $43 million. This more modest increase can be chalked up to the fact that the total wealth management assets on the company's books have not exactly moved all that much in recent years. At the end of 2020, they totaled $4.17 billion. At the end of 2022, they were actually a bit lower at $4.06 billion. It is worth mentioning, however, that the metric did climb to $4.27 billion in the first quarter of this year.

At the end of the day, both the net interest income and the non interest income for the company helped to push its net income up from $32 million to $52.9 million. As you can see in the chart below, revenue for the business continues to increase. But a decline in non-interest income, combined with elevated costs, have resulted in net income for the company during the first quarter of 2023 coming in lower than it was the same time last year. One data point a trend does not make. But investors would be wise to consider watching over these bottom line results moving forward.

Takeaway

Fundamentally speaking, I can understand why the market was initially worried about Cambridge Bancorp. The company had a sizable portion of its deposits classified as uninsured. That picture has changed significantly, though I would personally like to see its exposure drop even lower. The good news is that deposits remain robust considering the circumstances and the firm has managed to handle current market conditions without taking on a great deal of debt. Add on top of this the fact that shares are trading below tangible book value and that the stock is also trading at about 10 times last year's earnings, and I would argue that some upside likely exists from here.

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