Description

Cape Bancorp (CBNJ) is a well-capitalized savings bank with 13 branches along the South Jersey shore in Cape and Atlantic Counties, and 3 satellite offices on the suburban NJ and PA sides of Philadelphia.  Equity shares trade at 0.8x book and 1.0x tangible book, and carry a 2% dividend yield and a small stock repurchase program by the issuer.

During its 5 years as a public entity, CEO Michael Devlin has reduced branches by 30% from 19 to 13 as of June 30 (the most recent closure being a conversion to drive-up ATM) while growing deposits over the same period a cumulative 10% - the flight to quality (cash) and the improvement in the economy has likely supported some of that trend.  Since 2010 peak levels CBNJ has seen significant improvements in loan performance and asset quality.  In 2012, CBNJ sold its money-losing merchant card operation for a small accounting gain and began paying a dividend in the fourth quarter.  In April 2013, CBNJ announced a stock repurchase plan for 5% of shares which was completed in July with new plan authorized for another 5%.  In 2012 and 2013, CBNJ has continued its strategy of expanding into suburban Philadelphia regions in a capital-light fashion through Market Development Offices (MDOs), having opened its 3^rd in March 2013, which give the bank a growth channel through which it can utilize its excess capital and diversify its loan generation.  Discussions with management indicate intentions to sell the bank at some point in the future and all efforts today focus on streamlining operations, diversifying asset generation, and growing profitability, all to maximize value if the bank does engage in a sale process.

June 30 assets were $1.05B, loans were $734mm, deposits were $538mm and tangible book equity was about $120mm or $9.55/share based on 12.85mm shares outstanding.  The bank is well-capitalized with a 13.7% Tier 1 capital ratio and 12% tangible equity to tangible assets.  CBNJ holds 14% of Cape May County deposits (2nd out of 14) and 8% of Atlantic County deposits (6th out of 16).

Importantly, consensus estimates, albeit a small cap stock with limited coverage, show expectations for $0.36 to $0.40/share in EPS through 2015, which implies ~4% ROE for a bank with loan quality improvements, growing assets, a buyback plan being executed at or below tangible book, and a very active management team that continues to streamline the business model.

History

Cape is the result of a January 2008 merger with Boardwalk Bank (ticker BORD) and simultaneous mutual to thrift conversion of legacy Cape Savings Bank via IPO of the pro forma entity.  This transaction was similar to the magic doubling of shareholder capital that occurs when a mutual thrift converts to public ownership (no selling shareholders so IPO proceeds are paid in capital on top of already existing unclaimed equity capital), except that the effect was diluted somewhat by the BORD shares that were being acquired at a premium to Book.  Notably, Michael Devlin who served as CEO of BORD at the time (the target), had no record of open market purchases of BORD in the years prior to the acquisition announcement yet purchased nearly a quarter million dollars of BORD shares at the much higher affected price in the low $20’s/share, and total insider purchases following the announcement amounted to a relatively large $1.7mm all at around the affected price of ~$21/share (compared with the ~$100mm pro forma market cap company) and no shares were sold by insiders following the announcement. Prior, Cape had always been more of a residential lender while Boardwalk more of a commercial real estate lender, but both solely operated in Atlantic and Cape May counties along the Southern NJ shore, representing approximately 50 miles of coastline from Brigantine to Cape May and respective inland/mainland areas of those two counties.

Recent Operations and Outlook

Regional/Local economy’s growth masked by headline Casino Gaming revenue erosion:  As a local savings bank, CBNJ is implicitly dependent upon the stability of Atlantic City, but that’s different that being entirely dependent upon the consistently receding gaming revenues.  Non-gaming AC revenues continue to grow as the public and private capital has expanded the entertainment offerings.  Additionally, Cape and Atlantic Counties are some of the cornerstones of NJ shore tourism.

Although gaming revenues generated in A.C. casinos has fallen for a 7^th straight year, an almost direct measure on non-gaming entertainment revenues, the luxury tax, in A.C. indicates all-time highs.  The luxury tax is charged on hotel room purchases, ticket purchases for shows, and alcohol sold by the glass.  While A.C. will never be comparable to Vegas, there’s a similar trend in the shift to non-gaming revenues as A.C. seeks to transition to more of an entertainment destination.

In addition to the obfuscated A.C. picture, general tourism to CBNJ’s core shore markets remains robust.  Visitor spending in Atlantic County grew 2.4% for 2012 YoY and 3.4% in Cape May County, CBNJ’s two key markets.  NJ visits have grown at a 1.8% CAGR since 2007 and 7.8% CAGR since bottoming at 65.8mm visits in 2009, while tourism spending of $37.8B has surpassed 2007 peak levels of $37.3B.  2009 also marked the nadir of tourism spending at $34.3B.

CBNJ is a traditional lender: Cape’s lending practices are not unlike many small savings banks, generally providing commercial loans at 75% LTV and residential mortgages at 80% LTV.  Discussions with management indicate a willingness to increase commercial loan exposure (which carries variable rates) and scale back on fixed-rate mortgage loans as yield curve rises and/or steepens.  The bank thoroughly reviews non-performing loans weekly and CEO Devlin attends these credit review meetings (and in my discussions he had an intimate familiarity with the composition of the loan book).  CBNJ’s loan book can be summarized as follows: ~60% is commercial is (mostly commercial mortgages, <50 bps construction), ~33% are residential mortgages (more than 90% of mortgages are single family) both of which have been about the same past 3 years.  Cape’s general policy on residential mortgages is no more than 80% LTV (99% fall in this category) and same for Home Equity (where they have 1st or 2nd lien position).  Commercial mortgage loans max out at 75% LTV, with 5 to 10 year rate resets and 25 year amortization schedules.

Management focused on the core business and growing profitably: The bank recently sold its merchant acquirer business in 2012 for a small accounting gain. Despite the apparent attractive nature of auto lending from a risk and return perspective (i.e. NICK), CBNJ mgmt’s view is that they do not have the tools nor scale to execute in such a fashion.  Like many savings banks, they prefer traditional lending with prudent LTVs, and a focus going forward away from longer-dated fixed rate mortgages at the margin and instead toward variable rate commercial loans.  In 2012 they began a strategy of expanding through satellite offices (commercial office space executive suite leases for the locations), with locations in Burlington County and Mercer County NJ and recently as of March 2013 in Radnor PA.  Individuals at these locations will grow commercial loan volumes to utlize some of CBNJ’s excess capital and to diversify the loan book away from the apparent shore stigma.  Also unfolding presently is a switch to a new core processor Fiserv.

Loan quality continues to improve:  As of June 30, 2013, Non-performing loans to total gross loans improved by 135 bps YoY from 3.26% to 1.90%.  Allowance from loan losses to non-performers increased from 53% to 69% (recall that these are typically 1^st lien collateralized loans with at least 75% or 80% LTV).  Charge-offs have fallen steadily over the past few quarters, declining YoY from 47 bps to 11 bps for Q2 2013.  

Capital Allocation:  CBNJ began paying a $0.05/share quarterly dividend in Q4 2012.  The company announced in April a 5% stock repurchase plan which was completed in July, and quickly followed by another 5% repurchase authorization.  Given these purchases are taking place at or below tangible book, they should be both accretive and enhancing to ROE given the same asset base.  Mgmt is deliberately but prudently reducing shareholder capital to enhance ROE but not so much that regulators are knocking on their door.

Ownership and Board: CBNJ has an independent, refreshed board and two large shareholders, Philadelphia-based Patriot Financial Partners (which specializes in investing in financial institutions) owning 9.7% and NY-based Jacobs Asset Management owning 7% of equity shares.  Another notable although clearly a de minimis amount for his outfit is Michael Price at 2% of shares (consistent with a strategy he spoke of years ago of owning a basket of local banks).  James Lynch sits on the board so his shop is clearly influencing some of the ideas for growth.  New to a board seat is Althea Skeels, a business woman operating an RIA in one of CBNJ’s MDO markets (Moorestown, in Burlington County NJ).

Negatives

• Concentrated footprint and concentrated exposure to small and cyclical segment of NJ economy.
• Longer-term trajectory for savings bank questionable (commoditized technology offerings, competition with large institutions and small peers, competition with online asset gatherers and loan generators – with a growing comfort level by younger demographics to bank virtually).
• Rising yields could hurt marked to market loan values held on CBNJ’s balance sheet.
• Local property values tied to A.C. stability and shore tourism stability.
• Share repurchases are mostly offsetting share issuance over past 5 years (from 12.2 million to 12.8 million shares).

Catalyst