Community Financial System CEO defends rich valuation and eyes more deals

By Steve Gelsi

Component of the KBW Regional Bank Index has higher proportion of non-interest income

Community Financial System Inc. commands a richer valuation than other components of the KBW Regional Banking Index due to its income streams outside of traditional banking.

And it's likely going to stay that way, said Community Financial System's (CBU) Chief Executive Dimitar A. Karaivanov.

The company offers a "unique" story to Wall Street because of its combination of businesses, he said.

Along with its traditional banking business, Community Financial System has a wealth management unit, a growing insurance agency business called OneGroup Inc., as well as Benefit Plans Administrative Inc., its employee compensation services unit.

"There is no other [bank] that fits our business," Karaivanov told MarketWatch. "We have a unique valuation."

Still, of the five analysts that cover Community Financial System, four have neutral ratings on the stock, with one buy rating. That's a signal that Wall Street collectively feels the stock is roughly at fair value at its current levels.

Shares of Community Financial System trade for 3.97 times the company's tangible book value per share, according to data provided by FactSet. This is the second highest price/tangible book ratio among the 50 banks in the KBW Regional Banking Index XX:KRX, behind a valuation of 4.41 for First Financial Bankshares Inc. (FFIN) of Abilene, Texas.

With interest rate changes making banks' net interest income margins less predictable, other non-interest income has come into focus around the sector.

To build a case for a richer stock price, Community Financial System said it was planning to add to its non-banking businesses through organic growth and acquisitions.

The company's retirement business operates in a space that's been growing due to the aging U.S. population and it's helping to address the retirement crisis in terms of helping people trying to retire with dignity.

The benefits program has been influenced by a greater government focus on 401(k) plans.

"There's been government incentives for small businesses to set up those plans - that's a growth space for us," Karaivanov said.

It's also seeing a brighter future than others for the second-tier cities in New York State that it banks.

The company's Buffalo and Rochester regions have about $4 billion in deposits and $3 billion in loans. Its Syracuse region has $3 billion in deposits and $2 billion in loans.

"For decades, these markets had retreated with fewer people and businesses," Karaivanov said. "They've been part of the U.S. rustbelt. But for the past seven to 10 years that's been slowly turning. It's really accelerated with the overall move toward re-shoring of manufacturing."

One example of this revival is a roughly $100 billion chip-making plant planned for the Syracuse areasby tech giant Micron Technology Inc. (MU).

"We've learned how to grow [our business] without growth in our markets and now we have that tailwind on top of that," he said.

The company remains active in acquiring targets across its business lines, particularly in wealth management and the insurance brokerage space.

The company's wider array of business lines also help set the company aside from others.

"We have that broader opportunity set than our bank-only peers," said Financial Chief Joseph Sutaris.

There is more than one way to gauge the level of a bank's revenue coming from outside the traditional banking business of leveraging capital by gathering deposits and lending out that money or buying bonds with it to earn the spread between interest income and interest expense.

Over the past four reported quarters, Community Financial System's ratio of noninterest income to noninterest expense has been 59.06% - highest among the 50 components of the KBW Regional Banking Index, according to FactSet's data. The bank's ratio of noninterest income to net revenue (net interest income plus noninterest income) has also been highest among the components of the index, at 39.13%.

The company also expects to get a boost from the U.S. Federal Reserve's interest-rate cut because it'll lower its cost of borrowing.

"That would take a little bit of the pressure off for funding costs," Sutaris said. "It may also spur incremental loan demand which would be helpful. Both of these aspects of lower interest rates would help us grow and prosper."

At last check, Community Financial System's market capitalization was about $3 billion. In the second quarter ended June 30, the company's net income fell to $47.92 million, or 91 cents a share, from $48.29 million, or 89 cents a share, in the year-ago quarter.

Operating income of 95 cents a share beat the FactSet consensus estimate of 81 cents a share.

Revenue rose to a record of $183.2 million, up from $175.3 million in the year-ago quarter and ahead of the analyst estimate of $180.1 million.

The company reports its third-quarter earnings on Oct. 22.

Community Financial System's stock has risen 10.4% so far in 2024, while the KBW Regional Banking Index XX:KRX has risen by 1.3%.

Philip van Doorn contributed to this article.

-Steve Gelsi

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09-26-24 0651ET

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