Community Bank System

Moat: 2/5

Understandability: 1/5

Balance Sheet Health: 3/5

Community Bank System is a diversified financial services company with operations in New York, Pennsylvania, Vermont, and Massachusetts. Primarily a bank, it also provides financial planning, insurance, and wealth management services to its clients.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Community Bank System (CBU) operates in a highly fragmented financial industry and while it possesses some positive business attributes, its overall moat can be considered narrow.

Business Overview:

CBU’s business is primarily driven by its core banking operations, which constitute more than half of its revenues. It also generates a large amount of revenue from their wealth management services.

  • Revenues:
    • Net interest income (NII): CBU’s core revenue source. It arises from the difference between interest income earned on loans and other lending activities and the interest expense it pays on deposits and borrowings.
    • Wealth Management: CBU offers wealth planning services, financial advice, retirement planning, and estate planning for high-net-worth individuals, families, and institutions.
    • Insurance Services: CBU has insurance agencies that provide commercial and personal insurance services.

  • Geographic Footprint: The bank operates in the Northeastern United States and its main area of operation is New York. In addition, CBU also operates in Pennsylvania, Vermont, and Massachusetts.

  • Trends in the Industry:
    • The financial services industry is constantly changing with a lot of mergers and acquisitions happening, and more competition from fin-tech companies.
    • There is also increasing regulatory requirements, which is leading to consolidation in banking.
    • With the advent of technology, customers are demanding more and better online and mobile banking options.
    • With changes in the interest rate, the net interest margin that banks can get is also varying a lot.
  • Competitive Landscape: CBU faces tough competition from other banks and from wealth management and insurance services providers in the region.
    • The local market is highly fragmented, with many large and small banks competing for share.
    • There are large banks such as Citizens Financial and M&T bank that have bigger regional presence and resources.
    • These competitors can be very aggressive with promotions and competitive pricing, making it hard for CBU to sustain its moat.
  • What makes CBU different? CBU’s strategy is focused on a community-banking approach, where relationship banking and local services are emphasized. This has helped them build a strong local brand, which allows them to offer more personalized and curated services to customers. It also makes it hard for them to grow outside their geographical market.

Financials:

CBU has seen some financial performance fluctuations in recent years because of the impact of rising interest rates.

  • Margins: The company’s interest rate margins fluctuate because of fluctuations in interest rates and the general economy. Net interest margin (NIM) has been around 3%, but could see a benefit from interest rate hikes and deposit repricing in the long term.
    • On the whole, the operating margin is good, ranging between 30 to 40 percent which is good for a bank.
    • Profitability: CBU has maintained modest profitability over the recent few years. Their ROA (Return On Assets) has ranged between 1.1 and 1.4 which is decent.
    • Revenue Growth: CBU’s revenue growth is driven by loans, wealth management, and insurance products, and in the last few years, it has grown at around 4-7% annually.
  • Recent Concerns/Controversies

CBU has had some issues with increased deposit competition and higher interest rates. CBU’s management has spoken about a strategic shift to diversify its asset and liability structure which can reduce the impact of interest rate variations. But the immediate impact has been reduced NIM. CBU has also seen increased provision for loan losses which has led to a reduction in earnings. - In the most recent earnings call, CBU’s management noted that they expect margin pressure to persist through 2024, due to increasing funding costs.

  • The bank also faces uncertainty around further regulatory changes that may affect their performance, and therefore, they are making sure they have a high level of liquidity and capital.
  • Some investors are worried that the bank’s exposure to credit loans is a risk in a potential downturn.

Moat Analysis (2/5): - Intangible Assets: CBU does have a good brand in its local area, which provides some pricing power and makes customers more loyal. However, it’s brand awareness is limited to its geographic region, which makes it harder to grow outside of it. - Switching Costs: It is generally hard for a customer to switch banking providers because of issues such as setting up new account and changing direct deposit options. However, it is a very competitive market, and thus switching costs are not enough to make the moat wider. - Network Effect: CBU does not have a real network effect. It’s a traditional bank and not a social media company. Hence this is not an advantage for it. - Cost Advantage: CBU does not have any big cost advantage over its competitors. It has higher costs related to the labor force compared to competitors with a larger presence. Hence they are not a low-cost provider.

  • Therefore, CBU has a narrow moat that’s driven mainly by switching costs and strong local brand. But their moat isn’t very strong given the competitive landscape.

Risks to the Moat and Business Resilience

  • Competition: CBU faces aggressive competition from larger national and regional banks, as well as new fin-tech startups that can provide more seamless digital experiences.
  • Interest rate fluctuation: As their main source of income is the spread on loans and deposits, they are highly vulnerable to interest rate fluctuations. They have been trying to reduce the liability side but the effects of the policy are yet to be seen.
  • Loan Losses: An economic downturn may lead to more loan losses and impact the company negatively. The recent increase in provision for credit losses by CBU suggests that management is wary of this risk.
  • Regulatory Changes: New regulation on the banking and financial services industry may affect how they operate. This might create a lot of operational and compliance costs.
  • Cybersecurity Risk: With increased digitalization, banks are more vulnerable to cyberattacks, which may be very costly to handle if it happens.
  • Management Execution: As their strategy of transitioning towards a more diversified banking model and expanding into new territories depends on management execution and decision making, a bad strategy or a bad execution may negatively impact the company.
  • Technological disruptions Technological innovations can also render their operations and services obsolete which is a threat they will have to contend with to make sure they remain competitive.
    • Overall, CBU does have certain advantages that help it navigate difficult situations but a major downturn in the economy could seriously impair its performance.

Understandability (1/5): The business model of CBU is very simple and well-understood, a traditional bank with lending, wealth management and insurance arms. There are no complex operations and it is relatively easy to follow. Hence, the understandability score is 1/5.

Balance Sheet Health (3/5):

  • CBU is generally a well-capitalized bank, but it has seen fluctuations in debt levels and reserves due to changes in its operations and recent acquisitions. It is well capitalized according to regulations, and most ratios for asset quality are also on the higher side, or at a reasonable level.
  • Their tangible equity ratio has decreased in the last few years because of a decline in unrealized value of securities, and from amortization of goodwill.
  • They have significant loans on their books, which is a normal part of any bank’s operation but they have consistently been increasing loan loss provisions given the uncertainty in the economy.
  • For most of its capital needs, it relies on deposits as compared to relying on the capital markets, making it a less risky financial institution.
  • They have low amounts of debt, which is generally good.
  • Therefore, the overall health of the balance sheet is a bit above average, so given it a score of 3/5.