ELCO Financial Services SMA 2nd Quarter Report

ELCO Financial Services Separately Managed Account
2nd Quarter 2021 Investor Update

As we look back to what was a strong first half of 2021 boosted by a flurry of mergers and acquisitions as well as significant loan growth via the government’s PPP (Paycheck Protection Program) loan program we remain highly constructive the regional bank sector for the foreseeable future. Our confidence is rooted in the rapid growth of technology in the sector, continued share repurchases and dividend growth, the continued need to consolidate what remains a highly fragmented industry, and the anticipated interest rate increase.

Technology in a Post-Covid-19 world: Pre-pandemic, many banks chose the strategy of creating online and mobile offerings that included robust account management tools, alerts, and financial literacy features. When Covid-19 arrived this put those banks at an advantage. Those institutions had made it much easier for their consumers to make the transition to digital-only banking. The nation’s largest banks and credit card issuers have been continually innovating new digital solutions that support increasingly complex tasks, such as problem resolution, personalized alerts and profile management. This is driving increased engagement and significantly higher levels of satisfaction as the world shifts to digital. Many regional banks will be faced with a decision of whether to spend capital on digital enhancements or potentially merge with a larger banking institution that already offer those solutions. We believe this is already being discussed in many regional bank boardrooms and may been a factor in a number of announced deals. In fact, over 50 M&A deals were announced during the 2nd quarter at reasonable valuations (1.6x tangle book value) and premiums to the day before close of ~10-20%). We expect more deals and slightly higher valuations (historically valuations peak around 2.2x tangible book value).

Shareholder Friendly: Turning to share repurchases, one of our larger holdings in the portfolio Riverview Bancorp, the Vancouver, Washington based bank recently initiated a dividend and a $5 million ($157 million market cap) share repurchase program. Kevin Lycklama, Riverview’s president and chief executive officer said recently, “asset quality continues to be very strong. While there still remains some uncertainty in the overall economy, with improving consumer confidence, lower levels of unemployment and the robust vaccine rollout in Washington and Oregon, we believe we are well positioned to emerge even stronger as we navigate through this pandemic.” We welcome these shareholder friendly moves.

Professional Holding Corp’s Chairman and Chief Executive Officer Daniel Sheehan said of the Florida based institution “We are pleased to report another quarter of balance sheet expansion, total loans increased 4.3% to $1.7 billion. The balance sheet performance combined with our share repurchase activity resulted in a tangible book value increase to $14.21 per share (current share price ~19.80). We continue to benefit from a healthy pipeline of loan and deposit activities and look forward to more liquidity deployment opportunities.” The stock is inexpensive compared to current M&A multiples.

Spirit of Texas Bancshares which recently posted very positive earnings report. CEO Dean Bass stated, “I am extremely pleased to report another quarter of strong financial and operational results. While second quarter net income continues to be assisted by PPP fee income over the past year we have invested heavily in technology initiatives that increase profitability going forward. We have fully implemented cost-cutting initiatives across the organization to unlock value where possible and invested in restructuring our SBA loan department to drive growth in non-interest income over the next few quarters”. They also repurchased $14 million in shares during the quarter.

Continued M&A: One of our investments in the program Select Bancorp, a North Carolina-based bank with locations in the Wilmington market announced a definitive merger agreement. First Bancorp, the parent of First Bank, will acquire Select Bancorp in an all-stock transaction worth $314.3 million. Select Stock was up 20% on the day the deal was announced) The geographic footprint of both banks is very similar, with branches concentrated in the metro areas of North Carolina and a few locations in adjacent South Carolina and Virginia.
Anton Schutz, the programs sub-advisor has always stressed geographic location as one of his key components to stock selection. Regional banks need scale and depth in their respective markets to grow. This is done organically through better client service and investing in the underlying business, like the technology initiatives listed above or acquisitive growth through buying competitive banks. We remain excited on both of these fronts.

Interest Rates: As we write this note, The Federal Reserve considerably raised its expectations for inflation this year and brought forward the time frame on when it will next raise interest rates. While this can have an adverse effect on the overall market making it more expensive for companies to operate and borrow money, the financial sector sees the biggest benefit. Profit margins expand as rates climb something this sector has not experienced in quite some time. This is especially impactful to smaller regional banks whose main business lines are loan underwriting and saving accounts.

In summary, our confidence remains high on this portfolio as both national and localized economies continue to recover from the pandemic. There are many factors that will drive future M&A but it is without question the consumer has changed their behavior in regards to banking and the industry is evolving. This combined with continued share repurchases, healthy loan growth, and the promise of raising interest rates will help drive performance in the second half of the year and beyond.

Certain statements contained herein may contain “forward-looking statements” within the meaning of the Private Securities and Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of your account to be materially different from any future results, performance or achievements expressed or implied by such forward looking statements. Such factors include, among others, risks and uncertainties associated with the performance of bank and other financial institutions spending in the nation and worldwide, and general economic factors. This report is not a recommendation to either buy or sell any securities mentioned. Past performance is not a guarantee of future results.