Civista Bancshares (CIVB)

Civista Bancshares (CIVB), headquartered in Sandusky, Ohio, is the holding company for Civista Bank. Civista’s operating history traces all the way back to 1884 and it currently operates 35 Branches and 3 Loan Production facilities (primarily in Ohio, but footprint extends into Indiana and Kentucky).

Recent market weakness along with a negative reaction to Q3 2018 results has dropped CIVB shares nearly 35% since the end of September. After its earnings report on November 2nd, CIVB shares underperformed the BKX Index by ~10% as shares were under pressure due to some significant one-time expense items that weighed on earnings during the quarter. CIVB closed its purchase of Indiana-based United Community Bancorp in early September, and CIVB management decided to convert United Community’s systems and operations concurrent with the merger close (most banks wait a period of 6-12 months for conversion to smooth the expenses over multiple quarters). All told, CIVB reported $8.8 million of acquisition- and integration-related expenses during Q3 2018, or $0.63 per share. On its Q3 earnings call, management indicated Q4 noninterest-expense should return to a normalized ~$15mm run rate. I believe the earnings-related selloff provides a current buyer a nice ~10% discount on top of the ~25% revaluation the market slapped on just about every other bank stock in Q4.

Looking past the integration expenses and broad market selloff, there are many attractive components in Civista’s operational performance, balance sheet, and core deposit franchise. Since 2014, Civista has printed 1%+ ROAs and 9%+ ROEs for its shareholders and, after adjusting for acquisition expenses, the bank is printing a YTD ROA and ROE of 1.45% and 12.18%, respectively. A huge part of the attractive profitability metrics is the value of its deposit franchise; nearly 30% of the bank’s deposits are noninterest-bearing and only ~16% is higher-cost Time Deposits. Overall, Civista’s total cost of deposits is just 0.22%.

(Quick aside on stock structure – Civista currently has a convertible preferred (CIVBP) paying a 6.5% dividend. Unless the common price plummets in 2019, the company will likely call the preferred in December 2019, providing a small cost save).

The aggressive selloff provides a nice entry level to invest alongside a bank set up for strong performance over a full cycle and upside potential for a takeout. Primary drivers setting up CIVB shareholders for continued investment performance over the near- and longer-term:

  1. Compounding Earnings: Under the current regulatory environment, ROE should print a 10%+ rate and provide attractive growth and investment returns to shareholders.
  2. Dividend Income: CIVB pays a ~2.25% dividend yield (a very manageable 21% payout ratio).
  3. Potential M&A Upside: from an acquirer’s perspective, CIVB delivers a lot of value.
    • Market Geography: nestled in all 5 of Ohio’s, plenty of buyers to consider as a fit.
    • Deposit Funding: impressive, all around
      • 30% of CIVB’s deposits are noninterest-bearing
      • The cost of the interest-bearing deposits is 0.35%
      • The total cost of funds on CIVB’s $1.6 Billion deposit book is 0.22%
    • Capital Positions: Civista is well-capitalized when analyzing the as-reported capital ratios, or even after adjusting for its Trust Preferred borrowings (CIVB Tier 1 and Total Capital levels get the benefit of ~$29mm in qualifying Trust Preferred borrowings). If CIVB decided to call its TruPs, its capital levels would be closer to 13%, still very well-capitalized.
    • Asset Quality: credit book looks to be in decent shape, CRE loan mix is a little high but its manageable. Management speaks to its confidence in its credit work and maintain a conservative level of reserves; current LLR/NPL ratio is ~125%.

Some concerns that could pressure earnings/profitability/growth to keep an eye on:

  • CRE Mix – CIVBs loan mix is ~40% CRE and CRE as a % of Capital is ~270%, just shy of the 300% regulatory threshold/watch. I won’t waste the ink here given the amount of coverage CRE lending has received in the business press, but that concentration is worth monitoring.
  • Economic Cycle – Hard to forecast how close we are to a turn in the credit cycle, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in local and national economies.

Bank Description & Geography

Civista Bank’s roots trace back to 1884, and the bank currently has a 35 branch network in spread across the five largest MSAs in Ohio as well as some spillover into Indiana and Kentucky.

CIVB_geo

Source: Civista Investor Presentation (SEC.gov link)

Financial Overview

CIVB

Notable Ownership

  • Directors / Named Executives, as group – 4.1%
  • RMB Capital – 5.4%
  • BlackRock – 4.6%
  • Vanguard – 3.7%
  • Castine Capital – 2.7%
  • Maltese Capital – ~2% (assuming preferred stake is converted into common)
  • EJF Capital – ~1% (assuming preferred stake is converted into common)

Prospective Buyers

  • First Financial ($13.8B Assets / FFBC)
  • WesBanco ($12.6B / WSBC)
  • First Merchants ($11.1B / FRME)
  • Park National ($8.4B / PRK)
  • First Commonwealth ($7.7B / FCF)
  • Peoples Bancorp ($4.0B / PEBO)
  • German American ($3.4B / GABC)
  • S&T Bancorp ($7.1B / STBA)
  • FNB Corp ($32B / FNB)
Advertisements

LCNB Corp (LCNB)

LCNB Corp (LCNB), headquartered in Lebanon, Ohio, is the one-bank holding company for LCNB National Bank. LCNB’s roots trace all the way back to 1877 (founded as The Lebanon Citizens National Bank) and it currently operates a 33 branches in markets in or adjacent to Cincinnati, Dayton, and Columbus.

While recent market weakness has not spared many bank socks, LCNB’s share performance has been in a sustained downtrend since shares peaked after the 2016 election. While its hard to attribute the downtrend to a singular cause (the bank’s operating results support an argument that its not an earnings-related issue), there are a couple of items that could be at play. First, LCNB announced a fairly-large acquisition at the end of 2017 (Columbus First Bancorp) with a TBV earnback estimate of 4.3 years. Columbus is a new market for LCNB and that brings heightened execution risk and, typically, a bump in expense items beyond typical one-time deal charges. The one-time items have hit profitability YTD, but this is a proven management team and they should be able to normalize operational costs and begin to see deal benefits in the intermediate-term. Second, the rally in shares in late 2016 and early 2017 got ahead of itself: LCNB shares traded above 200% TBV for nearly the first half of 2017. Its hard for a bank to grow into and justify such a lofty valuation, which is another reason I think shares trended down mid-2017 to early-2018.

Beyond the share price and market valuation, there is a lot to like in LCNB’s underlying business and performance. LCNB managed through the previous financial crisis without printing a full year net loss. In fact, the crisis and credit overhang hit bank profitability the hardest in FY 2011, and LCNB still reported $1.20 EPS, 1.0% ROA, 10.9% ROE, and 2.53% NPAs (its highest level of nonperforming assets). At the risk of sounding like a dolt, I believe current market valuation of LCNB provides a good entry point for a long-term investment even as it is printing a lower EPS, ROA, and ROE than it did in 2011.

There is certainly some operational overhang to work through on the Columbus merger, but I think the aggressive selloff is not warranted and provides a nice entry level to invest alongside a bank set up for strong performance over a full cycle and upside potential for a takeout. Primary drivers setting up LCNB shareholders for continued investment performance over the near- and longer-term:

  1. Compounding Earnings: Under the current regulatory environment, ROE should normalize post-merger and return to a 10%+ rate and provide attractive growth and investment returns to shareholders. LCNB has printed a ROAA in 38 of its last 41 years of operation – I’ll take that.
  2. Dividend Income: LCNB pays a healthy 4.4% dividend yield. The 57% payout ratio is high, but current EPS is currently depressed by one-time merger expenses so that figure should decline as EPS normalizes. Even with the large payout ratio, the bank has already has a healthy equity/capital base and doesn’t see the need to retain earnings.
  3. Potential M&A Upside: from an acquirer’s perspective, LCNB has some nice attributes. I’m a sucker for valuable deposit funding and LCNB delivers on that front.
    • Market Geography: nestled in three larger markets in Ohio, plenty of buyers to consider as a fit.
    • Deposit Funding: impressive, all around
      • 24% of LCNB’s deposits are noninterest-bearing
      • The cost of the interest-bearing deposits is 0.51%
      • The total cost of funds on LCNB’s $1.1 Billion deposit book is 0.41%
      • LCNB has a ~85% loan/deposit ratio; acquiring banks are looking at $200 Million of “excess” (and cheap) funding.
    • Capital Positions: LCNB has a healthy capital position and an acquirer can easily shut down the current dividend payment to let that healthy income generation flow directly to its capital base.
    • Asset Quality: credit book looks to be in decent shape, CRE loan mix is a little high but its manageable. Biggest issue is the softer loan loss reserve balance relative to NPA/NPLs; ratios such as LLR/NPA are likely understated as they don’t include credit marks/discounts applied to acquired loans, but there is a risk an acquirer would have to consider an above-average credit market to normalize.

Some concerns that could pressure earnings/profitability/growth to keep an eye on:

  • CRE Mix – the arbitrarily-set industry threshold for CRE allocation is 300% of Capital, which LCNB (barely) currently exceeds. I won’t waste the ink here given the amount of coverage CRE lending has received in the business press, but that concentration is worth monitoring.
  • Economic Cycle
    • Hard to forecast where we are here, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in the local and national economy.

Bank Description & Geography

LCNB Bank was established in 1877 and currently has a 33 branch network in Ohio.

lcnb_geo

Financial Overview

LCNB

Notable Ownership

  • Directors / Named Executives, as group – 3.1%
  • LCNB National Bank – 4.7%
  • BlackRock – 3.6%
  • Vanguard – 2.9%
  • Castine Capital – 2.5%
  • Kennedy Capital – 1.7%

Prospective Buyers

  • First Financial ($13.8B Assets / FFBC)
  • WesBanco ($12.6B / WSBC)
  • First Merchants ($11.1B / FRME)
  • First Commonwealth ($7.7B / FCF)
  • Peoples Bancorp ($4.0B / PEBO)

First Northern Community Bancorp (FNRN)

First Northern Community Bancorp (FNRN), headquartered in Dixon, California (Solano County, near Sacramento) is the single-bank holding company for First Northern Bank. First Northern Bank was established in 1910 and currently has a 10 branch network in and around Sacramento.

The market weakness in bank stocks has not hit FNRN as hard as most of its peers as shares are down ~10% since the 2018 highs. The current valuation on shares of FNRN (14x P/E and 135% P/TBV) provides a good entry point to start accumulating a position in an attractive banking franchise.

Like most CA-based banks, FNRN had to work through some credit and income challenges during the financial crisis (albeit small, FNRN reported full year net losses in 2008-2009). Going into the crisis, the bank was positioned with a heavy allocation to Construction and Land Development loans (~22% of total loans) and Residential Loans (~18%). It seems hard to believe given the size of its land/construction book, but FNRN had returned to what I would describe a normalized operating/profitability profile by 2012. The credit turnaround and recent strength in performance metrics coincides with the appointment of Louise Walker as President and CEO (assumed role in 2011). Since the crisis, management has better allocated its loan composition (current mix detail in financial overview section).

The current management team has done a nice job of growing the bank’s balance sheet (all organic growth – no M&A activity) and the current funding structure provides a wonderful foundation to drive shareholder returns. In its Q3 2018 earnings report, FNRN reported YTD ROA and ROE of 1.02% and 11.9%, respectively, along with an expanding net interest margin (currently 3.77%). I’ll touch on the deposit book in a bit, but expect continued NIM expansion from FNRN going forward.

Primary drivers setting up FNRN shareholders for continued investment performance over the near- and longer-term:

  1. Compounding Earnings: Under the current regulatory environment, ROE should continue to compound at a 10%+ rate and provide attractive growth and investment returns to shareholders. First Northern has done a wonderful job establishing and strengthening its franchise and the bank is well positioned to continue to deliver healthy returns to its shareholders.
  2. Dividend Income: FNRN does not pay a dividend. Management prefers to retain earnings to fund organic growth and bolster its capital position.
  3. Potential M&A Upside: from an acquirer’s perspective, FNRN checks all the boxes and, I don’t say this lightly, FNRN has one of the best deposit franchises in the United States.
    • Market Geography: nestled in and around Sacramento, potential buyers abound!
    • Deposit Funding: impressive, all around
      • 36% of FNRN’s deposits are noninterest-bearing
      • The cost of the interest-bearing deposits is 0.17%
      • The total cost of funds on FNRN’s $1.1 Billion deposit book is 0.11%
      • FNRN only has $775 Million loans on its balance sheet, meaning acquiring banks are looking at $350 Million of “excess” (and cheap) funding available to them.
    • Capital Positions: FNRN has a healthy capital position and its income run-rate continues to flow directly to its capital base.
    • Asset Quality: Louise Walker and her team have done a nice job cleaning up the credit book and repositioning its loan assets to a more diversified allocation. Current NPLs total 0.88% the bank has loan loss reserve account totaling ~1.8x its current NPL position.

Some concerns that could pressure earnings/profitability/growth to keep an eye on:

  • CRE Mix – while below the arbitrarily-set industry threshold of 300% of Capital, nearly 50% of FNRN’s loan book is classified as CRE. I won’t waste the ink here given the amount of coverage CRE lending has received in the business press, but that concentration is worth monitoring.
  • Economic Cycle
    • Hard to forecast where we are here, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in the local and national economy.

Bank Description & Geography

First Northern Bank was established in 1910 and currently has a 10 branch network in and around Sacramento.

FNRN_geo.PNG

Financial Overview

FNRN

Notable Ownership

  • Directors / Named Executives, as group – 9.7%
  • Banc Funds – 3.4%

Prospective Buyers

  • Umpqua ($26B Assets / UMPQ)
  • TriCo Bancshares ($6.3B / TCBK)
  • First Foundation ($5.5B / FFWM)
  • Westamerica Bancorporation ($5.5B / WABC)
  • River City Bank ($2.2B / RCBC)

Eagle Financial Services, Inc. (EFSI)

Eagle Financial Services, Inc (EFSI), headquartered in Berryville, VA , is a bank holding company for the Bank of Clarke County. Bank of Clarke County currently operates 12 branch offices in Northern Virginia (west of Washington DC) and its largest market is Winchester, a city of ~28,000 residents in the Shenandoah Valley.

The weakness in bank stocks and the broader market has EFSI shares down ~20% since its 2018 highs. The current valuation on shares of EFSI (12x P/E and 125% P/TBV) provides a good entry point to start accumulating a position in an attractive banking franchise.

EFSI has proven its mettle over the years. Bank of Clarke County has been in business since 1881(!). EFSI managed through the previous financial crisis without printing a full year net loss. The crisis and credit overhang hit bank profitability the hardest in FY 2010, when EFSI reported $1.12 EPS, 6.7% ROE, and 3.34% NPAs (its highest level of nonperforming assets). Since 2012, EFSI has been firing on all cylinders with full-year ROAs above 1% and ROEs ranging from 8-11%. As positioned today, 1%+ ROA and 10%+ ROE profile is a reasonable forecast for returns during expansionary periods.

Primary drivers setting up EFSI shareholders for continued investment performance over the near- and longer-term:

  1. Compounding Earnings: Under the current regulatory environment, ROE should continue to compound at a 10%+ rate and provide attractive growth and investment returns to shareholders. Bank of Clarke County is well established in its banking markets (very attractive deposit/funding franchise) and is positioned to deliver continued returns on equity.
  2. Dividend Income: EFSI pays a current dividend yield of ~3.14% and the current payout ratio is a manageable 39%.
  3. Potential M&A Upside: from an acquirer’s perspective, EFSI checks off just about every box on a Bank M&A wish list:
    • Market Geography: Bank of Clarke County is a well-established deposit franchise in the Shenandoah Valley area of Northern Virginia. There are several in-market and adjacent-market competitors that would take a long look at EFSI.
    • Deposit Funding: Just like Peoples Bancorp of NC (PEBK), EFSI’s deposit position is as good as it gets in 2018. Nearly 37% of its deposits are noninterest-bearing, which is great, and the cost of its interest-bearing deposits is an attractive 47bps. This is a valuable deposit franchise. With a 0.30% total cost of funds: 0.30% and a ~85% loan/deposit ratio, a potential acquirer can forecast another $100 million in loan growth (agnostic to market geography) with a funding cost of 30bps.
    • Capital & Equity Positions: simply put, EFSI has excess Capital and Equity on its balance sheet, which is a lever an acquirer can pull to drive incremental earnings in its M&A model.
    • Asset Quality: the credit review and discount applied in an M&A purchase agreement can be tricky when “rural” banks are involved. EFSI has ~90bps of nonperforming loans as of 9/30/2018, which is a little high for my taste, but I can get behind a franchise with a proven credit underwriting track record: NPLs and Charge-offs never exceeded 5% and 1.5%, respectively, during the financial crisis. I’m not overly concerned about credit issues for potential buyers.

Some concerns that could pressure earnings/profitability/growth to keep an eye on:

  • Economic Cycle
    • Hard to forecast where we are here, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in the local and national economy.
  • Rural Geography
    • Always a wild card

Bank Description & Geography

Bank of Clarke County currently operates 12 banking offices, mainly in the Shenandoah Valley area of Northern Virginia, and 1 loan production facility near its headquarters in Berryville, VA.

efsi_geo.PNG

Financial Overview

efsi.PNG

Notable Ownership

  • James Wilkins, Jr. (age 72, Board member) – 8.0%
  • Directors / Named Executives, as group – 22.6%
  • Banc Funds – 2.0%

Prospective Buyers (active market a lot of potential buyers)

  • First Citizens ($36B Assets / FCNCA)
  • United Bankshares ($19B / UBSI)
  • Union Bankshares Corp ($16B / UBSH)
  • Sandy Spring Bancorp ($8.1B / SASR)
  • Eagle Bancorp ($7.9B / EGBN)
  • City Holding ($4.4B / CHCO)
  • Summit Financial Group ($2.1B / SMMF)
  • FVCBankcorp ($1.3B / FVCB)

Peoples Bancorp of North Carolina (PEBK)

Alright, ENBP was one for me, and here is one for the (3) readers of this burgeoning blog.

Peoples Bancorp of North Carolina (PEBK) of Newton, NC. PEBK operates as….wait for it….Peoples Bank.

elbow

Peoples Bank currently operates 19 banking offices, mainly northwest of Charlotte (Catawba, Alexander, Lincoln, Mecklenburg, & Iredell counties) and they are focused on growing its Wake county (Raleigh MSA) presence.

The weakness in bank stocks and the broader market has PEBK shares down ~20% since its 2018 highs. While PEBK’s P/E and P/TBV valuations have not retreated all the way back to pre-election levels, current valuation (13.7x P/E and 137% P/TBV) on PEBK shares are back at early 2017 levels and provide a good entry point to start accumulating a position in an attractive banking franchise.

PEBK has proven its mettle over the years. The bank was established in 1912 and all of the growth over the past 106 years has been organic, growing from the initial branch to its current 19 branch and 2 loan production locations. PEBK managed through the previous financial crisis without printing a full year net loss and PEBK has been printing some healthy returns since FY 2014. As positioned today, 1%+ ROA and 10%+ ROE profile is a reasonable forecast for returns during expansionary periods. PEBK shares have traded publicly for a long time, and just about any long-term cycle has management compounding equity returns at a 9%+ annualized rate.

Primary drivers setting up PEBK shareholders for continued investment performance over the near- and longer-term:

  1. Compounding Earnings: PEBK has proven over and over that banking done well is a good business. Under the current regulatory environment, ROE should continue to compound at a 10% rate and provide attractive growth and investment returns to shareholders. Peoples Bank has a wonderful geographic footprint with plenty of opportunity to leverage its franchise into new/adjacent markets. With a 14bps Cost of Funds, PEBK management has a very valuable funding source to drive attractive investment returns for shareholders.
  2. Dividend Income: PEBK pays a current dividend yield of ~1.9% and the current payout ratio is very manageable 26%.
  3. Potential M&A Upside: from an acquirer’s perspective, PEBK checks off just about every box on a Bank M&A wish list:
    • Market Geography: PEBK is positioned nicely in/around major markets in North Carolina, which has been an attractive market for both in-state and out-of-state buyers for several years now.
    • Deposit Funding: PEBK’s deposit position is as close to as good as it gets in 2018. Nearly 37% of its deposits are noninterest-bearing, which is great. But even better than the noninterest deposits is the fact that the interest-rate on its interest-bearing deposits IS ONLY 20bps! That is a phenomenal and incredibly valuable deposit franchise. And the cherry on top is the 88% Loan/Deposit ratio, which means PEBK has an immaterial amount of wholesale funding on the books.
    • Capital & Equity Positions: simply put, PEBK has excess Capital and Equity on its balance sheet, which is a lever an acquirer can pull to drive incremental earnings in its M&A model.
    • Asset Quality: Buyers unlikely to have to incorporate a material credit mark as NPL/Loans metric is 0.50% and the Loan Loss Reserves currently cover NPL’s by ~1.6x.

Some concerns that could pressure earnings/profitability/growth to keep an eye on:

  • Economic Cycle
    • Hard to forecast where we are here, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in the local and national economy.

Bank Description & Geography

Peoples Bank currently operates 19 banking offices, mainly northwest of Charlotte (Catawba, Alexander, Lincoln, Mecklenburg, & Iredell counties) and they are focused on growing its Wake county (Raleigh MSA) presence.

pebk_geo

Financial Overview

PEBK

Notable Ownership

  • Christine Abernethy – 12.1%
  • Directors / Named Executives – 11.2%
  • Tontine Financial – 7.0%
  • Jeffrey Gendell – 9.5%
  • Kennedy Capital – 3.6%
  • BlackRock – 3.5%
  • Vanguard – 3.4%

Prospective Buyers (active market a lot of potential buyers)

  • First Citizens ($36B Assets / FCNCA)
  • Fifth Third ($159B / FITB)
  • FNB Corp ($32B / FNB)
  • Pinnacle Financial ($24B / PNFP)
  • First Bancorp NC ($5.7B / FBNC)
  • Carolina Financial ($3.7B / CARO)

ENB Financial Corp (ENBP)

I’ll put disclaimer upfront – this name is illiquid, boring, and unlikely to fit anything but a retail position size. But I like the bank so I’m going to write it up.

ENB Financial Corp (ENBP) of Ephrata, PA. ENB operates as Ephrata National Bank, and it is a small community bank that has served SE Pennsylvania (footprint is around Lancaster, PA) since 1881. Folks, ENB is as boring and straightforward as banking gets these days. Prudent and seasoned management team with a proven track record of performance positioned to compound ROE’s at ~10% while paying a 3%+ dividend.

At its current P/TBV (102%) and P/E (12.4x) valuations, an investment in ENBP at current levels positions a new shareholder alongside an excellent management team executing at a level that should compound returns, with very little fanfare, at high-single-digits levels over a complete cycle. Unlike other names mentioned on this site, I would not  assign much of a probability to an upside M&A scenario given ENBP’s mission statement (and current scholarship ownership structure; as an aside, the story of the ENBP scholarship is great: http://www.ephratareview.com/news/scholarship-strikes-gold/).

Primary drivers setting up ENBP shareholders for a nice investment over the near- and longer-term:

  1. Compounding Earnings: simply put, ENBP management is very good at operating a community bank. Given its conservative nature, I don’t think we will see ENBP print ROA’s and ROE’s much higher than the current 1% and 10% levels, respectively, but that comes with a (comforting) layer of security when the credit cycle turns as ENBP has proven, very clearly, how well they manage the balance sheet to protect income and capital. A prime example of this protection can be seen by looking back at the 2007-2009 financial crisis and ensuing credit overhang banks experienced thru 2012. ENBP reported net income each year of the financial crisis and its *worst* fiscal year performance was 2008’s 0.60% ROA and 5.9% ROE. NPL’s peaked at ~180bps in 2008 and its worst year of charge-offs saw a 0.29% NCO (that is impressive) in 2009. By 2010, ENBP had returned to a “normalized” earnings profile (again, that is impressive). With confidence in management’s ability to operate and minimize downside risks, I’ll gladly sacrifice a little upside in order to sit back and appreciate the 10% ROE.
  2. Dividend Income: ENBP pays a current dividend yield of ~3.3% and the current payout ratio is very manageable 41%.
  3. Asset Quality, Loan Mix, & Deposit Funding: all three of these continue to highlight ENBP’s stellar management. The Bank has not swayed its loan mix in decades, asset quality and loss reserving is pristine, and the deposit book is spectacular. Contributing to a Cost of Funds metric of 34bps, ENBP’s deposit book is a very valuable liability.

Some concerns that could pressure earnings/profitability/growth to keep an eye on:

  • Limited-to-zero M&A upside
    • ENBP has grown organically from its founding and its mission statement is pretty clear: “To remain an independent community bank of undisputed integrity, serving the communities of Lancaster County and beyond.”
    • That aside, the business and valuation dynamic behind ENBP shares would make it a very attractive purchase for a multitude of acquirers if they ever entertained selling.
  • Economic Cycle
    • Hard to forecast where we are here, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in the local and national economy.

Bank Description & Geography

Based in Ephrata, Pennsylvania, ENB Financial Corp is the holding company for Ephrata National Bank, a full service, independent bank serving Lancaster County and parts of Lebanon and Berks county. ENBP has grown organically, rather than through mergers and acquisitions and ENBP is one of the few financial institutions in this market geography that remains an independent community bank.

ENBP Geo

Financial Overview

ENBP.PNG

Notable Ownership

  • J Harry Hibsham Scholarship Fund – 31.3%
  • Directors / Named Executives – 2.25%

Mercantile Bank Corporation (MBWM), and a quick word on the markets

Quick market note: Yes, the market has been choppy as most prognosticators have been attributing recent weakness to multitude of items (trade/geopolitical saber-rattling, Fed policy error & corresponding flattening in yield curve, normal test/reset/pause during expansionary cycle, etc…). I’m not going to debate these items or assign points for which argument is the most convincing. What I do see, specific to banks, is there has been a resetting of expectations as bank investors begin to consider the implications of a flatter/flat/inverted yield curve and a maturing/mature economic cycle. Many banks have struggled during the second half of 2018: loan pricing remains very competitive and deposit betas have increased, resulting in NIM pressure/compression. The bank franchises I’ve highlighted have shared a common thread: each company was an attractive deposit franchise trading at an attractive market valuation (P/E, P/TBV, etc…). I’m of the opinion that vetting deposit franchises and analyzing management execution and loan growth/spreads should strip the wheat from the chaff to position one’s capital investments amongst truly attractive bank franchises. With this in mind, the recent selloff has moved some previously fully- or over-valued bank franchises back to “investable” levels.

First up: Mercantile Bank Corporation (MBWM) of Grand Rapids, MI.

The recent selloff in MBWM shares provides an attractive entry point to invest in a bank franchise nicely positioned as Michigan’s third-largest bank by deposit market share. Mercantile’s management team has grown the bank in a conservative fashion recently as all growth has been organic since its transformational merger with Firstbank Corp in 2013. While MBWM’s footprint and management team make it attractive as a standalone banking franchise, there is undeniably some upside optionality as an acquisition target.

Recent market volatility has resulted in shares selling off by ~25% from its 2018 high and ~15% since September. When looking at valuations, shares haven’t been this cheap on a Price-to-Earnings and Price-to-TBV since pre-election 2016.

Primary drivers setting up MBWM shareholders for a nice investment over the near- and longer-term:

  1. Compounding Earnings: MBWM had comfortably printed ROA’s around 95bps and ROE’s around 9% prior to the recent loosening of regulatory requirements. With the loosening of standards behind the banking system, MBWM appears to be settling in at a ~1.2% ROA and ~10.5% ROE profile and there is not a reason to think those performance levels should not be treated as comfortable baseline levels going forward.
  2. Dividend Income: MBWM pays a current dividend yield of ~3.25% and has distributed out excess earnings/capital in 2016 and 2018. The current payout ratio is a very manageable 38%; unlike some banks with dividend yields above 3%, MBWM management is not forgoing growth initiatives in order to satisfy an income-hungry shareholder base.
  3. Potential M&A Upside: MBWM has a lot of things working in its favor when it comes to marketing itself as an attractive takeout target:
    • Market & Size: Michigan (yes, Michigan) has been an attractive market in recent years as it has seen some larger in-state (Chemical buying Talmer in 2016, Independent buying TCSB in 2017) activity. MBWM is positioned nicely as a strong deposit franchise that would look appealing to both in-state buyers looking to strengthen position and out-of-state buyers looking to enter a new market.
    • Low-Cost, Stable Deposit Funding: MBWM’s funding structure is very attractive. Noninterest Deposits make up ~35% of its deposit book and, while deposit costs have increased over the past year as short-term interest rates have increased, the total interest cost of MBWM’s interest-bearing deposits totals just 0.77%. MBWM’s overall cost of funds is 0.69% as of 9/30/2018.
    • Asset Quality: Buyers unlikely to have to incorporate a material credit mark as NPL/Loans metric is 0.18% and the Loan Loss Reserves currently cover NPL’s by 1.5x.

Some concerns that could pressure earnings/profitability/growth to keep an eye on:

  • Potentially acquisitive
    • Given MBWM’s current size and the current regulatory and M&A landscape, it would not be surprising if MBWM’s management looks to do another transformational acquisition. There are several smaller community banks in Michigan that would make sense for MBWM to consider (if the price is right). Any acquisition activity carries risks, upfront with economic costs and shareholder dilution before  longer-term risks via integration and execution complications.
  • Economic Cycle
    • Hard to forecast where we are here, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in the local and national economy.

Bank Description & Geography

Based in Grand Rapids, Michigan, Mercantile Bank Corporation is the bank holding company for Mercantile Bank of Michigan. Mercantile has assets of approximately $3.3 billion and operates 47 banking offices

MBWM_geo

Financial Overview

MBWM

Notable Ownership

  • Directors / Named Executives – 3.2%
  • Banc Funds – 7.5%
  • BlackRock – 6.9%
  • Dimensional – 6.5%
  • Renaissance – 4.8%

Prospective IL-based Buyers (active market a lot of potential buyers)

  • Fifth Third ($140B Assets / FITB)
  • Huntington ($104B / HBAN)
  • Chemical Financial ($20.2B / CHFC)
  • Comerica ($72.2B / CMA)