The Community Bank Investor Newsletter August 2016 · The Community Bank Investor – August 2016

The Community Bank Investor – August 2016

The Community Bank Investor Newsletter – August 2016

One of the big events of the week is the laughable report out of the White House that I discussed yesterday. In direct contrast to a 2015 study by the Government Accountability Office and a 2014 study by the Mercatus Center’s Small Bank Survey the White House Council of Economic Advisors decided that Dodd Frank had not hurt the community banking Industry at all. The study found that “While the evidence presented in this brief makes clear that community banks have remained healthy as the Dodd-‐Frank financial reform has been implemented, the long-‐standing challenges facing some smaller financial institutions underscore the importance of implementing Dodd-‐Frank in a way that allows community banks to compete on a level playing field.”

Compare that to last years GAO study which found that “With regard to select Dodd-‐Frank Act rules expected to have impacts on community banks and credit unions, community banks, credit unions, and industry associations GAO interviewed cited an increase in compliance burden associated with these rules. This included increases in staff, training, and time allocation for regulatory compliance and updates to compliance systems. Some of these industry officials also reported a decline in specific business activities, such as loans that are not qualified mortgages, due to fear of litigation or not being able to sell those loans to secondary markets. The results of surveys we reviewed suggest that there have been moderate to minimal initial reductions in the availability of credit among those responding to the various surveys and regulatory data to date have not confirmed a negative impact on mortgage lending.”

For further contrast listen to the testimony to the House Financial Services Committee in 2015. He told legislators that “Community banks are resilient. We have found ways to meet our customers’ needs in spite of the ups and downs of the economy. But that job has become much more difficult by the avalanche of new rules, guidances and seemingly ever-‐changing expectations of the regulators. This, not the local economic conditions ,is often the tipping point that drives small banks to merge with banks typically many times larger. The fact remains that there are 1,200 fewer community banks today than there were 5 years ago—a trend that will continue until some rational changes are made that will provide some relief to America’s hometown banks.”

Reading through the White House Report they do at least address the fact that smaller banks are having a tough go of it. The report finds that “At the same time, though, many community banks—especially the smallest ones—have faced longer-‐term structural challenges dating back to the decades before the financial crisis. These structural challenges underscore the importance of implementing Dodd-‐Frank in an equitable way that gives community banks a fair chance to compete, which has been a key priority for the Obama Administration.”

They even admit that banks need to deal with costs saying “At the same time, community banks have faced meaningful long-‐term challenges over the last several decades. Since at least the mid-‐1990s, big banks have held an increasing share of assets and accounted for more lending, while the number and share of assets held by all community banks as a group (banks with less than $10B in assets) has


declined. This trend held steady from about 1994 to 2008 but appears to have slowed following the financial crisis. The shift toward big banks since at least 1994, as well as evidence that many community banks grow over time and move into larger asset classes, suggests that economies of scale or scope may be at play in the longer-‐term trend. Larger scale may be important to pay for fixed costs like IT systems, or to engage in more diversification of product offerings.” Costs matter according to the White House economists. Just not regulatory costs.

Banks expressed their opinion of the report right away. The American Bankers Association President Rob Nichols was quick to issue a statement. He said “There is a serious disconnect between this report and the daily reality for America's hometown banks and the communities they serve. The 1,708 community banks that have disappeared since July 2010 would be best equipped to speak on this topic — except they can't. “The more than 24,000 pages of proposed and final rules bely the idea that Dodd-‐Frank had no impact,” he said, adding that “the rules intended for the largest banks are now considered ‘best practices’ for all banks, compounding the misery for smaller banks. Arbitrary size thresholds are stopping community banks from growing because of the added regulation, thus limiting the services they could provide.”

Republicans on the House Financial Services Committee went one step further and released remarks form actual bankers who have to deal with the costs and time suck of Dodd Frank. The bankers were in direct opposition to the White house report. Dale Wilson the CEO id First State Bank of San Diego said ““Managing this tsunami of regulation is a significant challenge for a bank of any size, but for a small bank with only 17 employees, it is overwhelming. Today, it is not unusual to hear bankers—from strong, healthy banks—say they are ready to sell to larger banks because the regulatory burden has become too much to manage. Since the passage of Dodd-‐Frank there are 80 fewer Texas banks. These banks did not fail. Texas has one of the healthiest economies in the country , we call it the Texas miracle. These were community bankers, and I have talked to many of them personally , that could not maintain profitability in an environment where the regulatory compliance costs are increasing between 50 and 200 percent.

David Williams, Chairman and CEO of Centennial Bank put it this way, ““In recent years, Centennial Bank has experienced a sharply increasing regulatory burden. The nature of our business has changed from lending and investing in our communities to compliance with ever-‐changing rules and guidance. In the past 10 years our compliance costs have grown from approximately five percent of overhead to 15 to 20 percent today. I believe this increase in regulatory burden has contributed significantly to the decrease of 1,342 community banks in the U.S. since 2010.”

Bill Isaac is a former FDIC Chairman and current Chairman of Fifth Third Bank was pretty emphatic in his remarks. He said, “The bigger banks can absorb it, the smaller banks can’t. I would not be surprised to see half of the community banks in this country go out of business if we don’t give some relief from Dodd-‐Frank for them. I think that Dodd-‐Frank is a terrible piece of financial legislation. It didn’t address any of the causes of the crisis that we just went through. It won’t prevent the next crisis. It heaped volumes and volumes of regulations. It’s hurting the people who need the money the most. It’s hurting small business. I think it is impeding economic growth.”

During the month S&P Global Market Intelligence/SNL Financial released their outlook for small banks. The report said that “The lower-‐for-‐longer rate environment, emerging credit headwinds and regulatory scrutiny over commercial real estate lending will weigh on small bank profitability in the near term. As rate hikes have become more elusive, S&P Global Market Intelligence has adopted a more negative


outlook for the banking industry, and smaller institutions are no exception.” The research firm sees lower net interest margins and a reversal of favorable credit conditions over the next few year. They aren’t expecting much from loan demand either saying” Loan demand should remain relatively weak, and fierce competition for credits, persistently low rates and the presence of loan pricing floors will keep pressure on loan yields in the near term. Unlike at large regional and national banks, material loan growth has failed to materialize for small banks. That is unlikely to change in the near term, in part due to smaller banks' exposure to commercial real estate lending, which is nearly double the level of their larger counterparts. “

KPMG released the 2016 Community and Regional Bank Outlook in late July. This year report is titled “A Matter of Momentum” finds that regional and community banks are well positioned to grow and learn from the past. The focus for Regional and Community banks in 2016 should be on kick-‐starting growth, improving management of regulatory risk, deciding whether they are going to be buyers or sellers in a fluid M&A market, and enabling the “branch of the future. Author John Depman is KPMGs leader of Regional and community banking and has 25 years’ experience with banking industry. He found in this years survey that “Only 8 percent of survey respondents believe a bank smaller than $1 billion in assets can survive. That size may vary depending on geography, but almost 5,400 of today’s banks fall below that asset size. In fact, there are still about 1,700 banks below $100 million in assets. Many fewer executives this year said they would “very likely’’ to be a buyer through mergers and acquisitions this year as compared to last year. Instead, many more told us this year that they are “somewhat likely’’ sellers than said so last year.”

Compliance costs remain a problem according to the survey. The report summary noted that “In addition, the continuing drain on banks from regulatory costs could be a reason for increased involvement in M&A. A full 47 percent of those executives polled said their regulatory costs represent between 11 and 20 percent of their total operating costs – up from 33 percent last year. "The need to absorb these costs over a larger asset base seems to be a driving factor in the interest in M&A that we have seen," said Depman.

KBW had their bank conference this week and the bankers themselves seemed a bit more upbeat on the future. KBWs wrap up notes said that “ Emerging from the conference and 2Q16 earnings, SMID-‐cap banks generally remain constructive on their ability to continue to produce organic loan growth at a rate 2-‐3x GDP, but also aware that top line growth may remain challenging given the combination of a low short-‐end and a flat long-‐end of the curve. As a result, a commitment to expense control , both organic and through select M&A strategies ,is one consistent strategy that remains in focus entering 2H16 and into 2017 budget season. On credit, general messaging remains consistent in that borrower health remains strong, though for the energy-‐dependent names with oil back at $40 versus $50 a month ago, this is serving as a reminder that ultimate credit resolution for this asset class is unlikely to be linear or immediate.”

CRE remains a concern and although bankers fell like most of the bank doing a lot of CRE lending have the expertise and experience to properly underwrite and manage the portfolios there is some talk of the regulators leaning on certain banks to cut back or even stop CRE lending. I do not see any signs of CRE lending slowing down at any of our banks but I will be watching developments closely.

I find all the negative guidance and concerns exciting. It is becoming clear to me that the Calvary is not coming for the smaller banks that are struggling to grow and they are going to have to sell. Itis not going


to be a buyer market however. As we saw in this quarters round of conference calls that there are plenty of banks that are looking to, and in some cases, have to buy. We should begin to see a pickup in deal volumes and a nudge upward in deal multiples once all the bankers get back from the mountains and beaches after Labor Day.

Fintech is becoming a major concern for many smaller banks as well. David SeLeski of Stonegate ban told the FDIC's Advisory Committee on Community Banking in Late July that “I think these nonbanks, Fintech-‐type opportunities, are going to be the biggest threat to, especially, community banks, going forward. Just one of the things that we have been monitoring and seeing is that some of the nonbanks, Fintech companies, are really looking for that opportunity where they see there's a particular aspect of a banking process that they can try to disrupt. There are so many services we offer our clients, but there's also a threat from nonbanks eating into our traditional profit areas.”

Cynthia Blankenship, vice chairman of Bank of the West in Grapevine, Texas worried that the presence of and potential partnership with Fintech companies could lead to increased risk. She said at the meeting “Generally, with technology, the biggest question is just risk versus reward. Where is our risk tolerance? And how much of that are we going to be forced into taking to stay relevant in the market?” The rising of Fintech and the need for a huge technology spend to keep up is going to be another market force that leads to many banks to choose to sell themselves to a larger institution.

The Jobs report was a pretty good report. There was a nice little pop in wages for a happy change and we saw some good higher paying jobs being created this time. Professional and business services added 70,000 jobs in July and has added 550,000 jobs over the past 12 months. Within the industry, employment rose by 37,000 in professional and technical services in July, led by computer systems design and related services and architectural and engineering services . Employment in management and technical consulting services continued to trend up. Employment in financial activities rose by 18,000 in July and has risen by 162,000 over the year. Much of the growth is still in lower paying healthcare, retail and leisure services but this was a decent report.

Decent mind you, not perfect. According to the report “The unemployment rate held at 4.9 percent in July, and the number of unemployed persons was essentially unchanged at 7.8 million. Both measures have shown little movement, on net, since August of last year. Both the labor force participation rate, at 62.8 percent, and the employment-‐population ratio, at 59.7 percent, changed little in July. The number of persons employed part time for economic reasons was little changed at 5.9 million in July. These individuals, who would have preferred full-‐time employment, were working part time because their hours had been cut back or because they were unable to find a full-‐time job. Basically we are right where we were a year ago. Better, not good. Although I am well aware the Fed really wants to raise rates this report by itself is not going to offer them enough of a reason to do so.

I spend a lot of my time reviewing the earnings releases and conference calls of the leading regional and community banks to get a feel for what I going on in my favorite industry. This quarter the big thing on everyone’s mind is M&A. Banks know they need to get bigger and in a slow growth world the only way to accomplish the task is to buy another bank. Knowing that there are active buyers we can assemble a list of likely targets and enjoy huge profits when they are taken over at a large premium to out purchase price. In the 2 and ½ years since I started Banking on Profits we have been involved in about 25 takeovers and as these bank CEOs are telling us on this quarter’s earnings calls the deal pace is going to accelerate the rest of this year and into next.


Terry Zink of Cascade Bancorp (CACB) for instance told his investors that “Well, I think as we looked, as we said, we believe Seattle should be a billion dollar bank for us. We're not going to get there strictly through organic growth over the next couple of years so I would think Seattle is a market that we're going to look very closely at for opportunity. Portland would be another market where we believe there is opportunity, there's some smaller banks there and we continue to see the economic pressure on the smaller banks continuing. So, those are probably two of the markets that we're going to look at.”

David Seleski of Stonegate Bank (SGBK) in Florida told his investors that “New mergers. We are actively looking and I'm still extremely confident that we're going to get something done before the end of the year, at least announced. We really have kind of fine-‐tuned how we're looking at acquisitions, we're really only looking in-‐market deals where we are currently. We think that real value Stonegate is adding market share in individual markets were in, such as, right now we're number one or will be number one in the closed region in the Broward County. We would like to be number one or number two in some of the other markets that we're in as well and we think that makes us a very attractive franchise. We're also seeing that those economies of scale and just having that many much larger of a sales force in a particular county in a geographic area creates more opportunities for us and we're simply seeing that's where the growth is and that's where we're getting better margins. It just makes more sense for us.”

Mile Rechin of First Merchants (FRME) responded to an analyst question about M&A plans saying “But our outlook for where we would execute the best for the First Merchants’ service level, I know would be really competitive is in the Mid-‐West. And so we think the Southern two-‐thirds of Ohio and the entire State of Indiana we will do really well. And then there is selected other areas where it be some of the metropolitan areas of Kentucky, certain middle parts of Illinois, all would get our consideration. But Indiana and Ohio have just been good to us and we have a depth of talent for we got people that could take on more responsibility, we feel like we know many of the franchises that could be good fits and then if you were to extent your question on the profile. $1.5 billion in asset size and down would be preferable.

Chris Martin of Provident Financial Services (PFS) said “Finally on M&A, while organic is our preferred method for growth, we have a strong capital position to support acquisitions whether it would be in bank or wealth management firms. Our culture and success and fully integrating acquisitions make this a viable and prudent use of capital and this consistent with our ability to leverage our relationship building philosophy with our operating platforms. We always focus on acquisitions that will add markets with strong customer demographics, quality personnel and synergies that come from any combination. And our expectation is that the challenges of low interest rates in combination with the growing cost of regulatory compliance will make M&A volumes increased throughout our industry in the upcoming 12 to 18 months.”

At United Community (UCBI) CEO Jimmy Tallent said on his call “Before I conclude my prepared remarks and open the call to questions, I want to mention a few things that are very important. Certainly the second quarter results show that investments in organic growth are achieving solid results. They almost always do and that is why they continue to be our primary focus. At the same time, acquisitions have been and will be an important part of our growth strategy. To appeal to us, an acquisition opportunity must meet four criteria; must be accretive to earnings per share; it must have a reasonable earn back of tangible book value dilution; it must be strategically compelling; and it must have low execution risk. To


meet our financial objectives from each acquisition, we must also achieve the expected cost saving and I’m pleased to report that we did just that with First National Bank and Palmetto.”

FDIC Chair Martin J. Gruenberg testified before Congress last month. He told the Committee on Oversight and Government Reform that “The post-‐crisis period has been marked by a gradual, consistent improvement in banking industry performance, even in the face of some significant headwinds. FDIC-‐insured institutions posted record earnings of nearly $164 billion in 2015. Almost two-‐thirds of all institutions reported higher earnings for the year than they did in 2014. Many banks have worked off significant volumes of noncurrent loans during the post-‐crisis period, and for most banks, this process is largely complete. Only eight institutions failed last year—the lowest number since 2007. By the end of the first quarter of 2016, the number of problem institutions declined to 165, the lowest level since mid-‐2008. This recovery in their financial condition has put FDIC-‐insured institutions in a better position to support economic activity by extending credit to creditworthy borrowers. Loan balances at FDIC-‐insured institutions at the end of the first quarter were 6.9 percent higher than a year earlier, marking their highest 12-‐month growth rate since mid-‐2008. Community banks have also posted a strong recovery in the post-‐crisis period that has, in several respects, outpaced the recovery at larger institutions. Loan balances at community banks grew by 8.9 percent in March from a year ago, exceeding the industry average by more than a quarter. Loan growth at community banks was led by an 11.9 percent increase in commercial real estate loans, an 8.6 percent increase in commercial and industrial loans, and a 5 percent increase in 1-‐to-‐4 family residential mortgages. In addition, net income at community banks grew by 7.4 percent in the first quarter of 2016 compared to a year earlier, while industry net income declined slightly. The decline in overall industry earnings was largely attributable to a drop in trading revenue and a sharp increase in reserves to recognize potential losses from noncurrent commercial and industrial loans related to the energy sector. However, neither of these factors had a material impact on community bank performance during the quarter.”

Conditions are ripe for M&A activity to accelerate n the last 4 and ½ months of the year. Earnings remain steady and credit is still excellent. We are still in the sweet spot of the trade of the decade.

Dividend Increases

Community banks should be a dividend growth leader for many years now that balance sheets have been restored. With tremendous improvements in credit conditions and high capital levels bank managers are now looking for ways to return capital and shareholders and we are seeing strong increases in payout across the industry.

Bar Harbor Bankshares ( BHB) announced that its Board of Directors declared at its July 19, 2016 meeting, a quarterly cash dividend of 27.5 cents per share of common stock, representing an increase of 0.5 cents, or 1.9%, compared with the prior quarter and an increase of 2.0 cents or 7.8% compared with the third quarter of 2015.

Greene County Bancorp, Inc. (GCBC) announced that its Board of Directors has approved a quarterly cash dividend of $0.095 per share on the Company’s common stock. The dividend reflects an annual cash dividend rate of $0.38 per share which represents a 2.7% increase from the previous annual cash dividend rate of $0.37 per share.


Home BancShares, I (HOMB), parent company of Centennial Bank, Board of Directors declared a regular $0.09 per share quarterly cash dividend payable August 31, 2016, to shareholders of record August 10, 2016. This cash dividend represents a $0.015 per share, or 20.0%, increase over the $0.075 per share cash dividend paid during the third quarter of 2015 and a 2.85% increase over the regular cash dividend paid out during the second quarter of 2016.

Mercantile Bank Corporation ( MBWM) announced that on July 14, 2016, its Board of Directors declared a regular quarterly cash dividend of $0.17 per common share, payable September 21, 2016 to holders of record as of September 9, 2016. The $0.17 cash dividend represents an increase of approximately 6 percent from the $0.16 cash dividend paid during the first and second quarters of 2016. "We are pleased that our sound financial condition has afforded us the ability to declare an increased third quarter cash dividend, reflecting our ongoing commitment to provide a meaningful return to shareholders," said Michael Price, Chairman, President and Chief Executive Officer of Mercantile. "Our strong capital position and earnings performance support the sustained cash dividend program, and the increased cash dividend demonstrates the confidence of our Board of Directors and management team in Mercantile's future."

The Board of Directors of South State Corporation (SSB)has declared a quarterly cash dividend of $0.31 per share payable on its common stock. This per share amount is $0.01 per share, or 3.3% higher than the dividend paid in the immediately preceding quarter and is $0.06 per share, or 24.0%, higher than a year ago.

Bryn Mawr Bank Corporation (BMTC) elected to increase the quarterly dividend by 5%, declaring a quarterly dividend of $0.21 per share, payable September 1, 2016 to shareholders of record as of August 2, 2016.

Central Pacific Financial Corp. (CPF) declared a quarterly cash dividend of $0.16 per share on the Company's outstanding common shares. This represents a 14.3% increase from the $0.14 dividend paid in the second quarter of 2016.

Columbia Banking System, Inc. (COLB) announced today that a quarterly cash dividend of $0.20 per common share, and per common share equivalent for holders of preferred stock, will be paid on August 24, 2016 to shareholders of record as of the close of business on August 10, 2016. This is a 5% increase from the $0.19 regular cash dividend paid during the second quarter 2016 and an 11% increase from the $0.18 paid during the first quarter 2016. In addition, the Board of Directors declared a special cash dividend of $0.19 per common share, and per common share equivalent for holders of preferred stock, which will also be paid on August 24, 2016 to shareholders of record as of the close of business on August 10, 2016. Melanie Dressel, President and Chief Executive Officer noted, "Our financial performance provides us with the opportunity to increase our regular cash dividend for the second consecutive quarter. In addition, our current capital position allows us to pay a special cash dividend for the tenth consecutive quarter. The regular dividend combined with the special dividend constitutes a payout ratio of 89% for the quarter and a dividend yield of 5.2% based on the closing price of our stock on July 27, 2016."

On July 26, 2016, the Board of Directors of Community Trust Bancorp, Inc. (CTBI) increased its quarterly cash dividend to $0.32 per share beginning with the October 1, 2016 payment to shareholders of record on September 15, 2016. This represents an increase of 3.23% in the quarterly cash dividend.


Eagle Bancorp Montana, Inc. (EBMT) Eagle’s board of directors declared a regular quarterly cash dividend of $0.08 per share. The dividend will be payable September 2, 2016 to shareholders of record August 12, 2016. The current annualized yield is 2.45% at recent market prices.

Hanmi Financial Corporation (HAFC) (“Hanmi”), the holding company for Hanmi Bank, today announced that its Board of Directors declared a cash dividend on its common stock for the 2016 third quarter of $0.19 per share, up 35.7% from $0.14 per share in the prior quarter. The dividend will be paid on August 23, 2016, to stockholders of record as of the close of business on August 8, 2016. “The 36% increase in our quarterly dividend reflects Hanmi’s recent strong financial performance and our Board’s confidence in the Bank’s future growth prospects,” said Mr. C. G. Kum, President and Chief Executive Officer. “This dividend, representing an annualized dividend yield of 3.07%, demonstrates our commitment to enhancing stockholder value and serves as a reward to Hanmi’s loyal stockholders.”

Provident Financial Holdings, Inc. (PROV), the holding company for Provident Savings Bank, F.S.B. announced that the Company’s Board of Directors declared a quarterly cash dividend of $0.13 per share, reflecting an eight percent increase from the $0.12 per share paid on June 7, 2016.

Two River Bancorp (TRCB) the parent company of Two River Community Bank ("the Bank") announced that the Board of Directors approved a 14.3% increase in its cash dividend, raising the quarterly amount to $0.04 per share of the Company's common stock for an annualized amount of $0.16 per share. This increase compares to the second quarter dividend of $0.035 per share, or an annualized amount of $0.14 per share.

United Community Banks, Inc. (UCBI) (“United”), reported that its Board of Directors approved an increase of one cent in the regular quarterly cash dividend to eight cents per common share. The dividend is payable October 5, 2016, to shareholders of record on September 15, 2016. “With our solid performance in the second quarter, our Board has increased our dividend to eight cents per share beginning in the third quarter,” stated Jimmy Tallent, chairman and chief executive officer. “This is 14 percent higher than our current dividend and a 33 percent increase from a year ago.”

NEW BUYBACKS

Shore Bancshares, Inc. ( SHBI) announced that its Board of Directors has approved a stock repurchase program. Under the new repurchase program, management is authorized to repurchase up to 400,000 shares, or approximately 3.2%, of the 12.7 million outstanding shares of the Company's common stock. The program may be limited or terminated at any time without prior notice. The program will expire on April 21, 2017. Lloyd L. "Scott" Beatty, Jr., President and Chief Executive Officer stated, "We believe that the current market price of the Company's stock does not accurately reflect our franchise value. Our strong capital levels and solid operating results provide us the flexibility to repurchase shares, which is an efficient way to deploy capital, as the current share price currently approximates tangible book value."

Patriot National Bancorp, Inc. (PNBK) announced today that its board of directors has authorized a new stock repurchase program for the purpose of repurchasing up to 500,000 shares of its common stock. “This program reflects our commitment to enhance shareholder value and our confidence in the ongoing operating and strategic direction of the Company," said Michael Carrazza, Patriot’s Chairman.


Mr. Carrazza reaffirmed that the Company is focused on executing a series of activities aimed at creating value for its shareholders.

On August 11, 2016, the Board of Directors of Bay Bancorp, Inc. (BYBK) amended its previously-‐announced stock repurchase program to (i) authorize the repurchase of an additional 250,000 shares of the Company's common stock, (ii) extend the repurchase period through August 31, 2017, and (iii) in the case of a privately-‐negotiated repurchase transaction, permit the Company to repurchase shares at a price that is less than the fair market value of a share of common stock at the time of repurchase. As of the date of this report, 4,508 shares of common stock remain available for repurchase under the prior authorization, so the amendment brings the total number of shares available for repurchase under the repurchase program to 254,508 shares.

Beneficial Bancorp(BNCL) adopted a second stock repurchase program for up to 10% of its outstanding common stock, or 7,770,978 shares.

National Bank Holdings Corporation ( NBHC) announced that its Board of Directors authorized a new program to repurchase up to $50.0 million of the Company's common stock from time to time either in the open market or in privately negotiated transactions in accordance with applicable regulations of the Securities and Exchange Commission.

An Interview With The CEO and CFO Of Lake Shore Bancorp

Tim Melvin: We’re on today with Daniel Reininga, the President and CEO, and Rachel Foley, the CFO, of Lake Shore Bancorp, Inc. (NASDAQ: LSBK) up in Dunkirk, New York. First guys, thanks for being on with us today.

Daniel Reininga: Thank you. Glad to be here.

Tim Melvin: Now, let’s touch on real quick, you guys are 125 years old and you’re a mutual holding company with 60% of the shares owned by the mutual holding company. Now, a lot of folks aren’t familiar with that particular ownership structure. Could you just kind of explain it real quick?

Daniel Reininga: The traditional operating model for Lake Shore Savings up until the year 2006 was as a mutual bank, fully owned by the depositors. In 2005, we determined that we had an opportunity to expand our footprint to the Erie County marketplace in western New York. In order to take advantage of the opportunity, we needed capital to grow the balance sheet and generate business or market share.

As a result, we completed a first step transaction to raise capital by converting to the mutual holding company structure. Under a mutual holding company structure, the mid-‐tier holding company, Lake Shore Bancorp, Inc. owns 100% of the stock of Lake Shore Savings Bank. Then the mid-‐tier Bancorp sells 40% of its own common stock to public shareholders and the common stock is listed on the NASDAQ; whereas the remaining 60% of the common stock is held by the top-‐tier mutual holding company, Lake Shore, MHC, which is under the control of the bank’s depositors. This afforded us the opportunity to raise enough capital to grow our balance sheet by approximately $250 million.

Tim Melvin: Now let’s talk about your marketplace a little bit and what’s going on up there. The recovery from the great credit crisis has been “uneven” let’s call it, with different parts of the country


participating at different rates. You guys are in Chautauqua County and Erie County, which of course includes the Buffalo market. How’s the economy up in that area of the country right now?

Daniel Reininga: We are in two distinct marketplaces. Recently, we have had bright spots on the horizon for Chautauqua County, resulting from Governor Cuomo’s initiatives to attract businesses in upstate and western New York. That being said, due to limited growth opportunities in the Chautauqua County market area, we have focused our growth efforts on the Erie County marketplace.

Erie County has been growing by leaps and bounds with business opportunities. That’s the reason we are more aggressively deploying our loan strategy on the commercial side of our business in this market area. Our balance sheet has traditionally been a thrift balance sheet, primarily composed of residential lending assets. We are now transitioning to a larger commercial profile with the right risk metrics attached, by originating C&I or pure commercial real estate backed loans. The Buffalo marketplace is experiencing growth due to the “eds, beds and meds” phenomenon. Recently there has been radical growth in medical related jobs and office space in the Buffalo marketplace. Potentially 17,000 new jobs are expected to be realized in a medical corridor that’s being developed, which includes construction of a new location for the University at Buffalo Medical School in downtown Buffalo.

This is generating demand and need for multi-‐family units, resulting in developers purchasing older commercial buildings to be renovated into residential units. We’re starting to see a little bit of excess inflation which obviously brings with it bubble concerns, but at the same time a lot of sustainable jobs are being created. Erie County’s growth is also supported by a pledge from Governor Andrew Cuomo to provide resources to grow industry and sustainable jobs in western New York. As an example, the governor has announced that a new production facility will be constructed that will bring anywhere between 900 to 1,400 jobs in the City of Dunkirk. The governor has also announced similar plans of a much larger scale for the Buffalo and Erie County marketplace, including support for the construction of a manufacturing facility for SolarCity Corp (NASDAQ: SCTY).

Tim Melvin: Are you guys engaging in some multi family lending?

Daniel Reininga: Yes, we are.

Tim Melvin: I know that’s been a real hot area. That’s also an area where people are a little concerned about a bubble there. Do you see any signs of that in the Buffalo market at this point in time?

Daniel Reininga: Not at this time. The growth is stable. The investors are very high net worth individuals who have a lot of real estate experience and are not speculative by any means. We remain tuned in to acquiring and bringing in quality assets with respect to properties that we finance. We are transitioning from what I call C properties to B+ or B-‐ properties. We require the investors to provide capital improvement money and evidence of sufficient sustainable rent.

Tim Melvin: It sounds like you know the good and the bad aspects of the local market, as well as who the players are and who the good guys are and the not so good guys are. That’s a real advantage as a banker.

Daniel Reininga: Yes. I think the key for anybody who invests in Lake Shore, regardless of what we’re doing, we have a very appropriate enterprise risk management function, and we bring that into our credit policy and into our overall perspective on anything we do. We’re not chasing loans. We’re not


chasing yields. We’re rotating the right kind of assets that are sustainable with the right credit metrics, so it’s not reaching critical threat by any means, so we’re going to get the goal for our investors.

Tim Melvin: I wanted to touch on that a little bit because I noticed when I was going through your reports this morning that you have done a very nice job of growing the commercial real estate and the C&I book over the last 3 or 4 years. But you’re non-‐ performing loans as a percentage of the commercial and the C&I portfolio is well below industry averages. How are you guys pulling it off?

Daniel Reininga: It’s asset quality, asset metrics. It’s knowing our borrowers and managing things properly. Of course we have some residential delinquencies in there. We tend to lag the rest of the marketplace by about 18 months. So if globally you see rates go up, you’ll see changes in our asset quality later than in other parts of the country. Our asset quality will hover lower and then eventually creep up a little bit, but we’re usually relatively low compared to peers. We do have 2 commercial loans that are currently a challenge in our loan portfolio, but we have a transition plan for one where the loan was sold to another individual owner.

Tim Melvin: You guys have what appears to be a pretty strong dividend and buy back plan in place for shareholders. Can you talk about those a little bit?

Rachel Foley: We have had a buy back plan in place for several years now. Our goal is to buy back shares around our tangible book value to create value for our shareholders. Furthermore, our dividend policy provides a solid return to our shareholders. We have a lot of community members who are shareholders and by providing a dividend, we are able to give them a tangible return on their investment. Our Board of Directors feels that it is important to give back to the investors who have invested in us and helped us grow.

Tim Melvin: Now, looking out to the future, growth plans for Lake Shore Bancorp. What are you guys thinking now?

Daniel Reininga: Well, we’re always talking about “clicks instead of bricks” and continuing to globalize our digital strategy. We do want to be able to be effective so that you as a customer of ours can do anything you want to with that mobile device that you have. So digital relevance is key for us.

Tim Melvin: Final wrap up question here. Both of you guys have been with Lake Shore for a period of time and in the industry and of course in real estate development before that, so definitely involved with banking at that level. The industry is changing and it’s changing pretty quickly. We’re seeing continued compression through mergers and acquisition activities. We’ve talked a little bit today about the rapid technology change. Where do you see the banking industry going over the next several years?

Daniel Reininga: Well from my perspective, Fintech opportunities are going to continue and the fact that the industry can become very efficient through Fintech or electronic interface will allow products to become very commoditized. This will create challenges for profitability if you cannot keep up with the rapidly changing technology.

ASSET REVIEW

Guest Commentary by Bill Moreland of BankRegdata.com


2016 Q2 call report data is available at BankRegData.com. Industry wide assets increased to $16.534 Trillion adding a hefty $240.55 Billion (1.48%) in the 2nd Quarter.

The $240.55 Billion Q2 increase is in addition to the $325.61 increase in Q1. For 2016 YTD Assets have risen $566.16 Billion over 2015 Q4 (3.55%) -‐ the largest 2 quarter $ and % gain since the $576.52 added in 2008 Q3 & Q4 (4.33% over 2008 Q2).

The $180.83 Billion increase in Net Loans and Leases stands out as does the $36.04 Billion Securities gain and the $37.16 Billion drop in Cash & Balances Due. As with all industry trends it's critical to understand the Big 4 and their impact on the overall numbers.


JPMorgan Chase: Chase added $18.35B in Deposits and $25.17B in Net Loans. They shed $6.71B in Securities (adding $2.7B in UST, dropping $3.51B in MBS and $5.96B in Foreign Debt) and $13.23B in Cash.

Wells Fargo: Wells added $20.43B in Securities and increased Net Loans a lower $14.67B. Interestingly, the Securities gain is entirely a result of a $21.07B increase (14.86%) in MBS (all FNMA).

Bank of America: BAC lost $1.37B in Deposits and decided to shed $13.35B in Cash and split the proceeds on increasing Net Loans by $5.33B and adding another $9.56B to their Securities portfolio. They added $3.99B in UST and another $5.25B in MBS.

Citigroup: Citi is interesting in that they lost $276.99M in Deposits and shed $5.52B in Cash and yet was able to grow Net Loans $21.45B and Securities $3.98B. Where did the money come from? They borrowed it as evidenced by their $10.13B increase in Other Borrowed Money. Just $2.50B of the increase was from FHLB Advances.

The $180.83 Billion quarterly increase in Net Loans and Leases came as surprise to me. To appease my inner curiosity demons I did a quick review of growth by quarter to determine where the quarterly growth ranked. Unfortunately, the following chart only let loose the demons to run amok on my daily calendar.

While impressive, the $180.34B in net loan growth was fairly run of the mill. In fact, had I looked at this chart last quarter I should have been able to predict a $180-‐190B increase for Q2.Note the Q2 and Q4 repeating pattern -‐ what is this? Why are banks ramping up lending in Q2 and Q4 much faster than Q1 and Q3?While there is a somewhat similar pattern with the Big Four it's much less pronounced and considerably smoother. My next thought was the Credit Card heavy banks (sans the Big 4) and while there is some seasonality there (Summer vacation and Christmas?) it's not nearly enough to account for increases. Curious indeed.

The flip side of Assets is Liabilities and Equity which shows that Total Deposits grew $98.54B and Other Borrowed Money (not just Citigroup) grew $84.55B.


Prior to reviewing Deposits and FHLB please note the total line of $16,533,978,042,000 and $240,547,796,000. These figures are off by $27,000 and $21,000 respectively compared to the earlier Assets table. This is explained by a tiny portion of banks having $1,000 rounding errors in their Call Reports that get magnified when aggregating all the banks. Total Deposits grew by $98.54 Billion Q on Q while Other Borrowed Money jumped 8.34% to $84.55 Billion.

The $98.54B quarterly increase in Deposits was down from the $239.49B in Q1 and the $199.56B in 2015 Q4. In fact, the $98.54B is the 3rd lowest figure in the past 12 quarters.This means that in order to grow loans banks had to borrow more as reflected by the $84.55B increase in Other Borrowed Money (OBM). FHLB Advances jumped $64.42B in the quarter and made up 76% of the OBM increase.


The $64.42B quarterly increase in FHLB Advances was the highest figure in 31 quarters and was the third highest since at least 2003 Q1.Interestingly, there is a notable pattern the past 3 years of Q2 and Q4 increases with offsetting Q1 and Q3 reductions. It's not dollar for dollar, but the pattern is comparable to the alternating pattern of Q2 and Q4 Net Loan growth seen above. Note the purple text indicating there was $911.5B in FHLB Advances in 2008 Q3 with a subsequent 14 quarter stretch of reductions to the 2012 Q1 low of $305.8B. From there we see an alternating pattern of quarterly increases until the $545.9B in 2016 Q2.Since $2012 Q1 banks have added an amazing $239.77 Billion in FHLB Advances. Almost a quarter of trillion dollars in 4 years. During this time frame 1-‐4 Family 1st Liens have risen from $1.743 Trillion (2012 Q1) to $1.896 Trillion (2016 Q2) a growth figure of $153.01 Billion.

Since the 2016 Q1 Quarterly Review we have added another section to the site detailing broader reporting of all loan portfolios and associated delinquencies and charge offs. The expansion of the Call Report starting in 2012 Q1 resulted in additional reported loan portfolios as well as further breakdowns of several categories (C&I, CRE and Construction).


There is ton of great analyses and commentary available, however, I'll hold off until a later missive. The one note I'll make is the $4.86 Billion and 49.63% quarterly increase in Foreign Government Loans. JPMorgan Chase added virtually the entire amount growing $4.66 Billion.


Insider Buying

The power of insider data is well known. When insiders buy shares of the company, they oversee it because they believe better times and higher stock prices are ahead. Insider Data is courtesy of the incomparable Jonathon Moreland and Inside Insights.com. The following banks had insider buying in the past month:

Symbol Company yld p/tbv ANCX Access National Corp 2.71 1.98 BAC Bank of America Corporation 1.34 0.91 BOCH Bank of Commerce Holdings Inc 1.78 1.01 BKSC Bank of South Carolina Corp 2.98 2.08 BOTJ Bank of the James Financial Group Inc 1.87 1.12 OZRK Bank of the Ozarks Inc 1.64 2.4 BCBP BCB Bancorp Inc 5.24 0.91 CCBG Capital City Bank Group Inc 1.06 1.28 CPF Central Pacific Financial Corp 2.18 1.55 CNBKA Century Bancorp Inc 1.1 1.09 CZWI Citizens Community Bancorp Inc 1.16 0.92 FNB F N B Corp 3.94 1.91


FISI Financial Institutions Inc 3.02 1.68 FNLC First Bancorp Inc 4.35 1.52 BUSE First Busey Corp 2.88 1.94 FIBK First Interstate BancSystem Inc 2.91 1.8 FBC Flagstar Bancorp Inc 0 1.5 FRAF Franklin Financial Services Corp 3.34 0.96 FSBW FS Bancorp Inc 1.23 1.33 FULT Fulton Financial Corp 2.68 1.52 GABC German American Bancorp 2.05 1.92 HTBK Heritage Commerce Corp 3.14 1.95 HEOP Heritage Oaks Bancorp 2.88 1.54 HOPE Hope Bancorp Inc 2.86 1.42 KRNY Kearny Financial Corp 0.6 1.2 LBAI Lakeland Bancorp Inc 2.77 1.64 MLVF Malvern Bancorp Inc 0 1.23 MPB Mid Penn Bancorp Inc 2.67 1.09 MOFG MidWestOne Financial Group Inc 2.13 1.49 NBN Northeast Bancorp 0.36 0.9 NRIM Northrim BanCorp Inc 2.95 1.13 PMBC Pacific Mercantile Bancorp 0 1.25 PPBI Pacific Premier Bancorp Inc 0 2.19 PBNC Paragon Commercial Corp 0 1.26 PGC Peapack Gladstone Financial Corp 0.96 1.17 PVBC Provident Bancorp Inc 0 1.41 SHBI Shore Bancshares Inc 0.95 1.05 STL Sterling Bancorp 1.64 2.3 SBBX Sussex Bancorp 1 1.38 TBBK The Bancorp Inc 0 0.65 TBK Triumph Bancorp Inc 0 1.37 TRCB Two River Bancorp 1.27 1.16 VABK Virginia National Bankshares Corp 1.72 1.04 WFBI WashingtonFirst Bankshares Inc 0.95 1.69 13F FILINGS

As we closed on this issue, money managers and investors were rushing to get their 13F report into the SEC revealing their buying and selling activity for the second quarter of the year. By comparing the quarters report to the prior one, we get a good look at what leading investors have been buying and selling in client portfolios. We delayed the issue a couple of days to get all the filings into this issue of Banking on Profits Monthly so we can look at what some of the biggest players in the Trade of the Decade in small banks have been up to this year. This is a great way to uncover ideas but keep in mind that this is a starting point. Do not blindly follow these movers but move the stocks to the head of your research now list.


Joseph Stilwell is one of our favorite activist investors to pirate ideas from13F and 13d Filings. His letters to the boards of banks he is targeting are always a great read, he has a very high success rate and has made us a lot of money of the years. This quarter he was buying:

Symbol Company yld p/tbv FBP First BanCorp 0 0.58 GCBC Greene County Bancorp Inc 2.19 1 HFBC HopFed Bancorp Inc 1.38 0.88 LSBK Lake Shore Bancorp Inc 2.11 0.7 MGYR Magyar Bancorp Inc 0 0.77 MSFG MainSource Financial Group Inc 2.56 1.41 OFG OFG Bancorp 2.61 0.73

Lawrence Seidman is a former SEC attorney who has posted an excellent record as a bank stock activist investor. He was a buyer of:

Symbol Company yld p/tbv ASBB ASB Bancorp Inc 0 1.06 CWAY Coastway Bancorp Inc 0 0.83 PBBI PB Bancorp Inc 1.32 0.86 PGC Peapack Gladstone Financial Corp 0.99 1.13 PBIP Prudential Bancorp Inc 0.83 1.03 SGBK Stonegate Bank 0.9 0 WSBF Waterstone Financial Inc 1.39 1.21

FJ Capital Management is a fundamentally driven, SEC-‐registered investment advisor founded in 2007 that analyzes and invests in the U.S. community banking industry through various alternative vehicles. The McLean, VA-‐based firm was founded by Managing Member, Martin Friedman and Managing Director Andrew Jose. These are very smart guys who have a strong track record when it comes to community banks stocks. In the first quarter of 2016 they were buying:

Symbol Company yld p/tbv BNCN BNC Bancorp 0.83 1.91 BLMT BSB Bancorp Inc 0 1.39 CLBH Carolina Bank Holdings Inc 0 1.46 CACB Cascade Bancorp 0 1.69 CNOB ConnectOne Bancorp Inc 1.74 1.55 EARN Ellington Residential Mortgage REIT 12.76 0.91 EQBK Equity Bancshares Inc 0 1.39 FCB FCB Financial Holdings Inc 0 1.81 FRBA First Bank Williamstown NJ 0 0.95 FXCB Fox Chase Bancorp Inc 2.75 1.35 FULL Full Circle Capital Corp 11.93 0.73


GTWN Georgetown Bancorp Inc 0.95 1.16 GBNK Guaranty Bancorp 2.38 1.68 HMST HomeStreet Inc 0 1.47 ISBC Investors Bancorp Inc 2.03 1.18 LBAI Lakeland Bancorp Inc 2.83 1.6 NBHC National Bank Holdings Corp 0.89 1.26 OCFC OceanFirst Financial Corp 2.75 1.89 ONB Old National Bancorp 3.64 1.72 OSBC Old Second Bancorp Inc 0.27 1.38 PPBI Pacific Premier Bancorp Inc 0 2.2 SMBC Southern Missouri Bancorp Inc 1.5 1.6 SNC State National Companies Inc 2.31 1.61 UCFC United Community Financial Corp 1.59 1.24 UVSP Univest Corp of Pennsylvania 3.62 1.76 VBTX Veritex Holdings Inc 0 1.63 YDKN Yadkin Financial Corp 1.57 2.08

Clover Partners is a Dallas based hedge fund that takes frequent activist positions in small bank stocks. In the 1st quarter, they were buyers of:

Symbol Company

Trailing Dividend Yield p/tbv

BLMT BSB Bancorp Inc 0 1.39 CSFL Centerstate Banks Inc 0.68 2.04 CFG Citizens Financial Group Inc 1.87 0.95 CSWI CSW Industrials Inc 0 4.98 FBNK First Connecticut Bancorp Inc 1.57 1.03 MLVF Malvern Bancorp Inc 0 1.23 SBCF Seacoast Banking Corp of Florida 0 1.77 SBSI Southside Bancshares Inc 2.88 2.13 OKSB Southwest Bancorp Inc 1.58 1.37 SCNB Suffolk Bancorp 1.21 1.9 UBNK United Financial Bancorp Inc 3.6 1.29

PL Capital is one of the best activists in the bank stock sector. According to their web site, PL Capital specializes in identifying and acquiring stakes in undervalued U.S. banks and thrifts and participates in the long-‐term consolidation of the banking industry. PL Capital manages four limited partnerships (LPs) focused on publicly traded banks/thrifts with between approximately $300 million to $3+ billion in assets, operating in attractive market areas, which are undervalued and in need of a catalyst to unlock shareholder value. The principals of PL Capital engage in shareholder activism (when needed) including


proxy contests, board representation, shareholder proposals, etc. to unlock shareholder value. In the 1st quarter they were buying:

Symbol Company yld p/tbv MSFG MainSource Financial Group Inc 2.56 1.41 TOWN Towne Bank 2.11 0 PNC PNC Financial Services Group Inc 2.43 1.21 COF Capital One Financial Corp 2.33 1.03 UBNK United Financial Bancorp Inc 3.6 1.29 PEBO Peoples Bancorp Inc (Marietta OH) 2.67 1.46 RVSB Riverview Bancorp Inc 1.47 1.32

Patriot Financial Partners is a private equity firm focused on investing in community banks, thrifts and financial services related companies throughout the United States. Patriot’s objective is to seek superior risk-‐adjusted returns by applying a hands-‐on, value-‐added investment model to non-‐control investments within the community banking sector, which consists of more than 1,000 public and privately-‐held depository institutions that have between $500 million and $5 billion of assets. Patriot has expanded its focus to include adjacent niche markets within the financial services sector. This Quarter they were buying:

Symbol Company yld p/tbv CASH Meta Financial Group Inc 0.9 1.83 OCFC OceanFirst Financial Corp 2.75 1.89 AVNU Avenue Financial Holdings Inc 0 2.13 Stieven Capital Advisors is a St. Louis based firm that has achieved a great deal of success investing in community bank stock. In the 4th quarter they were buying:

Symbol Company yld p/tbv MSFG MainSource Financial Group Inc 2.58 1.4 EWBC East West Bancorp Inc 2.29 1.78 PACW PacWest Bancorp 4.77 2.2 PPBI Pacific Premier Bancorp Inc 0 2.21 SIVB SVB Financial Group 0 1.57 OSBC Old Second Bancorp Inc 0.27 1.38 ZION Zions Bancorp 0.84 1 CUNB CU Bancorp 0 1.76 PVBC Provident Bancorp Inc 0 1.41 FLIC First of Long Island Corp 2.59 1.46 AVNU Avenue Financial Holdings Inc 0 2.13 HTBK Heritage Commerce Corp 3.12 1.95 WTFC Wintrust Financial Corp 0.88 1.39 QCRH QCR Holdings Inc 0.4 1.3 FBNC First Bancorp 1.72 1.33


INBK First Internet Bancorp 1.04 0.98 ONB Old National Bancorp 3.64 1.72

Basswood Capital is another bank fund with a strong record and willingness to take an activist stance when necessary:

Symbol Company yld p/tbv BOTJ Bank of the James Financial Group Inc 1.86 1.12 TCFC The Community Financial Corp 1.76 1.03 BMRC Bank of Marin Bancorp 2.01 1.39 WCIC WCI Communities Inc 0 0.94 AMP Ameriprise Financial Inc 2.96 2.21 CVTI Covenant Transportation Group Inc 0 1.64 SIVB SVB Financial Group 0 1.57 HBAN Huntington Bancshares Inc 2.82 1.35 HFWA Heritage Financial Corp 2.62 1.47 BBX BBX Capital Corp 0 1.01 VBTX Veritex Holdings Inc 0 1.63 SBNY Signature Bank 0 1.88 PNC PNC Financial Services Group Inc 2.43 1.21 EQBK Equity Bancshares Inc 0 1.39 TOL Toll Brothers Inc 0 1.16 TBK Triumph Bancorp Inc 0 1.34 CAA CalAtlantic Group Inc 0.33 1.42 BUSE First Busey Corp 2.86 1.95 OCFC OceanFirst Financial Corp 2.75 1.89 STL Sterling Bancorp 1.63 2.32 WFC Wells Fargo & Co 3.11 1.76 BOFI BofI Holding Inc 0 1.71 LBAI Lakeland Bancorp Inc 2.83 1.6 AER AerCap Holdings NV 0 1.36 COF Capital One Financial Corp 2.33 1.03 BANR Banner Corp 1.85 1.37 AL Air Lease Corp 0.68 0.88 ONB Old National Bancorp 3.64 1.72 KEY KeyCorp 2.63 1.04 OMF OneMain Holdings Inc 0 3.69 PGC Peapack Gladstone Financial Corp 0.98 1.14 FITB Fifth Third Bancorp 2.66 1.21 RF Regions Financial Corp 2.57 1.09


Key Takeaways

In spite of White House reports stating otherwise bankers still think that Dodd-‐Frank is a big problem and cost item, especially for smaller institutions.

Bankers on earnings calls this quarter anticipate using M&A as a path to growth.

Institutions and Insiders continue to accumulate shares of community banks

Documents

The Community Bank Investor Newsletter August 2016 · The Community Bank Investor – August 2016