ArrowMark Financial Corp. Q4 FY2020 earnings call

• Banking industry: Fourth quarter continued trend of better-than-expected earnings for banks, with banks well capitalized but concerns in pandemic-affected sectors. Community banks in portfolio serviced local markets well, PPP loans helped mitigate loan loss reserves.
• Community banks: Median net income up 16.8% QoQ, average Tier one capital ratio 12.3% (flat from Q3), change in reserves up 15bps to 1.37%, loan books flat.
• Regulatory capital sector: Investments performed extremely well with some paying down at par or amortizing ahead of schedule.
• Origination pipeline: Q4 primary markets active in regulatory capital ($3.5B) and community banking securities ($2.6B). Regulatory capital full year issuance ~$9B, optimistic for 2021; community bank sub-debt issued in 4%-6% range.
• StoneCastle results: Q4 net investment income ~$3.1M ($0.46 per share), up 11% from prior quarter; portfolio value $178.4M at quarter end (up 21% from Q3); NAV $21.44 per share, up $0.55 from prior quarter.
• Portfolio review: Invested $42.5M in Q4 (37.5M in regulatory capital, 5M in community bank preferred stock), new investments had weighted average coupon 10% and YTM ~10.4%, proceeds from calls/sales totaled $22.9M, estimated annualized effective yield ~9.65%.
• Transition to StoneCastle ArrowMark: New investments of $99.3M in 2020, Board declared $0.05 special dividend, NAV grew from $19 to $21.44 per share from March to year-end.

In the regulatory capital sector, investments performed extremely well during Q4 with several either paying down at par or amortizing ahead of schedule. In the community banking segment, most community banks reported sequential growth in net income with median net income up 16.8% versus the third quarter. These banks had average Tier one capital ratios of 12.3% (flat from Q3) and a fourth quarter change in reserves up 15 basis points to 1.37%, with loan books flat from the prior quarter. Absolute terms: Regulatory capital investments saw strong performance; community banks had net income growth, stable Tier one ratios, etc.

• Cautiously optimistic outlook for banking industry in first half of 2021, encouraged by government stimulus and agency programs likely distributed through banks like PPP.
• Optimistic on regulatory capital issuance in 2021 with full year 2020 issuance ~$9B and Q4 primary issuance $3.5B.
• Community bank sub-debt issuance likely to continue at historically low rates in 4%-6% range into foreseeable future.

Forward-looking statements involve substantial risks such as changes in securities or financial markets, general economic conditions, volumes of sales and purchases of shares of common stock, continuation of investment advisory administrative and service contracts, and other risks discussed in the company's SEC filings.

Q: Could you provide the average yield for the fourth quarter and any change in yield for investments made following the quarter end?

A: Pat Farrell mentioned the quarter end yield was 9.65%, and investments made post-quarter end are also strong, with some in the 9s and a couple in the 10s.

Q: Is it safe to say alternative investments will lead first half 2021 demand, especially given community bank sub-debt issuance slowdown?

A: Sanjai Bhonsle said community bank sub-debt issuance is in the 4%-6% range and is slowing, with liquidity likely deployed in regulatory capital investments in Q1 and Q2.

Q: Is the first quarter net investment portfolio growth not likely to be much stronger than indicated in the press release, given regulatory capital is seasonally lower?

A: Sanjai Bhonsle stated they made additional purchases in Q1, with activity in primary and secondary markets, though timing of repayments is uncertain but they have been active buying new investments in Q1