So far in 2012, financials (XLF) are among the leading economic sectors in the S&P 500. With the exception of the relatively small telecommunications services sector, the 13% return is the best and is well ahead of the 7.9% price return for the S&P 500. Smaller financial stocks are also outperforming the market. Considering that financials are the second largest sector in the market, the performance is even more impressive. The sector, however, has been a laggard for years, with a -16.5% five-year return compared to -2% for the S&P 500 through June 30, 2012, the worst performing sector by an extremely wide margin.
Last September, I suggested that high-quality financials offered a great opportunity for dividend growth investors, and I continue to believe that is the case, although many of the stocks profiled have performed quite well. With positive momentum in the sector, it's worthwhile to consider why investors may be finally buying some of these stocks. Here are a few reasons:
- Valuations are low
- Many have a domestic focus
- Fundamentals have been constrained -- one way to go
- Dividends are being restored/growing again
Large-cap banks get a lot of investor attention and appear to be quite cheap, but most of the largest banks have significant risks ranging from potential liabilities related to the mortgage meltdown to exposure to Europe and beached "whales." Still, with single-digit P/E ratios and dividends tending to be higher than the market, it's hard to dismiss these stocks.
For more conservative investors, smaller banks also seem to offer tremendous value. I set up a screen using Baseline to identify banks with strong balance sheets that are paying above-market dividends. Here are the parameters I used:
- Market Cap > $100 million
- Net Debt to Capital < 20%
- Dividend Yield > 2.5%
- Trailing P/E < 15
- Price/Tangible Book < 2
By definition, then, the resulting banks had reasonable valuations with large deposit bases. I ended up with 14 stocks, but I decided to throw in another requirement: The current dividend per share had to be at an all-time high. This left 10 names:
Please keep in mind that these aren't recommendations. This is quite a diversified list, with nine different states represented. With the exception of BOK Financial (BOKF), the stocks that made the cut are small-caps.
I highlighted stocks, ranked by dividend yield, that stood out with respect to certain parameters. First, three have no debt at all. Second, almost all of these banks have in excess of 90% of their liabilities in the form of deposits. One stock trades below 10 P/E on a trailing basis. Most of the stocks yield in excess of 3%. More than half have increased their dividends in each of the past five years. Half have grown their dividends by more than 6% per year over the past five years. Two stocks have high payout ratios, but six are below 40%. Finally, three stocks have pre-tax ROA in excess of 1.8%.
1. The highest-yielding stock, First Financial Bancorp (FFBC) is based in Cincinnati and is paying out 100% of net income for the next six quarters. At that time, the FDIC loss-sharing arrangement related to acquisitions in 2009 comes to an end, and the dividend will be cut. Insiders own 3.6%.
2. Univest Corp. (UVSP) is based in Souderton, Penn., with most of its business in the wealthy counties of Bucks and Montgomery. It was not a TARP participant. Insiders own 4.4%. This one has the poorest LT earnings growth of the qualifying banks, but deposits have been growing the past few years.
3. Bridge Bancorp (BDGE) is based in Bridgehampton, N.Y. Deposits have more than doubled over the past four years. Earnings are forecast to decline in 2012 and rise in 2013, but are still well below the peak from 2004. Insiders own almost 7%.
4. Community Trust Bancorp (CTBI) is based in Pikeville, Ky. While the growth has been modest over the past five and 10 years, it has recently posted record earnings. Analysts are projecting growth in 2012 and 2013. Insiders own 6.6%.
5. Southside Bancorp (SBSI) is based in Tyler, Texas. Deposit growth has been torrid, up 50% over the past three years. Like many banks, though, it is struggling to make loans, with total lending growing 2%-3% per year. Analysts are expecting earnings to decline this year and next after a surge to record levels in 2011. It's worth noting that M&A activity has picked up in Texas. Insiders own over 8%.
6.National Bankshares (NKSH) is one I know well, as it has been in my Conservative Growth/Balanced model portfolio for over 18 months. Based in southwestern Virginia, this one pays semiannual dividends and quite consistently (an increase every year since 1996). The bank must not face too much competition, as its pre-tax ROA is quite high at 2.2%. Like many others on this list, it is drowning in deposits, unable to lend at the same rate. Leverage is quite low, with loans at just a bit over 4 times tangible equity. Insiders own 4.5%. The stock has had a nice run, and I am trimming it in the model in order to fund another opportunity. Still, I think it has at least 20% upside over the next year (38.50) based on attaining 14 P/E.
7. German American Bancorp (GABC) is based in Jasper, Ind. The only thing declining at this bank is the payout ratio. It hasn't boosted its dividend since 2005, but earnings have doubled since then. In 2011, it completed a relatively large acquisition (American Community Bancorp). The bank has been growing in Bloomington. Insiders own 10%.
8. BOKF, based in Tulsa, Okla., is the largest on this list by far. It actually operates in several other states as well. Every time I have looked at this one over the years I have been impressed by their diversification. 43% of revenue is from fees and commissions. In recent years, loans have declined while deposits have grown. It has managed to grow EPS by 6% per year over the past five years despite the headwinds. Insiders own over 60%, with the vast majority of that held by Chairman George Kaiser or entities he controls.
9. Enterprise Bancorp (EBTC) is based in Lowell, Mass. Earnings are at an all-time high. Deposits are flooding in here too -- up 5% sequentially in Q1. There is no analyst coverage on this stock. Insiders own over 30%.
10. BancFirst Oklahoma (BANF), based in Oklahoma City, is the last but certainly not least. Deposits grew by 67% over the past five years, but loan growth has been muted. Insiders own 49%, mainly CEO Rainbolt (40%). Employees also own almost 7% through an ESOP.
So, we have looked at 10 deposit-rich banks that have been maintaining or boosting their dividends for the past five years despite a challenging environment. When rates rise or loan demand picks up (probably "and," not "or"), earnings growth should accelerate for these banks. The M&A environment might pick up as well, leading to potential acquisition for some of these over time. I like financials, and these small banks look good to me for yield-hungry investors seeking current income, dividend growth and potential capital gains.
Disclosure: NKSH is held in one or more models managed by the author at InvestByModel.com.