- Regional banks get pummeled when the yield curve inverts, and right now, the yield curve is strongly inverted.
- However, the yield curve should un-invert in the coming months.
- The five regional banks detailed below are based across the country, from Maine and Rhode Island to Kentucky and West Virginia to the Lone Star State of Texas.
- Their dividend yields range from 2.85% to 4.75%, but each has good dividend safety and growth prospects.
The noble community bank has certainly seen better days. Its basic business model is to borrow short for relatively low interest rates and lend long at relatively high interest rates, pocketing the spread. Simple enough, right?
Well, that simple business model is made much harder when the yield curve (the level of various interest rates from short to long duration) flattens or inverts. In the past twelve months, interest rates have flattened to the point of significant inversion twice: once around August 2019, and now again this past week.
It has gotten so bad that even the 30-year Treasury rate is offering almost the same yield as the effective Fed Funds rate (aka the "overnight" rate):
For your humble community bank trying to turn a profit by borrowing (or accepting deposits) short and lending long, this is an extremely undesirable situation. Borrowers are flooding their doors to refinance their loans at lower rates, and meanwhile, they still have to pay the same rates to their depositors and on their own short-term borrowings. Margins are getting squeezed.
Perhaps this is why we've seen five of my favorite high-quality, dividend-paying regional bank stocks get pummeled over the last several months:
The good news is that inverted yield curves tend not to last very long. Economic conditions inevitably shift such that either the short end of the yield curve falls below the long end, or the long end rises above the short end — or both simultaneously. I suspect that in the coming weeks or months, we'll see the short end falling while the long end bounces back up. That should provide some relief for beaten-down regional banks.
In the meantime, we investors now have a marvelous buying opportunity before us! So let's dive into five regional bank stocks that pay growing dividends, offer attractive starting yields, and could make good buys this week.
1. WesBanco Inc. (WSBC)
- Dividend Yield: 4.18%
- P/E Ratio: 10.6x
- Consecutive Years of Dividend Growth: 9
WesBanco is a $2.5 billion regional bank operating in West Virginia, Ohio, Kentucky, Pennsylvania, and Southern Indiana. What's more, with the recently announced $500 million acquisition of Old Line Bank, WSBC has gained exposure to Maryland as well.
Source: WSBC Q4 2019 Presentation
The bank has a century-old wealth management division worth $4.7 billion as well as a diversified loan portfolio, slightly under three-fourths (72%) of which is in real estate (48% commercial and 24% in residential).
Source: WSBC Q4 2019 Presentation
The slightly higher-yielding commercial & industrial and home equity line of credit loans are the fastest-growing, with five-year organic CAGRs of 6% and 5%, respectively.
Many of the bank's loans and wealth management clients are associated with the shale gas business in the Marcellus and Utica regions, making WSBC a play on natural gas (albeit an indirect one) over the long term.
And with a very conservative loan-to-deposit ratio of 90.8% (or loans equaling 0.908x of deposits), the bank still has room to expand its loan book.
The net interest margin in Q4 2019 decreased 17 basis points YoY to 3.55% (and core NIM was 3.33%, down 16 basis points YoY) but only 1 basis point QoQ. The NIM for full-year 2019 rose to 3.62%, rising 10 basis points over FY2018's average. Nonperforming assets as a percentage of the total came in at 0.70% in 2019, down from 2018's 0.71% and 2017's 0.89%.
Management announced that they will be opportunistically executing share buybacks in 2020. The timing of this buyback program couldn't be better, as the stock has scarcely been this cheap since the Great Recession.
And yet, the payout ratio (by both earnings in blue and free cash flow in orange) remains quite comfortable and significantly lower than it was prior to the recession. In 2019, the bank paid out less than a third of both EPS and FCF as dividends.
Assuming the dividend grows at an average annual pace of 7% (roughly in-line with its growth since emerging from the Great Recession), buying in at today's 4.18% starting yield would result in a yield-on-cost after ten years of 8.22%. Even assuming growth slows in the next recession and dividend growth averages only 5.5% per year, the 10-year YoC would still come to a respectable 7.14%.
Interestingly, the price dip has attracted several of the bank's directors to buy shares recently, and at higher prices than what are offered today. When it comes to buying stocks, I always like following the lead of the insiders who know the ins and outs of the company better than anyone else.
2. Community Trust Bancorp (CTBI)
- Dividend Yield: 3.93%
- P/E Ratio: 11.8x
- Consecutive Years of Dividend Growth: 39
Community Trust Bancorp is a small-cap (~$700 million) regional bank headquartered in Pikeville, Kentucky serving small to mid-size communities in Kentucky, West Virginia, and Tennessee. The bank offers the standard range of financial services, from retail and commercial banking to wealth management and insurance. About one-quarter of revenue comes from non-interest income such as wealth management and loan origination fees, with the remainder derived from loan assets.
Two-thirds of the bank's loan portfolio is in real estate, with more in commercial than residential. Note, however, the 21% in consumer loans.
Source: CTBI November Presentation
As of Q3 2019, the bank had $3.21 billion in loan assets and $3.62 billion in deposits, meaning that its loan-to-deposit ratio sits at a healthy ~0.89x. In other words, 88.7% of deposits were loaned out and generating interest income as of the end of September 2019.
The net interest margin fell from 3.66% in 2018 to 3.62% in the first three quarters of 2019, with the efficiency ratio rising from 60.17% to 61.32% in that time frame. Nonperforming loans as a percentage of the total jumped from 0.69% in 2018 to 0.98% in the first three quarters of 2019. On the positive side, however, return on average assets jumped from 1.41% in 2018 to 1.5% in 2019.
Most of the executive team of CTBI has spent decades at the bank, and insider ownership is fairly high at around 5% of the company.
The stock has become almost as cheap as it has been since the Great Recession, aside from a sharp selloff in 2012.
But the dividend remains as safe as ever, still well-covered by free cash flow. In 2019, CTBI paid out 40.3% of earnings per share (the lower end of the company's 40-50% range) and 35.3% of FCF per share.
Assuming the dividend continues growing at 5.5% per year on average (as it has over the past three years), buying in at today's 3.93% starting yield would result in a 10-year YoC of 6.7%. That may not be terribly exciting, but it's pretty decent for a company that has raised its dividend for almost four straight decades!
3. Washington Trust Bancorp (WASH)
- Dividend Yield: 4.75%
- P/E Ratio: 11.3x
- Consecutive Years of Dividend Growth: 10
Washington Trust Bancorp might just be Rhode Island's best-kept secret - at least as far as dividend growth investors are concerned. I wrote about this gem of a regional bank back in a September 2019 article, and since then the company has returned -3.27% versus SPY's 1.72%. For a while, I kicked myself for not having bought more, but now I'm glad I held back from buying at higher prices and never filled out a full position.
The bank doesn't do anything fancy, but it doesn't need to. Three quarters of its loans are for real estate, with slightly over half of those for commercial real estate and slightly under half for residential. Return on assets is slightly higher than the US bank average, and asset quality is high. Nonperforming loans as a percentage of the total is very low and barely budged higher during the Great Recession.
WASH has been rewarding shareholders, including and especially through dividends, for a very long time. Importantly, the company did not need to cut its dividend during the Great Recession. A flat dividend, as was the case for WASH in 2008-2009, is far better in my book than a cut dividend.
Like the previous two banks, WASH has not been this cheap since the Great Recession:
While WASH's free cash flow can be a bit volatile on a quarterly basis, it consistently covers the dividend over any twelve-month period. In 2019, the bank paid out 50.5% of earnings per share and 49.5% of FCF as dividends.
Assuming the dividend grows at an average annual rate of 7% going forward (lower than its average of 9% over the last decade), would result in an attractive 10-year YoC of 9.34%.
4. Bar Harbor Bank (BHB)
- Dividend Yield: 4.31%
- P/E Ratio: 14.1x
- Consecutive Years of Dividend Growth: 17
Bar Harbor Bankshares is a $356 million market cap regional bank based in the island town of Bar Harbor, Maine. On our vacation to Maine and Canada this past summer, my wife and I very much enjoyed walking the streets of the quaint little town, dipping into the unique shops, sampling craft beers at the breweries, and (for my wife, at least) trying one of Maine's famous lobster rolls. (I'm not much of a seafood person myself.)
And, of course, having discovered Bar Harbor Bank during my research into this little town, I made sure to snap a picture of the bank's headquarters when we passed by it.
Image Source: Author
Inside this humble building, the bank's management has created shareholder value for decades now, even while remaining committed to the local community and to the preservation of the beautiful Mount Desert Island on which the bank is headquartered. One important way BHB has created shareholder value is through 26 years of uninterrupted dividends and dividend raises in the last 17 consecutive years.
Of course, the only way a company can continue to pay a growing dividend for so long is by consistently covering the payout with free cash flow, as BHB has done. In 2019, BHB paid out 45% of earnings per share and 48.8% of FCF per share as dividends.Like the other banks in this article, BHB's stock price has been driven down due to falling interest rates. As I wrote in my July 2019 article on Bar Harbor Bank, earnings have been under pressure as borrowers refinance their loans in droves to take advantage of lower rates, even as rates on interest-bearing deposits hold steady. This certainly pressures the bank's net interest margin, but as already stated, flat (and especially inverted) yield curves tend not to last very long. Economic pressures typically force short-end rates down or long-end rates up - sometimes both simultaneously.
Since the core headwind for BHB is a flat/inverted yield curve, and flat/inverted yield curves tend not to last multiple years, I view the pullback in BHB's stock price as an attractive entry point for long-term investors.
Assuming average dividend growth of 6.25%, around the same as the previous 10-year average, buying in at the current dividend yield of 4.31% would result in a 10-year YoC of 7.9%. Considering the low-risk, recession-resistant nature of this company, I find that an attractive YoC projection.
5. Prosperity Bank (PB)
- Dividend Yield: 2.85%
- P/E Ratio: 11.85x
- Consecutive Years of Dividend Growth: 16
Prosperity Bank is a Houston, Texas-based retail bank. The company operates 243 full-service locations over most of the business-friendly state of Texas as well as central Oklahoma (Tulsa and Oklahoma City). Despite its widespread presence across the state, Prosperity only accounts for about 3% of deposit market share in Texas, giving it plenty of room for growth. The company pursues growth both organically and through acquisitions, having integrated dozens of smaller banks over the decades.
PB is one of the most recession-resistant regional banks I have come across, having grown its net interest income and net income right through the last two recessions. The huge oil price collapse of 2015-2016 did cause a temporary pullback, but the company seems to be on the upswing again.
The bank has a diversified loan book, with real estate accounting for only 55.5%.
Source: Q4 2019 Presentation
The average yield on all loans of 5.42% compares favorably to the average cost of all deposits of 0.61%, though both are likely to fall in the coming quarters as interest rates have fallen significantly, and the Fed is likely to follow up with rate cuts soon.
Over the last decade, both total assets and equity have grown impressively, overcoming the slow years around the oil price collapse.
Source: Q4 2019 Presentation
The loan-to-deposit ratio has risen from 0.6x (60.1%) in 2018 to 0.715x (71.5%) in 2019 as the bank expands its loan book, which should also expand net interest income and profitability. Speaking of profitability, the NIM seems to be on the upswing, having bounced off its lows of 3.09% in 2017 and crept back up to 3.18% in 2019.
Source: Q4 2019 Presentation
In 2019, PB paid out a mere 35.9% of earnings per share and 27.8% of FCF per share as dividends, making its dividend one of the safest in the regional banking industry. It has a long history of covering its dividend with FCF.
Assuming the bank continues to grow its dividend at an average rate of 11.5% per year over the next 10 years (as it has done over the past 10), then buying in at today's starting yield of 2.85% would result in a 10-year YoC of 8.46%.
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This article was written by
Austin Rogers is an REIT specialist with a professional background in commercial real estate. He writes about high-quality dividend growth stocks with the goal of generating the safest growing passive income stream possible. Since his ideal holding period is "lifelong," his focus is on portfolio income growth rather than total returns.Austin is a contributing author for the investing group High Yield Landlord, one of the largest real estate investment communities on Seeking Alpha, with thousands of members. It offers exclusive research on the global REIT sector, multiple real money portfolios, an active chat room, and direct access to the analysts. Learn more.
Analyst’s Disclosure: I am/we are long BHB, WASH, WSBC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
I may initiate a long position in CTBI and PB over the next 72 hours.
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