Dividends, Acquisitions, And Hidden Alpha: The Argument For Small Banks

by: Daniel Shvartsman

In a fully diversified portfolio there remains the need for a financial company, despite the turbulence in the sector over the past few years. I see five ways to go long in financials:

1. Hold a top big bank like JPMorgan (NYSE:JPM) or Wells Fargo (NYSE:WFC).

2. Pick a large U.S. regional bank that has limited European exposure and strong leverage in the sector.

3. Choose one of the underperformers in the sector in hopes of a long-term turnaround (Bank of America (NYSE:BAC) as the obvious play here).

4. Pick an insurance company that has the characteristics of a financial but holds a different part of the business. Fidelity National Financial (NYSE:FNF) is an example of an insurance company that has risen 39% from March 2011, and which rose in a much steadier fashion than the market at large.

5. Find a small bank or savings & loan institution to ride.

Here, I'd like to lay out the argument and some options for going with a small bank stock. Owning a small bank stock comes with tradeoffs. In trades away from small-cap stocks and to bigger safe havens, these banks can suffer. It is also harder to stay informed about the stock; major news sources don't cover the company, analysts are few and far between, and the banks themselves provide less information and help to individual investors, with many of them eschewing conference calls for earnings reports or providing detailed guidance on a yearly basis, let alone quarterly outlooks.

The flip side to all that is that if the investor can dig through, there's more potential to find the mythical alpha, the knowledge-added component that can put the investor ahead of the move. Small banks also are less burdened by new government regulations or exposure to bad (European) markets. They are closer to the customer and in some ways play a more essential role in the economy, directly supporting individuals and small businesses in their communities. These banks often pay better dividends than bigger members of the sector. Lastly, the banking industry is consolidating rapidly. This is not a good development for the industry, consumers, or the economy as a whole, but it continues unabated. Well-run, small S&L institutions and saving banks are the ground level for consolidation through mergers & acquisitions, so the possibility of a sudden big payoff lingers for shareholders.

I ran a screen for S&L institutions and Savings banks with a market cap between $400-900 million, a dividend yield above 2%, and average daily trading volume above 30,000, and then ran the numbers on revenue growth, dividend yield, earnings ratios, and book value. The results are below:

As of Q1 2012







Market Cap







Quarterly Revenue Growth (Y-over-Y)







Yearly Revenue Growth







EPS Growth (Annual)







Estimated Earnings Growth (next 3 years)







2011 P/E







2012 P/E







2013 P/E






















(Yield %)





.52 (3.88%)



.34 (3.79%)

.52 (3.57%)

Price Change (past 12 months as of May 9)







Average Analyst Ratings

(# of Analysts)













* Earnings growth for Berkshire is only for one year's data.

(Definitions: Revenue = (Non-interest Income + Interest Income), Yearly growth is 2011 v. 2010, Quarterly Revenue Growth Y-over-Y is Q1 2012 v. Q1 2011; EPS growth measured across past 3-5 years as applicable; Estimated earnings growth is based on average estimates from TDAmeritrade, WSJ; Book value/share is based on 2011 year-end share count; Average analyst ratings are based on WSJ research and ratings, averaged on a scale from 1 (Buy) to 5 (Sell))

A run through each of the banks listed:

Berkshire Hills Bancorp (NASDAQ:BHLB) - Berkshire Hills Bancorp is based in Pittsfield, MA. The bank just recently completed a transaction of the Connecticut Bank and Trust Company; as a result, the bank has 68 branches in Vermont, Massachusetts, Connecticut, and New York, and $4.3B in total assets. The bank is also in the process of acquiring Greenpark Mortgage Corporation's, "business model, expertise and certain other assets." This builds off two acquisitions/mergers in 2010, and has positioned the bank well in an admittedly rural area, but one that is a major vacation spot for both New Yorkers and Bostonians with money. A bank looking to connect customers from those two cities to their vacation areas could feasibly consider acquiring Berkshire.

BHLB, which dubs itself "America's Most Exciting Bank," certainly has the most exciting growth metrics of this group, with strong revenue and earnings growth over the past year and forecast for the next few years. Despite a solid past year, the stock remains undervalued relative to its peers and its forward earnings. The analysts covering the stock are unaminous in rating it a Strong Buy , with price targets between $25-26/share, an 11-15% rise from current levels. The dividend is low for this group, but BHLB raised it last fall for the first time since the crisis, and with a payout ratio of 43.5% and growing earnings, the bank has room to do it again. 12x 2013 earnings would have the stock at 25.68, while the book value of 30.8 offers 37% upside. This looks like a strong, relatively growth-oriented play in the sector.

Dime Community Bancshares Inc (NASDAQ:DCOM) - Based in the Williamsburg neighborhood of Brooklyn, NY, Dime predates the hipsters who clog Brooklyn's streets, and will survive them as well. The bank has 26 branches Brooklyn, Queens, the Bronx, and in Nassau County, and $4.02B in assets. The bank has mostly grown organically over recent years, with no major acquisitions in the past decade.

Dime's location is its obvious advantage, as the bank has access to a variety of immigrant communities and customers whose fortunes are tied to New York City. The company had a strong period of earnings growth over the past few years, but analysts expect that to grind to a halt over the next three years, with earnings forecast to shrink. The company has paid the same $.14/share quarterly dividend for 8 years, shocking consistency for both good and ill. While there is a little upside in the earnings valuation, the fact that the bank has the highest P/Book value ratio among this group and that it has passed its near-term growth peak suggests that while DCOM would be a better investment than a CD, it's not worth taking compared to its peers.

Flushing Financial Corporation (NASDAQ:FFIC) - Flushing is another New York boroughs bank play, with 17 branches mostly in Queens and Brooklyn. The bank has $4.4B in assets. The company is another that focuses on serving immigrant populations and focuses in presentations on reminding investors that Queens is the most diverse neighborhood in the country. This is another bank that has grown organically, with no mergers or acquisitions to report.

FFIC has missed earnings estimates for two quarters running, though it did beat on revenue last quarter. Whether because of that revenue beat or other factors, the stock has risen since earnings by nearly 7%. The bank has not raised the dividend since the crisis, and while there looks room in the payout ratio to increase the dividend, there is no indication that will come anytime soon. The stock seems close to appropriate value, and while not a bad one to hold, is not necessarily worth a buy at these levels.

Oritani Financial Corp (NASDAQ:ORIT) - Oritani is based in New Jersey. It has $2.6B in assets and 22 full-service branches. The bank is a standout in this sector for two reasons: the stock price has outperformed its peers comfortably over the past year, and the bank has actively sought to return value to shareholders, with three share buyback programs announced over the past year and two dividend hikes. This gives the bank the highest dividend yield in this group at 4.23%, as well as the highest payout ratio, at 82% of estimated 2012 earnings.

The market has appreciated these moves, and Oritani is the highest valued stock in this group. Based on the valuations, it is not worth buying. Still, an investor who likes to snag the best dividend in a group and/or one who reads into these buybacks and dividend hikes as a sign of aggressively confident management, a bullish sign for the future perhaps, could find a stock they like in Oritani.

Brookline Bancorp Inc (NASDAQ:BRKL) - Like its fellow Massachusetts-based peer BHLB, Brookline Bancorp has strong recent growth behind them and strong future growth forecast for them. Based in Boston neighbor Brookline, MA, the company is the parent of three banks: the eponymous Brookline Bank, the First National Bank of Ipswich (serving Northern MA), and Bank Rhode Island, the last acquired over the past year. The company has 44 branches across its three banks, with $4.9B in assets.

While growth has been there for BRKL, the valuation has followed right on. The potential accretion from the Bank Rhode Island transaction should have factored into analyst estimates; given that, the bank is valued highly compared to peers. The dividend has been at its current levels for a decade, and though the stock used to pay a special dividend of $.2/share every quarter, that hasn't happened since 2009. At these levels, Brookline is not the most attractive stock in the group, though its location is a good one and it remains an attractive acquisition target.

Provident Financial Services Inc (NYSE:PFS) - Our last bank is another New Jersey outfit, one with steady earnings growth and a recent dividend hike. Provident Financial Services is the largest bank in this group on market capitalization and total assets, with $7.12B in assets. Based on two major mergers in the mid-2000s, the bank has over 80 branches in northern and central New Jersey. The bank started in Jersey City as an immigrant-oriented bank, though it has expanded its focus especially over the past decade beyond retail and commercial-based banking.

The stock has performed positively over the past year. The quarterly dividend was upped a penny in the most recent quarter, the second consecutive first quarter hike of the dividend for the stock. With a 15% discount to its book value and the ongoing earnings growth, the stock seems to be the steadiest long-term play in this group.


Small banks can be frustrating to own at times and sway on low trading volume or unpredictable market forces. At the same time, they provide investors solid dividends, throwback conservative banking practices, and a good deal of possible alpha compared to what the broader market or other investors follow, with the possibility of acquisition always looming.

Of the banks discussed here, all of whom coincidentally happen to be Northeast banks connected to perennially strong economic regions, there is some stratification. BHLB is the strongest growth play, ORIT offers a strong dividend and some bullish signs, and PFS is a steady long-term play. FFIC and BRKL are decent holds if you already have them, and DCOM pays a nice dividend though otherwise appears unattractive.

Disclosure: I am long FFIC.