Mathew Emmert, author of the dividend-oriented newsletter Motley Fool Income Investor, originally published this article on Sept. 15, 2003. However, the stocks that he mentions here, as well as the resources that he provides in order to help you find your own quality, small-cap banks, are just as relevant today.
If you caught last week's commentary, you know I spoke of Burke & Herbert Bank and Trust (OTC BB: BHRB) as my favorite among small banking firms. However, there are many other solid banks in this underappreciated universe, and some offer a little more liquidity than Burke & Herbert, which can make it a bit easier to get your hands on the stock. That said, these companies are still very thinly traded and, as is the case with most stocks, investors should take a particularly long-term view when considering a purchase here.
One thing that was perhaps most refreshing during my interview with Mr. Burke and Mr. Collum for last week's piece on Burke & Herbert was that they spoke so plainly about their business, and I think that's something you'll notice about the management of all the companies I am about to discuss.
What I mean is, the comments made by these gentlemen are not the typical Wall Street bravado or thinly veiled attempts at marketing their company's stock. Though the collective accomplishments of the leaders of these financial institutions mean they have every right to pat themselves on the back, they remain all business. In this market, where you often find companies with more hype than substance, it's a refreshing thing to encounter.
With that said, prepare to be refreshed, as these remaining banks float in on the cool calm winds of their own success.
Solid as Granite
The first company today is Bank of Granite
Despite its comparatively miniscule size, the bank gained instant notoriety over its larger competitors when Warren Buffett referred to Granite as "the best-run bank in the United States" several years ago at a Berkshire Hathaway
This is particularly surprising when you consider that it has consistently whipped the pants off its competitors when it comes to just about every financial metric one can imagine. The firm has an outstanding return on assets (ROA) of 2.1% and a return on equity (ROE) that has historically hovered between 14% and 16%, which is respectable given its low cost of capital.
In addition to its proven ability to generate capital gains for shareholders, the company offers a relatively plump 2.4% dividend yield. The shares are running at about $20 per stub, which can be a little more manageable than Burke & Herbert's $2,000 price tag, and it trades about 13,100 shares per day.
Valued at two times book and 15 times forward earnings, the bank is very reasonably priced for such a strong performer.
The last frontier
Next up is a little-known moneymaker called Frontier Bank
With a market capitalization of about $570 million, this bank holding company is a bit larger than the others mentioned, though it's still safely below the multibillion-dollar market caps of the big boys in this sector. It also has a larger footprint than our other banks, operating 38 branches across several Washington counties. The firm provides a fairly diverse range of financial solutions to businesses and individuals, including investment and insurance products.
Valued at about 2.8 times book, the shares may appear fully priced, but it trades at a more reasonable 13 times forward earnings. Its 13% second-quarter dividend increase, the 14th consecutive quarterly hike since the company began paying a dividend in 1999, has helped pump the yield up to a healthy 2.3%.
At 2.03%, the bank's ROA would make any frontiersman proud, and its ROE is a hardy 20.18%. Its 40% efficiency ratio at the end of the second quarter continues Frontier's tradition of having one of the lowest in the industry.
In July, the company announced second-quarter earnings of $10.1 million, its first ever $10 million-plus quarter. That compares favorably to the prior year's $9.1 million and represents an 11.0% increase in net income and a 17% increase in diluted earnings per share. The earnings jump came from across-the-board strength in net interest income, non-interest income, and a decline in average diluted shares outstanding.
The bank has total assets of $2.06 billion and deposits of $1.68 billion, which are growing at 11.4% and 12%, respectively. In addition, nonperforming assets were cut in half compared to the year-ago quarter and nonaccruing loans decreased 43%.
This company is creating value for shareholders in every way possible. Since June 2002, it has repurchased $20.2 million of common stock in the open market, or about 4% of diluted shares. If you're into wide open spaces and wide open profits, Frontier is worth a look.
Don't stop here
There are a great many banks in this arena of high-quality money movers; it simply takes a bit more digging and a long-term focus to play here. In any event, I hope that I have you thinking about ways to build a diversified portfolio of quality banking and financial stocks over time.
Who will be the next diamond in the banking rough? Who knows, but perhaps looking in your own backyard, at your own small-town branch, isn't a bad place to start. It's important to be selective, as few banks are as strong as those mentioned here, but they're out there. And they're ripe for the picking.
If the bank has publicly traded shares, a telephone call or email should be enough to acquire some financials and an annual report, and even in this category, many have investor information on their websites. The best tools for researching such companies can be found online at the Federal Financial Institutions Examination Council (FFIEC) website.
Mathew Emmert expects more than lollipops and cat treats from his small-town banks, but those are nice, too. He owns shares of Berkshire Hathaway. If you're hungry for more quality, dividend-paying companies, Mathew reveals two such recommendations each month in the pages of Motley Fool Income Investor. The Fool has adisclosure policy.