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3 Small Banks You Need on Your Radar

By Matt Koppenheffer - Updated Apr 7, 2017 at 11:46AM

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The big banks may steal the spotlight, but looking small can pay off.

If you want the best deals that the market has to offer, you often have to look where other investors aren't. When it comes to banks, much of the focus tends to be on giants like Bank of America (NYSE: BAC) and Citigroup, and smaller banks that could be better investments are ignored.

Below are three small banks -- that is, banks with market caps between $500 million and $1 billion -- that are well worth keeping an eye on.

Brookline Bancorp (Nasdaq: BRKL)
As it stands today, Brookline looks like a relatively mediocre investment. If we look back over the past decade, the bank's return on equity peaked at 5.7%. That's not terribly exciting, particularly when the stock trades slightly above its book value.

But as investors, we're looking for upside, and there are some rumblings going on at Brookline to keep an eye on. First off, the bank is aggressively growing. Over the past two years, it's made two significant acquisitions -- First Ipswich Bancorp in 2011 and Bank Rhode Island in 2012 -- that have increased Brookline's footprint in central New England.

Also notable is the fact that while most banks are scrambling to increase the safety of their balance sheets, Brookline has been going in the opposite direction. Don't worry; this could actually be a good thing. Back when other banks were going crazy during the financial bubble, Brookline was arguably too conservative. While this undoubtedly helped the bank stay profitable during the crash, an under-levered balance sheet means lower returns for a bank. With a more levered balance sheet going forward, investors could see better equity returns.

On a high level, these changes likely stem from Paul Perrault taking over as CEO of Brookline in 2009. Perrault was previously the CEO of Chittenden Corp., a bank that he ran for 17 years, more than tripling its balance sheet over the decade ending in 2007 before selling the bank to People's United for $1.9 billion.

Dime Community Bancshares (Nasdaq: DCOM)
For investors familiar with New York Community Bancorp (NYSE: NYB), the business model at Dime Community will likely sound familiar. The bank operates out of New York City and is a bank in the classic sense of the word -- that is, it focuses primarily on collecting deposits and lending them back out to real estate borrowers. For Dime, like NYB, those borrowers are largely owners of multi-family residential buildings in New York.

Whereas Brookline (above) was a story of change, Dime Community is more a story of a good thing continuing. Dime CEO Vincent Palagiano has been heading up the bank since 1989 and has been a trustee or director of the bank since 1978. How has Palagiano's leadership worked out for the bank? Well, if we look over the past decade, the bank's book value per share has grown from $6.45 to $11.01, or about 5.5% per year. At the same time, Dime has paid out nearly $6 in dividends. For most of that time frame -- 2007 and 2009 being the exceptions -- the bank notched solid double-digit returns on its equity.

And it's also notable that Palagiano has his interests aligned with shareholders since he has, as of early this year, an ownership stake of more than 4% of the company.

1st Source Corp. (Nasdaq: SRCE)
So far we've looked at two banks that skated through the recession and currently have a ratio of nonperforming assets to total assets of less than 1%. That's laudable. 1st Source isn't quite there yet. The Indiana-based bank saw its nonperforming assets peak at 1.9% of total assets in 2009, and it has since come back to 1%. Directionally, that's great, but investors will want to see that continue to come down.

With the comparatively worse balance sheet, however, also comes a lower price tag. 1st Source trades at a tangible book value multiple of 1.22 versus 1.56 for Dime Community, and 1.44 for Brookline. While that's eye-catching, what I really like about 1st Source are three other aspects: growth, business, and management.

Over the past decade, you can find growth all over 1st Source's income statement and balance sheet, but I want to point you toward two specific areas. First, book value per share has increased from $13.28 to $22.34 since 2002. Better still, it's grown every individual year during that stretch -- even during the financial meltdown in 2008 and 2009. In addition, the bank's dividend has grown every single year during that stretch. Though all three of the banks that I've reviewed here pay healthy dividends today, 1st Source is the only one that can claim that kind of consistent growth.

For those investors looking at banks that are still skittish about residential real estate and consumer debt, it's notable that 1st Source's portfolio was only 17% invested in those two categories at the end of last year. The bank's business is more focused on business and commercial lending in areas like agriculture, auto and truck leasing companies, and aviation.

Finally, I'm a sucker for a CEO that's a consistent, dedicated leader at a company, and similar to Dime Community's Palagiano, 1st Source CEO Christopher Murphy III has been with the bank for more than three decades and owns nearly 9% of the bank. With long-term, aligned leadership like that, there's a better chance that management will be focused on the big picture.

Go big or go home?
While I plan to dig in further to all three of the banks above, I think Dime Community Bancshares looks particularly attractive. So much so, that I'm going to add it to my Motley Fool CAPS portfolio.

Of course, though I think there's potentially opportunity in the banks above, investing in small banks isn't for everyone. Bank behemoth Bank of America may be a complicated, closely followed institution, but that doesn't mean that an investment opportunity can't crop up there to. To get the complete picture of the risks and opportunities in B of A's stock, check out the special report from Fool bank analyst Anand Chokkavelu. Click here to find out more.

The Motley Fool owns shares of Bank of America and Citigroup. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Matt Koppenheffer owns shares of Bank of America, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

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Stocks Mentioned

Bank of America Corporation Stock Quote
Bank of America Corporation
$36.30 (1.09%) $0.39
New York Community Bancorp, Inc. Stock Quote
New York Community Bancorp, Inc.
$10.77 (1.13%) $0.12
Brookline Bancorp, Inc. Stock Quote
Brookline Bancorp, Inc.
$14.12 (1.73%) $0.24
Dime Community Bancshares, Inc. Stock Quote
Dime Community Bancshares, Inc.
1st Source Corporation Stock Quote
1st Source Corporation
$49.62 (1.25%) $0.61

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