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When investors view the financial sector as a potential investment opportunity, they typically look at the big banks. But there is a subset of companies within the broad financial sector that tend to go relatively unnoticed – the regional banks. These are smaller banks that cater to a specific region of the country. They are much smaller than the big U.S. banks but many of them are highly profitable and have a distinct advantage in that they are nimbler and can, therefore, more effectively respond to their customers’ wishes.
Although these banks may be under the radar for most investors, they are currently operating profitably and offer strong dividend yields that compare favorably to their large-cap industry peers, along with more growth potential because of their smaller size.
Community Bank System (CBU ) is a small regional bank with a market capitalization of just $2.1 billion. However, it has a long track record of stability, which is rare given the events of the 2008-2009 Great Recession. While many banks had to cut or suspend their dividends and got bailed out by the taxpayers, Community Bank has increased its dividend for the past 24 years including a recent dividend hike. Plus, Community Bank stock has outperformed the S&P 500 Index by a wide margin over the past one year, rising 37% not including dividends.
Community Bank System is a registered bank holding company based in New York. Its wholly-owned banking subsidiary has over $8.7 billion in assets and more than 200 customer facilities across New York and Pennsylvania. The company is highly profitable from year to year, which fuels its impressive dividend growth. Last year, the company earned $2.19 per share. While that was a 1% decrease from the previous year, the company incurred significant acquisition expense of $7 million for the year. Excluding this charge, adjusted earnings per share would have increased 2% from 2014.
The company achieved growth mostly from a 7% increase in loans. In addition, Community Bank achieved growth through acquisition. Last year, it acquired Oneida Financial, which diversified its business model by giving it entry into insurance and benefits administration. Because of the acquisition, revenue from wealth management and insurance businesses soared 57% in the fourth quarter.
This slow-and-steady growth is ideal for risk-averse income investors, because it reduces volatility and strengthens the company’s ability to pay dividends each year like clockwork. Going forward, analysts expect the company to continue its steady pace of reliable growth. Community Bank is expected to earn $2.31 per share this year, which would represent 5% earnings growth from 2015. Next year, Community Bank is projected to earn $2.38 per share, which would mean 3% earnings growth in 2017. That would be enough growth to justify another dividend increase next year and, if that happens, Community Bank would qualify as a Dividend Aristocrat.
Community Bank has focused on stable profit-generating businesses like consumer and commercial banking, as well as wealth management. By contrast, it has largely resisted the high-risk, volatile business segments like trading, which caused profits for many big banks to collapse during the Great Recession. This is why Community Bank has maintained such a long history of dividend increases, which it recently extended with a nice raise.
On Aug. 19, the Board of Directors declared a quarterly cash dividend of $0.32 per share. The raise is a 3% increase from the previous quarterly dividend. On an annualized basis, the forward dividend payout is $1.28 per share, which represents an annualized yield of 2.7% based on the stock’s closing price of $47.40 on Sep. 1. The dividend will be payable on Oct. 10 to shareholders of record as of Sep. 15. This increase marks the 24th consecutive year of dividend increases for the company.
Community Bank is a well-run business that has generated consistent growth each year. It has generated a 4.4% and 4.0% compounded annualized growth rate for book value per share and dividends per share respectively over the past five years.
Future earnings growth could accelerate, because regional banks including Community Bank stand to benefit greatly from a potential increase in interest rates. The U.S. Federal Reserve raised interest rates last Dec., which was the first rate hike in the past decade. Interest rates have been kept at historically low levels to help boost the economy by incentivizing borrowing. However, the Fed has not raised interest rates a second time yet, because of the heightened level of uncertainty brought on this year by geopolitical risk events, including the Brexit vote and slowing global economic growth.
However, the Fed has signaled it may raise rates again this year, perhaps as early as Sep. If that happens, it will be a real boost to the financial sector. Banks like Community Bank earn profit based on the difference between interest paid on deposits and interest earned on loans. When rates are low, it compresses the margin between the two. This spread is referred to as the net interest margin. Last quarter, Community Bank’s net interest margin contracted by another three basis points from the same quarter last year. The low net interest margin has suppressed earnings growth, but 2017 and beyond could signal acceleration in earnings growth for the company.
Income investors who are interested in gaining exposure to the financial sector – in light of possible interest rate increases – could consider Community Bank, a highly profitable company that has demonstrated growth for many years.