One way to take advantage of the bank "trade of the decade" is to look for stocks that pay decent dividends. This trade is going to take years to reach its best conclusion, so you might as well get paid while you wait for the profit improvements and M&A wave to work their magic.
You have to be somewhat conservative about buying dividend-paying banks, as the highest yielders often use cut dividends to preserve capital. In the last year or so several banks, such as First Niagara Financial (FNFG) and Hudson City Bancorp (HCBK), slashed payouts to protect or restructure the balance sheet. I want to look for banks that have many of the characteristics of a perfect bank, especially a high tangible-equity-to-asset ratio. By focusing on banks with excess capital and a good, but not spectacular, dividend yield, we can assemble a portfolio of bank stocks that throws off cash and has enormous upside potential over time.
One such bank is Oritani Financial (ORIT), which first caught my eye when it converted to a publicly owned bank from a mutual thrift in 2010. The 100-year-old bank has 24 offices in Northern New Jersey and, by the numbers, is very well run. The shares are a little rich at 1.1x tangible book value, but the bank has plenty of excess capital and a strong loan portfolio. The tangible-equity-to-assets ratio is a plump 24, and nonperforming loans are less than 1% of total loans. Unlike many banks, this bank has been growing earnings and been profitable over the past five years, even during the credit crisis. The large amount of excess capital should mean stock buybacks and dividend increases over the next several years. At the current price, the shares yield 3.94%. Insiders have been buying the stock on price weakness in recent months.
First Interstate BancSystem (FIBK) misses a little bit on the numbers, but the tangible-equity-to-assets ratio is a comfortable 10 and I love the Montana-based bank's franchise. It has 72 branches in Montana, Wyoming, and South Dakota -- hardly hotbeds of speculative real estate activity. The shares currently yield 3.55%, and the dividend was just increased by 6%. The payout is less than 60% of earnings, so I am confident they will be able to maintain and even increase the dividend as the economy improves. The bank has paid dividends for 16 years and has been profitable for the last 23 years -- a record not many regional banks can make these days. Stealing a page from former General Electric (GE) CEO Jack Welch's book, First Interstate is either first or second in market share in all of its markets.
The demographics of First Interstate's market are compelling. All three states are showing population growth and have solid finances. Major industries in their marketplace include growth areas such as agriculture, mining and energy. The energy markets include not only coal and natural gas but there is enormous potential for wind-related energy projects in the region. There are three large military bases in their service area with large military populations that need banking services. All of this bodes well for the growth and earning potential of First Interstate over the next decade. Trading at tangible book value with a decent dividend, this is a stock you can scale into this year and expect to be well rewarded.
The final stock is Astoria Financial (AF), a $17 billion institution that makes mortgage loans in the counties surrounding New York City. It has a very high-quality loan portfolio. Nonperforming assets are 2.5% of total assets and net charge-offs have been declining for several quarters. The tangible-equity-to-assets ratio is just shy of 10, and the shares currently trade for a little less than 80% of tangible book value. As with Hudson City and First Niagara, I would not be shocked to see a dividend cut. For now, the shares yield a very comfortable 5.6%. The dividend was halved back in 2009 and the payout ratio is just 53%, so there is a very good chance the dividend remains intact. This stock used to trade consistently around $30, and I expect to see it there again in the next decade or less. It was trading at $8.95, down $0.08, this afternoon.
The bank trade will play out over the next decade. Adding strong, dividend-paying banks to the portfolio helps me get paid while I wait for everything to work out in my favor. I am confident it will, in spectacular fashion, if I am patient and disciplined.