Forget the Big Banks — These 3 Regional Bank Stocks Look Much Better

A couple of weeks ago, several of the nation’s banks underwent a so-called “stress test” to determine whether they were healthy enough to survive a major economic contraction without requiring new capital. Some failed, but most passed.

Yet, even before the dust has settled from the good news, questions are starting to surface again. And, they’re surfacing for understandable reasons.

One of those questions puts Bank of America (NYSE: BAC) right back in investors’ crosshairs. Technically, BofA passed the test. Those who are more than just a little familiar with the situation, however, know Bank of America has been eating more than its fair share of loan losses, and it may have more than the anticipated $60 billion in liabilities to work through if the economy tanks again.

Citigroup (NYSE: C) flat out failed the test. So did SunTrust Banks (NYSE: STI) and a couple of other major financial institutions.

It all begs the question: If two icons of the U.S. banking industry — Citigroup and Bank of America — are looking troubled with or without a passing grade on the stress test, can any of them really be all that healthy?
Better alternatives
There is one common element among the banks that are struggling the most — they’re large banks that were big enough to dig themselves into a deep bad-debt hole in the first place.

Smaller, regional banks, however, were lucky in the sense that their holes were never that deep to begin with. Many of them have fully escaped the 2008 loan debacle and are actually growing earnings again. Indeed, three of these small banks stand out as attractive combinations of earnings growth and dividend yields.

1. Independent Bank Corp. (Nasdaq: INDB)
Although Massachusetts-based Independent Bank Corp. struggled on the earnings front in 2009 along with most other banks, 2011’s per-share income of $2.14 puts it right back in line with 2007’s income of $2.13 per share. And it’s a heck of a lot better than 2009’s $0.88 per share.

What’s so interesting about Independent Bank, however, is the $600 million company’s commitment to a growing quarterly dividend payment. Though the rate of payout growth slowed in 2009, it never fell backwards, and was upped to a record $0.19 in the first quarter of 2011. The amount was raised to $0.21 earlier this month, underscoring the bank’s commitment to sharing the wealth. The payout ratio (of earnings) is already at   36%, so don’t look for another dividend increase until earnings make decisive progress. But with the yield of 3.0%, it’s already outpaying bigger names like Wells Fargo (NYSE: WFC) and U.S. Bancorp (NYSE: USB).

2. West Bancorp. (Nasdaq: WTBA)

While it still has not reclaimed its pre-recession profit levels, regional bank West Bancorp is clearly on the road to recovery. The bank has ramped up its bottom line from $0.62 per share in 2010 to last year’s $0.74, and analysts say a profit of $0.87 per share is in the cards for this year.

The real story here, however, is its 3.0% yield. That’s at the very high end of the industry dividend range right now. Yet at the current quarterly payout of $0.08 per share, West Bancorp’s dividend is still miles below the peak quarterly dividend of $0.16 from 2008. A return to that payout level isn’t out of the question for the near future, either. The bank was earning about $0.27 per share each quarter in 2007 — about 31% less than what it’s earning now — yet was paying out double what it does now. (Last year, it earned an average of $0.18 per share each quarter.)

3. Community Bank System (NYSE: CBU)
Community Bank System boasts the strongest dividend rate of the three regional banks, with a yield of nearly 3.5%. It’s also shown the strongest commitment to consistent dividend increases. For perspective, the quarterly dividend of $0.13 in 2000 is now $0.25 per share. The trend barely paused in 2009, and resumed in 2010 when the economy was clearly back on firmer footing.

It’s not as if the bank is taking on a big liquidity risk by sticking to its ongoing dividend increases, though. Community Bank System weathered the recession exceedingly well, with per-share income falling from 2008’s peak of $1.49 to 2009’s modest lull to $1.36. Since then, the bottom line has been growing again, reaching $2.11 per share last year. The bank is distributing a little less than half of that as a dividend, but is growing the bottom line quite reliably.

Risks to Consider: While regional banks have proven to be more nimble than their large-cap counterparts and generally aren’t big enough for the federal government to scrutinize, it’s still conceivable that overzealous regulation measures could put up a road block for these smaller banks at some point in the future.

Action to Take –> Large-cap banks are easy to own because they’re familiar, but dividend lovers may find just as much luck — and a lot less stress — with one or all of these smaller banks. While all have a lot of upside compared to, say BofA or Citigroup, Community Bank Systems may be the best of the best. It’s already proven in can grow the bottom line by an average of 12% per year, and it’s more than demonstrated that it intends to apply a proportional share of that income growth to its dividend payout.