Investment thesis: Solid small-cap dividend grower

Located on Mount Desert Island just off the Maine coast, Bar Harbor is a quaint and colorful town that thrived on the influx of summer tourists. It is also one of the easternmost places in the United States.

The business center of this easy-going place is a long-established financial institution called Bar Harbor Bank (NYSE:BHB). But the fortunes of BHB are not tied solely to this small island on the Atlantic coast. Operations and offices have spread southwest, and with that expansion has come two decades of steady dividend growth for shareholders, barring brief pauses during the financial crisis and pandemic.

BHB is a small-cap bank with over 50 branches in the states of Maine, New Hampshire and Vermont in northern New England. The bank’s market cap as of this writing is less than $400 million and total assets are about $3.7 billion, but what BHB lacks in size it has made up for in growth historically.

This growth comes from four sources:

1. Population Growth: From 2020 to 2021, for example, almost every county in Maine experienced population growth as inward migration from urban areas more than offset a natural decline due to higher deaths than births.
2. Opening of new bank branches and credit bureaus in new areas.
3. Acquisition of other local/regional banks in contiguous areas or states.
4. Expanding a diverse range of fee-based, interest-free income sources, such as B. $2.4 billion AUM in wealth management.

Although BHB’s service businesses are largely dependent on the relatively cyclical tourism, agriculture and fishing industries, the bank has managed to generate steady growth without compromising on risk mitigation.

With a 4.1% dividend yield and a long history of steady growth, BHB seems to appeal as a dividend growth game to investors who are okay with its small size and trading volume.

Overview of Bar Harbor Bank

BHB has served Maine for 135 years. Over the past decade, the bank has expanded into neighboring states of New Hampshire and Vermont.

While these states (especially Vermont) aren’t the most business-friendly places, BHB’s longstanding management team has extensive experience operating profitably there.

In the first quarter of 2022, BHB had total assets of just under $3.7 billion, including net debt of just over $2.6 billion.

The loan-to-deposit ratio is a conservative 0.86x. In other words, the bank’s loan book accounts for 86% of deposits.

In fact, that’s for top-end US banks, which have struggled to generate credit sufficient to keep up with rising deposits during the pandemic. According to Bank Reg Data, the average loan-to-deposit ratio for US banks in the first quarter of 2022 was 0.56x, or 56% of loan-to-deposits. For banks in BHB’s total assets category ($1 billion to $4.9 billion), the LDR was slightly higher at 71%.

A higher LDR is a good thing as long as the loans are well underwritten, resilient and backed by strong assets as it implies BHB is able to use a larger percentage of its extremely low cost or free deposits on productive loans to generate more income per generate deposited dollars.

Of course, risk reduction is key here. A bank should not try to lend just to increase its LDR. One way to determine the quality of a bank’s loans is to look at non-performing assets and/or loans as a percentage of the total.

As you can see, NPAs and NPLs (NPLs) as a percentage of their respective totals have declined well since the pandemic era. Distressed assets accounted for just 0.25% of the total in the first quarter, compared to 0.38% in the first quarter of 2021.

Significantly, BHB had zero bank-owned real estate in the first quarter, a sign that either foreclosures are rare, or all of its own real estate is selling quickly, or both.

BHB’s net interest margin (a key profitability metric for banks) of 2.95% is up from 2.88% in Q1 2021 and compares favorably to the average NIM for all US banks in Q1 2022 of 2.32% ( Source: Bank Reg Data).

Meanwhile, the bank is reasonably well positioned to benefit from any fed fund rate hikes. As President & CEO Curtis Simard explained in the Q1 results press release:

Given the asset sensitivity of our balance sheet, we expect to continue benefiting from potential Fed rate hikes.

At the same time, BHB has positioned itself to cope with a “long-term lower” interest rate environment should the US economy return there. Fee-based (interest-free) income as a percentage of total income increased from 17% in 2020 to 21% in 2021. In the first quarter, fee income increased 11% year over year.

In the first quarter of 2022, BHB reported remarkable commercial loan growth of 21%, versus full-year 2021 commercial loan growth of 10%. Commercial loans now account for nearly 2/3 of BHB’s loan book.

The bank made a conscious decision to reduce its portfolio exposure to residential mortgages by selling most of its newly originated mortgages on the secondary market. For most of 2020 and 2021, residential mortgage rates were extremely low, making them less profitable for banks than commercial lending. Why would a bank keep a 30-year mortgage on their books with an interest rate of 3% or less when they could make a commercial loan at a floating rate or with a 5-year adjustment date?

Now that the 30-year mortgage rate is back up to nearly 6%, it will be interesting to see if BHB decides to increase the proportion of its loan portfolio to residential mortgages.

Also note that BHB’s efficiency ratio (lower is better, as it implies less spending per dollar of revenue) was 62.4% in Q1 2022, just slightly above the U.S. banks’ average of 61.9% in the first quarter quarter (Source: S&P Global Market). Intelligence). However, in the fourth quarter of 2021, BHB’s efficiency ratio of 60.7% was lower than the US bank average of 63.1%. In short, there is nothing to worry about here.

While it’s worth noting that BHB’s core earnings were slightly inflated last year due to the transitional benefit of PPP loans (which should fully terminate in Q2 2022), the bank’s trailing four-quarter payout ratio was just 36% of core earnings. In the first quarter of 2022, the payout ratio increased only slightly to 38.7% as the boost from PPP loans faded.

bottom line

BHB’s tangible book value per share (excluding securities portfolio fluctuations) increased 7% on an annualized basis to $20.07 in the first quarter of 2022. That gives BHB a tangible book value (excluding securities) price of about 1.25x, based on a stock price of about $25 at the time of writing.

However, at the end of the first quarter, book value per share was $27.11, meaning BHB is currently trading at a discount of about 8% to book value. Outside of the pandemic period, this is one of the best book value prices BHB has traded at in the last five years.

With a dividend yield of 4.1% and a two-decade history of steady dividend increases (including the most recent 8% dividend increase announced in April), BHB is a very interesting dividend growth stock for dividend investors.

I owned it once from 2019 until sometime in 2021 but sold it out of fear that interest rates would stay as low as they were forever. I underestimated BHB’s ability to (1) survive in a low interest rate environment and (2) the bank’s ability to grow noninterest income. I now see it as an attractive long-term buy-and-hold for my very financially-heavy stock portfolio.