Small Banks Warm Up to Bigger Dividends as Downturn Wears Off

It is important to give back. In banking, it is important to give back to shareholders.

Banks are steadily reinstating and increasing dividends. Data compiled by Hovde Group show that 27% of publicly traded banks increased their first-quarter dividend.

The inclination is to believe that those banks are struggling to deploy capital, whether through acquisitions or organic growth. That's certainly a factor for some institutions, but several bankers assert that higher payouts provide more proof that the industry has emerged from the 2008 economic collapse.

While most big banks recovered quickly, plenty of smaller banks are just starting to regain confidence in their operations and an understanding of new regulation tied to capital. Those factors, combined with a range of outside pressures, are spurring higher dividends.

Ameriana Bank in New Castle, Ind., is among the institutions gradually increasing its dividend, which it reduced to a penny during the financial crisis. The $483 million-asset bank recently bumped its dividend up to 4 cents a share.

"The increase is largely a reflection of having clarity now on the capital rules," Jerry Gassen, Ameriana's chief executive, said. "We will consider additional increases as we maintain earnings."

Several bankers said higher payouts represent a mere step toward a bigger goal of boosting how much profit is returned to investors. Possibly reflecting what bigger banks are permitted to pay under the Comprehensive Capital Analysis and Review, the overall banking industry seems to be moving toward a benchmark of paying dividends equal to about 30% of earnings.

Still, smaller banks remain short of that mark despite recent increases.

Scott Siefers, an analyst at Sandler O'Neill, said the payout ratio for the smallest banks in his coverage universe is 22%. "The smaller you go, the later you have banks coming through the credit cycle," he said.

"While there's balance sheet growth, it is not super robust, so these companies end up husbanding a lot of capital," Siefers added. "There are a finite number of places capital can go and the dividend is one of them."

Bankers, for the most part, said they don't want to move too quickly.

"We've had a goal since coming out of the recession that we would return our dividend levels to an optimum range and we've been fairly slow and deliberate about it," said Mark Hardwick, chief financial officer of First Merchants in Muncie, Ind.

The $5.9 billion-asset company decided on a goal of returning about a quarter of its earnings to shareholders through dividends. Its 38% increase, which took the dividend to 11 cents a share, positions the company's payout ratio to end up in a range of 20% to 25% of its expected 2015 earnings.

A 30% payout ratio would be "a very nice and balanced amount," said Ramsey Hamadi, chief financial officer of NewBridge Bancorp in Greensboro, N.C. NewBridge, which recently announced its first dividend since 2008, is on pace for a roughly 10% payout ratio compared to its projected 2015 earnings.

"Raising the dividend depends on the function of opportunity for growth," Hamadi said. (NewBridge, however, has been an active acquirer in recent years.)

CenterState Banks in Davenport, Fla., wants to reach a 20% to 25% payout ratio over time. The ratio is currently 10%, after the $3.8 billion-asset company announced plans to double its dividend to 2 cents a share.

"We would like to work in that direction," said Ernest Pinner, CenterState's chief executive, adding that the decision to increase the dividend was partially a result of peer pressure. "When you compared us to our peers, we were on the low end … so it made sense to get into the same bracket."'

At Southwest Bancorp in Stillwater, Okla., dividend increases reflect more confidence after the financial crisis and high capital levels. The company's 13.5% tangible common equity ratio at March 31 is significantly higher than the 8% to 9% mark that most other banks target.

Still, the $2 billion-asset company is being diligent with capital given the volatility of energy prices. Southwest, which is aiming for a 28% to 35% payout ratio, is closely watching what happens to the Oklahoma economy.

Energy lending is not a significant part of Southwest's portfolio, but Joe Stockley, the company's chief financial officer, said oil prices could have broader effects on Oklahoma's economy. "It is certainly a factor and a caution that our management team will continue to evaluate," he said.

Bankers like Pinner and Hamadi said their banks cut dividends during the downturn for the same reason: They raised money to survive and it didn't seem right to immediately return capital to shareholders. While higher dividends are important to retail investors, they are not as critical to the institutional shareholders that helped prop up struggling banks during the downturn.

"Institutional money is not really interested in cash flow," Hamadi said. Big investors are "most interested in long-term returns. Still, everyone likes some level of dividends."

Some banks are raising dividends in response to growing pressure from activists. For instance, Metro Bancorp in Harrisburg, Pa., which has been the target of at least three activists since June, recently reinstated its dividend. The $3 billion-asset company, which plans to pay out 7 cents a share, also agreed to add a principal at one of the activist shareholders to its board.

Even banks that are not feeling heat from activists might raise dividends to stave off pressure to deploy excess capital. In that regard, analysts said an increase might relate to a lack of M&A opportunities.

"There is a subset of banks that haven't been able to participate, or participate as much as they had hoped," said Joseph Fenech, an analyst at Hovde Group. "You can sit on that capital for only so long. The longer you're sitting on a growing pile of capital, the more subpar your profitability on return on capital is going to be."

Fred Cummings, president of Elizabeth Park Capital Management in Pepper Pike, Ohio, said during a recent conference that a big dividend ratio "signals to the market that a bank doesn't have other ways to use capital."

Bankers agreed that it is difficult finding ways to deploy capital, though a lack of M&A prospects is not prompting increased payouts. Besides getting back to normal, most bankers said they are overcapitalized and are simply trying to keep capital from growing too much.

"We're not sending the signal that we are out of buying with this," Pinner said.

Of course, some banks that did well during the downturn are continuing to thrive, including CVB Financial in Ontario, Calif. Chris Myers, CVB's chief executive, said the $7.4 billion-asset company recently raised its dividend to 12 cents from 10 cents, where it had been since mid-2013, because of improved profitability.

"We had record earnings last year," Myers said. "We made $104 million, and it was the first time we've broken the $100 million barrier."

Paul Davis contributed to this report.