When I posted earlier today that I would keep Bank of America (BAC) in my Dividend Portfolio I said the decision rested largely on the ways that Bank of America wasn’t like the “average” bank. Chief among these “ways” was the bank’s ability to use its fee income–from things like its investment banking unit and its online brokerage–to offset a slowdown growth in net interest income as a result of the Federal Reserve’s decision to put a hold on interest rate increases in the first nine months of 2019 before, maybe, cutting rates in the last quarter of the year.
In contrast I added Independent Bank (IBCP) to my Dividend Portfolio because it was a well-managed plain vanilla bank. I’m selling it out of the Dividend Portfolio today because with the Fed’s change in direction, plain vanilla banks are not as attractive as they were in 2018.
Let me use the bank’s first quarter earnings to show what I mean.The bank reported earnings of 39 cents a share versus 42 cents a share in the first quarter of 2018. Much of that drop had to do with a change in the mortgage loan service rights valuation of the bank’s mortgage portfolio. (This valuation of existing mortgages changes with interest rates.) If the change is excluded from fully diluted earnings, instead of a drop earnings show a year over year increase of 26%. (It’s clear to me that changes in the value of a portfolio of mortgage servicing rights needs to be treated with a grain of salt both when rates are falling and valuations are too and when rates are climbing and valuations are rising and pushing earnings higher. Most opinions of earnings results from quarter to quarter gloss over this contribution or deduction from earnings.)But the issue of mortgage servicing rights valuation aside, look at the nature of revenue from Independent Bank. It comes from the plain vanilla model of banking. Net interest income of $30.2 million was up 26.3% from the first quarter of 2018. The loan portfolio grew at a 6% annualized rate. Total deposits were up 3%, annualized. The bank finished the quarter with $2.93 billion in total deposits. Of those 78% were in non-maturing deposit accounts–in other words in savings and checking accounts rather than CDs. That kind of deposit is sticky–savers don’t scout around for a better deal as do owners of CDs. And they’re a relatively cheap source of capital for a bank.In some environments this is exactly the kind of bank stock you want to own. And this was the case when I added these shares to my Dividend Portfolio on March 20, 2018. Then we were looking at an environment of rising interest rates from the Federal Reserve that soared right into the sweet spot of this banking model.Now, however, with rates on hold or heading downward in the end of the year, this model doesn’t provide any buffer in the form of fees to a slowing of growth in net interest income.
If you think that the Fed’s switch to stead or lower interest rates is a passing fancy, you might want to hold onto these shares. They do pay a trailing 12-month dividend yield of 2.86%. And a modest share buyback program adds a buyback dividend of 2.39% for a total yield of 5.25%. That’s well below the total yield at Bank of America of 8.84% but still above the five-year average for the bank of 3.49%.
On the other hand, if you think we’re just witnessing the beginning of an extended period of steady or falling interest rates from the Fed, then holding on here means owning these bank shares in an uncomfortably long period when they will be fighting that Fed headwind.You can guess my call on intent rates by the fact that I’m selling today. I show a 13.57% loss on these shares (not including dividends) since I added them to this portfolio on March 20, 2018.