Bar Harbor Bankshares Remains Resilient Amid The Banking Turmoil

Bar Harbor Bankshares (NYSE:BHB) is a Northern New England regional bank headquartered in Bar Harbor, Maine, with 53 branches stretching from Maine through New Hampshire to Vermont. The bank ended 2022 well-capitalized, diversified across interest and non-interest income sources, and more profitable (as measured by its net interest margin) than it has been in years.

But that was at year-end 2022. Since then, small banks like BHB have seen a massive outflow of deposits. In the month of March, small banks suffered a collective deposit outflow of $165 billion.

Some of this money is going to larger banks, some of it to high-yielding money market accounts, and some into Treasuries (GOVT).

How vulnerable is BHB in this mass exodus from smaller banks?

While there is always the risk that depositors at BHB have been pulling big chunks of funds out of their accounts, thereby triggering a destructive chain of events at the bank, I don’t believe BHB to be one of the higher risk small banks.

While BHB will likely face larger than expected headwinds from (presumably, somewhat minor) deposit outflows in at least the first half of this year, I believe the bank is prepared to handle these headwinds and emerge the other side stronger and equally capable of growth.

Moreover, with a dividend payout ratio of only 35%, BHB stock’s ~4.2%-yielding dividend appears to be quite safe and liable to continue its 19-year growth streak, even if this year’s hike is slower than previous years. That’s why I recently highlighted BHB as one of the “2 Dividend-Growing Regional Banks To Buy In The Banking Crisis.”

While not without some conspicuous risks right now, I believe the current selloff presents a good buying opportunity for long-term investors. In what follows, I’ll explain why.

Overview of Bar Harbor Bankshares

To gain a quick grasp of BHB’s financial situation, here is a smattering of pertinent metrics as of the end of 2022:

• 95.4% loan-to-deposit ratio (compared to 83% at year-end 2021)
• Non-FDIC-insured deposits represented only 11% of total deposits
• Cash & equivalents as a percentage of total assets: 2.4%
• Securities available for sale as a percentage of total assets: 14.3%
• Weighted average yield of the securities portfolio: 2.99% (compared to 2.63% at year-end 2021)
• Average remaining length to maturity of securities portfolio: 9.4 years (compared to 5.3 years at year-end 2021)
• Net unrealized losses on securities equal to 12% of securities value
• 90% total liabilities (deposits plus debt) to total assets

In the first half of 2022, BHB drew down its cash position to deploy into loans, and in the second half of the year, the bank took on a bit of debt in order to continue making loans.

While deposits remained fairly flat for most of the year, there was a net outflow in the final three months of the year.

Here’s a quote from the 2022 Annual Report:

While deposit balances were consistent with 2021, we did see a decline during the fourth quarter of 2022 primarily in institutional accounts with low activity, which tend to be most rate sensitive.

For money that’s just sitting there for long periods of time, depositors figure they might as well earn a higher yield from it than what they can get at the bank. And though banks like BHB do offer money markets, their typical <1% rate on those pales in comparison to the >4% you can get from brokerage money markets. So, it’s a safe bet that those deposit accounts continued to see outflows into the first quarter of this year.

Overall, though, BHB is at very low risk of a bank run, in my estimation. In its namesake town of Bar Harbor in Maine, competition among banking institutions is extremely limited.

A gradual shift toward higher-yielding accounts, while bad for banks, is not the same as a Silicon Valley Bank-esque bank run. If and when interest rates fall again, much of the lost deposits should flow back into accounts at BHB.

Notice a few more items in the table above.

First, BHB’s dividend payout ratio ticked down slightly from 2021’s 36% to 2022’s 35%. This strikes me as a very prudent and comfortable payout ratio for a bank.

Second, BHB’s efficiency ratio has come back down to its 2018 level, which was before the acquisition of 8 bank branches in central Maine from another bank in 2019.

Third, BHB’s profitability as measured by return on equity and net interest margin are higher today than they have been in many years, in large part due to higher interest rates. While high enough interest rates eventually lure away depositors, low enough rates suppress profitability.

Loan Portfolio Analysis

But deposit outflows are only one risk that regional banks are facing right now. Another is eroding fundamentals in certain areas of commercial real estate, namely office properties. Amid entrenched hybrid work arrangements, tenants are downsizing space as their leases come due, which is pressuring office landlords and in turn creating problems for the banks that lent to those landlords.

But I believe BHB is at low risk of an erosion in credit quality from this problem.

First, consider the obvious: BHB doesn’t have a lot of large office buildings in its service territory.

The biggest city in Maine is Portland, and BHB doesn’t have a big presence there. Instead, BHB is mostly present in smaller cities and towns that have benefited from the shift toward remote work. What’s more, office utilization in these small towns tends to be much higher than in the big cities because of shorter commute times and lower rent rates.

But in any case, BHB’s primary markets are not the kind of cities that feature significant office space anyway. Instead, primary industries include tourism, food service, agriculture, and hunting & fishing.

About 2/3rds of the loan portfolio is categorized as “commercial”…

…and most of that segment is backed by commercial real estate. Only 14% of total loans are commercial & industrial.

For the most part, small businesses start with founders’ savings, home equity, and/or equity investments from family members and friends. Less small business financing comes from bank loans than one typically thinks. The exception is owner-occupied real estate, which usually makes sense to finance through a mortgage.

Most of BHB’s CRE loans, however, are investor-owned (40%) rather than owner-occupied (8%).

Notice that BHB has a very small exposure to higher-risk construction loans, and C&I loan balances have actually fallen year-over-year.

When it comes to loan maturities, though, it should be noted that non-construction CRE loans maturing this year make up a mere 0.6% of total loans, while only C&I loans maturing this year are only 1.8% of total loans.

Total loan maturities in 2023 equal 3.2% of total loans.

Next year, non-construction CRE loan maturities equal 17.8% of total loans, making 2024 a bigger year for mortgage maturities. But given the nature of Northern New England’s commercial real estate, I highly doubt this will trigger a wave of loan defaults.

Bottom Line

I am buying the pullback in BHB’s stock price. Between the ~4.2% dividend yield and roughly 6% average annual dividend growth, I view this well-run bank as a great dividend growth investment.

While BHB was cheaper on a price to book / tangible book basis during the depths of the COVID-19 pandemic, it otherwise strikes me as being cheap relative to the level of interest rates.

BHB traded at a lower price to book in the low interest rate era immediately preceding COVID-19, but I am skeptical at this point that we will return to that ultra-low level of interest rates anytime soon.

If interest rates come down from here but remain above that ultra-low level where it hovered for most of the 2010s, I believe BHB will be able to perform quite well.

Over the past few decades, through two recessions, BHB has produced vastly superior total returns to either the SPDR S&P Regional Banking ETF (KRE) or the SPDR Financial Sector ETF (XLF):

In my view, the current selloff is a great entry point for investors who believe, as I do, that this long-term outperformance will continue.