(By Mani) Shares of small-cap banks, whose market cap generally falls under $2 billion, increased 13 percent in 2012, in line with the S&P 500 but underperformed the mid/large-cap banks, which rose 16 percent on average. Historically, the profitability for smaller banks has lagged that of their larger peers.
While these companies face similar challenges to their larger peers such as low interest rates, tepid loan demand, and increased regulatory costs, small caps are expected to generate a higher rate of pre-tax, pre-provision revenue growth in 2013.
Smaller banks still face many of the same challenges. While most small-cap banks have escaped some regulatory restrictions, such as the Durbin Amendment due to being below the $10 billion asset threshold, they were still impacted by others such as Reg E, which reduced banks revenue related to customer overdraft charges.
Small-cap banks also tend to have less diversified revenue streams relative to the larger brethren. For example, from 2008 - third quarter of 2012 small-cap banks generated just 24 percent of their total revenue from fee revenue sources with the remaining 76 percent produced via net interest income from lending and deposit gathering. In comparison, the fee income revenue split for larger banks has been 35 percent/65 percent over the same time frame.
"Consequently, new regulations have presented a larger challenge for the smaller banks as is it more difficult for them to make up the lost revenue by adjusting products and pricing in other business lines," Oppenheimer analyst Terry McEvoy wrote in a note to clients.
Increased expense levels have also challenged many small-cap banks. Expenses have been driven higher by a variety of sources, including additional regulatory requirements and environmental costs related to elevated nonperforming assets.
"However despite the headwinds discussed above, 70% of the small banks in our study are expected to report YoY growth in pre-tax, pre-provision net revenue (PPNR) in 2013. This is slightly better than the outlook for mid- and large-cap regionals where 64% are expected to report higher PPNR in 2013," McEvoy noted.
Additionally, small-cap banks are expected to report a median growth rate in PPNR of 4.5 percent with the expectations for mid- and large-caps slightly 4.3 percent. So, while there are clearly challenges to the small bank model in 2013, almost two-thirds are expected to show growth.
Following are a handful of small-cap bank stocks with the best and least attractive risk/reward from an investor perspective:
Banner Corp. (NASDAQ: BANR)
BBCN Bancorp, Inc. (NASDAQ: BBCN)
Brookline Bancorp, Inc. (NASDAQ: BRKL)
CapitalSource, Inc. (NYSE: CSE)
Cathay General Bancorp (NASDAQ: CATY)
Central Pacific Financial Corp. (NYSE: CPF)
CVB Financial Corp. (NASDAQ: CVBF)
First Community Bancshares, Inc (NASDAQ: FCBC)
Hanmi Financial Corp. (NASDAQ: HAFC)
Lakeland Financial Corp. (NASDAQ: LKFN)
National Penn Bancshares, Inc. (NASDAQ: NPBC)
State Bank Financial Corp. (NASDAQ: STBZ)
The Bancorp Inc. (NASDAQ: TBBK)
ViewPoint Financial Group (NASDAQ: VPFG)
Wilshire Bancorp, Inc. (NASDAQ: WIBC)