In a frustrating year for bank stocks, investors are surely on the hunt for areas to hide out. One way to play the sector could be to embrace the notion that smaller is better.
That thinking, however, goes against the decadeslong move toward consolidation in the industry, which is predicated on the notion that larger banks with diversified revenue streams are better equipped to handle turbulent economic conditions. But a review of economic downturns over the past few years by analysts at Piper Sandler found that smaller banks fare better than their larger peers.
During the financial crisis of 2007-2009, banks with assets in excess of $50 billion saw their share prices plunge an average of 71% over a 26-month period, while the decline for banks with assets under $1 billion was 49%. Even during the pandemic-induced selloff in early 2020, the larger banks saw shares drop 48% while smaller banks fell 35%.
Part of the reason for the relative outperformance of smaller banks is something that can be considered both a blessing and a curse. There is more liquidity with the bigger names, so they’re likely to face more selling pressure in a downturn, according to Mark Fitzgibbon, an analyst at Piper Sandler.
Smaller banks, obviously because of their size but also the greater likelihood of insider control, are less liquid. That is fine if you are eager to hold on to shares, but for an investor who may have to sell in a down market, it could be a problem.
Fitzgibbon also says investors appreciate the simplicity of smaller banks’ balance sheets in a downturn, as well as those lenders’ tendency to have higher capital and reserve ratios. His team identified 21 banks that have market capitalizations below $1 billion, with the potential to have their shares climb 20% or more.
From that group, Barron’s identified four banks with market caps in excess of $500 million and dividend yields greater than 3%, reasoning that higher payouts help to compensate investors for the risk of owning smaller companies. On the shortlist are
(ticker: CATC), Heritage Financial (HFWA),
So far this year smaller banks are faring slightly better than the larger banks. The
SPDR S&P Regional Banking ETF
(KRE) is off by 7.3% and the
SPDR S&P Bank ETF
(KBE) is down by 8%. This is in some part due to smaller banks being more able to benefit from the Federal Reserve’s rate increases because they can reprice their loans quickly and benefit from wider spreads. While big banks also get a benefit from rising rates on their loan portfolios, some of those gains are offset by weaknesses that higher rates lead to in their advisory business.
Despite touting small lenders as a haven for hard times, Fitzgibbon said he believes a “solid case can be made for a rebound” in banks in general later this year, as long as macro conditions remain stable.
Write to Carleton English at email@example.com
Read More: Smaller Banks’ Stocks Do Better in Rough Markets. 4 Lenders for a Downturn.