When it comes to banking shares, smaller is better. First Financial Bankshares ( FFIN), Tompkins Financial ( TMP), NBT Bancorp ( NBTB), SY Bancorp ( SYBT) and Arrow Financial ( AROW) have outperformed larger financial companies such as Goldman Sachs ( GS) and BlackRock ( BLK). First Financial, which carries a "buy" recommendation from TheStreet.com Ratings, is a top performer, based not only on stock performance but also on fundamentals. Focusing on the regional market in Texas, the bank has carved out a profitable niche. Although third-quarter revenue declined 5.57%, the company managed to boost earnings per share by 8.5%, outperforming the industry average and the S&P 500. Gross margins widened to 81.39% from 71.97% a year earlier, and operating margins stretched to 46.06% from 40.71%. Regional, national and international banks have reported massive losses as a result of exposure to subprime mortgages. First Financial, which has a market value of about $1 billion, has avoided common pitfalls by staying true to the fundamentals of sound lending, maintaining regional focus and providing outstanding customer service. Investors have recognized the bank's potential, fueling a one-year price appreciation of 34.6%. Consequently, the stock is trading at a premium to its industry peers based on price to earnings, price to book and price to sales. However, the stock is below its 52-week high of $67. Other regional banks demonstrated a similar resistance to the pessimism that plagued financial stocks in 2008. The aforementioned stocks aren't cheap on an absolute basis, but there may be upside potential for people looking to play a trodden sector.
There are numerous risks facing small-cap financials. Many have a high institutionally owned percentage and thin trading volume. Also, while large banks have sustained heavy losses from subprime-related investments, most have survived and will live to fight another day. However, these regional players are susceptible to immediate bankruptcy if bets turn against them. Rescuing small-cap financials doesn't top the list of Treasury priorities.
Still, First Financial management declined to petition for TARP funds and appears confident that it has the liquidity to endure, and perhaps capitalize on acquisition opportunities, in the coming months. As of Sept. 30, the company had a tier-one risk-based capital ratio of 15.41%, well above the regulatory requirement of 6%, indicating strong reserves. The company owns 10 banks, with 44 locations across Texas, and also controls a technology operating company, and a trust and asset management firm. Each of the 10 banking subsidiaries operates a full-service commercial-banking business and is governed by its own board and officers. This system of corporate hierarchy offers each subsidiary a degree of independence and regional focus. First Financial has a strong dividend yield of 2.68% and a reasonable debt-to-capital ratio of 0.36. The stock is covered by seven research firms and currently receives five "hold" ratings and two "sell" recommendations. Keep in mind, research has been bearish on small-cap financials throughout 2008. Nevertheless, a remarkable percentage of top-performing small-caps were from the financial sector. Ninety-five stocks in the S&P SmallCap 600 Index rose in 2008, and 31 of those were financials. Whether these stocks can retain momentum is debatable, but with more negative press circulating about banking giant Citigroup ( C) and other international players, it may be possible for small-cap financials to capitalize on their relative safety and continue the upward battle. As always, consider macroeconomic and idiosyncratic risk before investing.