NEW YORK (TheStreet) -- While smaller banks have been hurt more than their larger peers by the Federal Reserve's near-zero rates, they may benefit more, proportionately, when rates eventually rise.

It all comes down to their relationships, according to Ted Peters, CEO and Chairman of Philadelphia-based Bluestone Financial Institutions Fund. Prior to joining the Philadelphia-based firm, Peters served as a board member of the Philadelphia Fed from 2009 through 2014 and as CEO of two community banks.

"Community banks have very strong what we call 'core deposits,'" said Peters. "They have great relationships with their clients and because of that, there's a lot of money that's not overly price sensitive. If rates go up 100 basis points, a lot of these community banks will only have to increase their deposit rates 30-40 basis points, so you'll get an increased spread."

While large and small banks alike have struggled with low rates, the effect is more acute at small banks that are unable to rely on other lines of business when times are tough. Small banks deal primarily in loans and deposits, while their larger counterparts like JPMorgan Chase (JPM) , Bank of America  (BAC) and Citigroup (C) rely on investment and trading businesses to bolster revenues.

"Loan rates have come down faster than deposit rates have," Peters said. "You're getting a natural squeezing effect on what we call our net interest margin. The profitability of all banks, especially community banks, has been affected by low interest rates."

The Fed lowered interest rates to nearly zero to spur economic activity after the financial crisis of 2008-09, and markets have anticipated a rate hike prior to the end of this year as economic data -- particularly employment numbers -- improve.

Confidence regarding a near-term rate hike has dwindled in the past month, however, amid concern that a slowdown in China would hurt the U.S. economy.

Still, Peters remains hopeful that the Fed will begin raising rates soon, and the fund he manages is betting that small banks will benefit significantly from the action.

Furthering the projected success of small banks is their agility. When rates rise, the effect will be seen first in the net interest margin, the spread between the interest earned on loans versus the interest paid on deposits. And, thanks to their community relationships, even as repricing occurs on deposits, small banks won't face as much pressure to increase the interest they pay. 

"In general, small banks will remain asset-sensitive, meaning, they will reprice their loans faster than they will reprice their deposits," Peter said. "Small banks will do well when interest rates start to increase."

The megabanks, of course, stand to benefit, too. Bank of America CEO Brian Moynihan said in a presentation Thursday morning that the Charlotte, N.C.-based company's net interest income might rise as much as $3.9 billion over the next 12 months as interest rates climb.

The value of the bank's $1.15 trillion deposit base would become more visible, too, he said.

 

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