Small banks, big payoff?

Wilbur L. Ross Jr. in a file photo. When billionaire Ross and his company sank $50 million into struggling Sun Bancorp on July 8, shares of the New Jersey lender surged 37 percent. Not surprisingly, investors quickly began searching for The Next Small Thing -- other small banks that might be recipients of private equity largess.

NEW YORK (Reuters) - When billionaire Wilbur Ross and his company WL Ross & Company sank $50 million into struggling Sun Bancorp on July 8, shares of the New Jersey lender surged 37 percent. Not surprisingly, investors quickly began searching for The Next Small Thing -- other small banks that might be recipients of private equity largess.

But analysts and traders caution that while there are plenty of banks in need of a capital infusion, the ones that do get private equity aren't always such a sure shot.

Almost by definition, some banks that get emergency capital infusions are often just a few steps from failing and being seized by the Federal Deposit Insurance Corp. And there's no guarantee that the cash infusion can revive them.

"There are a bunch of people who get all giddy when they see Wilbur Ross's name and they just want to tag along," said Brad Golding, a manager director with Christofferson, Robb & Co., who often bets against small bank stocks. "My assumption on many of these close to failing banks is that they are not a great deal."

The Congressional Oversight Panel on the Troubled Asset Relief Program (TARP), led by Elizabeth Warren, recently issued a report saying that although large Wall Street banks have mostly recovered, many smaller U.S. banks are having trouble repaying TARP money. In fact, the number of banks on the FDIC's confidential list of problem institutions has reached 775.

There are many reasons small banks are under stress, but a big problem for many institutions is that they made too many construction loans before the real estate market collapsed.

Despite all the caveats, the guessing game goes on.

In a July 1 report by Keefe, Bruyette & Woods Inc, analyst Chris McGratty listed seven banks which may be gobbled up in mergers and acquisitions. The list included Abington Bancorp, Boston Private Financial Holdings Inc, Cardinal Financial Corp, Encore Bancshares, Susquehanna Bancshares and Wilmington Trust.

"We think we're closer to returning to open bank M&A than we were 18 months ago," said McGratty. "Price discovery is improving and bank balance sheets are healthier."

Some regions of the U.S. where private equity money may be most likely to pursue small banks are the Southeast, Pacific Northwest and Mid-Atlantic.

Matthew Kelley, a Sterne Agee analyst, said the Mid-Atlantic region is particularly ripe for merger activity because many of the banks there "are struggling but not yet on the verge of failure."

(Editing by Matthew Goldstein, Jim Impoco and Claudia Parsons)