The S&P/ASX Small Ordinaries Index (ASX: XSO) is down 0.012% on Friday and up 3.45% in the year to date (YTD).

The S&P/ASX All Ordinaries Index (ASX: XAO) is down 0.54% today and up 2.71% over the YTD.

In terms of ASX financial shares, there has been much focus on the strong performance of the big four ASX 200 bank stocks.

In particular, the extraordinary gains of Commonwealth Bank of Australia (ASX: CBA) shares, up by more than 80% since November 2023.

Perhaps it's time for investors to turn their attention to some promising small-cap ASX financial shares?

The interest rate-cutting cycle that has begun in the US, Australia, and many other nations is a tailwind for all ASX small-cap shares.

This is because they're typically young companies that tend to carry more debt than the larger companies to fund their early growth.

Blackwattle Small Cap Quality Fund portfolio managers Robert Hawkesford and Daniel Broeren discuss two small-cap ASX financial shares in their latest monthly report, both of which are up by more than 40% in 2025 alone.

Here's what they had to say.

2 ASX financial shares up by more than 40% in 2025

Generation Development Group Ltd (ASX: GDG)

The Generation Development share price is $5.35 on Friday, down 0.93% and up 54% in the YTD.

Generation Development Group is a market leader in retirement and investment solutions, including bonds.

The company has been in the news over the past year for its August 2024 acquisition of investment research and ratings company Lonsec and financial services firm Evidentia, which it bought and integrated into Generation Development in February.

Hawkesford and Broeren attribute this ASX financial share's 34% price surge in May to the re-election of the Labor Government.

They said Labor's re-election raised the likelihood of superannuation tax reform, which would make investment bonds more attractive.

The Labor Party has proposed raising taxes on superannuation earnings above $3 million, including unrealised capital gains.

The analysts also spoke favourably about Generation Development's strategic alliance with US global asset management giant, Blackrock.

Generation Group announced the alliance on 8 May.

The partnership's key goal is to help Australian retirees transition from accumulation to decumulation by providing sustainable income streams with longevity protection.

Generation Development Group's CEO, Grant Hackett OAM, said:

This transformational relationship brings together Generation Life's innovation in retirement income with BlackRock's global scale and expertise, delivering solutions that address the evolving needs of Australian retirees while creating long-term value for advisers,superannuation funds, and shareholders.

The companies will co-design and distribute a product called Holistic Retirement Solutions. They hope to launch it over the next year.

The analysts said this product addresses longevity risk and benefits from long-term tailwinds from the retirement income covenant.

The retirement income covenant is an Australian law requiring superannuation trustees to develop a strategy to help members achieve sustainable income in retirement. This includes considering their financial needs and preferences.

Hawkesford and Broeren see a bright future for this small-cap ASX financial share.

The analysts said:

Despite the recent share price run, we still see plenty more upside as GDG capitalises on the structural tailwinds of managed account penetration, superannuation tax reform and the retirement income covenant.

Australian Finance Group Ltd (ASX: AFG)

The Australian Finance Group share price is $2.21 on Friday, down 1.12% today and up 42% in the YTD.

Australian Finance Group is one of Australia's largest mortgage aggregators and securitised home loan lenders.

This small-cap ASX financial share enjoyed 20.9% share price growth in May.

Hawkesford and Broeren said the stock was supported by a reignited housing market and another interest rate cut in May.

They said expectations of further rate cuts in the near term "should drive increased mortgage activity and strengthen AFG's competitiveness on mortgage lending relative to the banks".

The analysts see this ASX financial share as good value, despite the recent run, commenting:

AFG's valuation is compelling, trading on 15x P/E, offering mid-teens earnings growth and a ~5% fully franked dividend yield.