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Hedge Fund Hotshot Banks on M&A Wave

Laurie Kulikowski

The frothy bank M&A market has got one hedge fund manager, Cutler Capital Management, rooting for more deals in the sector.

The Worcester, Mass.-based investment firm, which has $250 million in assets under management between two hedge funds and individual accounts, has scooped up positions in what it sees as the most likely of acquisition targets -- community banks.

Like many observers, Cutler Capital is predicting that intense competition, deteriorating credit quality and pressure on interest income will force many banks to consider selling in the coming months.

U.S. bank acquisitions, including commercial and investment banks, thrifts and credit card firms, are on the rise already. Four months into 2007, there have been 106 deals worth $70.7 billion. That puts the sector's M&A pace on track to beat last year's full-year tally of $119.2 billion, according to Dealogic data.

"The volume of deals will increase in 2007," says Dave Grenier, president of Cutler Capital and a former banker at Fleet Financial. "Smaller institutions are coming to the realization that it's very difficult to compete and they're choosing to make a deal."

Cutler Capital is certainly not the only observer expecting more M&A among banks.

"We heard for months now that M&A chatter amongst CEOs is picking up," says Peter Winter, a bank analyst at BMO Capital Markets. "What we're starting to hear is that it is starting to turn more serious because of these earnings headwinds. Right now there doesn't seem to be much light at the end of the tunnel."

Winter adds that because smaller banks aren't trading at such big premiums as they once were, the valuation gap has "narrowed" between large and small banks, ultimately making it cheaper for banks to purchase targets.

Grenier wouldn't name all the banks that the firm has positions in. But he says one company where it has recently benefited from the M&A boom is Commercial BankShares(CLBK Quote) of Miami, he said.

In January, it agreed to be acquired by Colonial BancGroup(CNB Quote) of Montgomery, Ala., for $317 million in cash and stock.

The firm had a small position in the $1 billion-asset bank for the last 18 months "in anticipation of something happening," Grenier says. At the end of December, Cutler's position was worth $1.8 million.

For the most part, Cutler chooses small banks located in Florida and Texas, where the demographics are quickly growing, making the areas attractive for banks looking to expand their presence. The firm also looks for banks with solid earnings, owners or CEOs that are nearing retirement age, says its founder, Mel Cutler.

He started the investment firm in 2003 to focus on investing in convertible securities, real estate investment trusts and dividend-paying equities, but he has had a particular affinity to the banking sector since the 1970s.

As a former civil engineer, Cutler was involved in the building of several bank branches. Cutler says he became envious of the easy hours bankers maintained (there were no seven-day, 24-hour branches at this point) and the simple business plan of profiting from spread income.

Eventually with just $3 million, Cutler and a colleague launched Florida-based Madison BancShares in 1985. Two years later, they opened Flagship Bank and Trust in Worcester.

While Cutler was excited at the prospect of being in the banking business, he says it was harder than it looked.

"I'm not a banker," he said in an interview with TheStreet.com. "The banking business turned out to be like any other business. There is no free lunch in banking. Over the years it has become extremely competitive."

Cutler and other shareholders agreed in 1996 to sell Flagship to Chittenden(CHZ Quote), a $6.6 billion-asset banking company in Burlington, Vt. It still operates under the Flagship name.

Madison was sold to New Orleans-based Whitney Bank(WTNY Quote) in 2004 for $66 million in cash and stock.

Whitney bought the four-branch bank in Tampa Bay for 3.6 times book value and 26 times earnings -- a deal that he could not refuse, Cutler says.

Interestingly enough, both Whitney and Chittenden are also considered possible takeout targets. According to Securities and Exchange Commission filings, Cutler Capital owns positions in both.

In fact, some observers say Chittenden's management may be starting to consider a sale.

Chittenden did not return a request for comment. But Winter says that during a roadshow last week with analysts, Chittenden's management spent a lot of time answering questions about a potential sale. He declines to discuss who might be a suitable partner for Chittenden.

"The standard answer was we'll consider anything," he says. "The tone has shifted."