Hedge Fund Hotshot Banks on M&A Wave

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.