A good time to buy small banks? Phila fund raises $305MM

Patriot Financial Manager LP, the Philadelphia-based investment firm headed by ex-bank CEOs James Lynch, Kirk Wycoff, James Deutsch, and investor Ira Lubert, has finished raising its second fund and has already invested more than a third of the $305 million it raised from more than 100 investors. The group's previous $300 million fund opened in 2007-08, just in time for the financial crisis that crippled bank values. Both focus on banks with $1 billion to $5 billion in assets.

What's different this time? Back in 2008, "all of a sudden the industry was very distressed and people needed a lot of capital to take care of loan losses, securities losses and chargeoffs," Wycoff recalls. So Patriot I "became a capital replenishment fund," tkaing stakes in banks the partners thought had a strong chance of recovery.

Why not collect wrecked institutions at a fraction of their book value? Wycoff said his experience is that's a tough way to turn a profit, as he learned running the former Progress Bank in the 1990s and early 2000s: "The employees and customers leave, and it takes a long time to build it back. At Progress, it took us 15 years. Most invesotrs only want to hold for 5 to 7 years. So we looked for good banks that had a particular issue that needed to be solved -- a credit issue, a management issue, an operational issue."

How did that work, over the past 8 years? Wycoff says the partners expect to eventually more than double investors' money. That could take some time longer: As of Dec. 31, one investor, the Pennsylvania State Employees' Retirement System, said it had so far received back $8.8 million of the $25 million it invested with Patriot. Waiting for principal and profits, SERS pays Patriot a stream of annual fees -- $475,000 in 2014.

Success stories include North Carolina-based, venture-focused Square1 Financial, whose pending sale to Los Angeles-based PacOne will pay Patriot "in excess of five times" its investment; Florida-based Guaranty Bank, with scattered offices (including one in Plymouth Meeting), currently valued at triple the fund's investment cost; and expansion-minded Bank of North Carolina, an example of the kind of ambitious small lenders who are growing toward a size that commands a higher price-to-book multiple, rewarding early investors like Patriot, Wycoff says.

Patriot's resembles a contrarian or value-style argument: Small banks have attracted investors in the past couple of years because their prices have not risen like those of larger banks, making them look like bargains with the prospect of fatter payoffs to come.

Wycoff says he's encouraged by the recent sale of Florida Business Bank in Tampa at a more comfortable multiple: "Banks whose currencies have appreciated and are willing to pay us 2x book or better" are likely acquirers for the Patriot portfolio. Patriot bought into Bank of California at book value in 2013; the bank has since doubled in size, trading above book value and poised, Wycoff says, to go higher.

Patriot II has an increased appetite for tech-based banks, Wycoff says: "We are seven years later in the technological revolution," with young people banking by smartphone and bank underwriters sharing loan data for quick decisions. "All that causes significant changes in thoughts of how to invest in the bnaking industry."  Patriot II will buy more branchless and specialty lenders like Square1, and focus more on Florida, which has been late recovering from the last recession.

Patriot is also active in the Northeast -- seeking small institutions in New England, Long Island -- seeking to replicate, for instance, the recent sale of Continental Bank (which Wycoff used to head) to Bryn Mawr Trust at a comfortable premium.

Patriot I bought into Philadelphia's Beneficial Bank and Cape Financial down at the Shore, but Wycoff cites his partner Jim Lynch's longtime contention that Philadelphia loan pricing is unusually competitive and bank profits here are correspondingly weak. "We are overbanked," he said. FNB, the upstate Pennsylvania bank most associated with Marcellus Shale profits, paid a handsome premium for Vernon Hill-founded Metro Bank of Harrisburg recently. "Nobody is going to pay premiums like that for banks smaller than a billion dollars, or banks that don't make at least 10 percent returns on equity."

I asked if the ongoing criminal prosecutions of senior officers at Wilmington Trust Corp. for allegedly hiding significant loan losses will likely have a chilling effect on other lenders in the region. Given the accusations, which he noted haven't been tried in court, "my experience is that Wilmington Trust is much closer to an outlier," a rarity among banks, Wycoff said. "Most people particularly in the next layer below the C-suite have a very good moral compass. They understand what a good loan is and isn't. In my turnaround days we had some very hard rules on that."

While "every loan is a good loan the way you make it," Wycoff adds, "a borrower needs to be repaying the bank every month. When they can't, you need to be realistic about your course of action."