Here’s something you can bank on.

Late this Friday afternoon, somewhere in America, regulators will swoop into at least one small or midsize bank, shut it down, seize such assets as commercial and residential mortgage on its books, and sell those assets, probably to another bank. It’s happened 42 times so far this year, ahead of last year’s blistering pace. Last year, it happened 140 times.

FDIC Chairman Sheila Bair, whose agency insures failed banks’ depositors, certainly expects more bank failures this year than last. "We think this is going to peak this year, and it's going to get considerably better next year," Bair said earlier this year.

All that may seem like bad news, and in many ways it is, of course. But for some, it spells opportunity. And in areas like Atlanta and Washington, investors are banding together to bet on small banks, taking the risk that the banks they buy into will be survivors of this downturn.

A fund in the Atlanta suburb of Buckhead, Georgia, has seen big returns on small investments in community banks, the Atlanta Business Chronicle reports.

The investors behind the Sagus Financial Fund LP have had remarkable success so far, posting a 26.3 percent net return since January 2008, compared with the S&P 500 bank index’s net loss of 45.9 percent during that same period.

Investment banker David Brown, who leads Sagus Partners LLC, put it this way: “This cycle, like the last cycle of the 1980s and 1990s, is going to transform the industry, eliminate some parties, and make others stronger.”

The window of opportunity, Sagus principals say, is generational. The firm has been buying stock in select smaller lenders with $500 million to $5 billion in assets that are trading at an extreme discount.

The bets are made that these institutions will survive the current cycle of failure to be later bought for a premium as bigger rivals seek greater market share or be consolidators themselves even after the failed bank sweepstakes comes to a close.

The team has avoided community banks in the hardest-hit markets or that were overly gung-ho on residential development loans. The team also scoped out banks with solid branch networks and stable core customers in growth markets that weren’t likely to be forced to raise capital at gunpoint, diluting investors.

Sagus invests mostly in illiquid stocks—though it has placed money in some publicly traded banks. The plan is for longer-term holds, waiting for the cycle of natural merger and acquisition activity to begin after the failed bank bonanza has run its course.

Investments in smaller lenders, many of them not publicly traded, is where real money can be made, industry observers say. Adam Aspes, institutional equity trader for Sterne Agee & Leach Inc. in Atlanta, said Sagus has a deep team and breadth of knowledge of the region’s smaller banks.

“There’s no doubt that there’s a huge opportunity to recapitalize small banks and [Sagus] is in the middle of it all,” Aspes said. “They’ve got all the relationships and know who to support and who not to.”

Smaller lenders are still trading at distressed prices, and FDIC-assisted transactions for smaller banks can prove to be “transformative,” Aspes said. The group invests typically up to 5 percent of a bank’s stock, and would prefer to remain under 10 percent in ownership to avoid onerous regulatory requirements.

Sagus invested its first dollars in early spring 2008 and had invested 50 percent of its capital by the end of that year. Most of its capital is currently deployed, though liquidity remains for other investment opportunities.

“We felt that strategy was conservatively aggressive,” Brown said. “We were buying when no one else was.”

In the Washington area, the business journal reports, at least five investor groups are raising capital and positioning themselves to buy troubled or undervalued banks, most with the plan of recapitalizing them, rolling them up with other institutions and selling them.

“This area is awash with cash,” said Khash Montazami, chairman of Xerxes Capital. “It’s about getting people to realize that traditional stocks and bonds are not the only game in town.”

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