With Backing From the Blackstone Group, This Bank Is a Turnaround Worth Watching

Sometimes, all that a small company needs is a little help from a larger, connected partner with deep pockets.

That's exactly what this bank got late last year, and the results since have drawn the attention of several specialist hedge funds who think this is a turnaround story worth following.

A small bank drawing a lot of big-name attentionNewStar Financial is a specialty finance company that makes loans to support working capital, acquisitions, and growth to middle-market companies. The bank will finance mergers and acquisitions, recapitalizations, as well as traditional loans backed by assets and cash flow.

NewStar reported $3.5 billion in total assets and a 5.2% return on average equity as of the second quarter. Adjusting for payments related to the payment of some balance sheet debt, the bank's return on average equity would have been a more attractive 7.4%.

The FDIC reports that the average return on equity for banks with total assets between $1 billion and $10 billion was 11% in the second quarter.

Hedge funds are swooping inSecond Curve Capital, a financial industry specialist fund, reported owning 2.3 million shares of the company, 9% of the fund's investment portfolio, and a 9% increase from the first quarter. Second Curve had been selling off its position, which peaked at 4.9 million shares as of March 31, 2014, but reversed course in the second quarter with the new buys.

Another financial industry specialist, William Black's Consector Capital, owned 620,000 shares as of the second quarter, about 5.22% of the investment portfolio. The fund's position declined 22% from the first quarter in terms of shares owned, but remained fairly stable around 5% of the total stock portfolio.

Corsair Capital had the largest hedge fund position in the bank at quarter end, controlling over 9.5 million shares.

Lots of capital to fuel fast-paced growthLast year, the bank closed a series of deals for new funding withFranklin Square Capital PartnersandGSO Capital Partners, a subsidiary of theBlackstone Group

That funding helped the bank boost its capital position, but even more important than that, it created a strong strategic relationship that has generated a huge jump in new deals for NewStar. The extra funding and backing from these large asset managers allows NewStar to offer a broader and more comprehensive product package to its middle-market niche, as well as a new source of deal flow via referrals from both Franklin Square and GSO.

And so far the partnership seems to be working out extremely well. NewStar did over $1 billion of deals in the second quarter, a 68% jump from the first quarter. The assets-to-shareholder-equity ratio is a low 5.3 times as well, meaning the bank has plenty of capital left to continue this rapid growth.

The key for an investment to work out, though, is returns, and that's a metric where NewStar still has some work to do.

The bank's 5.2% second-quarter ROAE trails the industry by a good margin, but it is getting better, doubling from the first quarter. Adjusting for the impact of the debt paydown, second-quarter ROAE nearly tripled over the first quarter.

An uncertain future but cause for optimismBased on the significant jump in deal flow and returns since signing the new partnerships, management's work to boost performance is off to a great start. However, one strong quarter does not make a trend, and a successful turnaround remains far from assured.Either way, this bank is worth keeping an eye on for the next few quarters.

The article With Backing From the Blackstone Group, This Bank Is a Turnaround Worth Watching originally appeared on Fool.com.

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