Prime Solution in Action: WestAmerica Bank

We spend overmuch much time on dead zombie banks. Let's switch gears now and talk about how strong, well-managed banks are helping the FDIC and state regulators create what we've called the Prime Solution, putting troubled assets and deposits in strong hands, and how this ongoing process is the example members of Congress should be taking in developing responses to the crisis.

The FDIC closed and/or merged several more banks on Friday, adding to the list of resolutions to date. For example, after the close Friday, County Bank, Merced, California, was closed by the California Department of Financial Institutions, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver.

To protect the depositors, the FDIC entered into a purchase and assumption agreement with the sole bank unit of WestAmerica Bank Inc. (NASDAQ:WABC), San Rafael, California, to assume all of the deposits of the $1.8 billion asset County Bank. At the end of Q3 2008, County was rated "F" by the IRA Bank Monitor with a overall stress score of 21.6 vs. the 1.5 industry averaged stress or more than one order of magnitude above the industry mean for Q3.

This resolution fits the pattern of past FDIC actions, with high stress scores for ROE degradation and charge-offs, but County's efficiency and capital stress scores were also above average. County had been rated an A as of Q1 2008, but slipped to "F" in Q2 2008 due to a large surge in charge-offs and operating losses. The bank had FHLB advances equal to 8% of total assets at the end of Q3 2008. The estimated loss rate to the FDIC from the County transaction will be $135 million or less than 10% of the failed banks total assets, not a terrible outcome if the actual resolution tracks the projections.

All 39 branches of County Bank were reopened as branches of WABC's subsidiary bank yesterday and FDIC personnel will be on hand to facilitate the handoff to WABC managers. Americans should be very proud of the thousands of FDIC, other federal and state regulatory personnel, government contractors, legal and financial advisers, and employees of the federal bankruptcy courts, who worked all weekend to make this and other resolutions possible.

Notice how the FDIC and other regulators are managing this resolution process, scheduling the closures of several institutions on Friday and thereby minimizing public stress and anxiety. And the list of banks, funds and investors actively participating in the shelf facilities established to help FDIC to quickly move failed bank assets into strong hands is growing.

By the way, WABC was rated "A+" by the IRA Bank Monitor as of Q3 2008, with an aggregate level of stress of 0.7 vs. 1.5 for the entire industry. At Q3 2008, WABC was 30% below below the 1995 stress baseline in the IRA Bank Stress Index for the entire industry. WABC's bank unit boasts an efficiency stress rating of 0.6 vs. 1.2 for the entire industry. The efficiency ratio for the sole bank unit of WABC was an amazing 39% at the end of Q3 2008. We call that righteous.

WABC's bank unit had "only" 6.35% leverage at end of Q3 and about the same in Q4, putting them slightly below peer in terms of capital, but with an ROE of 13% at the end of Q3 and 14.9% at the end of Q4 2008, equity capital is not an issue. Charge-offs for WABC bank unit increased from 31bp in Q3 to 52bp at year-end 2008, well below peer loss rates for both periods. But analysts note the two key positives on WABC as it ends 2008: strong earnings and excellent operating efficiency.

With the branches of County Bank, WABC will be a $5 billion asset regional player in CA and well positioned to take advantage of opportunities as 2009 proceeds. Did we mention that WABC closed over $48 on Friday, up 10% for the day? The 90-day equity volatility on WABC is 167% based in the EOD pricing from our friends at Morningstar, which is less than half the implied volatility of larger bank names. For all of you stock pickers out there who are users of the IRA Bank Monitor, consider that a hint.

If members of Congress and the Obama Administration take one lesson from us this week, then they ought to look at the growing crowd of investors - several who are working with IRA - forming to purchase assets cleansed through the process of insolvency. Banks, branches and individual loans are being bought and sold by investors with capital and the ability to manage credit. These are the beginnings of economic recovery and are an early indicator that the bull case is reappearing for financials - if not yet ripe.

Stock position: None.