How to Profit From Bank Failures

by: Stephen Rosenman

Guess which sector is showing the greatest activity in M&A? Energy? Mining? Tech? No, it's the regional banks, courtesy of the FDIC. Since the beginning of 2009, 327 banks have become insolvent; thirty have collapsed in just the last two months.

Every Friday, the FDIC announces those banks that have bitten the dust. And every Friday we learn which financially-sound banks have won their bids for the assets and deposits of these insolvent institutions. The winning banks usually acquire the deposits without a premium. They take over the assets with the government guaranteeing 80% of each loan's potential losses. This "M&A" occurs without middle men: there are no investment bankers to be paid and no "paying up" to purchase companies. In fact, often the failed bank's assets are bought at bargain basement prices.

The last 2 years have been very active. What does the future look like for this market?

The FDIC reports 884 problem banks with $390 billion in assets. It is likely this financial crisis will see the vast majority of the 884 "iffy" banks crumble. $390 billion is a huge potential market. In the last financial debacle (1989 - 1993), over 1700 banks closed, with 20% of all banks closing or acquired. Bank colossuses formed. We're seeing a replay of that period. Over the next two years, many hundreds of teeter-tottering banks will close, only to reopen under sounder financial underpinnings. The 7700 current banks will probably dwindle to below 7000. The winners: the regional banks that have been stepping up to the plate.

I've been acquiring shares of those regional banks which have been particularly active in this market: New York Community Bancorp (NYB), Bank of the Ozarks (NASDAQ:OZRK), First Citizens BancShares (NASDAQ:FCNCA) - with an interest in Home Bancshares (NASDAQ:HOMB), Umpqua (NASDAQ:UMPQ), and City National (NYSE:CYN). These have purchased failed banks repeatedly. BB&T (NYSE:BBT) is also of interest with its huge buy of Colonial. I've coined these Regional Banks Eating Other Banks the REBs. Simply put, they are able to grow their asset and deposit base with little to no risk of failure.

Disclosure: I am long NYB, FCNCA, OZRK.