Crowning the Four Kings of Regional Banks

by: Stephen Rosenman

In my last article, I painted a bleak picture of the industry. Yet, one small group of banks stands to gain from the financial crisis. They're the financial institutions who take the assets and deposits of the failed banks. I've dubbed the group the REBs, or Regional Banks Eating Other Banks. The FDIC has auctioned off the vast majority of the banking failures at extremely attractive terms. For just about every collapse, there is a bank waiting to scoop up the assets and deposit base. The buyers must have strong balance sheets which already sets them apart from most of their competitors.

I favor banks that have made repeated acquisitions because they have demonstrated their expertise. They bid carefully for their loans. After all, over pay for assets and you get buried in paperwork with little to show for it. I like the banks that keep coming back. They have the resources, skill set, and daring to make it work.

What do they get?

1. They acquire banks at a discount. Usually, they report "bargain" purchase gains that show up on their P&Ls right away. This often capitalizes the venture. Many banks, as a result, do not need to do equity offerings to finance the deals. Contrast that to mergers financed with dilutive equity offerings.

2. The FDIC covers 80% of each and every loan's losses. The profit from performing loans goes solely to the acquiring bank. Upside with a capped downside.

3. The acquired loans generally have higher interest rates. The performing covered loans give these banks a far higher net interest margin (NIM) than their peers.

4. Banks are having trouble generating loans. The REBs don't need to go to the market place; they acquire loans that are backed by the FDIC.

5. They are able to expand, enter new geographies, and acquire branches at favorable terms. As the economy improves, they will be in an enviable position.

Right now there are over 800 problem banks on the FDIC list. The REBs are going to have plenty of failed banks to bid on. They are seizing an once in a 20 year opportunity to grow at minimum risk and cost.

So, which banks are winners?

Top of the pack and King of the REBs: OZRK. This one stands above the rest. It's taken on 5 FDIC-assisted helpings of bank failures. The 4 which were done in 2010 were successful, resulting in "bargain" asset gains of $1.11 a share (29% of EPS), as well as a rise in loans and NIM. NIM is at a breathtaking 5.18%.

To put that NIM in perspective, HCBK's was 1.73%. This is a bank that had $28 million in assets in 1979. Its CEO turned OZRK into a $3 billion asset power house. This company is all about growth. Their CEO plans to do many more FDIC-assisted deals this year, asserting in his conference call that his balance sheet can easily manage 8 to 12 takeovers. He sees no problem winning more failed banks.

Of note, the company has maintained excellent liquidity measures despite doing its last 5 takeovers without issuing a share of dilutive stock. OZRK surpassed EPS estimates the last 4 quarters. The earnings beats are startling (see latest earnings report here).

Next quarter, OZRK will easily clobber consensus $0.69 estimates. For instance, OZRK just grabbed another wasted bank; those "bargain" gains haven't yet been factored in the $0.69 estimates.

Not too far behind is FCNCA. FCNCA has been gobbling up banks right and left. It's taken 4 FDIC failed banks. Again, no equity offering needed. Purchases funded courtesy of one time gains due to "bargain" purchases. The company gains performing loans, expands its geographic footprint, increases its NIM. Only FBR follows this $21 billion asset bank (it's practically an orphan). It's the biggest bank hardly any one covers, and yet, the company is extraordinarily profitable. This isn't your I-almost-closed-Citi-type-of-bank. Their CEO probably holds the record for the number of times he's bought stock, making 18 separate purchases this year. If you are at all influenced by insider buying activity, FCNCA is your stock.

Next in the winner circle is NYB. NYB swallowed one gigantic failed bank AmTrust Bank, and one smaller one. The covered loans acquired by the deal helped to boost net interest margin to 3.61%. With a 5.4% dividend and a shoe-in for the S&P 500 Hall of Fame, NYB is an excellent long term position for the conservative investor.

HOMB, parent of Centennial Bank, deserves honorable mention for taking on 6 failed banks. One has to ask oneself: "Should there be a limit on how many banks you can buy?" (Sort of like limiting 6 packs of soda that are on sale at the grocery store). This $600 million market cap bank out of Arkansas is aggressively taking every available opportunity out there.

Every Friday, the FDIC announces the banks that have bitten the dust. The REBs will have hundreds of opportunities throughout the next 2 years to buy these on the cheap.

Disclosure: I am long NYB, OZRK, FCNCA.