The more than 50% one-day drop in shares of Colonial BancGroup (NYSE:CNB) following its third quarter earnings release may have been an overreaction by investors who were spooked by the firm management's aggressive actions to get rid of bad loans quickly. Colonial BancGroup has $26 billion in assets and 340 branches located in Florida, Alabama, Georgia, Nevada and Texas. (To determine if a bank is worth investing in, read Analyzing a Bank's Financial Statements.)

The Bad
Colonial BancGroup reported a loss of 35 cents per share for the third quarter of 2008. The reason for the loss primarily can be attributed to the provision undertaken by the bank to cover loan losses totaling $159 million. Other weak asset quality measures reported by the bank include:

  • $121 million in loan charge-offs in the quarter;
  • An increase in allowance for loan losses to $285 million, or 1.88% of loans; and
  • 4.43% non-performing assets to loans and other real estate owned (OREO) ratios, compared to 2.62% in the previous quarter.

In addition, Colonial suspended its dividend, which will save the bank $77 million every year. Since the dividend is paid to shareholders in cash, its suspension will help preserve capital immediately.

The Good
The bank maintains strong capital ratios, despite recent losses. Colonial BancGroup reported a Tier 1 Leverage ratio of 7.29%, a Tier 1 Risk-Based Capital ratio of 10% and a Total Risk-Based Capital ratio of 14.17%. The minimum ratios for a bank to be considered "well-capitalized" by the government are 5%, 6% and 10%, respectively.

Colonial is pro-active on managing its bad loans and has established a "war room" in Tampa to keep track of bad credits. "We have got a very aggressive program going on to attack these credits,"said CEO Bobby Lowder. "We have set up a war room in Tampa, Florida that we have staffed with a large number of people." Most of the bank's problems stem from residential construction loans made several years ago, centered mostly in Florida, Texas and Georgia.

Colonial also indicated that it was exploring participation in the federal Troubled Asset Relief Program (TARP), which would allow the bank to sell preferred stock to the U.S. Treasury. This capital is considered Tier 1 Capital, which would further strengthen the bank's assets. The TARP program limits investments to the lesser of $25 billion or 3% of total risk-based assets. Using the June 30, 2008 number of $19 billion, the bank would be eligible for capital of approximately $570 million, which would significantly boost capital ratios of the bank. However, Colonial would have to pay a 5% dividend on the shares.

Colonial BancGroup ended the third quarter with a tangible book value of $6.56 compared to a stock price in the $3 per share range. In addition, the bank is selling at about 50% of tangible book value. (To learn more about this valuation metric, read Digging into Book Value.)

Other Florida banks that are becoming non-performing are BankUnited Financial (Nasdaq:BKUNA), which replaced its Chairman and CEO last week, BankAtlantic Bancorp (NYSE:BBX), which charged off $23.2 million in bad loans during the third quarter and Seacoast Banking Corporation of Florida (Nasdaq:SBCF), which reported its ratio of non-performing assets to loans and other real estate owned at 4.6% for the third quarter.

The Bottom Line
The large selloff of Colonial BancGroup may have been an overreaction to the decision an aggressive management team eager to get rid of non-performing assets. However, the drastic drop in share prices could be a welcome opportunity for investors.

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Tickers in this Article: CNB, SBCF, BBX, BKUNA

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