Value Investing In The Banking Sector

By Eric Fox | November 24, 2009 AAA

Many investors have correctly commented on the weakened condition of the American banking system, yet many banks that have emerged from the financial crisis healthy and sound. Several of these banks are using the financial crisis to their advantage by acquiring the deposits and loan books of failed banks at cheap prices. These acquisitions come with loss sharing agreements with the federal government that makes the deals highly lucrative for the banks involved.

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In a typical loss sharing agreement, the FDIC covers 80% of the losses incurred by the buyer on the asset pool. The agreement covers credit losses as well as certain expenses. The FDIC uses loss-sharing agreements in certain situations because it considers them the least costly method of seizing a failed bank.

The FDIC has entered into 53 loss sharing agreements through August 2009, covering $80 billion in total assets.

Taking In Some Sun
IberiaBank Corp (Nasdaq:IBKC) recently took over two banks in Florida. Iberiabank Corp took over Orion Bank, located in Naples, and Century Bank F.S.B. located in Sarasota. The takeovers gave IberiaBank Corp an entry into the formerly coveted Florida market, and $3.1 billion in total assets, along with total deposits of $2.5 billion.

The important part of the deal is that the Federal Deposit Insurance Corporation (FDIC) is providing a loss sharing agreement to IberiaBank Corp. The FDIC consents to share a portion of the loss on a specified pool of assets. For Century Bank F.S.B., the size of the pool is $656 million, and for Orion Bank, the pool size is $1.9 billion.

The deals were a home run for IberiaBank Corp., as the institution was able to get into the Florida market at a cheap valuation, while its competitors bought into Florida years ago at as much as three times book value at the peak of the bank acquisition craze. The bank estimates the purchases will be accretive by $1.00 to earnings per share in 2010. (Learn more about accretion and dilution in Accretion/Dilution Analysis: A Merger Mystery.)

Other Banks Buying In
Other publicly traded banks have also bought the assets of failed banks and entered into loss sharing agreements with the FDIC. In October 2009, U.S. Bancorp (NYSE:USB) purchased the assets of nine banks and has a loss covering agreement covering $14.4 billion in assets.

When Colonial Bank failed back in August 2009, BB & T Corp (NYSE:BBT) bought $22 billion of its assets and got loss sharing on $15 billion of them.

Loss sharing doesn't always happen when the FDIC seizes a bank and seeks to dispose of the assets. Earlier in 2009, Omni National failed and the FDIC became the receiver of the
bank. SunTrust Banks, Inc. (NYSE:STI) became the paying agent and operated the six branches of Omni Bank for the government. This was done presumably because the assets of Omni Bank were unattractive even with a loss sharing agreement.

The Bottom Line
Many banks that sat out the bank acquisition binge are acting like bottom fishing value investors, acting in a way that would make Warren Buffett himself proud. These institutions now have a weekly pick of assets in coveted areas to consider at bargain prices.

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