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  Banking on change

BENJ GALLANDER and BEN STADELMANN

Thursday, November 11, 2010

No sector offers up more potential opportunities to the contrarian, at least in terms of raw numbers, than U.S. regional banks. Hundreds of these institutions have already been closed or forcibly amalgamated; hundreds more sit on regulators' "problem bank list."

The volatility of publicly traded banks' stock prices has been high, to say the least; nimble traders have had some dynamite chances to make hay. This went to a bizarre extreme in April of this year, when scores of banks rapidly saw their market values double, triple, and more. The frenzy reached a peak in the last week of the month, then dissipated as suddenly as it arose.

For those with a longer-term perspective and an eye towards purchasing bona fide turnaround plays, figuring out when to pull the trigger has been a quandary. The main problem is, it is so difficult to get a handle on the value of a bank's loan portfolio.

Sure, it's obvious that the value of real estate collateral is impaired, but by how much? What does it mean when an institution's loss provision drops? Are the decks finally getting cleared of non-performing loans, or is the bank's "optimism" regarding future losses tied to anxiety that capital ratios are insufficient to absorb another big hit?

For investors, this is the difference between the light at the end of the tunnel and being obliterated by the train.

One bank that has been followed carefully is Mississippi-based Cadence Financial. In addition to about 20 branches in that state, it operates another 20 in Alabama, Florida, Georgia and Tennessee. During a ten-year span from 1998–2007, this community bank had an excellent record of growing revenues and assets, and of steady profitability. By the end of this period, assets were $1.4 billion, the stock was at $14.49 and it paid out a dollar a year in dividends.

Fast forward to this year, and the bank was just barely limping along, with the stock price opening January at $1.65. The annual report filed in late March was a bleak document, detailing a brutal loss of $112 million for 2009 and warning that credit quality was still weak and capital would have to be raised. Nonetheless, the stock was inexplicably swept up in the mania and hit $4.80 on April 23.

Despite a deep skepticism for the market's ability to rationally price stocks, when something like this happens, one has to wonder what was missed. By the end of June, the stock was down to $1.15. It's an odd sensation to go from kicking yourself in the butt to patting yourself on the back so quickly. But the question remained, was this a good entry point?

This was still being mulled in September when a takeover of Cadence by Trustmark of Jackson, Mississippi, was announced. The deal was no great shakes — no cash, only stock worth around two bucks a share. This sort of thing happens to stocks on our Watch List fairly regularly. But the big surprise was a subsequent offer from Community Bancorp, a Houston-based equity firm, for $2.50 a share in cash.

This could be an important bellwether for the industry. There have been plenty of predictions of a wave of merger-and-acquisition activity, but so far, consolidation in the industry has been mostly limited to institutions cannibalized at the behest of the FDIC. Community has $900 million in the kitty, and is backed by William B. Harrison, former CEO of JPMorgan Chase. The capacity and know-how is there to vacuum up a bunch of struggling banks in the southern U.S.

Once this ball gets going, it will likely accelerate as other private equity firms jump into the action.

None of this is to say that the housing crisis is over, or that bank failures will not persist, but property has some value, and a portion of loans will be paid back. For investors who have been reluctant to buy, it appears that it is an opportune time to redouble efforts and cherry-pick the most promising candidates from the field. That is at the top of the agenda for the Vice-President's Portfolio, and will be in addition to Fidelity Southern and VIST Financial, already in the president's portfolio.


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