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FEATURE failures has everything to do with construction, real estate, and mortgage loans. The fact is, says Walter L. Zweifler, most small and community bank presidents have only a vague notion about the nuances of banking and consequently didn't have enough safeguards in place to mitigate risks. "The typical director of a community bank does not know how to read a call report and has only a vague understanding about how to value the bank and evaluate its performance," says Zweifler, ASA, CBA, and president of Zweifler Financial Research in New York City. When the recession hit and loans began defaulting, small banks that were overexposed in the real estate market took heavy losses and quickly went through their capital reserves. With no money left, the banks were seized by the FDIC. When banks started failing, the FDIC was very aggressive, offering a sweetheart deal to buyers. The FDIC covered 90 percent of the failed bank's losses and the purchasing bank absorbed the remaining 10 percent, thus greatly mitigating the buyer's risk. "I think the FDIC has been creative in resolving failed banks," Winick says. "I think go- ing forward they have been less aggressive and are giving failed banks more time to pursue open market solutions that ultimately don't cost them anything." In fact, the FDIC has altered its current offer to a less attrac- tive but still pretty good 80/20 ratio. But a purchasing bank can still get burned if it doesn't do its homework. "The trick is to try to price the embedded losses correctly," Friedman says. "If you do that, you have bought an institution at a good price. But not everyone is successful. Sometimes they miss on the pricing and they pay too much. That happens." The Right Price for the Right Bank O ver the course of his long career in finance, Zweifler has valued somewhere in the neighborhood of 75 banks. So there is very little that he doesn't know about sussing out how to strike the right price for a bad bank. Like Friedman and Winick, he doesn't think that just because a bank is available and the terms look good, it is a desirable buy. The search for the right failed bank to buy should be deliberate, starting with a detailed accounting of the purchasing bank's health and assets, Zweifler says. Once that is done, the process breaks down into strategic importance, financial health, and asset quality. Having a crystal ball to gazing into the economy's future wouldn't hurt. If the economy is actually rebounding, Zweifler recommends scampering down to Florida or out to Arizona and California to start scooping up well-priced mortgages. But if it isn't and there is yet another downturn, then acquiring a failed bank can be a big mistake. "The equity of a typical bank is only a percentage point or two," Zweifler says. "So if there is a significant charge-off of any kind, it can wipe out your equity very quickly. It is a risky business." Targeting a failed institution to buy has a lot to do with a Industry Insiders Talk Failure and Recovery Speaking out on controversial companies that collapsed in the wake of the housing crisis, industry professionals discuss the extended impact of financial institutions' failures. B eing chosen by your peers as the most important company in a category is usually a great honor. But not when you are chosen as the most important bank/lender failure in modern history. Washington Mutual was the unani- mous choice for that dubious distinction by our three industry professionals. "Washington Mutual is obviously the big- gest and had some controversy around it," says Martin Friedman, chief investment of- ficer of FJ Capital Management in McLean, Virginia. "It pales in comparison to anything else. They took a lot of people out." Walter L. Zweifler also had Washington Mutual at the top of his list, with Countrywide Financial Corporation a close second. "Those two are my quick answer to that," says Zweifler, president of Zweifler Financial Research in New York. He says the two companies were the leaders in "sloppy bookkeeping and bad paperwork and documentation and loans made to unqualified borrowers." Washington Mutual, along with Bank United, and Wachovia were the top three larger bank failures for Jon Winick, president of Chicago-based Clark Street Capital. And while those three and others have had a last- ing impact, Winick is more concerned about the number of smaller bank failures. "I think a lot of the small bank failures have been devastating to their communi- ties," he says. "When a town loses its community bank and it's acquired by someone two hours away, it is potentially devastating to that community." 32 | THE M REPORT