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FEATURE Failing Upward Financial institutions set to make the most of failed asset acquisitions. By Bob Calandra T he first thing you notice about the FDIC's list of failed bank buyers is who is not on it. Nowhere to be found are names like JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo. Instead the list is populated with the names of small banks that before 2009's Great Recession were familiar only to the people in their community or region. A good example is the Bank of the Ozarks. Pre- recession it was a healthy, well-run community bank doing a great job serving its local customers. Because it was well capitalized, the Bank of the Ozarks was able to not just weather the economic collapse, but to thrive on the financial industry's chaos coming out of it. And thrive it did. Today anyone remotely related to the banking industry knows the Arkansas-based company's success story. Making smart decisions, the Bank of the Ozarks has gone from a small community bank to a regional powerhouse, expanding its business into Florida and Alabama. In the past three years, the bank has purchased four failed institutions with FDIC help and three others on its 30 | THE M REPORT own. It now has more than $4 billion in assets and was named the top bank in the American Banking Journal's Top Performers for 2011. Then there is the Lafayette, Louisiana-based IberiaBank, which, over the past few years has purchased five companies from the FDIC list and more than doubled its size. Amazingly, neither company ranks among the most active small banks gobbling up their failed breth- ren. Why are small banks at the forefront of purchasing failed institutions? They have the assets and are seizing the opportunity to grow. "Really it is a way for [small banks] to gain market share without paying a huge premium on the deposits and yet have a great deal of protection on the asset side," says Martin Friedman of FJ Capital Management, an investment fund that currently owns 85 small banks across America. "It's a good bet if, like anything, you price it right." If it's such a good bet, then why aren't the financial indus- try's 800-pound gorillas claiming their share? After all, there are still 450 or so banks Friedman calls "zombie banks" because they exist but can't do anything. The answer is twofold: First, the big banks simply can't handle anymore market share. Second, the size of the banks aren't, well, worth their time or effort. "The problem banks that are left are small community banks," says Friedman, "A Wells Fargo won't have an appetite for a $200 million or $500 million or even a $1 billion company. It won't move the needle for them. It's too much of a headache. But a $500 million bank buying a $500 million FDIC transaction moves the needle quite a bit." And the needle has been danc- ing off the dial for buyers like Minneapolis-based U.S. Bank, which has purchased 12 FDIC banks; Georgia's State Bank and Trust, which purchased six FDIC banks; Chicago's MB Financial, which now owns four failed banks; and Sterns Bank in St. Cloud, Minnesota, purchaser of four failed institutions. "A failed bank acquisition is an attractive way for a bank to grow assets, grow customers, and grow their portfolio," says Jon Winick, president of Clark Street Capital in Chicago. "But very often in any failed bank acquisition, there is a pretty high level of customer attrition. So while the purchasing bank is go- ing to acquire attractive assets at an attractive basis, usually there is a fairly high amount of loan and deposit runoff." That drain-off is just one of the many things an acquiring bank has to take into consider- ation before rendering a bid on a failed bank. There is a high level of due diligence necessary to ensure that the buyer is getting a bad bank at a good price. And the purchasing bank doesn't get much time in which to do it. The questions are many and the answers not always clear, start- ing with selecting a failed bank and analyzing its problems. "Is there a good bank here? Are there good customers here? Do I have the people and resources to work out the bad assets," are the kind of questions Winick says the buying bank needs to ask. "It is ultimately a strategic, financial, and asset quality decision." Why Small Banks Failed A s most everyone knows, the number of small bank