Iowa bankers have little nostalgia for the late 1980s.

"It was a very difficult time," said Charles S. Howard, chairman and chief executive officer of Mahaska Investment Co. in Oskaloosa. "I still cringe when I think about the loans we had to write off." But as it turns out, the depression that struck the Farm Belt was not a complete wash for Mahaska. In 1988, when the crisis was at its worst, the company bought a pool of distressed assets from the Federal Deposit Insurance Corp. for $18 million.

That desperate move to diversify its balance sheet has become a thriving business at Mahaska, a $500 million-asset holding company for four Iowa community banks. Since 1988 it has netted more than $55 million by purchasing pools of nonperforming loans at a discount then curing them by negotiating new payment schedules with borrowers.

Those profits have financed Mahaska's expansion and helped it recover from an unsuccessful foray into commercial financing. In fact, Mahaska would have lost money in each of the last 11 quarters had it not bought the distressed assets.

And the business is likely to grow. Mr. Howard said he expects loan pool activity to pick up as the economy slows and banks begin to have higher rates of nonperforming assets.

Because of the obvious risks, few banks enter the distressed-asset business. Holmes Foster, superintendent of the Iowa Division of Banking, said Mahaska is the only banking company in the state that invests in loan pools. And Keith Leggett, senior economist at the American Bankers Association, said Mahaska is the only U.S. bank he knows of that does not sell these loans on the secondary market.

"They're following a unique strategy where you really have to have a specialized skill to succeed," Mr. Leggett said. "That is probably why you don't see more banks doing it."

The reason Mahaska holds the loans is simple: It makes more money servicing them itself. At the end of the third quarter, Mahaska's loan pool investments totaled $57.8 million and the yield on the assets was 11.72% - more than it makes on the loans it originates or on its investment portfolio.

Mr. Howard said loan pools are his most important business, and the company's third-quarter results support that assertion. Mahaska charged off $610,000 in loans from its now-defunct commercial financing venture in the three months but stayed in the black because it made $1.7 million from loan pool investments.

Mahaska attributes its high yield to the discounted price pays when it acquires the nonperforming loans. Once it assumes a loan, it tries to collect the full amount from the borrower and reap a generous spread.

"The key is to buy the asset correctly and collect as much of its face value as possible," Mr. Howard said. "This is not a hit-and-run thing. Our stated goal has always been to collect 100 cents on the dollar."

David A. Meinert, Mahaska's executive vice president and chief financial officer, said most of the loans the company buys are for one-to-four-family housing and small commercial real estate. The company focuses its loan-pool activity in the Northeast, South, and Midwest but owns properties throughout the country, Mr. Meinert said.

Mahaska obtains its loan pools from other banks and from the FDIC, both of which sell them to the highest bidder. This year it has lost more bids than it has won, but Mr. Meinert said the company refuses to enter into bidding wars with the finance companies, which are generally its competitors.

That policy has served Mahaska well. The company has never lost money on one of its loan pool investments, and Mr. Meinert said the proceeds from the pools have helped it found two banks - one in 1994 and one in 1997 - and buy Midwest Bancshares, the holding company for the Midwest Federal Savings and Loan Association of Eastern Iowa, in 1999. Mahaska State Bank, the holding company's flagship subsidiary, dates back to 1883, and the holding company was created in 1994.

"We've been able to expand because this investment opportunity was there," Mr. Meinert said. "It has lessened our reliance on the local economy and spread out some of our risk."

Mahaska's loan-pool cash has come in handy over the past 18 months, when the company struggled to get over the commercial financing flop, On-Site Financial Services Inc. It created the unit in 1995 to lend to small businesses unable to qualify for conventional loans, and Mr. Howard now admits it was a mistake.

"We were not cut out to do that type of lending," he said.

The subsidiary ran into trouble almost from the start. Mahaska charged off just $42,000 in 1995, but by 1998 chargeoffs had risen to $817,000, with $343,000 attributable to On-Site.

Mahaska shut On-Site down in May 1999, at the same time boosting loan-loss reserves by 74% - to $3.3 million - to cover the avalanche of bad loans. Since its nadir in the second quarter of 1999, Mahaska has charged off loans totaling nearly $2.7 million.

Brad Ness, an analyst at Howe Barnes Investments Inc. in Chicago, rates Mahaska's stock as "hold" but said its rating could improve now that the company has either sold or charged off most of its commercial lending portfolio.

"I'm optimistic things are trending upward," Mr. Ness said. "To their credit, they realized commercial credit wasn't working and they got out."

Mr. Ness also does not expect Mahaska to draw much interest as an acquisition target. Though a wave a consolidation has left Mahaska as one of the largest publicly traded banks in Iowa, its reliance on loan pools has "probably scared away some potential buyers."

"Loan pools are not your traditional assets," he said. "I don't know of any other banks that invest in distressed assets."

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