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As the U.S. banking industry continues to muddle through to recovery, the universe of publicly traded bank stocks offers plenty of vulture opportunities.

But unless you're a big bank like Toronto-Dominion , which can buy South Financial Group by working with the regulators, you're more likely to get burned by buying the stocks of banks that are struggling to avoid getting seized.

Let's take a look at a truly fantastic story from this spring out of Washington state. Frontier Bank, one of the state's biggest commercial lenders, had been struggling for some time with a rising level of problem loans. Its desire for more capital had been known since 2008, and by early 2010 it was public information that regulators had given it until April 15 to find some new investment or risk seizure.

April 15 came with no news of a rescue, yet Frontier Financial Corp., the bank's Nasdaq-traded parent, still commanded nearly $3 (U.S.) a share in the following days.

On April 26, Frontier Financial shares shot up to nearly $8 before closing at $5.88, nearly a 100-per-cent gain, on no news. More than 23 million of its shares traded, compared with a typical day's volume of about 200,000.

The local media were mystified - but that's because they missed the "story" posted that day on the Associated Content website by a blogger calling himself "Gabriel Infinity Acts." The item said the "Infinite Freedom Foundation" of King County, Wash., "was in the process of making a bid for the entire company for $8.88 [U.S.]per share." The erratically written piece also said the foundation "proposed" that the deal's financing would come from financier George Soros (with zero indication that Mr. Soros or any of his investment companies had any idea his name was being bandied about).

By week's end, the Tacoma News Tribune reported that "Gabriel Infinity Acts" was actually Gabor Sandor Acs, a Hungarian native. The paper also quoted a television producer named William Wilson who arranged the interview with Mr. Acs as saying "I can tell you he doesn't have any money … Sometimes you just have to wait for him to get back into orbit … We don't understand him, we just help him." Mr. Acs told the News Tribune that he was "planning on approaching" Mr. Soros because "he's Hungarian and I'm Hungarian."

While the bank did its part by issuing a statement denying the rumours, there was little help for the bank's remaining investors: The stock stayed above $3, higher than before the blog posting, until April 30 - when federal regulators seized the bank. On May 3, Frontier Financial said it would file for bankruptcy.

When trading resumed several days later, the stock plummeted to 43 cents a share - and, improbably, has since rallied to as much as 75 cents. A phone message left for the former CEO of Frontier was not returned.





Frontier Bank's story is not typical, but one need not have such a fantastical tale to see unmerited investor enthusiasm for a troubled institution.

Another example? TierOne Bank of Lincoln, Neb., and its holding company TierOne Corp. The bank warned as early as January, 2009, that it was in regulator's sights for asset-quality and capital issues and, appropriately, the stock slid.

Now, to be fair, there were glimmers of hope along the way: In September, 2009, TierOne said it had a deal to sell nearly half its branch network in order to raise capital. Yet the company's capital ratios remained far below what regulators required.

The banking company's stock was selling for pennies, but there were some bizarre bumps along the way. The best example: On a Sunday, April 25, TierOne disclosed that its auditor, KPMG, had resigned the previous Friday and told the company's management that the 2008 financials had "material misstatements." The next day, TierOne stock jumped 46 per cent to 82 cents.

Those who thought a bank with no usable financial statements was a good speculative buy were promptly thumped. Regulators vetoed the branch sale, saying it would actually place TierOne in worse shape. An April 30 deadline for a rescue plan came and went.

The bank's shares still managed to trade for at least 20 cents until June 3, the day before regulators seized the bank. (A call to TierOne's investor relations department was met with a recording saying it is "no longer in operation.")

Rob Wessel, a portfolio manager at Toronto investment firm Hamilton Capital Partners, shakes his head at the speculative frenzy. Mr. Wessel, who pointed me to these two examples - and who was selling each short at the time - specializes in investing in the U.S. banking market.

"These banks are very risky long investments and retail investors should stay away," he said. "At any time, investors could be either massively diluted if the bank manages to pull off a Hail Mary capital raise, or worse, lose their entire investment if the bank is seized."

Best leave the troubled-bank buying to the TDs of this world.

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