Bank fire sale reignites fear about asset quality

November 2, 2010

Why should the fate of a bank in one of the tiniest American states be of any concern to the global banking sector? After all, Delaware is hardly the place to look for broader trends. But the manner in which one of the state’s banks, Wilmington Trust, was forced to sell to rival M&T for a song could end up haunting the entire industry.

Wilmington didn’t look shockingly spooky initially. The bank has been struggling for a while, losing money each quarter since the first half of last year. And in early October it became clear chief executive Donald Foley, who only took over in June, was looking to raise more capital. That left the bank looking like any number of regional institutions, including more than 600 that took money under the Troubled Asset Relief Program, that were still struggling with the after-effects of the real estate crash.

But the general impression was that, while loan losses would hurt the bank for some time, Wilmington had taken its lumps at the end of the second quarter. That’s why its board’s decision to sell to M&T for just $351 million was such a shock. The price, at a 45 percent discount to its previous day’s closing price, makes it one of the biggest so-called “take-unders” in recent Wall Street memory.

In reality, given the bank’s dismal third-quarter results, the valuation isn’t that bad. At some 91 percent of tangible book value, it’s not that out of whack with where more healthy banks have been trading. The trouble is that until the deal was announced, investors thought Wilmington’s tangible book was worth twice as much.

What changed that was losses taken after the bank — presumably under mounting pressure from regulators—reassessed its assumptions about its mortgage and construction loan book. Worryingly, these were mostly loans made in Wilmington’s own back yard. M&T reckons they could lose another $1 billion.

Wilmington was more exposed than most, with almost half its loans extended to construction and real estate. But that it only now, under new leadership and regulatory pressure, recognized that they were worth far less than they’d carried them at could spark concern that many other banks have more dross on the books than they’re letting on. The First State’s Wilmington bank debacle may not be the last in U.S. banking.

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If you think WT’s valuation is shockingly low check out all the bank loan closed end funds. Exactly the same type of loans sliced, diced, pooled, and wrapped up in a closed end fund are suddenly worth a PREMIUM.

I own some bank loan funds which I bought at the depth of the crisis because at one point they seem priced for the world to end… the pendulm has swung to the other extreem. Investors proceed with caution.

Posted by y2kurtus | Report as abusive