TruPS Recoveries from Section 363 Bankruptcy Sales Remain Volatile TruPS Overview: Financial Crisis Deferrals Trust preferred securities (TruPS) are often thought of as hybrid securities because they have features of both debt and equity. Trust preferred securities generally have a very long term (usually 30 years), are interest only, are unsecured, are subordinate to all other debt issued or to be issued by the issuer, and include a provision that permits a five year consecutive deferral period on interest payments. On the other hand, the holders of trust preferred securities benefit from traditional remedies accorded to a lender. The primary issuers of trust preferred securities are bank holding companies (BHC), which generally down‐streamed the proceeds to their bank subsidiaries, generating favorable tax and regulatory capital treatment. This combination precipitated TruPS popularity as a source of funding for banks in the late 1990s through the mid‐2000s. The financial crisis that began in 2007‐2008 and the deterioration of the economy in the years after strained the banking industry. As bank asset quality weakened many banks that had issued TruPS began to defer interest payments on their TruPS in 2009 and 2010. For these issuers the five year deferral period has ended or will end soon. According to Fitch Ratings, as of May 2014, in the 78 TruPS CDOs monitored by Fitch Ratings there are 224 issuers that are currently deferring $2.6 billion of collateral.1 Wilary Winn currently values 60 TruPS CDO deals and has identified 73 banks that are deferring their interest payments and have less than 12 months remaining on their deferral period. Of these 73 banks in deferral, 58 are currently operating with regulatory scrutiny in the form of either a cease and desist order, a formal agreement, consent order or a prompt corrective action. This regulatory burden complicates the distribution of capital from the subsidiary bank and subsequently, the ability to upstream capital from the subsidiary to the BHC to cure the deferring issue. We expect that many of these banks will cure their deferrals in the coming year, and we expect some will enter into monetary default. 363 Sale Process Upon monetary default the whole principal amount of the issue will become immediately due and payable and the creditor(s) may file a lawsuit for breach of contract under the indenture governing the issuance of the TruPS. This will likely force the BHC into involuntary bankruptcy and a subsequent sale of the BHC’s assets under Section 363 of the Bankruptcy Code. It should be noted that a monetary default event is not a required precursor for a 363 sale as a BHC may voluntarily file for Chapter 11 bankruptcy to facilitate a sale of its assets free and clear of all liabilities, as in the case of Idaho Bancorp’s 363 bankruptcy sale. 1
Fitch Ratings Inc. (2014). U.S. Bank TruPS CDOs Combined Default & Deferral Rate Declined [Press release] Retrieved from http://www.businesswire.com/news/home/20140522006449/en/Fitch‐U.S.‐Bank‐TruPS‐CDOs‐
Combined‐Default Section 363 of the bankruptcy code provides a mechanism for the sale of property, including equity interests, outside of the ordinary course of business, subject to the court’s approval of the transaction. While there is no express provision in the code that prescribes an auction of the debtor’s assets, courts have allowed the cultivation of such processes in efforts to efficiently maximize the value of the bankruptcy estate on behalf of creditors. Upon filing for bankruptcy the Bank Holding Company will become a debtor in possession. This status, as defined in Section 1107 of the bankruptcy code, attaches fiduciary duties to the debtor in possession along with reporting requirements as ordered by the bankruptcy court. The U.S. trustee is also responsible for monitoring the compliance of the debtor in possession with the reporting requirements of the court and approving compensation and reimbursement of outside advisors. Pursuant to Sections 341 and 1102 of the bankruptcy code the U.S. trustee will appoint a committee of creditors and facilitate a meeting of the creditors along with the debtor to ascertain relevant facts regarding the debtor’s acts, property, administration of the bankruptcy case and facilitate a plan of reorganization. This committee, in most 363 sales, is the committee of unsecured creditors and has become increasingly assertive in efforts to establish expansive auction periods, reduce minimum overbids and other provisions aimed at increasing the competitiveness and inclusiveness of the bankruptcy auction process to maximize the bankruptcy estate. For most BHCs the only significant assets are shares of the subsidiary bank or banks. Thus the recovery for the TruPS holders (and other creditors) is related to the value of the subsidiary bank or banks, many of which are undercapitalized, have poor asset quality and may be operating under regulatory consent orders. The proceeds of the BHC asset sale are then distributed to the creditors of the BHC based on the seniority of the debt interest, with any remaining proceeds available to the BHC equity holders. For TruPS holders the 363 sale process differs significantly from a bank failure resulting in receivership of bank assets by the Federal Deposit Insurance Corporation (FDIC). In receivership the assets of the failed insured depository institution are placed under the control of the FDIC as receiver, in this capacity the FDIC will seek to efficiently maximize the disposition of the assets of the failed institution and pursue any legal claims of the failed institution. The proceeds of the disposition and pursuit of claims will then be distributed to creditors. However, in a bank failure usually the largest creditor of a failed depository institution is the FDIC itself, thus mitigating, and often eliminating any meaningful recovery for other creditors of the bank. The bank failures that occurred in the early stages of the financial crisis were failures of the subsidiary banks that resulted in FDIC receivership, with very limited recoveries for TruPS holders. In contrast to the insolvency of the subsidiary bank and FDIC receivership, the issue driving 363 sales is the default of the BHC on issuances of TruPS and a subsequent liquidation of BHC assets in bankruptcy on behalf of the BHC creditors. Recent Trends in Bank Valuation Multiples Recent trends are encouraging for improved TruPS recoveries for issuers that enter into 363 sales. Bank valuations as evidenced by price‐to‐tangible equity and tangible book premiums to core deposit multiples have improved in the past few years as the banking sector has endured through the financial crisis and a severe credit cycle. The following two tables, from SNL Financial, highlights the rise in median deal value to tangible equity from 2010 through June 30, 2014. As the table above indicates the median deal value multiples to common and tangible equity have increased since bottoming out in 2011. The increases in these multiples reflect the abatement of credit risk in the market and a stabilizing economy. The increases also reflect that many banks of poor asset quality failed or merged with other banks early in the financial crisis. We note that many mergers are being driven by increasing regulatory burdens creating further incentives for economies of scale. We expect these trends to continue in the near term. As the table above indicates the average and median tangible book premium to core deposits for all bank transactions has increased since a low in 2011 through June 30, 2014. Section 363 Bank Sales since 2010 According to SNL Financial, since 2010 there have been 13 judicially approved 363 sales of banks. The outcomes for TruPS holders in 363 sales have varied significantly. The following table highlights the deal value to tangible equity and tangible book discount to core deposit multiples for the completed 363 sales since 2010 and an estimated haircut on the principal of the TruPS of each issuer. Buyer
D.L. Evans Bancorp
RKSJ
Olney Bancshares of Texas Inc.
Talmer Bancorp Inc.
Simmons First National Corporation
United Community Bancorp, Inc.
First Farmers Financial Corporation
First Bancshares, Inc.
Western Alliance Bancorporation
Talmer Bancorp Inc.
Strategic Growth Bank Incorporated
Home BancShares, Inc.
First Bank Lubbock Bancshares, Inc.
SKBHC Holdings, LLC
Target
Idaho Banking Co.
First Mariner Bank
Park Cities Bank
Four subsidiary banks of Capitol Bancorp Ltd.
Metropolitan National Bank
Mercantile Bank
Bank of Indiana, National Association
First National Bank of Baldwin County
Centennial Bank
First Place Bank
Mile High Banks
Premier Bank
Jefferson Bank
AmericanWest Bank
Seller
Idaho Bancorp
First Mariner Bancorp
North Texas Bancshares, Inc.
Capitol Bancorp Ltd.
Rogers Bancshares, Inc.
Mercantile Bancorp, Inc.
Indiana Bank Corp.
First Baldwin Bancshares, Inc.
LandAmerica Financial Group, Inc.
First Place Financial Corp.
Big Sandy Holding Company
Premier Bank Holding Company
Outsource Holdings, Inc.
AmericanWest Bancorporation
Completion/Te
rmination Date
Pending*
6/17/2014
12/9/2013
1/1/2014
11/25/2013
12/13/2013
10/26/2013
4/30/2013
4/30/2013
1/1/2013
12/31/2012
12/1/2012
7/28/2011
12/20/2010
Deal Value
TruPS
($M) outstanding ($M)
10.0
7.7
17.7
51.0
11.9
34.0
6.5
151.3
53.6
41.2
NA
61.9
NA
0.0
3.3
7.3
57.5
NA
45.0†
61.9
5.5
29.9
1.4
12.0
2.0-11.0
5.0
6.5
41.2
Tang. Book
Deal
Prem./Core Value/Tangible
Deposits (%)
Equity
7.6
297.7%
-1.7
64.4%
-5.0
56.1%
-4.9
NA
-1.0
88.9%
NA
NA
NA
NA
-0.4
91.9%
-7.8
55.6%
-5.3
14.4%
-1.9
7.7%
-3.6
15.9%
-1.1
21.2%
-2.7
18.6%
*The 363 sale of Idaho Bancorp is currently pending. †Talmer Bancorp expressly assumed liability for First Place Financial Corp.’s TruPS as part of the 363 sale. In a 363 sale the consideration available to TruPS holders is reduced by the amount of bid protections for the stalking horse bidder, legal and financial adviser fees and any other debt interests of the BHC, as the TruPS securities are subordinate to all other debt interests of the BHC2. The bid protections, legal and financial professional fees are subject to the approval of the presiding bankruptcy judge and review by the U.S. Trustee for the relevant geographic region. These reductions can reduce the proceeds available for distribution considerably. For example in the North Texas Bancshares Inc. 363 sale, bid protections and professional advisors fees totaled $2.64 million or approximately 22% of the $11.89 million of consideration offered. Many 363 sales contain unique deal provisions that alter the prospect of TruPS recoveries and lead to a wide range of outcomes for TruPS holders. For instance, in the 363 sale of First Place Financial Corp.’s assets the acquirer redeemed a portion of the TruPS immediately and assumed liability for the remaining balance of the TruPS, thus resulting in no loss of TruPS principal. As the table above highlights, in Rogers Bancshares, Inc.’s 363 sale, a strategic buyer won the auction with a bid over 25% in excess of the TruPS outstanding of the BHC, leading to no loss in TruPS principal. It is also possible that TruPS holders will be made whole in the 363 sale of Jefferson Bank to First Lubbock Bancshares, Inc., subject to payments conditional upon adjustments of book value and post‐merger losses suffered by the 2
Cordell, L., Hopkins M., Huang, Y. Research Department, Federal Reserve Bank of Philadelphia. (2011). Working Paper No. 11‐22 The Trust Preferred CDO Market: From Start to (Expected) Finish. Retrieved from http://www.philadelphiafed.org/research‐and‐data/publications/working‐papers/2011/wp11‐22.pdf acquiring institution, there has so far been little information that has been publicly available regarding the status of this deal, and the subsequent payments. In contrast, the 363 sales of Premier Bank Holding Company and Big Sandy Holding Company yielded consideration that was between 10‐20% of the BHC’s outstanding TruPS. We note that these 363 sales occurred before 2013 and bank valuations, as indicated on previous pages, have increased as the economy has stabilized. The following table summarizes weighted deal value to tangible equity multiples for announced and completed 363 deals since 2010. Deal Period
2013‐ June 2014
2010 ‐ 2012
All Announced or Completed Deals
Number of 363
Deals*
Weighted Average Deal
Value/Tangible Equity
6
3
9
78.6%
15.1%
50.1%
*As the purpose of our analysis is to analyze the developments from the perspective of the TruPS market, we have excluded deals from this table that include unique provisions that expressly assume liability for outstanding TruPS, have contingent future payments or were not for full bank franchises. Therefore we have excluded the 363 sales for First Place Financial Corp., Outsource Holdings, Inc. and Capital Bancorp. For 363 sales announced or completed from January 2013 through June 2014 the weighted average deal value to tangible equity was 78.6%, a significant increase from the 15.1% for 2010 through 2012. FDIC Cross Guaranty Liability One significant obstacle to TruPS recovery in a 363 sale is the Federal Deposit Insurance Corporation (FDIC) asserting cross‐guaranty liability against a BHC. The FDIC’s cross guaranty provisions are statutory provisions that trace back to the Financial Institutions, Reform, Recovery and Enforcement Act of 1989 (FIRREA), and the aftermath of the savings and loan crisis. Cross guaranty liability allows the FDIC to seek reimbursement from a BHC for losses the insurance fund has incurred in taking a failed subsidiary bank or banks of the BHC into receivership. This reimbursement in the context of a 363 sale would come from the consideration tendered by the purchaser. Cross guaranty liability is a seldom used option for the FDIC. Prior to the financial crisis, the FDIC had only asserted cross guaranty liability “in approximately six cases since being given cross guaranty authority in 1989, all of which were in the early to mid 1990s.”3 In many cases where it may be applicable the FDIC has waived the right to assert it. The FDIC has historically wielded the threat of asserting cross‐guaranty liability to secure settlements with BHCs that are selling other remaining subsidiary banks. Per SNL, the terms of settlements in recent years with the FDIC to waive cross guaranty liability have been in the range of 80‐100% of net proceeds. 3
Federal Deposit Insurance Corporation (2009). FDIC Cross Guaranty Provision [Press release] Retrieved from http://www.fdic.gov/news/news/press/2009/pr09195b.html The settlements reached by the BHC’s in two previous transactions have eliminated meaningful recoveries for TruPS holders. Both Community Bankshares, Inc.4 and Capitol Bancorp reached settlements with the FDIC that would give the FDIC 85% of the net proceeds from their sales of remaining subsidiary banks in exchange for the FDIC granting a waiver of its right to assert cross guaranty liability on previous losses suffered by the FDIC regarding failed subsidiaries. Given these precedents, TruPS holders of BHCs that have failed subsidiaries are unlikely to realize material recoveries in the future. Overall, the significant increase in the number of TruPS issuers that are nearing the end of their deferral period presents significant challenges and volatility to TruPS valuation. While each issuer’s situation and the condition of the underlying assets of the BHC are different, recent transaction history is indicative that many TruPS will recover value in 363 sales. Author Jacob Heidkamp, Financial Analyst Mr. Heidkamp joined Wilary Winn in March of 2013. Jake graduated from the University of St. Thomas with a Juris Doctor and a Master of Business Administration. Mr. Heidkamp teams with senior Wilary Winn consultants on a variety of engagements including valuation of trust preferred CDOs and determination of fair value, including mergers and acquisitions. Prior to joining the firm, Jake clerked at a Minneapolis law firm focusing on securities litigation. 4
Community Bankshares, Inc. sale of subsidiary bank Citizens State Bank of Cortez was not conducted under Section 363.