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The Bankruptcy Option   Recapitalization Through A 363 Sale
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The Bankruptcy Option Recapitalization Through A 363 Sale


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Bank holding companies ("BHC"s) across the US have billions of dollars of holding company debt and trust preferred stock ("TruPS"). Deeply troubled banks with highly leveraged …

Bank holding companies ("BHC"s) across the US have billions of dollars of holding company debt and trust preferred stock ("TruPS"). Deeply troubled banks with highly leveraged holding companies are struggling with bond and TruPS holders who either cannot or will not consider any restructuring to facilitate a recapitalization or sale. These BHCs should exhaust all alternatives to complete a recapitalization of the BHC. If those efforts are not successful, they should consider a bankruptcy and a sale of bank stock pursuant to 11 U.S.C. §363 (a "363 Sale") to avoid seizure of the bank.

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  • 1. The Bankruptcy OptionThe Bankruptcy Option - A Compelling Alternative to Bank FailureBy Mindi H. McClure, Managing PrincipalBank holding companies ("BHC"s) across the US have billions of dollars of holdingcompany debt and trust preferred stock ("TruPS"). Deeply troubled banks with highlyleveraged holding companies are struggling with bond and TruPS holders who eithercannot or will not consider any restructuring to facilitate a recapitalization or sale.These BHCs should exhaust all alternatives to complete a recapitalization of the BHC.If those efforts are not successful, they should consider a bankruptcy and a sale ofbank stock pursuant to 11 U.S.C. §363 (a "363 Sale") to avoid seizure of the bank.How we got here - Pooled and securitized TruPS created a way for mid-cap banks toaccess the fixed income capital markets efficiently. During the early and mid 2000swhen $45 billion of TruPS were issued to 1,500 small and mid-size banks, issuancecosts and coupons declined dramatically, creating an attractive, low cost form of Tier 1Capital for banks and BHCs. The unforeseen outcome of the efficient securitizationvehicles that bought all that low yield trust preferred is that most (but not all) of theentities that hold this $45 billion of TruPS are passive and governed by rules that makethem near impossible negotiating partners.This daisy chain of events has left many troubled banks in the uncomfortable positionof requiring a recapitalization but being stymied in their efforts because of theirholding company debt issues.In a normal troubled company restructuring, debt and bond-holders are rational actorswith the ability to respond to restructuring proposals. Not so with the passivesecuritization vehicles: No manager exists to evaluate a proposal and in many casesthe trustee is unwilling or not incentivized to forward restructuring proposals to theunderlying bondholders. Additionally, many underlying bonds are now in the hands ofvulture investors who are unwilling to negotiate their positions. Page 1
  • 2. The Bankruptcy OptionTable 1- Hypothetical Leveraged Bank Holding Company ABC Corp (BHC) ABC Bank (Bank)Consolidated Assets $2 billion $2 billionTrust Preferred $100 million NATangible Common Equity 0% / $0 5% / $100 millionRequired Loss on Sale of $100 million $100 millionTroubled AssetsPro Forma Tangible -5% / $(100) million 0% / $0Common EquityAbility to Attract Investors Very Unlikely PossibleTable 1describes a troubled bank and its parent BHC with significant TruPS. The BHChas exhausted its tangible common equity, yet the Bank continues to have 5% tangiblecommon equity. In this hypothetical example new investors require that the bank sellcertain non-performing and criticized assets as a condition of their investment. Thissale results in an additional $100 million loss. On a pro forma basis, the BHC has 5%NEGATIVE tangible equity - a very tough re-cap candidate. The Bank, while its proforma equity is zero, could possibly access capital.Table 2 - Bank Holding Companies with Assets Between $500 Million and $50 Billion BHCs With High Leverage Greater Than 30% of Tier 1 Equity Texas Ratios Number of Average Average NPAs/ Banks Tangible Assets Equity/ AssetsTexas Ratio 360 123 4.24 8.61Greater Than50%Texas Ratio 132 70 2.66 11.14Greater Than100%Source: SNL Financial Page 2
  • 3. The Bankruptcy OptionTable 2 describes the number of bank holding companies with assets between $500million and $50 billion with high Texas Ratios and high holding company leverage atDecember 31, 2011. Nearly 35% of the BHCs with Texas Ratios greater than 50% haveBHC leverage exceeding 30%. Over half of the BHCs with Texas Ratios greater than100% have significant leverage. Some of these institutions will need to consider aChapter 11 Bankruptcy and 363 sale of the bank stock in order to effectuate a bankrecapitalization.The 363 Sale SolutionFew BHCs have completed 363 sales because the need has only recently been identifiedand addressed. In the Sterling Financial Corporation and Pacific Capital Bancorprecapitalizations, the TruPS holders refused to negotiate after and exhaustive and timeconsuming tender process. The recapitalization investors ultimately capitulated andagreed to invest without any relief from the pooled TruPS, a victory for the TruPSbondholders, but perhaps a short lived victory. Sterling and Pacific Capital were likelythe last of the big franchises to recapitalize or fail. the recap investors, all extremelyknowledgeable and rational, nonetheless had big incentives to "get in the game" withthese last few large recapitalization candidates. The banks represented in our Table 2above may face a different reality. They are generally much smaller and lack thefranchise value and scale necessary to attract similar institutional capital.Securitized TruPS and their accompanying complexity did not exist in the S&L Crisis.Therefore a 363 sale was not a solution in the recapitalization and restructuring toolkitof banking professionals as we entered this crisis.The TruPS deferral option has become a double-edged sword in restructurings. TruPSallow troubled BHCs to defer dividends for up to five years before typical defaultremedies apply. This deferral option was a requirement of the Federal Reserve when itdeemed TruPS an acceptable form of Tier 1 Capital for BHCs in 1996. The deferralperiod was intended to enable troubled BHCs to get their corporate houses in orderbefore being subject to typical bond covenants. But the deferral option structure didntcontemplate that most deferring BHCs would have issued multiple series of TruPS Page 3
  • 4. The Bankruptcy Optiongoverned by multiple indentures. Nor did the deferral option contemplate a financialcrisis of the severity experienced in the past few years and the inevitable necessity ofrestructuring and renegotiating multiple BHC obligations. The end result: A deferringBHC often may not repay or restructure ANY of its obligations. The RestrictedPayments restrictions triggered by deferrals include dividends on common andpreferred stock; other trust preferred and debt; and principal repayments ormodification of any parri passu obligations.The bondholders in each pooled TruPS securitization (there are approximately 84pooled TruPS deals that together hold the $45 billion of pooled TruPS) create anadditional layer of complexity as most of the pools are non-managed. A modificationof any collateral in the pool (i.e. TruPS) is conditioned on the consent of bondholders.If a deferring BHC is fortunate enough to negotiate discounted pay-offs orrestructurings of some of its debts, it is blocked from doing so unless it receives theconsent of 100% of every class of note holders of each affected TruPS pool. DeferringBHCs with TruPS in multiple pools must separately gain the consent of each pool, atask which requires contacting multiple bond trustees and hundreds of bondholders indozens of countries worldwide (full disclosure, our broker-dealer division, TBCSecurities, has acted as lead dealer-manager in many such efforts). Even if thetrustees were cooperative and the bondholders willing, the lengthy process ofobtaining consent creates additional risk to the ailing bank.A "363 Sale" is the sale of assets by a bankrupt BHC subject to the rules of Section 363of the US Bankruptcy Code (11 U.S.C. §363). A 363 Sale is advantageous, because itenables the BHC to sell its assets, primarily the stock of its ailing bank subsidiary to anappropriate recap partner without the consent of creditors or the approval ofshareholders. Additionally, it enables the sale to take place quickly. For an ailing bank,the time consuming shareholder approvals process and near impossible creditorconsent process can create a recipe for failure as regulators weigh its impendingseizure. A traditional M&A proxy process may take six months or more. A sale ofbank stock under Section 363 can be effectuated in under two months. Page 4
  • 5. The Bankruptcy OptionTable 3 – Comparison of Traditional M&A with Section 363 Sale Traditional Section 363 M&A SaleSecurities and Exchange Commission Review Y NShareholder Vote Y NCreditor Approval Y NBankruptcy court approval NA YRegulatory approvals (Federal Reserve, FDIC, OCC, Y YOTS, DFI)A successful 363 Sale must have several important features: It must convince the courtthat it is the only option available to save the bank; that the price is fair and defensible;and that the stalking horse bidder will be approved by all the appropriate regulatorsand is capable of capitalizing and managing the bank going forward. In addition, allthe parties must work hand in glove with all appropriate regulatory agencies to gainthe required approvals for the transaction. Once a troubled BHC has exhausted allavailable opportunities to effect a BHC recapitalization or sale, it should explorerecapitalizing its bank subsidiary through a BHC bankruptcy and a Section 363 Sale ofthe bank subsidiary.About the Author: Mindi McClure is Managing Principal of The Bear Companies, an investment bankingand advisory firm located in the Washington, DC area. Ms. McClure and The Bear Companies principalshave completed numerous bank recapitaliztions and restructurings during the past 23 years. TBC Page 5
  • 6. The Bankruptcy OptionSecurities recently served as exclusive Dealer Manager negotiating the contingent discounted payoff ofTruPS and sub debt for Pacific Capital Bancorp, Sterling Financial Corporation and numerous other BHCs. Page 6