Hundreds of bank and thrift holding companies are facing potential default on debt they took on to fuel growth in their bank subsidiaries. Much of this debt was trust preferred securities (TruPS), which had the benefit of counting as regulatory capital for the holding company, as well as allowing companies to defer interest payments for 20 consecutive quarters. For banks and thrifts that may have grown aggressively and later suffered losses, regulators have imposed orders prohibiting the payment of dividends to their holding companies, and without cash flow from their subsidiaries, the holding companies have been unable to make payments on their debt. Now, the end of that five-year deferral period is nearing for many holding companies, and they are facing default. So what should a board do? Kilpatrick Townsend & Stockton LLP’s Joel Rappoport discusses the options for those holding companies.
What strategic options are available for holding companies approaching default?
Most holding companies in this situation will need to raise capital. Relying on earnings alone is unlikely to be enough to persuade regulators to allow a repayment of deferred interest. The best outcome usually will be to find investors to invest in the holding company, or even find a buyer for the holding company, as these strategies will preserve at least some value for stockholders. Anyone who invests directly in the holding company must be willing to take on the debt, because debt must be repaid before equity investors can get any return.
What if you cannot find an investor for the holding company?
If you have a high amount of debt that exceeds the bank’s capital, equity investors may be scared away because they don’t want to take on the debt. In that situation, you could consider selling your bank outright to another bank or investor group that will then recapitalize the bank. You also could try to negotiate a deal with your creditors to take less than what is owed.
What are the obstacles to these options?
It can be difficult to work out a settlement with creditors. First of all, you may have trouble finding someone to negotiate with. Often, the TruPS owner is a CDO, a collateralized debt obligation, which is an asset pool that issues bonds backed by the assets. Some of these pools are managed, and those managers can negotiate a settlement for the CDO. If the owner of your debt happens to be an unmanaged CDO, there is a cumbersome process to get the consent of bond holders to any debt restructuring. There also are tax rules that complicate the process of bringing in new owners or investors. Many banks and holding companies have deferred tax assets that can be very valuable. A major ownership change may mean that future owners do not get the full value of these tax assets. You should try to structure any transaction so as to preserve these tax benefits.
With trust preferred securities, debt covenants don’t allow a sale of bank, so holding companies have to file for bankruptcy because that is the only way a sale can be done. This is called a Section 363 sale, which is the Bankruptcy Code section that allows a debtor to sell assets, and for a bank holding company, the primary asset is the stock of its bank subsidiary. Essentially, it requires an auction so creditors can get the best possible recovery.
What actions will creditors take if and when holding companies default on their debt?
Until recently, creditors fought Section 363 transactions because the results were so poor. Early auctions yielded no competitive bidding and minimal recoveries for creditors. But recent 363 transactions have produced two or more competitive bidders, with much better results for creditors. Creditors now seem to be more comfortable with Section 363 transactions and, in two cases, have even tried to force holding companies to auction their banks by filing petitions for involuntary bankruptcy. When this happens, the holding company might be forced into bankruptcy before it is ready.
What should bank holding companies or buyers interested in them do?
I would say that buyers have an opportunity here to look at these bank holding companies that are under pressure to take action quickly. Holding company boards should explore options early and not wait until close to the end of your deferral period. By then it may be too late, and it may be out of your hands. You may lose the chance to control your destiny.