Many bank holding companies (BHCs) are beginning to face tough choices as the five-year interest deferral period on their trust preferred securities (TruPS) is coming to an end. Consider the following: on Feb. 10, 2014, First Mariner Bancorp, immediately following the end of its five-year interest deferral period on $52 million of TruPS, filed a voluntary Chapter 11 petition and announced its plans to sell its wholly owned subsidiary, 1st Mariner Bank, in a court-supervised Section 363 sale.
Like First Mariner, many other BHCs began deferring interest payments on their TruPS during the height of the economic crisis. Now, for these BHCs, the five-year deferral periods are beginning to come to an end, and the consequences are substantial. If a BHC cannot pay the amount owed at the end of the five-year deferral period, the BHC will be in default on its TruPS. An event of default generally entitles the trustee or a certain percent of holders of the TruPS to declare the entire principal amount and all accrued and unpaid interest to be due and payable immediately. This could put a defaulting BHC in a critically difficult position.
For BHCs facing the end of their five-year deferral period, creating and implementing a strategic plan to avoid or prepare for default is a critical task. Over the past several years, BHCs have considered five basic options:
- Raising capital
- Sale of BHC and/or Bank Subsidiary(s)
- Settlement or negotiation with TruPS holders
- Section 363 sale of Bank Subsidiary(s)
- Pre-packaged Chapter 11 restructuring
Management and directors of BHCs nearing the end of the five-year interest deferral period need to work collaboratively to review the availability, advantages and disadvantages of each of these options. Prior planning is critical, as a BHC that has not assessed its options prior to nearing default could find itself in a position where it is no longer in control of the process or must take actions detrimental to its shareholders that could have potentially been avoided with prior planning. A key component of the planning process is to understand the specific timelines and regulatory approvals applicable to execute a plan with the TruPS holders or other options available to the BHC. In many instances, completing the planning process and executing on the options available can take six to 18 months.
For a BHC nearing default, one option is to raise cash, either by selling common or preferred stock or by borrowing funds. The BHC could then use the cash to bring deferred interest payments current, thus resetting the clock for another five-year deferral period. However, finding an investor to purchase stock or a willing lender is likely to be difficult given the BHC's presumed challenged financial condition. Moreover, even if a BHC can raise the cash it needs to bring its deferred interest payments current, if it is subject to a regulatory enforcement action, it may not be able to pay the interest on the TruPS, or issue additional debt, without the prior approval of the Federal Reserve. Management and directors should immediately evaluate whether there is internal or external interest in providing capital or if any preexisting lender relationships can be mined as sources of funds.
Sale of BHC/ Bank Subsidiary(s)
Another option for a BHC nearing the end of its five-year deferral period is to seek a buyer to acquire the BHC and thus assume its TruPS obligations. Finding an acquirer willing to pay off the TruPS, or to assume the TruPS as part of the purchase price, could be difficult. In addition, directors of BHCs that are currently insolvent on a consolidated basis or could enter the zone of insolvency as a result of a pending TruPS default must be mindful of balancing competing obligations to shareholders and creditors, while also keeping in mind that existing shareholders are subordinate to the TruPS holders. Directors must focus on their fiduciary obligations to the BHC's stakeholders and how those obligations can shift as the BHC drifts toward default.
Settlement or Negotiation with TruPS Holders
An alternative option for a BHC approaching the five-year mark is to attempt to reach a settlement with the TruPS holders, perhaps at a discount, provided that the terms of the TruPS allow for it. A major impediment with settlement initiatives exists, however, as a result of the pooled nature of most TruPS issuances. BHCs have issued TruPS mostly into conduits—collateralized debt obligations -which can make identifying the holders who actually own the securities very difficult. Further, even if a BHC is able to identify the TruPS holders, at least a large majority, if not all, of the holders must agree to negotiate a settlement or make any other major change to the TruPS. In contrast, for BHCs that have issued TruPS to private investors through a private placement in a non-pooled offering, there is a better chance of negotiating a discounted settlement. Management and directors should be certain to understand the make-up of the BHC's TruPS holders in order to assess the viability of successful settlement to avoid default and a potentially lengthy timeline to negotiate a settlement. In addition, any Trups settlement may require consent from the Federal Reserve which should also be factored into the overall planning timeline for the upcoming five-year default.
Section 363 Sale
Like First Mariner, other BHCs on the verge of default may consider a Section 363 sale, in which it voluntarily files for Chapter 11 bankruptcy and simultaneously enters into an agreement to sell the stock of its subsidiary bank(s) in a court-supervised auction process. This is typically an option that is pursued if a BHC cannot raise capital, find a buyer or successfully negotiate with the TruPS holders. This process requires bankruptcy court and various bank regulatory approvals. Not surprisingly, many of the Section 363 sales announced thus far have faced objections by TruPS holders seeking to avoid being forced to accept a significantly-discounted pay-off. Despite these challenges, Section 363 sales have proved to be a viable option where the bank subsidiary(s) has positive fair value on a standalone basis. Since 2010, there have been approximately fifteen Section 363 sales in the banking industry, half of which occurred in 2013. Section 363 sales, however, require a substantial amount of work and planning. A BHC needs to have arranged a fully negotiated sale transaction upon filing for bankruptcy, and thus management and the directors need to have identified and entered into an agreement with a buyer prior to filing. The process also needs to be structured with the expectation that TruPS holders and other interested parties will challenge the sale in court.
Pre-Packaged Chapter 11 Restructuring
Lastly, another option for a BHC nearing the end of its five-year deferral period is to enter into a pre-packaged restructuring under Chapter 11 pursuant to which the BHC's debt holders, including the TruPS holders, agree to accept a discounted return on their debt, generally in conjunction with an infusion of new capital. TruPS holders, and other creditors, can find this alternative preferable to a Section 363 sale if it provides a greater return for the debt holders. As with a Section 363 sale, however, a pre-packaged restructuring also requires bankruptcy court and various bank regulatory approvals. Moreover, a pre-packaged restructuring often requires the approval of the senior creditor and the identification and agreement of a BHC's TruPS holders, all of which can be difficult to obtain. Management and directors should fully evaluate the BHC's debt structure in order to assess if a restructuring coupled with a capital infusion could be an available alternative.