Posts filed under ‘Capital Purchase Programs’

“Ticking TRUPs” Threaten Bank Holding Companies

Written by: Mike W. Lochmann

Trust preferred securities (TRUPs), the hybrid security that counted as Tier 1 regulatory capital but generated tax deductible interest payments, were a favored source of capital for community banks. When the financial crisis hit, many bank holding companies (BHCs) with troubled bank subsidiaries exercised the right to defer interest payments on their outstanding TRUPs for up to five years. Interest continued to accrue during the deferral period, but the deferral was not a default and there was nothing that the TRUPs holder could do but wait. Many deferral periods that began late in 2009 and early 2010 are about to expire. TRUPs holders − long shackled by contractual stand still covenants – are about to be unleashed to exercise their creditor rights against the troubled BHCs that issues the TRUPs.

Deferred Interest Becomes Due and Payable In most cases, the five years of deferred interest on the TRUPs becomes due and payable in full when the deferral period ends. If the accrued interest is not paid, then the TRUPs holders may declare a default, accelerate the principal and demand immediate repayment of all principal and accrued interest on the TRUPs. The trustee for the unpaid TRUPs has all the rights of an unsecured creditor, may obtain a judgment against the BHC and can force the BHC (but not its subsidiary bank) into bankruptcy, which has already happened to at least three BHCs.

Dividends from Subsidiary Bank The obvious solution is for the BHC to pay all accrued interest on the TRUPs when the deferral period ends (after which a new five-year deferred period could begin). In many cases, however, the BHC may not have millions of dollars of liquid assets available to pay the accrued interest. The BHC may be dependent upon dividends from its subsidiary bank to make the interest payment due on the TRUPs. All of the accrued and unpaid interest may, in effect, be capital of the subsidiary bank (because during the deferral period, dividends were not paid by the bank to the BHC to pay the interest on the TRUPs). This retention of capital strengthened the subsidiary bank, helping it recover from the financial crisis. The subsidiary bank may no longer be in a troubled condition, but in many cases it will not have excess capital sufficient to pay an extraordinary dividend and remain well capitalized. The OCC and FDIC may be unwilling to approve an extraordinary dividend from the bank to the holding company. Also, the Federal Reserve may not permit a troubled BHC to pay the accrued interest due on the TRUPs.

Proceeds of Stock Offering Some BHCs may raise funds to repay TRUPs accrued interest by issuing new common stock. Convertible preferred stock is preferred by some private equity funds. A stock offering will usually dilute existing shareholders, but is generally preferable to a default on the TRUPs.

If the BHC and/or subsidiary bank are still in a troubled condition, regulators may prohibit the BHC from using the proceeds of a stock offering to pay the TRUPs interest. The Federal Reserve could direct a troubled BHC to retain such proceeds to be a source of strength to the subsidiary bank. In one instance, the Federal Reserve permitted a BHC to issue stock with proceeds placed in escrow and used by the escrow agent (not the BHC) to pay the TRUPs accrued interest. The Federal Reserve has indicated that structure may not be permitted in the future.

Merger with Acquiror Another alternative is for the BHC to sell by merging with a financially stronger BHC. In that case, TRUPs indentures generally require that the buyer assume all the obligations of the seller under the TRUPs. TRUPs holders have been unwilling in most cases to negotiate any discount with the buyer. The result is a lower price for the selling BHC’s shareholders. In most cases, the TRUPs indenture prohibits the BHC from selling or merging its subsidiary bank unless the acquiring bank and BHC assume all the seller’s TRUPs obligations.

Downsizing the Bank TRUPs indentures generally do not prohibit the subsidiary bank from selling its assets or branches. A bank may raise capital by selling deposits and branches, shrinking its balance sheet and increasing its regulatory capital ratios. If the downsized bank remains viable and well capitalized, banking regulators may approve a dividend of any resulting excess capital to the BHC.

Section 363 Sale in Bankruptcy If a BHC cannot receive dividends from its subsidiary bank, use proceeds from a stock offering or merge with another BHC, then the BHC must consider a holding company bankruptcy as a possible solution. If the subsidiary bank is viable, but the BHC is illiquid, then the debtor BHC may engage in a Section 363 sale (named after the bankruptcy code section authorizing such sales) of its subsidiary bank. Under bankruptcy court supervision, the BHC may sell the stock of its subsidiary bank free and clear of the BHC’s debts (including the TRUPs). Proceeds from the sale of the bank stock are then distributed according to the bankruptcy code:

  • First, to any secured bank stock lender
  • Second, to unsecured creditors, including TRUPs
  • Third, to any preferred stockholders
  • Fourth, any remainder to the common stockholders.

Holders of defaulted TRUPs may initiate an involuntary bankruptcy, but strategically, the BHC may want to file a voluntary bankruptcy. This is more likely to result in a favorable sales price for the subsidiary bank. The debtor BHC can pre-arrange for a stalking horse acquiror to submit a reasonable and competitive bid to purchase the stock of the subsidiary bank. Creditors, shareholders and third parties are then given a limited amount of time to top the stalking horse bid for the bank stock, usually in a bankruptcy court auction. The highest bidder purchases the stock of the bank, and receives a bankruptcy court order that it acquired the stock free and clear of all liens and claims of third parties (including the TRUPs).

Section 382 Recapitalization in Bankruptcy A BHC with significant net operating losses (NOLs) may pursue a Section 382 bankruptcy transaction. In this complex tax-driven transaction, the debtor BHC retains and recapitalizes its subsidiary bank, cleans the BHC balance sheet and preserves the economic value of its NOLs. Under bankruptcy court supervision, the BHC converts the TRUPs and other BHC debt into equity (in which the existing common shareholders are severely diluted or wiped out). The BHC then raises new equity from investors, which must constitute less than 50 percent of total equity. The reorganized and debt free BHC then operates the recapitalized subsidiary bank and uses its NOLs to shelter income and increase capital and value until the BHC and bank are subsequently sold.

Conclusion Troubled BHCs and healthy but illiquid BHCs that have TRUPs deferral periods about to expire face unique problems. There are various ways to address such problems, but careful advanced planning is required. BHCs that do not have a plan to deal with their maturing TRUPs may lose control to the TRUPs trustee and the bankruptcy court.

This article first appeared in Issue #18-November 2014 of the Western Independent Bankers CFO & Finance Digest linked here.

November 19, 2014 at 10:31 am Leave a comment

President Announces Community Bank Program to Increase Credit Flow to Small Businesses

The President announced plans today that, if put into action, would lead to the realization of at least some much-needed and long-sought-after assistance for community banks.  A copy of the President’s announcement is available here. (Skip to Page 2 for Details).

According to the President’s proposal, which is part of the White House’s “Financial Stability Plan,” the program would target small business lending, but would also offer a mechanism for banks with less than $1 billion in assets to access capital with an annual dividend rate of 3%.  The announcement is short on specifics, but here are the basics:

(1) Banks will receive capital in an amount equaling up to 2% of risk-weighted assets; 

(2) The annual dividends on the capital will equal 3% for the first five years and 9% thereafter; and 

(3) Banks seeking to participate in the program will submit a “small business lending plan” in which the bank explains how additional capital will help increase its lending to small businesses.  (Banks approved for the program that elect to participate will also be required to follow up with quarterly reports detailing small business activities).

Over the next few weeks, Treasury will work with community banks and the small business community to hammer out the program’s specifics.  Notably, the release contemplates that banks already participating in the capital purchase program will be able to replace existing capital, which carries a 5% dividend (7.7% for S-Corps), with investments under the new program.   

 The President also announced support for legislation that would increase the size of key Small Business Administration (SBA) loans. The aim of the increase would (supposedly) allow the SBA to ensure that more small businesses can get access to credit.

 The first prong of the proposed legislation would increase the Maximum 7(a) loan from $2 million to $5 million, providing greater access to capital that businesses could use to boost working capital as well as purchase machinery equipment and real estate.  

The second prong of the proposed legislation would increase the maximum 504 project loan from $2 million to $5 million for standard borrowers (supporting a total project of $12.5 million) and from $4 million to $5.5 million for manufacturers (supporting a total project of $13.75 million), thereby increasing the qualifying borrowers’ ability to undertake larger projects.

And the third prong of the proposed legislation would increase the maximum loan size of the SBA microloan programs from $35,000 to $50,000.

October 21, 2009 at 10:11 pm Leave a comment

Treasury Releases Executive Compensation Restrictions for TARP Participants

The U.S. Treasury Department has released an Interim Final Rule (the Executive Compensation Rule) establishing governance and compensation standards for institutions participating in the Troubled Asset Relief Program (TARP).  Any institution participating in the TARP Capital Purchase Program is subject to these rules so long as any obligation to Treasury remains outstanding.  Review the press release announcing the IFR, and review the entire IFR.

Some of the IFR’s most important provisions include the following: 

  • Limitations on the amounts and types of bonuses payable to senior executive officers and other highly compensated employees.
  • A ban on golden parachute payments—a term that reaches much farther than most people think, including almost any type of compensation received upon a covered employee’s departure from the institution.
  • A “clawback” provision that requires an institution to recover any bonus, retention award or incentive compensation paid to a covered employee if the bonus, retention award or incentive compensation was paid in reliance on inaccurate financial information.   
  • Several corporate governance and board certification requirements, including a requirement for perquisite disclosures and for implementing luxury expense controls.       
  • A requirement for all TARP participants to provide shareholders with an annual, non-binding vote on the compensation of the institution’s executives.   
  • An affirmation that the rule’s restrictions will not apply to institutions receiving indirect financial assistance from UST, such as institutions receiving loans from the Term Asset Loan Facility.

If your institution is currently participating in any TARP program, you are required to comply with these rules. The following initial steps should help:

  • Identify which of your employees will be subject to which restrictions.  The number of employees covered by a given restriction varies depending on the type of restriction and the amount of Capital Purchase Program funding the institution has received.
  • Review your institution’s employment and other compensation-based agreements, especially severance provisions, to verify that they comply with the IFR.  
  • Designate appropriate board committees to confer with the institution’s senior risk officers to identify compensation policies that may encourage unnecessary risk taking.

June 12, 2009 at 4:23 pm Leave a comment

Treasury Announces Plans to Re-Open Capital Purchase Program Application Window

The TARP banner keeps unfurling. In a speech delivered to the Independent Community Bankers of America on May 13, 2009, U.S. Treasury Secretary Tim Geithner announced plans to re-open the TARP Capital Purchase Program (CPP) application window for financial institutions with less than $500 million in total assets. And unlike the relatively brief application window for prior CPP consideration, the re-opened window will remain open for six months. The window will be open to all entities eligible for CPP participation—public and private corporations, Subchapter S corporations and mutual institutions.

Secretary Geithner also announced that Treasury will increase the amount of CPP capital that qualifying institutions will be eligible to receive. While previous CPP investments were limited to 3% of an institution’s risk-weighted assets, Treasury will increase its CPP investment limit to up to 5% of an institution’s risk weighted assets. In addition, institutions that have already received CPP funding under the 3% limit will be allowed to apply for additional capital under the new 5% limit. Secretary Geithner added that the window for small banks to form a holding company to participate in CPP will also be re-opened for six months.

Although the announcement may be welcome news for community bankers who did not apply for CPP funding during the previous application period, Secretary Geithner’s speech was short on details. For example, he did not indicate whether previously declined applications will be reconsidered, and he did not provide the date when the application window will re-open. Rest assured, however, that Stinson Morrison Hecker LLP will be scrutinizing the details of the re-opened application process and will keep you informed of the facts as they unfold

May 18, 2009 at 9:16 pm Leave a comment

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