Treasury's Grip on Public Purse Proves Loose in Tarp Bankruptcies

First Place Financial arrived in federal bankruptcy court last December with a bold proposal. The Warren, Ohio, banking company proposed selling in a rapid process that would pay existing private creditors three-quarters of the $60 million they were owed, wipe out the $70 million borrowed from the U.S. Treasury under the Troubled Asset Relief Program and leave the reorganized institution in the hands of new private owners.

The company's nongovernment creditors vehemently opposed the sale. They obtained detailed information about the proposal and filed two objections with the federal bankruptcy court in Wilmington, Del.

On the eve of a crucial hearing, the creditors obtained a new offer that paid them back their entire $60 million, as long as they waived $5 million in accrued interest.

At the hearing the next day, the Treasury made its own protest. But the government was "still getting up to speed" on the matter, assistant U.S. Attorney Ellen Slights conceded.

"Your honor, as I stand here today, I have had access to very little information," Slights told Judge Brendan Shannon, who approved the sale. "Treasury was not one of the regulators that was included in the know."

Under the law, the Treasury Department has extensive authority to monitor banks holding Tarp bailout funds. Rather than a lack of access or leverage, the Treasury's problem in the first two voluntary Tarp bank bankruptcies appears to be that the government simply failed to flex its muscles.

Christy Romero, the special inspector general for Tarp, has already faulted the Treasury for failing to work closely with other regulators in monitoring its distressed investments. But the Treasury says other regulators won't share such information with it, complicating its management of Tarp stakes.

One risk is that such inaction could encourage others among the 200 banks yet to repay Tarp funds to follow First Place Financial's lead and try to shortchange the government. Many of these banks are expected to face trouble making repayments. Collectively, they owe the Treasury $6.6 billion.

"If Treasury isn't willing to actually stand up for itself, then they're going to keep getting hosed," says Brett Jefferson, the chief investment officer for Hildene Capital Management. The New York City-based hedge fund was a creditor in another Tarp institution, Premier Bank in Tallahassee, Fla. Hildene unsuccessfully courted the Treasury's support to challenge Premier's bankruptcy sale.

The Treasury rejects the claim that it should be doing more. Some losses along the lines of the two voluntary bankruptcies are inevitable in a program that it says has turned a profit for taxpayers.

"Both banks tried to raise capital, and they weren't able to," says a Treasury official who discussed the First Place and Premier bankruptcies on the condition that he not be named. "We're trying to get every last dollar we can here."

Strategic Bankruptcies

During a typical bank failure, the Federal Deposit Insurance Corp. seizes a lender's assets, sells them to the highest bidder and distributes any money left over from paying off depositors to creditors. Creditors have little say in the process.

In a relatively recent development, executives at several banks have made strategic decisions to file for bankruptcy as a way to garner recapitalizations from outside suitors.

Such maneuvers typically enable the banks to repay creditors a portion of what they're owed and extinguish the rest of the bank's debt. Shareholders get wiped out.

Creditors presented with the prospect of a strategic bankruptcy face the question of whether it is in their best interest. The answer can be murky, as it was in the case of First Place Financial.

The first sign of serious trouble at First Place came in October 2009, when the bank fired its auditor following a disagreement about the $3.4 billion-asset bank's internal controls. The bank's problems snowballed, leading regulators to order it to raise capital, a delisting from the Nasdaq and the firing or departure of most of its leadership. Last year, First Place stated that it needed to restate earnings back to 2007.

Rather than filing revised financials, the company filed for bankruptcy and sought court permission to sell itself for $45 million to Talmer Bancorp, a Troy, Mich., company backed by the billionaire investor Wilbur Ross. First Place argued the deal it had negotiated with Talmer was the best its creditors could hope to get.

Creditors disagreed. Holders of First Place's trust-preferred securities, or Trups, combed through the bank's financials, filed two 30-page objections and recruited a bank mergers expert who argued that the sale provided cover for the bank to walk away from its commitments.

To bolster their case, creditors argued that First Place had earned $20 million and $25 million, respectively, in the two quarters immediately preceding its bankruptcy filing and had boosted capital.

"The committee is not aware of a single large bank or thrift with the debtor's capital position and asset quality that has failed during the pendency of the recent financial crisis," they wrote in court papers filed Nov. 21.

The Treasury holds its Tarp stakes in preferred stock, which is subordinate to Trups claims. It also opposed the sale. But rather than filed the sort of substantive objections that the Trups creditors did, Treasury filed a four page brief arguing that the bankruptcy process was being conducted too quickly.

Treasury officials may have thought they could piggyback on the Trups holders' efforts, but that did not prove true. On the eve of a crucial bankruptcy court hearing, Talmer agreed to up its offer to $60 million from $45 million. That meant the Trups investors would be able to recoup the entire face value of their holdings.

With an offer on the table that would make them whole, the Trups holders dropped their objections to the bankruptcy filing.

That left the Treasury to fend for itself, which proved to be a stretch.

The Treasury official told American Banker that Trups holders' senior standing gave their reversal extra importance.

"We were objecting to a sale as were they," he said.

Slights, who represented the Treasury, conceded that the Trups holders also had a superior grasp of the case. The Trups holders "were able to get access to much more information than my client has had," she said. Slights asked the court to delay the sale.

Government attorneys proved equally ill prepared in to cross examine First Place's chairman, Samuel Roth, over the claim that he was "very concerned" delaying the Talmer sale would lead to a run on the bank or bring about its collapse.

Treasury was hampered in the case by the abruptness of First Place's deal with private creditors and the fact that other federal regulators were unwilling to share information about banks' financial condition, according to the official who spoke on condition of anonymity.

"They feel that's [withholding information] proper under their legal responsibility," the official said. "We talked to the regulators generally about this issue, about how much they can tell us. We have a different role than they have."

Other regulators declined to comment on what information they would be willing to provide to the Treasury. Regardless of why such information is not being shared, Romero argues that the Treasury's unfamiliarity with borrowers' financial condition is hampering the department's ability to wind down Tarp.

"Obviously Treasury had complete access to supervisory information when it made its initial Tarp investments," says Neil Barofsky, a law professor at New York University who preceded Romero as inspector general. "It is puzzling to me how or why it would be cut off from that information when making decisions concerning the exit of those institutions from the program, particularly when the taxpayer is being asked to shoulder a loss."

If the First Place sale left the Treasury open to criticism that it was unprepared to protect the public's interests, the bankruptcy sale of Premier Bank raises another issue.

The bank owed $13.2 million to Trups holders and another $9.5 million to the Treasury. After struggling to raise capital, Premier filed for bankruptcy last August. It proposed to sell itself for $1.4 million to Home Bancshares, a $4.2 billion-asset company based in Conway, Ark.

Hildene Capital, one of Premier's Trups investors, opposed the sale on the grounds that Premier should have held out for a deal that would preserve $14 million in deferred tax assets and enabled creditors to recoup more of their investment.

After Karen Specie, a Tallahassee federal bankruptcy court judge, approved the sale in December, Hildene returned to court alleging that Premier's executives had acted in bad faith. It asked to undertake discovery aimed at determining whether Premier's management had cut a sweetheart deal to save its jobs.

Hildene flagged two aspects of the sale to Home Bancshares that the hedge fund claimed looked suspicious. One involved the apparent inconsistency between claims by Premier executives that they had no pre-existing employment agreements with Home Bancshares and the acquirer's announcement prior to completion of the purchase that it intended to retain Premier's executives.

Matthew Brown, Premier's chief executive, testified in September he had an "informal arrangement" to stay on after Home Bancshares' purchase. The following month John Allison, Home Bancshares' chairman and co-founder, cited as one reason for the purchase that his company would "pick up some good management" from Premier.

Premier's attorney declared in Tallahassee bankruptcy court on Nov. 27 that there were "no other deals, arrangements or agreements of any kind whatsoever" that would benefit former executives.

A bankruptcy judge approved the sale two days later. Four days after the approval was granted, Home Bancshares announced that Brown would be its Tallahassee market president for Centennial Bank, a unit of Home Bancshares.

Hildene also argued that Premier had failed to provide other potential bidders with sufficient information about its financial health. The bank had not commissioned an independent analysis of its loan portfolio, which deprived potential buyers of vital information, Hildene claimed.

Mark Duedall, an attorney who represented Premier, dismisses as "character assassination" and "grassy-knoll conspiracy theories" the notion that anything untoward occurred. On the contrary, a loan review would have been a poor use of Premier's dwindling assets, he argues.

"We told Hildene and other creditors six weeks before the deadline we don't have [a loan review], and if you want to raise the issue with the court, please do so," he recalled.

Hildene countered that it was Premier's responsibility to prepare itself for a competitive bidding process.

Peter Ostrowski, of Ostrowski & Co. in Cranford, N.J., an M&A advisor, calls the lack of a third-party review "extraordinary."

"If you look at the data room [set up for potential acquirers to do due diligence] and there's not much in the way of data, that gives you a clear sense of where things are going," Ostrowski says. "You're looking at a deal where [the seller bank] is not welcoming you in. At that point, I've put aside the bank's file and moved on."

Hildene sought the Treasury's support for its motion to block the sale. It says it got nowhere with that request.

Ultimately, the court sided largely with Premier at a post-bankruptcy hearing in early March. Judge Specie scolded Hildene for being so aggressive in seeking to block the sale and rejected efforts to reverse it. The judge left open the possibility that she would authorize additional fact-finding regarding the question of whether Brown had breached his fiduciary duty toward creditors.

The Treasury official dismisses the notion that taking a position in the effort to block Premier's sale would have served the government's interests. There was no plausible way that holding the sale could have resulted in a recovery for the government, this person argues.

Jefferson disputes that. Even verbal support from Treasury attorneys might have changed that outcome, he argues.

"It was a free and sensible option," says Jefferson. "If Treasury had advised the bankruptcy court that it thought some discovery was appropriate to ensure that taxpayer money was not needlessly squandered, the court may well have listened."