More Banks Could File for Bankruptcy to Escape Debt

Bankruptcy filings were once the unicorn of the bank-recapitalization world — a fun idea, but something far removed from reality.

Suddenly, they seem on their way to becoming its workhorse.

Capitol Bancorp (CBCRQ) in Lansing, Mich., and Premier Bank Holding in Tallahassee, Fla., this month announced bankruptcy filings to try to resolve holding company debt issues and bank capital problems. At least five other banking companies have filed for Chapter 11 since 2009.

Bank advisors for several years have touted bankruptcy as a way to keep a bank from failing. Though the stockholders' interests in the parent company are crammed down — if not completely wiped out — the banking unit has a chance to move on, proponents say.

It's still a tricky maneuver, but conditions are ripe for more bankruptcies, deal advisors say.

"There is no question that we are going to see more bank holding company bankruptcies," says Christopher Zinski, the chairman of Schiff Hardin Strategic Advisers, which has several debt restructurings in its pipeline. "We are in a more stable climate, but debt continues to be a real blocker to raising equity. Bankruptcy unlocks the underlying value of the franchise."

There are several possible ways to structure a bankruptcy, but the most discussed approach involves an asset sale under section 363 of the Bankruptcy Code. In that scenario, a struggling holding company finds an investor or another bank to submit a bid for its banking unit to the bankruptcy court.

Buyers must be comfortable with the targets because they get them as is, without loss-sharing agreements or other protections. That was likely an insurmountable hurdle for many banks that pondered bankruptcy earlier in the cycle because potential bidders had a harder time getting a handle on the quality of their loan portfolios than they would now.

The slow process of bankruptcy has become a more feasible alternative also because regulators are not seizing banks as quickly as they had in prior years.

"Banks aren't deteriorating as fast as they were before. The troubles have slowed down," says Randy Dennis, the president of DD&F Consulting, an advisory firm in Little Rock, Ark. "That gives banks more time to consider a 363 sale or some other structure."

There are several instances where a banking company tried bankruptcy, but still had its bank seized. Nexity Financial in Birmingham, Ala., tried in 2010, but its would-be buyers were unable to raise enough capital to buy it. The buyers instead created a new charter, AloStar Bank of Commerce, and bought Nexity Bank from the Federal Deposit Insurance Corp. after it was seized in April 2011.

As credit quality improves, holding company debt, which largely involves trust-preferred securities, emerges as the banner issue standing between a bank and its recapitalization. Outsiders might be comfortable with a loan book but are unwilling to take on the debt as a buyer, or as investors rank behind debtholders on claims in the event of default.

"The new capital is unwilling to stand on a perch below the trust-preferred holders," Zinski says. "That is why we haven't seen more conventional acquisitions. Investors can't find the value with the existing debt load."

In the case of a 363 sale, debtholders like those who own the trust-preferred securities, receive a portion of a sale's proceeds. However, Capitol Bancorp has filed a Chapter 11 reorganization plan that calls for its debtholders to receive common equity. All existing stakeholders would keep a 53% stake of Capitol's common equity, and a new investor would hold the other 47%.

Bankruptcies might become more popular because of a shortage of alternatives that separate an impaired bank from its debt-heavy parent. A popular alternative involved selling the operations of the bank, including branches, assets and deposits, leaving the troubled assets and debt for the holding company to sort out.

BB&T (BBT) and BankAtlantic attempted that structure in November, but the seller's debtholders filed a lawsuit to block the deal, claiming that the indenture agreements for trust-preferred securities prevented such sales. A Delaware judge sided with the debtholders; BB&T and BankAtlantic had to restructure the deal to satisfy the debt obligations.

"We might see more bankruptcies because the BankAtlantic case showed us you can't sell substantially all assets without the buyer assuming the seller's trust-preferred debt," says Chip MacDonald, a partner at Jones Day who was more pessimistic about the bankruptcy structure in 2010 and 2011. MacDonald still cautions that it is a difficult path.

"It is a complicated dance, and it is not for the impatient," he says.

More companies might look to the bankruptcy structure over the next couple of years as they approach the end of their deferral period with their trust-preferred securities, said Ed del Hierro, a partner at Kirkland & Ellis.

Issuers are allowed to defer up to 20 consecutive quarters, but at the end of that period the holders could pressure the companies to restructure. Companies would be better off tackling that issue on their own, rather than allowing their holders to push them into a restructuring.

"If I'm advising an institution, I would suggest controlling our own destiny, opposed to allowing someone to push us into a restructuring," del Hierro says.

Finally, more filings will encourage more filings. The success of the AmericanWest Bancorp bankruptcy has likely encouraged others to explore it, Zinski said. In that case AmericanWest Bank narrowly escaped failure in late 2010 through a 363 sale to SKBHC Holdings.

Its parent company's bankruptcy is ongoing, but AmericanWest Bank through its new ownership has done several deals on the West Coast.

"There is some trepidation or reputational risk, but AmericanWest managed it effectively and showed the industry that they could pull it off," Zinski says.

The 363 experience was a last resort and difficult, Kelly McPhee, director of communications for AmericanWest Bank, wrote in an email. To companies pondering a restructuring, she said, openness is crucial.

"It's a complicated solution that requires complete coordination on many levels, including communication because mention of the word 'bankruptcy' understandably triggers strong reactions," she wrote. "Even in those challenging times we remained committed to transparency and openness—our customers told us they valued our approach and stuck by us."