Investor demand for pooled trust-preferred securities may be dead, but the market for trust-preferreds issued by individual banks is making a comeback.
Single-issue deals were popular in the late 1990s and early 2000s and then were all but abandoned when small banks and thrifts found they could reduce underwriting costs by joining pools made up of dozens of financial institutions.
But the pools dried up when the market for collateralized debt obligations collapsed last year, so now some banks eager to raise capital without diluting their common stock are issuing trust-preferred securities on their own.
"The CDO collapse of 2007 put a big cannon shot in the whole claim that diversity reduced your risk," said Michael Iannaccone, the president of MDI Investments Inc. in Chicago.
"The sentiment now is, 'I'd rather just invest in one company that I know is good.' "
At least nine banking companies have completed trust-preferred deals since August, according to data from SNL Financial LC, and another, S.Y. Bancorp Inc. in Louisville, has one in the pipeline.
Jeff K. Davis, a principal at Wolf River Capital LLC, said single-bank deals "are absolutely doable if the bank is a high performer with opportunities in front of it and has a strong following. The capital markets haven't been completely shut off."
Unlike in pooled deals, where investors were typically other banks, hedge funds, or institutions, single-issue offerings are more likely to attract investors who know the banks more intimately.
Virginia Commerce Bancorp. Inc. in Arlington, completed a $25 million offering in September by selling the securities to its directors and executives.
S.Y. Bancorp is working with the investment bank J.J.B. Hilliard, W.L. Lyons LLC on its $30 million offering, and Mr. Davis said that since both are Louisville companies, they are likely to target local investors.
For some banks, issuing trust-preferreds erases the rationale for seeking funds in the Treasury Department's Troubled Asset Relief Program. And even if they apply for Tarp money as well, they do not necessarily have to take the maximum.
The $1.6 billion-asset S.Y. Bancorp intends to use the proceeds of its trust-preferred offering to pay down a line of credit from another bank, as well as to fund growth and pursue general purposes.
"We recognize the importance of raising additional capital now to strengthen our competitive position and help us better withstand the impact of the current economic downturn," said David Heintzman, the chairman and chief executive, in a Dec. 5 press release.
"We believe our markets will present many exciting loan opportunities, and this additional capital provides the ability to make these loans."
(The company is in a quiet period and said it could not offer further comment.)
Mr. Davis said he believes S.Y. Bancorp will probably be able to raise the funds without a problem since it is already well-capitalized and has few problem loans on its books. He said it is well positioned to win business from larger competitors in its Louisville and Indianapolis markets that are preoccupied with loan problems.
Given the state of the economy, investing in a single healthy institution like S.Y. Bancorp is a safer bet than buying into a pool of banks, said MDI Investments' Mr. Iannaccone.
But solo deals are not exactly cheap. The efficiencies for things like processing and legal fees created by participating in a pool are gone, and even if investors trust the company, they expect a better return in this market for their gamble, Mr. Iannaccone said.
During the boom years of the pools, banks would typically pay investors 130 to 140 basis points above the London interbank offered rate. Now, their rate is likely to be fixed and would typically fall between 8% and 10%, similar to the rates paid in the late 1990s when single-issue deals were in vogue.
Despite the higher coupon and overhead, Mr. Iannaccone said, trust-preferreds remain a relatively inexpensive way to raise capital and do not dilute common stock.
Local investors might even be willing to accept slightly lower rates, he said, because there is a perception of less risk in "a company that they believe in."
Peter Benoist, the president and CEO of Enterprise Financial Services Corp. in Clayton, Mo., said his $2.2 billion-asset company chose the trust-preferred route because a stock offering would have been too dilutive, given the current stock price. The stock was trading at $14.75 a share at midday Thursday, down 42% from its 52-week high.
"We are trading at historical lows, and our share price is not indicative of value," Mr. Benoist said. "The market is much too volatile. Trust-preferreds are more stable right now."
Enterprise announced the completion of its $25 million convertible trust-preferred deal on Dec. 12. The securities have a 9% coupon and are callable after five years. Mr. Benoist said the company hopes its stock price will have rebounded by the time the shares convert to common stock in two years.
Enterprise has been approved to get up to $60 million from the Treasury program, but Mr. Benoist said he expects to take only $35 million. He said he opted to raise the other $25 million through trust-preferred securities because the company wants to be able to take advantage of opportunities that may arise in the market — for instance, buying a wealth management firm — without worrying whether it fits the bailout money's mission.
"We see this is as a period of real opportunity," Mr. Benoist said. "And we wanted capital to use whatever way we see fit."
S.Y. Bancorp said in its press release that it is still considering participation in the Treasury program but thinks issuing trust-preferred securities might make more sense because of the warrants tied to the Treasury program and the potential for changes as a new administration takes over.
"This trust-preferred offering is a long-term solution as opposed to any capital we might obtain from" the Treasury, "as we believe we would later decide to replace that capital," Mr. Heintzman said.
Mr. Davis said the concerns of S.Y. Bancorp and Enterprise are being felt nationwide but that not every bank company is in a position to raise capital on its own.
"If every banker had his druthers and could raise private capital at a decent price, he'd choose that over the Treasury money," Mr. Davis said.
