Midwest Banc Holdings Inc. has won one round in its battle for recapitalization.
The $3.5 billion-asset company in Melrose Park, Ill., announced Friday that it persuaded 82% of its Series A preferred shareholders to convert to common shareholders.
Although Midwest still faces stiff headwinds given its severe credit problems, its leaders view the exchange as an essential step in a plan to revive the capital-strapped company, which includes getting the Treasury Department to cooperate and seeking as much as $190 million from investors.
Industry observers applauded news of the exchange. Still, they said, Midwest faces significant challenges and an uncertain future.
"It is definitely a good move for them. It strengthens their common equity, it makes it easier to attract other investors," said Steve Gerbel, the founder and chief executive of Chicago Capital Management, a merger arbitrage hedge fund. "But is it enough to keep them alive and afloat? I don't know. It is really going to depend on how bad the loans on the books are and how bad things are going to get."
The company's chief executive officer said the conversion represents an important milestone.
"Our vision for Midwest has been to build a new foundation to support its long-term growth and profitability. With the exchange offer completed we are closer to realizing that vision," Roberto R. Herencia, Midwest's CEO, said in a press release Friday.
The company's next hurdle will be winning approval from the Treasury Department to convert Midwest's $84.8 million investment made under the Troubled Asset Relief Program from preferred shares to common equity. Midwest said in Securities and Exchange Commission filings that it is in advanced conversations with the Treasury on doing just that. The filings, however, indicate that the Treasury would consider such a measure only following the Series A conversion.
If Midwest can convince the Treasury, that conversion would allow the company to further boost its common equity as well as to simplify its capital structure, thereby making it easier to seek other investments.
Midwest said in the prospectus for the exchange that its credit quality continued to deteriorate in the fourth quarter. It warned that its bank's capital ratios had fallen from well capitalized at the end of the third quarter, to undercapitalized at the end of the fourth quarter. As well, it indicated that it had entered into a written agreement with regulators to boost its ratios at the bank.
Midwest's problems date to September 2008 when the government took Fannie Mae and Freddie Mac into conservatorship, and in so doing reduced Midwest's $64.5 million investment in preferred shares of the government-sponsored enterprises to zero overnight. The Tarp infusion helped to plug the hole, but did not provide a buffer for credit losses Midwest incurred in the past year. In the first nine months of 2009, it lost $123 million.
Although the exchange does nothing to improve the regulatory ratios at its undercapitalized Midwest Bank and Trust Co. unit, it moves $35.4 million out of the preferred stock pot and into the company's depleted common equity pool. At the end of the third quarter, Midwest was technically insolvent, given its negative tangible common equity ratio.
Kenneth Kohler, a partner at Morrison & Foerster LLP, said the industry and regulators are becoming increasingly focused on tangible common equity.
"This whole shift to tangible common equity is a back-to-basics approach on the part of regulators and the investment community," Kohler said. "Common equity is simple, straightforward, not complex or difficult to understand. It's a lot easier to analyze common equity than preferred stock that has a whole string of terms in its name."
Under terms of the agreement, holders of depositary shares — or fractions of preferred shares — agreed to accept common stock valued at $2.80 a share, a significant premium to Midwest's stock price, which has not traded above $2 a share since October 2008. On Friday, Midwest's stock closed at 50 cents a share.
Justin Barr, managing principal of Loan Workout Advisers LLC in Chicago, said it is not surprising that preferred shareholders were willing to take part in the plan. "They don't really have any other good alternatives," Barr said. "What else are they going to do but go along with this?"
If the Treasury agrees to convert the shares, Midwest certainly would have won an exception. In February, the Treasury created its Capital Assistance Program, which would have facilitated such conversions. Midwest was one of a few companies to say it applied. The Treasury, which did not return a phone call for comment, closed the program in November without making a single investment.
In its filing, Midwest reported that it has had indications of interest from investors for as much as $190 million. Yet analysts emphasize that the Treasury will have to agree to the conversion before other investors are willing to invest in the struggling company.
"There are so many investment opportunities out there," Gerbel said. "There is no way that an investor would put money into a bank in this shape unless you were either at the same stance or above the government."
