Pressure Mounts for Banks to Unload Trust-Preferred Securities

Small banks worried about dilutive capital raising could be better off hitting investors up now rather than risk drawing more attention when regulators implement Basel III.

Nearly 600 banking companies will need to remove trust-preferred securities from their calculations of Tier 1 capital under existing Basel III proposals, based on June 30 data.

Bankers know they must fill the capital hole, but few of them are acting due to fears that they might have to sell stock or take on debt at unfavorable terms. But some industry observers say that waiting could pinch banks against Basel III deadlines. Holding out could further turn off investors who have already shown a distaste in funding emergencies or procrastinators.

"Some bankers will be brazen to say raising capital is impossible but I disagree with impossible," says Christopher Marinac, an analyst at FIG Partners in Atlanta. Those banks will "soon be out of compliance, and that's what is irking everybody."

Many bankers say they will wait to raise capital until financial performance improves, but that just means more banks will end up going to the market around the same time. By the time these bankers feel healthy enough to pursue capital, investors will likely find other sectors producing higher returns than the banking industry. A large part of that is due to heightened regulation weighing down earnings at financial services companies.

"There is only a certain amount of appetite for financial securities so if lot people are going to the market at the same time, it does make it more difficult," says Drew Hostetter, the chief financial officer at Susquehanna Bancshares in Lititz, Pa.

Susquehanna is among the community banks looking to get a jump on redeeming its trust-preferred securities, either paying it off with retained earnings or raising capital elsewhere. Last week, Susquehanna raised $150 million by issuing senior notes to repay obligations that included $50 million in trust-preferred securities. CVB Financial in Ontario, Calif., and Associated Banc-Corp in Green Bay, Wis., have also announced plans to redeem some of their trust-preferred securities in coming months.

CVB is redeeming trust-preferred securities, in part, because "we do not want have to go through the lumpiness of a potential capital raise and a potential scrambling to meet regulatory demands" later, says Chris Myers, the company's president and chief executive.

CVB has already paid off $26 million of its $115 million in trust-preferred securities this year, and it plans to redeem another $20 million next month.

Myers estimates it will save CVB more than $600,000 annually. "We're looking at this as an overall strategy to purify the balance sheet and get as cost effective as possibly can," he says.

Some banks lack the financial capacity to redeem their trust-preferred securities, and the option of raising capital remains dismal for them. There are about 50 banks among those with trust-preferred securities that are adequately capitalized now but would fall under Basel III regulatory restrictions after removing their trust-preferred securities, according SNL Financial data compiled by American Banker.

"Investors want to invest in something that has an offensive story. …If it's just replacing Trups, that sounds like a tread water story," says John Corbett, the president and chief executive of CenterState Banks of Florida in Winter Haven, Fla. "It's hard for banks to find capital without diluting shareholder who have already been punished."

The hardest sale will come from banks that deferred interest payments on their trust-preferred securities during the financial crisis. Deferrals peaked during the third quarter 2009, with 88 banks deferring interest, according to TrupsInfo.com, a website managed by Hildene Capital Management.

Those deferral periods typically last five years, so many of them will expire around the same time as banks are supposed to be phasing out trust-preferred securities under Basel III. The timing leaves those banks a little more than a year to earn enough to start winding down their reliance on the securities. Some banks that issued trust-preferred securities may have to sell or file for bankruptcy protection if they are unable to find another solution.

"Whether through retained earnings or a capital raise or selling themselves, banks are going to have to pay back their Trups," says Brett Jefferson, the president at Hildene Capital Management, which holds trust-preferred securities in many small banks. "I didn't force you to go borrow this money. You knew what you were doing."

Jefferson commends Capitol Bancorp in Lansing, Mich. for filing for Chapter 11 bankruptcy earlier this month after spending more than three years trying to recapitalize. Capitol failed to convince the holders of $158.3 in debt to exchange it for equity. He says that Capitol's strategy is a "saving grace" for many other banking companies with trust-preferred securities.

Regardless of the Basel III proposal, "I guarantee you that if you're a bank and want to pay dividend but have Trups outstanding, the regulators are going to want you to pay your Trups off," Jefferson says.

"They want banks that are just simple organizations," Jefferson adds. "They don't want to go down this road again."