Many troubled banks are pleading with investors to sell trust-preferred securities back to them at a discount, warning they may fail otherwise. But a small group of investors are calling the banks' requests a bluff.

In recent months, several struggling banking companies have sought to retire their trust-preferreds for less than face value, frequently as part of a plan to raise fresh equity. But for those that issued the securities into pooled collateralized debt obligations, getting the approval to buy them back has been all but insurmountable: At least 10 institutions have failed to gain approval for discounted collateral repurchases since late last year, according to Fitch, and several of those have since failed.

Investors like Hildene Capital Management are a big reason the purchases have not gone through. The hedge fund believes that most if not all of the banks trying to buy back their trust-preferreds are either beyond salvage or simply malingering. Operating under a motto of "Par or Failure," Hildene has emerged as the most vocal of a small group of funds adamantly opposed to accepting haircuts.

Though Hildene's $160 million in assets make it a relatively small hedge fund, the diversified nature of trust-preferred CDO collateral means that it holds at least a small stake in the trust-preferreds of virtually every bank that issued them into CDO deals. Hildene's also had some success in rallying other investors to its side. Barring a significant change in how Bank of New York, the main trustee for the CDOs, handles repurchase requests, it's likely that Hildene and a few similar funds can block virtually all of them.

That has some banks and even other investors stewing. They argue that a recapitalization based on a trust-preferred buyback is the best hope for some institutions' survival and for creditor recoveries — and grouse that players like Hildene are going to precipitate failures that will cost the Federal Deposit Insurance Corp., the banks, and fellow investors a lot of money.

"It is a bit of a poker game," said Eric Luse, a partner at the law firm Luse Gorman Pomerenk & Schick PC. "It is a lot of posturing that without the deal the bank will fail and the other side saying they are confident that it won't."

The fight over trust-preferred repurchases is vexing to banks, creditors, and regulators. Who's in the right depends on everything from one's take on specific creditors' rights, to the broader outlook for community and regional banks, to the health of specific institution in question. It's possible that some banks requesting haircuts are exaggerating their stress — assuming every dollar they can induce creditors to give up is another dollar they keep. But it's also conceivable that some are in circumstances where concessions from trust-preferred CDO holders are the only way to salvage value for creditors and save the bank.

Hexagon Securities, a small investment bank focused on facilitating bank recapitalization, believes it's wrong for Hildene to indiscriminately oppose recapitalization deals that would require trust-preferred haircuts. Many of the banks it's sought to help aren't going to recover without such sacrifices, it says.

Hildene dismisses such complaints as self-serving.

"For some reason, the people at Hexagon don't understand we're not going to take a hit. We don't have to," Jefferson said. "We're not the only people who feel this way. We're just the loudest."

So far, Hildene appears to be winning. Bank of New York, which is the trustee for the overwhelming majority of trust-preferred CDO deals, has sided with Hildene's interpretation that the securities of deferring banks that have stopped paying subordinated debt can't be sold with even a two-thirds majority of the noteholders. Bank of New York insists on a far higher standard — as much as unanimous consent. In many cases, banks complain, Bank of New York has refused to even permit banks from getting in touch with Trups holders to tell them how severe a bank's distress really is. Bank of New York declined to comment for this story.

Some investors say they're frustrated that they've been unable to consider the offers. Through Hexagon, American Banker got in touch with a representative of senior noteholders with positions many multiples the size of Hildene's portfolio. The officials handling that portfolio say that they do not consider Hildene's blanket position to be constructive.

"We're looking to make our decision on a case by case basis," one person said. "What we'd like is the option to sit down and determine whether taking a haircut makes sense."

But there's a strong case to be made that Hildene is well within its rights to oppose deals, says Gene Phillips, a director for PF2 Securities, a firm that evaluates Trups portfolios.

"Their objective is not to save banks," Phillips said. "That's the regulators' job. They've got serious responsibilities to their shareholders."

Hildene has been investing in Trups since May of 2008. Its investment thesis — that the economic environment is improving and that the government intends to save as many banks as possible from failure — dictates that taking haircuts is a bad deal as a general rule. Trust-preferred holders have seniority over equity by definition, the fund notes, so the idea that they are obligated to make sacrifices for the good of a bank's management and equity investors is wholly unreasonable.

"Over the last few weeks, we've seen seven acquisitions where the Trups get out OK," Jefferson said. "I don't care if these banks receive one penny of their common equity. … We're willing to play it out."

One example of a situation that Hildene is currently content to watch is BankAtlantic, a Fort Lauderdale, Fla., company advised by Hexagon. In February the $4.7 billion-asset company declared that it was seeking to buy back $285 million in trust-preferreds at an 80% discount as part of a recapitalization plan. In SEC filings the company said it had lined up the support of a two-thirds majority of its Trups holders.

Then Hildene got involved.

In response to the offer, the firm released a letter claiming that it had persuaded enough trust-preferred holders to defect to rob BankAtlantic of the necessary creditor support, and that the company's failure to disclose this in an 8-K filing on this constituted an SEC reporting violation. BankAtlantic must be able to pay off its debts at 100 cents on the dollar, Hildene says — otherwise, how could it have afforded to double the 2009 compensation of Chief Executive Officer Alan Levan and his son, Jarrett Levan? Or to continue sponsoring recent local events? (BankAtlantic recently supported the Wing Ding Golf Classic.) Finally, why would a bank that's allegedly at dire risk of failure without creditor concessions be suing analyst Dick Bove for having previously alleged that BankAtlantic was at risk of failure? BankAtlantic officials did not return calls seeking comment.

The fund's assumption is that BankAtlantic has clear value, and while it may continue deferring interest payments on its trust-preferreds, it will either pay down the road or get bought by a healthier competitor. There is no reason that BankAtlantic should ask debtholders of any stripe to take a hit while there's still equity value in the company, Hildene says.

"They cried poverty, came out and offered 20 cents on the dollar. And then they quickly raised to 60 cents," Jefferson said. "That tells me they're able to pay par. And they're going to, or they're going to fail."

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