Until a few weeks ago St. Martin Bank and Trust in St. Martinville, La., expected to use trust-preferred securities to finance its most recent buyout deal.
But the $200 million-asset bank turned to alternative funding after discovering spreads on the securities had doubled this quarter.
“We realized there was really a problem,” said Paul Durand, St. Martin’s president and chief executive officer. “That market is strained.”
Bankers and other industry insiders say that the pricing on trust-preferred securities has shot up in recent weeks to as high as 300 basis points over the three-month London interbank offered rate, and that some banks have not been able to obtain this funding at any price.
They said a disruption in the securitization market — caused by the subprime blowup — was the main reason.
For the past seven years a handful of asset managers have been pooling trust-preferred securities to be sold in the securitization market as collateralized debt obligations. The pooling made trust-preferreds accessible and affordable for small banks that might not have attracted investors on their own.
But lately many investors in the secondary market have shied away from CDOs in general, even though those backed by trust-preferreds continue to perform well. Asset managers have either trimmed volume or temporarily halted the pooling.
“A lot of these people that invested in bank CDOs also invested in CDOs with subprime exposure,” said Tom Killian, a principal with Sandler O’Neill & Partners LP in New York.
The subprime troubles caused liquidity problems, and many investors had to sell off whatever they could, Mr. Killian said. “It put pressure on bank CDO paper,” causing spreads to widen, he said.
That has left some bankers wondering whether to shelve projects or scramble for alternatives to what has become a favorite capital tool.
St. Martin’s $15 million cash deal for American Bank in Welsh, La., announced last week, is a case in point. Mr. Durand said it intends to use a loan from a banker’s bank to pay for the deal, because the rate is considerably lower than on trust-preferreds. But St. Martin’s hopes to retire the loan early by issuing securities after the recent market disruption passes, he said.
Chet Fenimore, a managing partner at the law firm Hunton & Williams in Austin, which advises banks making acquisitions, said asset managers that pool trust-preferreds to be sold in the securitization market have shown less interest in the transactions lately. “We’ve seen people either back out of commitments or reprice commitments to be more in line with the current market.”
Since the trust-preferred CDOs were created, in 2000, about $54.5 billion of them have been sold in the securitization market, including $6 billion this year, according to the rating agencies. Banks and thrifts account for most of the volume, though insurance companies, real estate investment trusts, and home builders also issue the securities.
The market disruption is not expected to cause an immediate drop in trust-preferred CDO volume. Asset managers warehouse the securities while preparing to bring a CDO to market, so they still have inventory to work through.
But Trapeza Capital Management in Cincinnati, Bear Stearns & Co. Inc. in New York, and Stone-Castle Partners LLC in New York are said to be among the asset managers tightening the spigot on new issues.
Bob McPherson, a managing director at StoneCastle, said his company has toughened credit-quality standards for the bank securities it will accept, but he declined to give details.
“We probably have as many inquiries as ever, but with the credit constraints of the market, we are looking to higher-quality credit,” he said.
Trapeza sold a $750 million bank and insurance hybrid CDO to investors on Aug. 15.
Ashleigh White, a managing director at Trapeza, said the company is still actively pooling the securities, but she would not say whether its volume has declined. She said it plans to market another trust-preferred CDO to investors in the first quarter.
Bear Stearns would not discuss the issue in detail. “We continue to monitor the pace of trust-preferred originations in connection with the current market volatility, and plan to be a continued presence in the market as CDO spreads stabilize,” a spokeswoman said by e-mail.
Jim Windgett, the managing director of structured finance for FTN Financial in Memphis, said he has been involved with trust-preferred CDOs since the first ones were created and has never seen spreads widen as rapidly as they have in the last six weeks.
He said he does not know when investor angst might let up. “Investors are going to demand a risk premium at least for the near future,” he said.
FTN pooled about $5 billion in trust-preferreds last year, he said. As a unit of First Horizon National Corp., it has been able to continue warehousing the securities through its parent company despite the market volatility, but it has widened the spread at least 100 basis points, Mr. Windgett said.
“Our competition, we believe, they are funded through third-party facilities, and it may be more difficult for them now,” he said.
Mr. Killian said that though Sandler O’Neill has not left the trust-preferred market completely, it is telling banks not to raise money now unless it is absolutely necessary.
“We are still talking with clients about issuing trust-preferred financing, but cautioning them that spreads are significantly higher now relative to a couple of weeks ago, and advising them to wait until the market returns to more normal levels,” he said.
He said he expects spreads to tighten over the next few weeks. “However, there is no assurance” that they will “return to levels of a few months ago.”
The fat spreads are not bad for everyone. Orca Asset Management LLC, an investor in trust-preferred CDOs, sees the rates and still strong credit quality of the underlying collateral in the CDOs as a buying opportunity, said Kevin Meenan, Orca’s CEO and chief investment officer.
“We were excited about the market before there was a correction,” he said. “Now we think we will be paid a better return for taking basically the same risk.”
The credit quality of bank trust-preferred CDOs remains better than ratings agencies’ models predicted, with lower-than-expected default rates, Mr. Meenan said. “The good news is there have been about 2,000 banks issue into trust-preferred CDOs in the last seven years,” Mr. Meenan said. “Ratings models show there should be about 25 banks in deferral. Right now there are only four.”
Charlie Miller, a managing director in the financial institutions group at the $2.2 billion-asset Bankers Bank in Atlanta, said his specialty bank had originated trust-preferreds for individual banks years ago, but had been working only as a referral agent for the larger poolers recently. However, if the change in the market creates a void that community banks need filled, Bankers Bank could get deeper into the business, he said.
“Perhaps we will evaluate becoming directly involved. In a disrupted market like this, you have to study it before you decide which way to go,” he said.
The $2 billion-asset OceanFirst Financial Corp. in Toms River, N.J., raised $10 million through trust-preferred securities in June.
OceanFirst is paying 175 basis points above Libor on the securities, which it used to fund dividend payments and stock repurchases, said Michael Fitzpatrick, its chief financial officer. Had the company waited until now, it would not have issued trust-preferreds, he said.
But he called the current spreads “a temporary aberration” and said he remains optimistic that investor worries will subside and trust-preferred securities will become a viable funding source again.
