Hundreds of community banks and thrifts that were among the first to sell trust-preferred securities through investment pools could soon be looking to refinance.
Five-year call periods on securities issued through pools in 2001 and 2002 are coming up, and bankers and investment bankers say many issuers are eager to pay off the high-rate securities and issue new ones at more favorable spreads. Refinancing could save banks hundreds of thousands of dollars a year in interest payments.
Investment banks that assemble the pools are doing their part to make the refi process easy. In some cases, they are buying the securities from issuing banks and holding them until they assemble their next pool, so community banks do not have to wait for new pools to form before issuing securities.
Most investment banks have also eliminated the up-front fees they once charged to cover legal expenses and the cost of marketing investment pools to investors. Typically, this fee was 3% of the amount issued - or $300,000 for a bank that sold $10 million of the securities.
"The market has changed dramatically in terms of issuance costs," said Glenn Potolsky, a managing director with Bear, Stearns & Co. Inc.
There is some concern about how investors might respond to what could be a flood of refis, and investment bankers say that banks should look closely at the penalties they could incur.
But generally, observers expect refi activity to pick up this year, and they say it could continue for perhaps three more years. In fact, the economic argument looks so clear cut, investment bankers say, that the main choice for many banks may be whether to issue the new securities before retiring the old ones.
West Coast Bancorp in Lake Oswego, Ore., issued $15 million of securities last month, even though the five-year call period on the trust-preferreds it issued in 2001 is not up until December. New South Federal Savings Bank in Birmingham, Ala., is considering refinancing before its call period is up in March.
The $1.9 billion-asset West Coast issued $15 million of trust-preferreds. Anders Giltvedt, its chief financial officer, said it will use $10 million of the proceeds to fund a pending acquisition and $5 million to replace securities it expects to call in December.
West Coast did not issue the securities through a pool - it sold them to Keefe, Bruyette & Woods Inc., which is warehousing them until it assembles its next pool.
Pooled trust-preferred securities were created in 2000 and began to take off in 2001. That year hundreds of banks and thrifts sold trust-preferreds through six pools, raising roughly $3.4 billion, according to Bear Stearns.
The spreads, though, were much higher in those days than they are now. In 2001 issuing banks sold the securities for about 3.5 percentage points above the three-month London interbank offered rate. In more recent pools the spreads on the securities were about 1.5 percentage points above three-month Libor.
Mr. Giltvedt said that West Coast refinanced now, rather than in December, because there is a chance spreads could go up by then. Though they are not likely to approach the spreads of five years ago, they could rise as more banks look to refinance and investors, sensing an oversupply, demand higher spreads, he said.
"We felt with the uncertainty as to the appetite for the product in this lower-interest-rate environment, spreads may go up," Mr. Giltvedt said.
There is evidence that spreads, which have been falling steadily since 2001, are starting to widen. Stifel Nicolaus & Co., a St. Louis investment banking firm, said they are about 30 basis points higher now than they were when they reached an all-time low late last year.
Mr. Giltvedt would not say what rate West Coast is paying on the securities it issued last month. But he said his company could easily justify carrying the additional $5 million of trust-preferred securities for a few months by retiring other short-term debt or plowing the capital into loans.
Mike Anderson, a vice president of capital markets at the $1.7 billion-asset New South Federal, said it almost definitely will call $16.5 million of trust-preferreds in March, five years after they were issued. His bank is mulling the idea of issuing securities worth the same amount well before then.
It would save about $300,000 of annual interest expense if it refinanced at today's rates, Mr. Anderson said. Executives with his bank would prefer not to double up on trust-preferred interest payments for several months, but they might do so if it works out in New South Federal's favor.
Trust-preferreds, which have characteristics of both equity and debt, are a popular capital-raising tool for banks. They cost considerably less than common stock, because interest payments are deductible from taxable income, while dividend payments are not.
But unlike with other debt, banking regulators let banks count trust-preferred securities as up to 25% of their Tier 1 capital. This is because their maturities are long - usually 30 years - and banks can defer interest payments to investors if they run into financial trouble.
Large banks that have debt rated by credit agencies began issuing trust-preferreds in 1996. Four years later investment banks began organizing pools of small-bank issuers with unrated debt that might not have attracted investors on their own. The first couple of pools had 10-year no-call provisions. The first with a five-year no-call term was sold in July 2001, Mr. Potolsky said.
At first the pools paid high yields, because they needed to attract investors, but spreads narrowed as investors became more confident in them. About 2,000 banks have participated in 62 pools since 2000, according to Bear Stearns.
"The expectations were for good performance," said James E. Moss, a financial institutions analyst with Fitch Inc. "But I think the performance has even outstripped people's expectations."
Banks that issue trust-preferreds directly, rather than through pools, also refinance regularly. For example, First Busey Corp. of Urbana, Ill., which issued $25 million of trust-preferreds in June 2001, plans to refinance next month. Barbara J. Harrington, the $2.3 billion-asset company's chief financial officer, said it expects to cut its fixed 9% rate to about 7%, said thereby saving $500,000 of annual interest expenses.
Thomas Killian, a principal in the investment banking group of Sandler O'Neill & Partners LP, said that even though refinancing is a good idea for most banks that participated in the early pools, the decision to do so should not be automatic.
Banks with call penalties in their trust-preferred contracts need to consider how long it would take to recover that cost through the anticipated savings of interest expenses, Mr. Killian said. They also need to consider how the market would react if a call penalty hurt the bank's earnings, he said. Mr. Stoneman is a freelance writer in Albany, N.Y
