Albina Community Bancorp nearly managed to wriggle out of a trust-preferred vise, but it could still find itself getting squeezed.

Hildene Capital Management, a New York distressed-debt hedge fund, has threatened the Portland, Ore., company with involuntary bankruptcy — or other legal consequences — if it defaults on its trust-preferred debt. Albina has been deferring interest on its trust-preferreds for five years and will default on about $6 million in debt and accrued interest on Sept. 17 if it doesn't pay.

"We certainly intend to enforce the obligation," said John Scannell, Hildene's chief operating officer. "It's hard, but we'll find a way to do it."

Threats of involuntary bankruptcy are nothing new for debt-burdened community banks, and they are likely to become more common after a judge ruled in creditors' favor last month in the case of FMB Bancshares in Georgia.

What's unusual about Albina's situation is that the company has already sold a majority interest in its bank unit. Last year, Albina sold a 90% stake in its bank to Beneficial State Bancorp in Oakland, Calif., by issuing new stock at the bank level, thus bypassing the debt-burdened holding company.

The unusual recapitalization saved the bank, but it could expose the parent company to further legal challenges. The sale was bitterly opposed by Hildene and other creditors, including Zions Bancorp and a unit of Assured Guaranty, which claimed the deal violated their rights. Asked if the fund could pursue further legal challenges related to the Beneficial sale, Scannell said, "We'll see."

The deal was necessary to save the $137 million-asset bank, which had suffered heavy losses and was on the brink of failure, said Graham Bryce, Albina Community Bancorp's chairman and chief executive.

"I guess [the Beneficial deal] was unusual, but we didn't spend a lot of time asking what everybody else did," Bryce said. "We said, 'What are our alternatives?'"

Bryce declined to discuss the dispute with Hildene. Scannell said Hildene has reached out to Albina about repaying the trust-preferred debt, but those discussions have been "unproductive."

Trust-preferred debt lets issuers defer interest payments for five years, after which point creditors can demand full repayment. About 240 community banks have reached the end of the five-year deferral period for trust-preferred debt, and another 200 are nearing the end. Many of them, like Albina, are under regulatory orders barring them from paying trust-preferred creditors.

Caught between creditors demanding payment and regulators forbidding it, many community banks have found themselves left with no option but bankruptcy. In these cases, the bank is sold at auction to pay the holding company's debts.

Albina is one of few companies in this position that managed a recapitalization without bankruptcy. Its recap left Albina Community Bancorp with just 9.9% ownership in the bank; Beneficial has a 90.1% stake. The transaction gave the bank nearly $9 million in capital, but it did not solve the holding company's trust-preferred problem.

Albina has the support of deep-pocketed backers. Beneficial, like Albina, is a community development financial institution, owned by a nonprofit foundation created by hedge fund billionaire Tom Steyer, who founded Farallon Capital, and his wife, Kathryn Ann Taylor. They have contributed nearly $50 million to support Beneficial since the financial crisis.

Yet Albina's creditors have expressed concern over the quality of Beneficial's management and the bank's reliance on capital from Steyer and Taylor. The $364 million-asset Beneficial, formerly One PacificCoast Bank, has lost money in all but two years since its 2007 founding, though it made $1.2 million during the first half of this year.

The recapitalization was approved in September by the Federal Reserve Board of San Francisco, despite loud complaints from Hildene and other investors in collateralized-debt obligations backed by Albina's trust-preferred securities.

The recapitalization has not been challenged in court, but Scannell left that possibility open, calling the sale to Beneficial a "back-room deal." In comment letters to the San Francisco Fed last year opposing the sale, the fund said the deal violates the trust-preferred indenture.

The deal also raises the possibility of legal claims for breach of fiduciary duty by Albina's directors, as well as interference in contracts by Beneficial, Hildene and Zions wrote in a letter objecting to the transaction.

"Creditors of Albina Bancorp may be forced to litigate these issues, at great expense to Albina Bancorp, its management" and possibly Beneficial, Hildene and Zions wrote.

The San Francisco Fed, in approving the deal, said it lacked the authority to adjudicate the dispute with the creditors, and that the investors should look to the courts to resolve the issue. The San Francisco Fed declined to comment on the dispute or the recapitalization.

Whether Hildene or other investors can form a legitimate legal objection to the sale, nearly a year after it closed, depends on the language in Albina's trust-preferred documents, which are not public.

Many indentures bar holding companies from selling the majority of their assets. The Albina sale was structured as a stock sale by the bank, not the holding company. In a letter objecting to the transaction, Hildene and Zions claimed that the trust-preferred agreement does not permit the holding company to sell the majority of its assets without the acquirer also assuming the debt.

"It all comes down to the exact points in the trust-preferred indenture, and they are not all the same," said Joel Rappoport, a lawyer at Kilpatrick Townsend & Stockton who is not involved with any party in the dispute.

Other banks have tried to structure sales and recapitalizations in ways that avoid the buyer taking on the seller's trust-preferred liability, with mixed results.

The most well-known example is BankAtlantic Bancorp's 2011 plan to sell its performing assets to BB&T without the Winston-Salem, N.C., acquirer taking on its trust-preferred debt. After objections by Hildene and other trust-preferred investors, a judge ruled that deal violated the trust-preferred agreement.

Prosperity Banking in Florida tried to sell a stake directly in its bank unit to private equity firm Patriot Financial Partners. After regulatory delays, Prosperity sold itself to Ameris Bancorp in Georgia last year in a more conventional transaction.

Other community banks have successfully employed more creative approaches. Liberty Bancshares in West Des Moines, Iowa, effectively separated its bank from its over-indebted holding company last year, selling branches and bank assets before voluntarily liquidating the bank. Liberty structured the sales as direct sales from the bank, rather than the holding company.

The difficulty of taking such an approach as an alternative to bankruptcy is that it can be challenged by creditors, says Rob Klingler, a lawyer at Bryan Cave who isn't involved involved in the Albina dispute.

"You need to be very careful to show that you have been fair to the holding company investors," Klingler said. "You don't have the benefit of a bankruptcy court blessing the transaction. On the other hand, you avoid the costs and risks of a bankruptcy."

If a creditor decides to sue over the transaction, directors of the holding company could find themselves targeted. "Almost regardless of the validity of that argument, you could be looking at the costs of defending yourself," Klingler said.

Any attempt by Albina's creditor to try to unwind the transaction or seek compensation for being diluted would run into "extremely murky" legal and regulatory issues, Rappoport said.

Albina could make a strong argument that the recapitalization was in the investors' interest because it saved the bank, and that dilution was better for the creditors than failure.

By threatening action, Hildene may be hoping to send a message to other banks rather than secure a legal victory. "This could be a shot across the bow of other [trust-preferred] issuers who have thought about selling a stake in their bank," Rappaport said.

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