Debtholders battling with community banks over recapitalization plans have clearly scored a victory — but will it be a win-win?

On Tuesday, Pacific Capital Bancorp in Santa Barbara, Calif., announced that a unit of Ford Financial Fund LP was going ahead with its $500 million investment in Pacific, even though the company was unable to persuade any of its trust-preferred shareholders to exchange their holdings at a discount. That had been one of the conditions of the deal.

A call for such exchanges became a cornerstone of recapitalization deals last year, as new investors seek streamlined capital structures that focus on common equity. But a new crop of hedge funds that have bought the debt are not interested in taking hits on companies that can survive.

Observers said Pacific Capital's outcome could be a mixed blessing for other community banks' recapitalization efforts.

"The good news is that they are getting the capital they need," said Kenneth E. Kohler, a partner at Morrison Foerster in Los Angeles. "But it could be bad news for community banks that have trust-preferreds. It encourages the holders to hold on. This, of course, is the gamble they are making and here it paid off."

The deal, announced in April, called for the $7.1 billion-asset Pacific Capital to get at least 70% of the holders of its $68 million of trust-preferreds to exchange their stakes at 20 cents on the dollar. Further, it called for $121 million of subordinated debt to be tendered at 30 cents on the dollar.

Those offers were bumped up to 40 cents and 65 cents, respectively, in June. As of Tuesday, holders of $68 million of the subordinated debt had agreed to the exchange, yet none of the trust-preferred holders had agreed.

John Scannell, the chief operating officer of Hildene Capital Management, a hedge fund that holds some of Pacific Capital's trust-preferreds, said his firm views this as a win-win outcome.

"We are very happy with it. Pacific Capital got the money it needed and it didn't involve the debtholders having to take a hit," Scannell said in an interview Thursday.

In other deals, new investors have argued that if debtholders did not comply, they would walk away and the bank would be left to fail. Essentially, their proposition to debtholders was that something is better than nothing.

Scannell said the companies getting recapitalization deals are those that have the potential to survive. If that's the case, his firm would rather hold the debt to maturity.

Kohler said the proliferation of firms such as Hildene has shifted bargaining tactics. The initial holders of the debt have moved on, selling their stakes to hedge funds that will eke out as much profit as they can from the distressed assets.

Though Pacific Capital was largely unsuccessful with its debtholders, it managed to persuade the Treasury Department to accept $72 million of common equity in exchange for the $194 million of preferred shares issued as part of the Troubled Asset Relief Program and deferred dividends, another tenet of the agreement.

In an interview, Carl Webb, a senior principal at Ford, said Pacific Capital's value outweighed the less attractive return the firm will take as a result of the debtholders' stubbornness. Ford's investment is set to close at the end of August.

"There were a lot of seats at the table and although we would have liked to be able to say 'you're getting this,' that wasn't quite the case," Webb said. "We never modeled this deal at traditional private-equity, big-double-digit, headline-grabbing returns. Suffice it to say now what we are getting is not a headline-grabbing return, but it is adequate for us because of all the upside potential we see."

Ford is the private-equity vehicle of Gerald J. Ford, the former chief executive of Golden State Bancorp, a company he and his team expanded from $12 billion to $60 billion of assets before selling it to Citigroup Inc. in 2002.

Webb, who was the president of Golden, said the Ford team has been keeping tabs on Pacific Capital for years. "We were always somewhat envious of its franchise and deposit base. Even before our due diligence, we knew them well," he said. "Credit notwithstanding, we like the company for what it is today and after this transaction, we think it will be a very formidable force in central California."

That means it is interested in acquisitions.

"I am not saying we are planning the same trajectory of Golden State, but we are acquisitive by nature," Webb said. "There will be organic growth, but this will be an acquisition platform going forward."

Pacific Capital has been deeply wounded by its exposure to residential and commercial real estate. Its bank has been operating under a regulatory order since last year, and late last month the Office of the Comptroller of the Currency issued a new action against the bank. Last year Pacific Capital sold its tax-refund anticipation business, its most profitable line, at the behest of regulators.

On Tuesday, it reported a second-quarter loss of $60.1 million, compared with a loss of $370 million a year earlier. Nonperforming assets totaled $604 million, or 8.60% of total assets, up 30% from in the first quarter.

Though Ford was unable to strike the deal on the terms it initially laid out, Charles Crowley, managing director of Paragon Capital Group, said its willingness to invest is a positive sign.

"It is proof there is still risk-oriented equity capital coming into the industry," Crowley said.

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