More community banks may soon be jumping into the market for trust- preferred securities despite proposed legislation that threatens to remove the securities' tax deductibility.

In his recent budget, President Clinton proposed elimination of tax deductions on certain hybrid securities, including the trust-preferred issues, which enable banks to raise capital inexpensively.

The proposal for the most part has slammed the window of opportunity shut for large bank holding companies, but ironically opened it for community banks.

Market observers note that the anti-hybrid securities proposal is applicable only to corporations that file with the Securities and Exchange Commission. This means that the more than 1,100 community banks that are privately owned and not required to register with the SEC could have the marketplace all to themselves.

At the same time, Wabash Capital LLC, a securities firm in Oak Brook, Ill., is attempting to make it easier for the smaller players to get in the trust-preferred game by creating securities that consist of several banks' trust-preferred issues.

"Large banking organizations with direct access to the capital markets have moved quickly to bring their own deductible-preferred securities to market. But community banks have been shut out of the market because many are unable to bring to market large liquid issues big enough to attract institutional investors," said John J. Madden, a principal and attorney with Wabash Capital.

Issuers with assets of $1 billion and less have been hit with underwriting fees as high as 4%, Mr. Madden said. Other obstacles include a $15 million minimum issue size and significant legal accounting and related costs.

Small banks usually want to issue between $3 million and $15 million, said Mr. Madden. "For the size of issuer that we are talking about, anything larger than that is a big chunk of their equity base."

Mr. Madden and his brother, Martin P. Madden, say that the obstacles preventing community banks from issuing can be resolved if a group of banks combine their small issues of trust-preferred securities to create a large liquid one.

Wabash Capital would buy the securities with funds raised through a limited market partnership interest. Mr. Madden expects to securitize the pool of securities, which will enable him to dilute the underwriting fee, which he expects to be no higher than 1.5%, and cut the associated costs to $50,000.

Nearly 50 community banks have expressed interest in the idea, said Mr. Madden.

Duff & Phelps Credit Rating Co. analyst Thomas Stone said that he sees several benefits to such a project.

A collection of trust-preferred securities brings diversification to the pool and minimizes the risk, he said. The banks that are in the pool could lower the cost of their preferred stock.

Mr. Stone pointed out that securitization has been a successful financial structure for other assets, such as car loans, credit card receivables, and even more exotic products like singer David Bowie's future royalties and loans for plastic surgery.

Mr. Madden said he expects to complete his securitization project by the end of March and expects it to capture an investment grade rating; most community banks have ratings in the single-B and low double-B range.

Hunt Bonan, president of Market Street Bancshares, Mount Vernon, Ill., is eager to participate in the project.

"Trust-preferred securities is the difference between the haves and the have-nots," said Mr. Bonan, whose bank has $209 million in assets. "Access to capital markets is an issue that can make or break small institutions. That's why we jumped onto this project."

Robert Young, chief financial officer of First Western Bancorp Inc., New Castle, Pa., also sees the project as a good idea.

"I don't need to issue now," said Mr. Young, whose bank recently completed a $25 million deal, "but if someone had approached me with the idea earlier, I would have considered it."

However, he noted that such an endeavor is not without its challenges.

"I think it would be difficult to coordinate with a rating agency because they have the burden of looking at the securitization and all the issuers involved in the project," he said. "It is an interesting concept, but it is one that has yet to be perfected."

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