The bankruptcy case of Park Cities Bank's holding companies offers a clue of what lies ahead of investors with trust-preferred securities in struggling banks — and it's not an appealing option.

North Texas Bancshares and North Texas Bancshares of Delaware filed for bankruptcy last month to help them sell the $425 million-asset Park Cities to a Dallas investor group.

But a judge's ruling in the case reinforces concerns that trust-preferred shareholders can end up losing big in an environment where bankruptcy is becoming an increasingly popular way to recapitalize banks.

U.S. Bankruptcy Court Judge Kevin Gross ruled last week that North Texas Bancshares can auction the bank's assets, with the Dallas investors placing an initial bid of roughly $7.4 million. A group of creditors had fought the auction procedures, arguing in a court filing that the process "provides virtually no recovery for unsecured creditors of the debtors' estates."

The objecting creditors hold about $34 million in trust-preferred securities and include affiliates of Hildene Capital Management, a New York hedge fund, and Cohen & Co. Financial Management.

"This is the most-blatant back room deal ever put together," says Brett Jefferson, Hildene's president.

A similar fate could await more trust-preferred shareholders in bankruptcy cases, especially since it has been five years since a number of banks suspended payments on those securities, says Randy Dennis, president of DD&F Consulting in Little Rock, Ark.

"It's going to be interesting for those Trups holders," says Dennis, who is not involved in the Park Cities bankruptcy case. "They haven't been paid for five years and they're still not going to being paid."

The Dallas investors, organized as Park Cities Financial Group, are the stalking-horse bidder for Park Cities, meaning they were the first bidder and set the bar for competing bids. Stalking horse bids also have some financial protections in an auction conducted through bankruptcy, compensating them for the risk of making the first bid.

The bank's unsecured creditors complained to Judge Gross that the Dallas group was given too much protection for the auction, including bid protection of $1.23 million, or about 17% of the total bid amount. Bid protection acts like a break-up fee.

The auction process "is unreasonably restrictive and will not allow for potential value maximizing offer to be put on the table," the unsecured creditors claimed in their court filing.

There are a large number of banking companies that are financially "upside down" and still hold unredeemed trust-preferred stock, Dennis says. As bankruptcy becomes more common, investors with trust-preferred shares stand to lose because the bankruptcy process is, in many ways, designed to favor the stalking horse bidder, he says.

"That's the game that the stalking horse plays," Dennis says. "They're willing to step up and pay something to get this bank out of failure."

Jefferson, of Hildene, says he's "not worried" that his investment will be wiped out by a bank failure. "They all try to give this sob story that the FDIC is sitting out in the parking lot but the fact is there aren't that many banks that are failing right now," he says.

John Ashmead, a lawyer at Seward & Kissel who is representing the unsecured creditors, could not be reached for comment.

John Dienes, president and chief executive of Park Cities Bank, and Tobey Daluz, a lawyer at Ballard Spahr representing North Texas Bancshares, did not return calls seeking comment.

At least there are some positive trends for those who hold trust-preferred stock. Prodded by new capital rules and traditional M&A, banks are redeeming more of those shares. At Sept. 30, the amount of outstanding trust-preferred stock fell 6% from a year earlier, to $28 billion, according to data from Hildene.

Only $3.4 billion of those shares, or 12%, was held by banks that are deferring payments. That compares to $4.9 billion, or 16.4%, a year earlier. Industry sources say that decline is tied to several factors, including a resumption of payments and bankruptcy related moves similar to what Park Cities is pursuing.

The Park Cities case is also notable because of its indirect ties to the family that founded Walmart. Providence Bank, a $661 million-asset bank co-founded by one of Sam Walton's nieces, is a secured creditor in the bankruptcy proceedings.

Providence inherited that status after it bought the failed Premier Bank in Jefferson City, Mo., which had outstanding loans to North Texas Bancshares' directors, Dennis says.

Providence Bank's shares in North Texas Bancshares are valued at roughly $5.2 million, according to a court filing. Kit Stolen, Providence's president and chief executive, and Craig Martin at DLA Piper, the bank's lawyer, could not be reached for comment.

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