This summer, American Bancorp in St. Paul, Minn., and FMB Bancshares in Lakeland, Ga., were each forced into involuntary bankruptcy by trust-preferred creditors. Both companies had reached the end of their 20-quarter deferral periods owing millions of dollars in unpaid debt and interest.
Speculation has since centered on whether hundreds of other bank holding companies reaching the end of their deferral periods will also be forced to auction their banks. Often overlooked in this discussion are the holding companies that have issued debt secured by the stock of their subsidiary banks. The same factors that are motivating trust-preferred creditors to force auctions will likely drive secured creditors to do the same, creating additional opportunities for deal-hungry acquirers.
Until recently, it was unclear how creditors would react following the expiration of trust-preferred securities deferral periods. Bank holding companies had previously attempted to sell off their assets in voluntary bankruptcy auctions, known as 363 sales, with mediocre results: no other bidders had emerged to challenge the initial offer. However, recent 363 bankruptcy auctions for Metropolitan National Bank, Park Cities Bank, 1st Mariner Bank and Idaho Banking have been successful for creditors, with multiple bidders driving up prices.
Moreover, while many creditors feared that bankruptcies could risk the health of the subsidiary bank through bank runs or other crises of confidence, such crises have not materialized. It is now clear that the worm has turned: trust-preferred creditors view bankruptcy auctions favorably. Indeed, the ratings organization Fitch has opined that involuntary bankruptcies can add value for creditors.
For similar reasons, secured creditors are likely to conclude that forced auctions will be their best avenue for recovering outstanding debt. Under the Uniform Commercial Code, a secured lender foreclosing on its bank stock collateral must sell the bank stock in a commercially reasonable mannertypically an auction, with the bank going to the highest bidder. Any value realized in excess of the debt goes to the holding company debtor to benefit unsecured creditors or, secondarily, stockholders. Just in May, for example, a secured lender foreclosed on the stock of Advantage Bank in Loveland, Colo., and began a foreclosure auction.
Like bankruptcy auctions, foreclosure auctions allow the purchaser to acquire the bank without acquiring its holding company's debt. The UCC includes a number of other provisions that protect value for good-faith purchasers.
However, foreclosure auctions can also be risky because there is no acquisition agreement between the buyer and the foreclosing lender or the debtor. This means that the buyer of bank stock sold in a foreclosure auction is unlikely to have the benefit of contractual warranties, negative covenants, closing conditions and other provisions typically included in acquisition agreements to protect the buyer. Because of the limited warranties, it is of paramount importance that buyers do thorough due diligence on the bank and the bank stock collateral. Buyers should protect themselves by ensuring that the auctioned stock represents all of the bank's outstanding stock and that the lender has a valid and legal security interest in the bank stock securing its loan.
A bank stock foreclosure auction may present a unique buying opportunity for an opportunistic buyer, especially one who is familiar with the bank in question. Meanwhile, managers of holding companies facing looming debt deadlines would be well-advised to act early to work with creditors for repayment extensions or to restructure payment terms. If that's not possible, indebted holding companies should coordinate with secured lenders to facilitate an auction process that is most likely to obtain the best value.
Joel Rappoport and Joe Scibilia are partners at Kilpatrick Townsend. Joel Rappoport advises financial institutions and their holding companies and other public and private entities in structuring, negotiating and executing complex corporate transactions. Joe Scibilia leads the firms leveraged finance practice.