TruPS Dartboard

Are bank recapitalizations involving TruPS about to get easier?

At DealVector we have seen and heard many reasons why potential bank restructurings involving TruPs securities are difficult to execute. New money generally argues that the economics of such recapitalizations do not support full repayment of TruPs liabilities. So renegotiating with holders (how much of a haircut will they take?) is a prerequisite to moving forward. But such negotiations appear to be really, really hard.

First, why are they so hard? Many TruPs were bundled into blind pool CDOs that make it difficult for bank issuers to even find their liabilities. Even when they do, these CDOs typically require 100% of note holders to approve a restructuring prior to an event of default—a practical impossibility. Once a bank has gone into default, the threshold often drops to 2/3 of the controlling class. While this is more feasible, corralling 2/3 of the class is still a steep hill to climb (unless you have access to an identity-protected communication platform that allows you to send messages to holders of specific assets (hint, hint).) Furthermore, going into default can itself seriously erode the value of the bank: depositors withdraw cash and REO assets get picked off at fire-sale prices.

Since TruPs at the Holdco level face these challenges, some have tried to pursue recaps at the OpCo level. But this approach is likely to be highly dilutive to the HoldCo. That dilution, depending on its extent, risks triggering regulatory hurdles because the transaction can be deemed a sale of assets. This kind of transaction therefore would also require approval of the TruPs liability holders.

These obstacles are such that some issuers opt to pursue a 363 bankruptcy proceeding, despite the scary implications of the word “bankruptcy” for depositors and investors. The chief advantage of this process is that a “clean” entity can emerge at the back-end, assuming regulators are kept in the loop along the way and depositors are shepherded with a pro-active communication strategy.

The availability of this path sets up an interesting game-theoretic framework for holders of TruPs. Putting aside the mechanical difficulties related to CDO voting, when should TruPs holders negotiate a deal early? And when should they hold out to risk being subject to the 363 process, the result of which may be a wildcard?

The answer depends on data. The bad news is that there is not enough of it. The good news is that there soon should be. (Well, maybe that is actually bad news since the data consists of bank bankruptcies.) This new data could break the log-jam, one way or another. Why?

On the TruPs dartboard, only a few darts have been thrown. A couple are bulls-eyes, but a couple have ruined the wallpaper. That is to say, some bankruptcies have resulted in very high (close to par) recoveries for TruPs holders; some have resulted in effective goose-eggs. There is very little in between, and very few data points overall. But since we are entering the end of the 5 year deferral period for many TruPs securities, we are about to see a lot more darts thrown.

If we at DealVector are right in our thinking, the mechanical challenges are hard, but they are not the real problem. The real obstacle to bank recaps is the fundamental difference of opinion in the market. Are TruPs worth zero or are they worth par? 2014 should begin to answer that question empirically.

Who’s feeling lucky?