New Challenges in Bank Recapitalizations

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New Challenges in Bank Recapitalizations

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Bank recapitalizations are continuing to occur, but new challenges exist.

Many bank holding companies are in or are nearing default under their Trust Preferred securities as a result of not paying interest on those securities for more than five years. If a default is called by the holders of the Trust Preferred securities, all of the outstanding principal and interest under those securities becomes due. If a bank holding company does not have an ability to pay the amount due to the Trust Preferred holders, and to any other creditors calling a cross-default as a result of the Trust Preferred default, access to fresh capital becomes a necessity. This is often times easier said than done for banking institutions facing these types of challenges. As a result, bankruptcy may become a necessary step for a bank holding company to initiate. Alternatively, Trust Preferred holders seeking to maximize their returns following a default have taken steps independently to put a defaulting bank holding company into involuntary bankruptcy. Due to these possibilities, it is important for a bank holding company with Trust Preferred securities to be focused the potential for a default and, if the potential for a default exits, the creation of an action plan to access fresh capital and/or prepare for bankruptcy. Both of these options have their own challenges and requirements, but planning ahead as early as possible for either alternative helps to achieve successful execution.

If access to fresh capital is a viable option, it is important that the banking institution focus on preserving net deferred tax assets. The preservation of net deferred tax assets can be impacted negatively if the fresh capital provided in a recapitalization is large enough to be a “change in control” under applicable tax law. Although recapitalizations can typically be structured to preserve any net deferred tax assets, it is important that any additional capital invested in the banking institution following the recapitalization does not independently result in a “change in control”. In order to guard against this possibility, many recapitalizing banking institutions adopt shareholder restrictions on the transfer or issuance of its equity post-recapitalization. In recent recapitalizations, however, the banking regulators have been focused on these restrictions and how they may negatively impact the ability of the banking institution to raise fresh capital following the recapitalization. Working with the banking regulators on this issue takes expertise not only on the legal aspects of a recapitalization, but also on the tax rules for the preservation of the net deferred tax assets.

At Schiff Hardin, we are well versed in all of these issues related to recapitalizations in the current market. Our team of Financial Institution attorneys has advised on all aspects of bank recapitalizations, including bankruptcy options, the preservation of deferred tax assets and navigating these issues with the banking regulators. In addition, Frank O’Connor, a Senior Consultant in our Financial Institutions group, has extensive experience in accounting and tax matters relating to deferred tax assets and can provide a wide range of non-legal tax assistance in this area. Whether you are a banking institution attempting to recapitalize, an investor or an advisor working on a recapitalization, or simply interested in speaking with us about these issues, please feel free to contact us.