02/26/2010

Skepticism Surrounds Trups-Buying Strategy

Two Highland Capital partners are trying to purchase trust-preferred securities issued by a bank they partially own - shares that currently reside in the underlying portfolio of a collateralized debt obligation.

The unnamed individuals, operating through an entity called Highland Capital Management Services, are angling to buy $15 million of NexBank securities from a Bear Stearns deal called Soloso CDO, 2007-1. They're offering to pay 12 cents on the dollar.

The Highland partners are also offering almost $1.6 million of additional incentives to owners of Soloso's equity to permit the maneuver - taking advantage of a structural twist in which the issue's voting power lies in the hands of first-loss investors. In doing so, they could pit senior bondholders against subordinate classes.

Like many investors in trust-preferred CDOs, Soloso's equity holders long ago stopped receiving payments due to weakened collateral performance. So it would seem they have nothing to lose by accepting the Highland partners' proposal.

Owners of the issue's senior bonds, who stand to lose millions of dollars on the trade, decry the proposal as unethical and a violation of the spirit of deal documents. They do have some recourse though. The offer gives senior noteholders possible veto power, which a few have already exercised. Investors have until March 12 to weigh in, according to a Feb. 19 report from trustee Wells Fargo.

The motivation of the Highland partners remains unclear. One source said the purchase would be part of a buy-and-hold strategy for Highland Capital Management Services. That operation, which isn't technically affiliated with Highland, apparently has been investing in structured products for some time.

But there's no clear indication that it plans to buy any other trust-preferred shares from CDOs. Rather, the close relationships between the various parties involved have led to speculation that the Highland executives are actually working on NexBank's behalf. Or they might plan to use their influence at NexBank to retire the preferred shares at a higher value.

A number of banks have attempted to buy back their own trust-preferred shares at discounts in recent months. In most cases, the hope has been that investors would find the prospect of discounted upfront payments appealing in the face of ongoing market instability. For example, BankAtlantic, a community bank in Fort Lauderdale, Fla., wants to pay 20 cents on the dollar to retire almost $300 million of shares held by a number of CDOs and other investors.

The Highland partners' proposal is reminiscent in some ways of a contentious move in which TPG Credit Management offered late last year to pay equity holders in Soloso and six other CDOs for approval to buy trust-preferred shares from the deals' collateral pools. Senior bondholders including Citigroup and Bank of America protested, prompting Wells, as the issues' trustee, to seek federal-court intervention in November.

The TPG offer differed, however, in that it didn't give veto power to senior investors. And TPG didn't issue the shares it tried to buy.

Soloso 2007-1 priced in June 2007 with a face value of $552.3 million. Management of the deal has since passed from Bear to Maples Finance.

Trust-preferred shares, or Trups, were once a popular way for mid-size banks and insurers to manage their balance sheets, as they act like debt from a capital-raising standpoint while earning treatment as equity from regulators and rating agencies. Many of the issues landed in CDO pools, and they've performed poorly as the issuing institutions have come under duress amid the global financial crisis.

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