Ten years after the financial crisis, subordinated debt remains a tough sell for regional and community banks.
“If you look at the regulatory requirements in terms of Tier 1 capital requirements and total capital requirements ... essentially you would expect banks to issue roughly a quarter of their market cap in subordinated debt,” said Navid Abghari, a senior portfolio manager at the private equity firm Angel Oak Capital. But “If you look at their capital structure," it’s averaging "about 95% equity.”
But by and large, they are not, he told a panel at IMN’s ABS East conference in Miami on Tuesday.
A more efficient means than committing equity is to utilize low-cost debt through an initial fixed-rate 10-year bond series, a strategy that banks currently employ to the tune of about $40 billion to $60 billion in mostly private-placement issuance annually.
But that level is far below the levels many believe community banks could potentially issue, and potentially use for other purposes such as acquisitions. The bonds could also feed an investor market hungry for these high-yield assets.
“It’s been a little bit underwhelming how much issue has come through on the sub-debt side,” said fellow panelist Scott Levy, a senior managing director at Guggenheim Securities. “I can remember sitting with some of my colleagues in 2012 and 2013 talking about $60 or $70 billion pre-crisis is going to turn into $100 billion in the new era."
“And here we are, five or six years later, and there isn’t a lot happening there.”
This disappointing levels of activities can likely be attributed to the tarnished reputation of original pre-crisis trust-preferred securities (or TRuPS) through which banks obtained dirt-cheap unsecured funding through securitized debt obligations. The market for TRuPS collapsed during and after the financial crisis, causing many investors and issuers to subsequently shun any talk of debt securitization, according to Regina Richardson, the president of EJF Capital.
“When we started doing our [sub-debt] deals ... in 2016, people would think of it as a CDO and they’re like, I don’t want to invest in it because it has the name ‘CDO,’ ” Richardson said at the panel. “I think we’ve come a long way in the past two years in educating people, having new issues to get people to realize these are really solid structures.”
Both EJF and Angel Oak – through its Buckhead One Financial Opportunities affiliate headed by Abghari – have been part of a post-crisis resurrection of community-bank debt securitization, which to date has totaled a minuscule $2.8 billion, according to data from Guggenheim Securities (by comparison, outstanding TRuPS “1.0” deals still have more than $25 billion in outstanding notes).
Subordinated debt is listed as Tier 2 capital, and is primarily used by banks to fulfill capital needs. That market for the bank to issue and market its own bonds is limited, however, prompting the securitization reboot of sub debt.
“The investor demand is there, but it’s taken awhile to educate people that these new deals are not the same as pre-crisis deals,” said Richardson. “They are a lot less levered, less concentrated.”
“It’s just a matter of time,” said Abghari. “And we do think the size of this market will continue to grow as these issuers understand this is a necessary part of their capital structure toolkit.”
