Hildene Capital Management, a longtime investor in distressed bank debt, is for the fifth time securitizing a rated collateralized debt obligation portfolio that includes legacy trust-preferred securities of U.S. community banks.
According to Moody’s Investors Service, the asset management firm — which already manages 32 legacy CDO portfolios of $9.8 billion in bank trust-preferred securities acquired in recent years — is marketing two classes of notes backed by the receivables of outstanding Trups as well as recent-vintage subordinate debt bonds, all issued by 31 undisclosed banks and insurance firms.
A substantial portion of the deal is represented in $177.125 million of Class A notes that have priority on cash flow as well as strengthened loss protection from subordinate tranches in the capital stack. That effective subordination cushion against losses is 33.4% for the senior notes, which carry preliminary A1 structured-finance ratings from Moody’s and are expected to price with a coupon of three-month Libor plus 3.5%.
While that represents investment-grade status, the A1 rating is a step below the Aa2 rating garnered by a prior Hildene CDO in May 2019. Moody’s noted that bank debt carries slightly higher risks now, stemming from Fed moves to reduce interest rates to buoy a pandemic-ravaged economy. Those reductions will cut into net interest margin and and profitability for banks, the ratings agency report stated.
Most of the pooled assets (totaling $161.1 million) are made up of debt bonds issued by community banks.
Hildene has long been a secondary-market investor in trust-preferred securities, having snapped up Trups as bargain-priced distressed assets in the years after the crisis, supporting double-digit annualized returns for the firm’s opportunities fund. Hildene assumed ownership stakes in 28 pre-crisis Trups CDOs between 2017-2020, according to Moody’s, and has sponsored four new-issue Trups CDO vehicles since 2018, including resecuritizations of trust-preferreds included in retired CDO deals. All of its CDOs are managed by affiliate Hildene Structured Advisors.
Trust-preferreds are long-term obligations (with lengthy maturities of up to 30 years along with 10-year noncall periods) that were issued by small banks and thrifts in the pre-crisis era to raise capital. Most were ported over into CDO vehicles that totaled over $60 billion before the Trups market collapsed in 2007 as defaults mounted in the space (over 28% of issuers defaulted in 2010 alone, according to Federal Deposit Insurance Corp. data).
In addition, the trust-preferreds also had multiyear interest-deferral periods that many banks enacted at the onset of the financial crisis era. The default and deferral actions contributed to steep losses for trust-preferred CDO investors — a group that included the banks themselves, having purchased $12 billion of the lower-rated, riskier tranches of trust-preferred CDOs before 2008, according to the Federal Reserve Bank of Philadelphia.
The subordinated debt notes in the Hildene 2020-3 pool are more recently issued debt instruments from 2018 and 2019, according to Moody’s. Subordinated debt has displaced trust-preferreds as a capital-raising vehicle for community banks. In addition to qualifying as regulatory capital (unlike trust-preferreds), subordinated debt carries less risk for investors because of shorter maturities (with expected payoffs within five years) as well as the exclusion of interest-deferral features.
A majority of the issued debt in Hildene’s CDO is beyond the noncall period, according to Moody’s. The deal will not permit Hildene to reinvest in new assets during the shelf life of the portfolio, but the firm can sell off assets due to credit risk or if those underlying debt instruments fall into deferral or default status.
The Hildene Trups Securitization 2020-3 deal is underwritten by Jefferies.
