Trust-preferred securities hurt Philadelphia-area banks

Oct 29, 2009 (The Philadelphia Inquirer - McClatchy-Tribune Information Services via COMTEX) -- NPBC | Quote | Chart | News | PowerRating -- As if local banks did not have enough trouble with bad loans, some of them are also dealing with persistent losses on an exotic type of security that soared in popularity during the real estate bubble.

National Penn Bancshares Inc. threw in the towel today, deciding to dump its portfolio of the securities, which contain a hybrid of debt and equity sold by small banks and other financial companies.

Wilmington Trust Corp., Fulton Financial Corp., Sun Bancorp Inc., and other smaller banks in the region also took third-quarter losses related to the same type of investment, which was attractive to banks because of a supposedly strong yield.

National Penn recorded an $84.7 million pretax charge. Its total loss on the investments, which it bought starting in 2006, was $165 million. It had taken previously write-downs on the investments, which are pools of so-called trust-preferred securities.

Mike Hughes, National Penn's chief financial officer, said the bank had pulled the plug on the investments because of the deteriorating condition of the banks underlying the securities and because National Penn was low in the "pecking order" relative to other investors in the pool. That meant National Penn was among the first to take losses and among the last to get paid.

It is not clear whether National Penn will be able to sell the investments. "We believe a market is emerging. We've started receiving phone calls," Hughes said.

During the boom years from 2004 through 2007, U.S. banks issued $19.5 billion worth of the securities, according to Thomson Reuters. They were attractive to the banks because they counted toward the money that regulators require banks to set aside, while the interest paid on the securities was tax-deductible.

Two companies with Philadelphia headquarters, Resource America Inc. and Alesco Financial Inc., were major players in the business. The two firms were involved in issuing more than $15 billion in trust-preferred securities -- including many from insurance companies and real estate investment trusts -- that were pooled into collateralized debt obligations, known as CDOs.

CDOs became notorious for their role in the subprime-mortgage collapse because they were designed to package thousand of highly risky mortgages into securities that could garner a "AAA" blessing from ratings agencies.

The same thing was done with trust-preferred securities from banks that were too small to issue the securities on their own. Fitch Ratings Inc. said last week that a significant percentage of the more than 100 banks that have failed were among the issuers of trust-preferred securities.

Those troubles are contributing to widespread losses. Wilmington Trust last week reported a $55 million write-down on its holdings of the securities. Since June 2008, the estimated fair value of the securities has fallen to $51.7 million from $227.2 million. In South Jersey, Sun Bancorp wrote off its remaining $1.9 million of a $7 million investment in a trust-preferred CDO, which it bought in 2004.

Fulton Financial, of Lancaster, has written down $12 million of an original $34 million investment in trust-preferred CDOs.

National Penn has also been on the other side of the deal, raising money through trust-preferred securities, but Hughes, the CFO, said it had kept up its end of the bargain. "We're the good guys," he said.

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