First Mariner Bancorp faces a year-end deadline to pay millions in interest or risk default.
The company's weak finances and the regulatory constraints on its bank, 1st Mariner Bank, leave the Baltimore-based holding company with few options, said banking experts who have reviewed the Baltimore company's regulatory fillings.
"The question comes up: Now what do they do?" said banking consultant Bert Ely. "They are in between a rock and a hard place."
First Mariner, in a statement, said the pending interest payment is an issue affecting only the parent company — not 1st Mariner Bank, which will continue to operate as usual with deposits insured by the Federal Deposit Insurance Corp. The bank holding company is negotiating with investors to try to resolve the matter.
About a decade ago, many bank holding companies turned to so-called trust preferred securities — a hybrid between a bond and stock — as an easy and inexpensive way to raise capital without diluting the value of their common stock. Investors liked the securities, too, because they were tax-friendly and seemed safe, banking experts said.
But in the 2010 Dodd-Frank reform act, Congress limited banks' use of money raised from these securities to meet their capital requirements. Meanwhile, investors grew unhappy with the investments because of poor returns and mounting losses, banking experts said.
In the case of First Mariner, the company created a half-dozen trusts between 2002 and 2005 and raised money by selling a stake in the trusts to institutional investors. The trusts then used the proceeds to buy $52.1 million of subordinated debentures — a form of interest-paying debt — from First Mariner, according to regulatory filings with the Securities and Exchange Commission.
Starting in 2009, First Mariner took advantage of an option that allowed it to defer interest on this debt for up to five years. But this deferment concludes at the end of this year, and after that, the interest — which amounted to $8.3 million in the first four years — must be paid.
If not, the trusts' investors could declare a default, which would allow them to demand the repayment of the entire principal — or $52.1 million.
First Mariner acknowledged in SEC filings that it doesn't have the cash to resume interest payments on the debt.
First Mariner and its bank haven't fully recovered from the 2008 financial crisis. After five years of losses, First Mariner recorded a $16.1 million profit for 2012. So far this year, the company has lost money — $11.3 million through Sept. 30, it reported last week, largely because refinancings fell when interest rates rose.
Compounding the problem is that its bank, 1st Mariner, is not in a position to help out. The bank has been under regulatory orders since 2009 to raise capital, reduce bad loans and improve earnings. It also is prohibited from paying dividends to its parent, First Mariner, without approval from regulators.
And a separate agreement with banking regulators explicitly prohibits the holding company from making payments on the trust preferred securities, according to the company's SEC filings.
First Mariner said in an April SEC filing that it won't be able to make interest payments to investors unless regulators lift the 2009 order against 1st Mariner or the bank becomes profitable enough that it can pay dividends to its parent.
"Even if the bank is able to resume paying dividends, we cannot be assured that the amount of dividends would be sufficient to pay the entire amount of interest due under the subordinated debentures at the end of the deferral period," First Mariner reported.
In its statement Wednesday, First Mariner said, "The company has been in regular communications with holders of its trust preferred securities. It's important to recognize that the interest payment due on the trust preferred securities is an obligation of First Mariner Bancorp, not First Mariner Bank. Therefore, the operations of First Mariner Bank will continue in their normal course and will not be impacted in any way."
The company hopes those talks with the investors will allow it to renegotiate the terms of the securities in some way.
"We have been in a long-standing discussion with the company for the last few years and believe that processes are in place that will ensure the safety and soundness of the bank," said Vik Ghei, a partner with HoldCo Advisors, which is advising a $10 million holder of 1st Mariner Bancorp trust preferred securities.
HoldCo in a New York firm that specializes in managing the distressed debt issued by troubled financial holding companies.
First Mariner never expected to be in the predicament it is in today when the company originally offered the trust preferred securities, said Edwin F. Hale Sr., the founder of First Mariner who stepped down as CEO and chairman two years ago.
"I truly don't have a clue of what is going to happen," said Hale, adding that First Mariner may be able to work something out with the investors.
Hale remains First Mariner's largest shareholder, although he has sold nearly 116,000 shares since early September for $118,401, according to regulatory filings.
Banking experts say it's unclear what might happen next. Other banks similarly have delayed interest payments for five years, and they, too, are just coming to the end of their deferrals, the experts said.
First Mariner might be able to renegotiate the interest or principal it owes with investors — although such a deal would be difficult, the banking experts said.
Another option is for the banking holding company to file for bankruptcy and then sell the bank, said Ely, the banking consultant.
"The bank doesn't fail; the holding company fails," he said.
First Mariner declined to comment beyond its statement.
A buyer only steps in if the bank has a good business model, Ely added. In the case of 1st Mariner, he said, the bank has relied too heavily on refinancings, and that's a business that's not likely to rebound soon.
Another alternative would be for the company to convince regulators that it has a plan to restore profits and capital, so that regulators allow the bank to pay dividends to First Mariner, which in turn, can make the interest payments, said Cliff Rossi, a finance professor at the University of Maryland, College Park. But, he conceded, that's an unlikely scenario.
"They are definitely in crisis mode," Rossi said.
First Mariner's problems go beyond the pending interest payments, Rossi added, describing the company as "a ship that's been torpedoed multiple times."
"The company has taken a hit during the crisis," he said, "and they have never been able to regain any kind of solid ground."