February 23, 2012
Authored by: Robert Klingler
On February 15, 2012, Broadway Financial Corporation announced that it had reached a definitive agreement with the Treasury Department pursuant to which Treasury will exchange preferred stock in the company for new common stock valued at a discount of 50% to the aggregate liquidation preference of the outstanding shares of preferred stock held by Treasury. As previously noted, while Treasury is unwilling to consider a blanket discount on the repayment of TARP, it remains open to restructuring its investment to facilitate additional capital, so long as it is treated equitably with other investors.
Although exact terms of the agreement are not yet publicly available, the company’s press release indicates that Treasury has agreed to convert its TARP CPP investment in the company into common stock at 50% of its liquidation value and the accrued unpaid interest on such investment at 100% of the accrued amount. The conversion is condition on a number of factors, including: (i) the exchange of the Company’s other preferred stock at the same 50% discount; and (ii) at least $5 million being raised in new common equity.
The company has previously announced that it had an agreement in principal with its senior bank lender to exchange a portion of its senior line of credit, which is in default, for common stock at 100% of the face amount to be exchanged and to forgive the accrued interest on the entire amount of the senior line of credit. In the company’s 3rd Quarter Form 10-Q, the company indicated that these conversions would result in the issuance of approximately 7.5 million new shares of common stock, which in turn would constitute approximately 80% of the pro forma outstanding shares.
The Company has a total of $15 million in TARP CPP funds, and, as of January 31, 2012, had $1.1 million in accrued unpaid dividends on the preferred stock. In addition, the company has approximately $2.5 million in other preferred shares, a $5 million fully-drawn line of credit, and $6 million in trust preferred securities. Before conversion, the company had approximately 1.7 million shares of common stock outstanding, and closed at $1.50 per share on February 15, 2012 (the day the company announced its agreement with Treasury), or approximately 39% of book value. Assuming the company is able to raise capital at that $1.50 price and that the conversion is done at the same price (both of which are significant assumptions) and that half the line of credit is converted to equity, the new shareholders would break-down accordingly:
- Existing Common Shareholders – 1.7 million shares – Approximate Value – $2.6 million – 13% Ownership
- New Investors – 3.3 million shares – Approximate Value – $5.0 million – 25% Ownership
- Treasury – 5.7 million shares – Approximate Value – $8.6 million – 43% Ownership
- Other Preferred Investors – 0.8 million shares – Approximate Value – $1.3 million – 6% Ownership
- Bank Lender – 1.7 million shares – Approximate Value – $2.6 million – 13% Ownership
Based on this analysis, while a 50% discount is significant, it is also clear that the dilution this restructuring will cause for existing common shareholders means that they will also share substantially in the losses the company has experienced, and become significantly limited in their participation in any recovery the company may be able to achieve.
For other institutions looking at requesting comparable exchanges with Treasury, I think it’s also appropriate to look at Broadway Federal Bank’s financial condition. As of year-end, the bank had retained relatively strong capital levels (although as a small bank holding company Broadway was able to downstream all of the cash at the holding company as Tier 1 capital for the bank), with a leverage ratio of 8.23% and a total risk-based ratio of 12.83%. However, the bank had also encountered significant asset quality constraints, with non-performing assets exceeding 15% of the bank’s total assets and a Texas ratio of 124%. In that respect, one of the more surprising aspects of the Treasury’s acceptance of the transaction is that the company need only raise $5 million in additional capital (compared to $35 million in existing Tier 1 capital at the bank level). If the bank only raises $5 million, and asset quality otherwise remains the same, the pro forma Texas Ratio of the bank is likely to only fall to about 108%. (Of course, this assumes that Broadway is able to find new investors that are willing to invest at these levels.)