SVB Financial debt investment thesis percolates as bond trading highlights price discrepancy

News Analysis 26 April

SVB Financial debt investment thesis percolates as bond trading highlights price discrepancy

SVB Financial Group continued to reign as one of the most talked about names in distressed this week, with investors eyeing trading opportunities in the embattled debtor's USD 3.3bn unsecured notes. 

As the former parent of failed, tech-focused Silicon Valley Bank hashes it out with the FDIC in court to regain access to USD 2bn in cash, an investment thesis is making rounds in the market, sparking SVB's short-dated bonds to trade more than 10 points higher than its longer-dated debt, said three traders. 

The capital structure is currently split into seven tranches of senior unsecured notes with maturities spanning from 2025 to 2033. The notes are all in the same bankruptcy class, the sources noted. Yet, as of yesterday afternoon, its nearest-term USD 350m 3.5% note due 2025 changed hands at 69, while its USD 500m 1.8% notes due 2031 traded at 57, marking a 12-point price differential, according to MarketAxess. 

"A bunch of hedge funds bought these bonds in the 30s," said one of the traders. "They believe that there is enough value that they can get to par or they think there is a way to financially engineer a higher recovery, or both."

There is an argument floating around that the bonds could be reinstated, the sources said. "The shorter maturity bonds have no different claim on the assets than the longer bonds," the first source added. "There is an expectation of some probability of reinstatement."

Any reinstatement would amount to a rare occurrence in bankruptcy, but there is precedent in the banking world for holding company creditors to achieve large recoveries following spectacular bank failures. Case in point, Washington Mutual exited bankruptcy in 2012 in a reorganization that repaid bondholders at par with interest.

Telecom group Charter Communicationsmeanwhile, successfully executed a “cram-up” reorganization in 2009 that reinstated its debt, but an effort that year by Young Broadcasting to reinstate debt was rejected by the bankruptcy court.

PIMCO, Centerbridge and Davidson Kempner were identified as creditors in Silicon Valley Bank’s parent company ahead of SVB's bankruptcy filing last month. The trio were among holders that formed a group and retained PJT Partners as financial advisor, according to a WSJ report. Appaloosa Management bought bonds and SVB’s preferred shares, according to the FT.

There has been significant trading in SVB bonds in recent weeks, leading to changes in the group of senior unsecured bondholders represented by Davis Polk, Angela Libby, counsel to the group, said during the debtor's second-day hearing today before Judge Martin Glenn of the US Bankruptcy Court for the Southern District of New York.

The USD 2bn impasse

As buyside shops take positions in the debt, the crucial plot point in the beleaguered parent company's recovery story is its dance with the FDIC over USD 2bn in cash that was on deposit at its subsidiary Silicon Valley Bank prior to the failure.

SVB filed for bankruptcy last month, days after banking regulators seized its subsidiary Silicon Valley Bank and appointed the FDIC as receiver. In the interim period between Silicon Valley Bank’s failure and the holding company’s bankruptcy, the FDIC froze the USD 2bn deposit even though the government announced it was guaranteeing all uninsured deposits.

SVB has written to the FDIC to ask for an explanation for the seizure and has yet to hear back, debtor’s counsel Jim Bromley, of Sullivan & Cromwell, said during the hearing. The FDIC is working to prepare a response but there is potential for the receivership and SVB’s claims against each other to be netted, said Derek Baker of Reed Smith, who is counsel for the agency.

Judge Glenn gave the FDIC one week to explain its position under Title 12 of the US Code that governs banking.

"This fight between the FDIC and the bankruptcy court is not a small issue," the first trader said. "The bankruptcy court is used to saying they have jurisdiction over everything, and the FDIC is saying 'we're the government and don’t really care what you say’ . . . Part of the confusion in the market is that this is some sort of easy thing, but it's a huge mess."

In addition to the USD 2bn, the holding company's assets include two operating businesses – SVB Securities and SVB Capital. SVB is exploring options to “maximize value” from its businesses and expects an update in the near term, Bromley said at the hearing.

The FDIC previously asserted in a filing that the agency has “statutory rights” to administer its own administrative claims process as receiver for Silicon Valley Bank and that the bankruptcy court was prohibited from “restraining or affecting” the FDIC’s rights.

FDIC counsel Baker said during today’s hearing that when the FDIC sold Silicon Valley Bridge Bank, it transferred all of its deposits to the buyer, First Citizens, except for SVB’s USD 2bn deposit.

Two attorneys following the case said they did not believe the FDIC could treat SVB’s deposit at the bank differently than other depositors.

Lawrence Kaplan, an attorney for Paul Hastings who specializes in banking law, said that the FDIC has had weeks to explain its actions and has yet to publish the systemic risk order that guaranteed all uninsured deposits or detail the basis for freezing the SVB deposit. “They appear to be hiding their rationale for their unusual actions,” he said.

The FDIC could choose to pursue claims against SVB under a banking doctrine that requires a holding company to serve as a “source of strength” for its underlying bank and support its capital position, attorneys said. The bankruptcy code further provides that any commitment between a bank and its holding company is automatically carried over into a bankruptcy.

The FDIC has had a limited track record making source of strength claims in past cases.

Courts have ruled that the FDIC needs to assert an “enforceable monetary obligation” and cannot make a “nebulous” source of strength argument, said Robin Russell, Deputy Managing Partner of Hunton Andrews Kurth, who served as counsel to the trustee in the long running bankruptcy case of Bank of New England Corp.

When a bank is struggling, regulators often require its bank holding company to sign a formal order committing to providing capital to its bank, said an attorney who has worked with the FDIC in past cases.

Several attorneys said Silicon Valley Bank collapsed so quickly that they doubted regulators had enough time to secure a commitment from SVB.

SVB did not return a request for comment.

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