Description

BVS – Bay View Capital Trust I Preferreds - $29.07

Bay View Capital Corporation is the holding company for Bay View Bank, a San Francisco bay area commercial bank with 57 branches. At June 30, 2002, Bay View had $3.75 billion of assets. The common stock of Bay View Capital Corporation trades on the NYSE under the symbol “BVC”. The Bay View Capital Trust I Preferred stock trades on the NYSE under the ticker symbol “BVS”. It is the Trust Preferred stock (“BVS”) that is the subject of this recommendation. First I will give background of the Company’s situation bringing the reader up to date, then I will discuss the liquidation of the Company. Finally, I will discuss why the 9.76% Trust Preferred shares of 12/31/28 are so compelling.

BACKGROUND OF BAY VIEW
Pre-1996, Bay View Bank was primarily a mortgage provider, funding itself from retail CDs. From 1996 to 1999 Bay View transformed itself into a commercial bank, replacing most of its mortgage loans with consumer and commercial loans and leases. In 1996 the Company also formed an auto lending division to provide financing options through auto dealers nationwide. In January 1998, Bay View acquired 36 banking branches to become the largest deposit franchise operating exclusively in the San Francisco Bay Area.

In November 1999, Bay View acquired Franchise Mortgage Acceptance Company, or FMAC. Franchise lending hit a wall in 2000, and the Company recorded losses per share of $6.47 and $2.55 in the third and fourth quarters of 2000, respectively. In September 2000, the Company decided that an immediate shutdown of franchise loan production was the best course of action for the Company. In 2001 Bay View sold what was left of this business.

Because of these losses and the resulting declines in its capital ratios, Bay View entered into a written agreement with the Office of the Comptroller of the Currency (the OCC), and entered into a written agreement with the Federal Reserve Bank of San Francisco, both in September of 2000.

In March 2001 the Company changed management and brought in Robert Goldstein from the Jefferson Division of Hudson United Bank to lead the Company out of its troubles. Goldstein is a highly respected manager who had a good track record turning around ailing banks. Prior to Jefferson, Goldstein ran Regent Bancshares Corp. of Philadelphia, which he recapitalized after tripling its book value prior to merging it with Jefferson.

In May 2001 the Company completed a rights offering at $4.59 per share, raising $137.5 million. The Company shifted its strategy to focus on multi-family and commercial real estate lending, consumer auto and home equity lending and commercial business financing.

Goldstein continued to sell off loans and business that were not central to the new strategy and hired CSFB to try to find a buyer for the whole Company.

THE LIQUIDATION
Finally, on July 22, 2002, Bay View announced its liquidation and two significant transactions towards that end. First, it announced that it signed a definitive agreement to sell the 57-retail banking branches of Bay View Bank to U.S. Bank, a subsidiary of US Bancorp (NYSE: USB) for a whopping 14.3% deposit premium. As part of the deal, USB will assume deposit liabilities of $3.03 billion and will pay Bay View a premium of $429 million. Additionally, USB will purchase Bay View’s single family, home equity and business loan portfolios totalling $376 million and approximately $9 million of property at book value.

Secondly, Bay View announced a definitive agreement to sell a portfolio of approximately $1 billion of multifamily and commercial real estate loans to Washington Mutual (NYSE: WM) at a slight premium to book value. $911 million of these loan sales were completed on August 7 and the balance should close by the end of August.

On August 7, Bay View filed with the SEC a preliminary draft proxy for shareholders to vote on the Company’s dissolution and liquidation. In a recent conference call, the Management indicated that selling loans to one buyer and deposits to another buyer (and subsequent liquidation of remaining assets) produced more value for shareholders than a sale of the whole Company to one buyer. On August 20, Bay View file with the SEC a preliminary draft proxy for a meeting of the Trust Preferred holders.

For the common shareholder, the transactions, including the sale of the Bank’s deposits for a sizeable gain will allow Bay View to realize most of its deferred tax assets, resulting in no taxes being paid on the gain. The pro forma effect will be to convert intangible goodwill to a tangible asset and increase tangible equity from $3.60 per share at June 30, 2002 to pro forma assets in liquidation at June 30, 2002 of $7.00 per share.

The transactions and liquidation is conditioned on approval from the OCC and the Federal Reserve Bank as well as approval from shareholders. There are no state approvals necessary. The Company anticipates that substantially all liquidating distributions will be made to stockholders during 2003. While the Company has not said specifically what the proceeds to shareholders will be, they have said that the best guess is in the $7.00 to $.25 range.

The liquidation requires the prior repayment of outstanding debt, which consists of $50 million of 10% Subordinated Notes at the Bank and $99.7 million of 9 1/8 Subordinated Notes at the holding company level. At the closing of the USB transaction, Bay View will provide for the redemption of the 9 1/8 Subordinated Notes at 104.563%. The Bank will redeem its $50 million of 10% Subordinated Notes following the closing of the USB transaction, but no later than the end of Q1 2003.

As stated earlier, the remaining loan sales to Washington Mutual should close by the end of August 2002. The shareholder vote to approve the dissolution should occur in early October. FRB and OCC approval to conclude the USB transaction should occur in late September/early October, which the actual closing of that transaction in October. It should be noted that the regulators should be eager to see the deposits get transferred from a weak institution to a strong institution such as USB. Indeed, on an August 14, 2002 conference call, management indicated that “in general, regulators appear pleased with the progress we’ve made. No resistance from any of our regulators as to the plan. They’ve seen the proxy and they understand the various sales we’ve made public, and we’ve had no negatives whatsoever.”

THE TRUST PREFERRED STOCK
The trust preferred has a $25 liquidation value and a 9.76% distribution rate, or $.61 per quarter. There are 3.6 million shares outstanding, for a total liquidation value of $90 million. The common equity value of BVC totals $3.60 million with the common trading at $5.75. Over the past three months, average daily volume was just under 9,200 shares. Bay View can defer at most 20 quarters of distributions. The distribution payable on June 30, 2002 was the eighth deferred distribution in a row. Unlike the common stock, which faces uncertainty as to the timing and amount of distributions under the liquidation, the payout on the preferred is ascertainable, and the timing is clear.

Unpaid distributions on the preferred compound quarterly at the annual 9.76% face rate. The last distribution was made on June 30, 2000. Taking the compounding into account, at June 30, 2002, the cumulative, unpaid compounded distributions total $5.32, and at September 30, 2002 they grow to $6.06.

The BVS draft proxy filed on August 20 and Bay View management have indicated that Bay View’s intention is to get shareholder and trust preferred holder approval (probably in late September/early October), and to get FRB and OTS approval (probably in early October), and to then pay accrued unpaid distributions to the trust preferred holders in the late October timeframe. So I assume we get $6.06 of distributions on October 31. The sources and uses are outlined in both the BVC and BVS proxies, so I won’t regurgitate that here.

Bay view will then seek, early in the first quarter of 2003, to redeem (at the holders option, i.e., not mandatory but voluntary) the trust preferred shares at a price of $25, plus accrued and unpaid distributions. At this point in time, there would be only one quarter of unpaid distribution, or $.61. Calls for redemption would require a minimum notice of 30 days and a maximum notice of 60 days. I use a Feb 15, 2003 date for receipt of the final payment of $25.61. So buying the trust preferred today at $29.07, getting a $6.06 distribution on October 15, 2002 and getting a final payment of $25.61 on February 15, 2003 produces a total profit of $2.60, for a gross profit of nearly 9% in six months, and an IRR of 23%. All with the risk characteristics of a bank merger. Those of you who know the risk arb game know that arbs play bank mergers for 4-5% annualised rates of return. The return on this trade is much higher, and I would argue that the risk/reward is better.

Note that to the extent holders do not choose to redeem their trust preferred shares, Bay View will provide payment to the trustees of the trust preferreds to provide for distributions and redemption at 12/31/03 (the earliest mandatory date under the indenture), in effect, defeasing the trust preferreds. For those holders who prefer hang onto the paper until the latest possible date, this scenario may prove more attractive. While the IRR would be lower in this scenario, the total dollar of profit would be higher.

Catalyst

Pending sale of loan portfolio to WM and USB, sale of entire branch network to USB, liquidation of remaining assets, planned optional redemption of BVS – Bay View Trust Preferred Shares.