On October 14, 2008, the Treasury announced it was exercising its authority under EESA to expand the definition of troubled assets to include senior preferred shares of a subset of financial institutions. The Treasury will use up to $250 billion of the amount allocated in EESA to purchase these shares at market price. The details of this program follow.
Eligibility and Application. The CPP is available to a subset of financial institutions (a term which, as we explained in previous updates, is broadly defined as any entity not owned by a foreign government) consisting of U.S. banks, savings associations, and bank and savings and loan holding companies that engage exclusively in financial activities. To qualify, an interested institution must consult with its primary federal regulator, then submit an application (available on the Treasury’s website) to that regulator no later than 5:00 PM EST on November 14, 2008. The new Office of Financial Stability will review the application along with the regulator’s recommendation (to which the Treasury will give "considerable weight") and decide whether to make the capital purchase. If the institution cannot obtain necessary internal approvals, such as any required shareholder approval to authorize the senior preferred shares, or otherwise make all of the representations and warranties in form agreements the Treasury soon will publish, the institution may still participate if it "robustly" explains any limitations and fulfills all outstanding requirements within 30 days of receiving preliminary approval.
Confidentiality. The Treasury will announce all transactions within 48 hours of execution, but will not announce any applications that are withdrawn or denied. Beyond that, an institution that needs information in its application to be kept confidential must separate that information from the public portion of the application, label it confidential, and enclose with its application a written request, demonstrating the harm of public availability. An institution’s regulator can pre-advise the institution whether certain information in its application can be kept confidential.
Size of Purchases. The Treasury will purchase senior preferred shares worth between 1 and 3% of an institution’s risk-weighted assets, with a maximum of $25 billion per institution. The senior preferred shares will constitute Tier One capital of the institution.
Dividend rate. The shares issued to the Treasury must pay dividends of 5% for the first five years, then 9% thereafter. Holding companies and their subsidiaries’ dividends are cumulative, meaning that they are not required to be paid annually; banks that are not subsidiaries of holding companies must pay non-cumulative dividends.
Voting. The Treasury’s shares will be non-voting shares, except for voting on matters that would uniquely affect the shares, such as authorization or any issuance of senior shares, any amendment to rights of the senior preferred shares, or any merger, exchange or similar transaction that would adversely affect the rights of the senior preferred shares.
Transferability. The Treasury’s shares will be fully transferable at all times.
Limits on Executive Compensation. EESA’s restrictions on executive compensation, which we have discussed in previous updates, apply to the CPP as well as to the TARP programs originally envisioned by EESA. Therefore, any institution participating in the CPP must maintain "appropriate standards" for executive compensation and corporate governance, including:
- Identifying to the Treasury and eliminating incentive compensation arrangements that encourage senior executives to take unnecessary and excessive risks that threaten the value of the financial institution.
- Providing for recovery of any bonus or incentive paid to senior executives based on materially inaccurate statements of earnings, gains or other criteria.
- Not making golden parachute payments to senior executives during the period in which Treasury holds an equity or debt position acquired under the CPP.
In addition, participating institutions must agree not to take tax deductions for executive compensation exceeding $500,000, even if the institutions would not be subject to the Tax Code provisions (e.g., Section 162(m)(5)) limiting that deduction absent their participation in the CPP.
These regulations apply to all entities in an institution’s "controlled group," not just the participating institution. However, where an institution that has participated in the CPP acquires or is acquired by a non-participating institution, the non-participating institution will not be subject to these restrictions.
Redemption and Repurchase by Institution. After three years, participating institutions can "call" the Treasury’s shares at their issue price, plus accrued and unpaid dividends. Before three years have passed, institutions can only repurchase the shares using the proceeds of an offering of other shares which yields at least 25% of the preferred shares’ issue price.
Restrictions on Transactions in Other Shares. Participating institutions can pay dividends on preferred shares that have a seniority equal to that of the Treasury’s shares, on a pro rata basis with the Treasury’s shares. Otherwise, during the first three years of the Treasury’s investment, the Treasury’s consent is required for any increase in common dividends per share on or repurchase of non-Treasury shares. In addition, participating institutions cannot declare a dividend on or repurchase or redeem non-Treasury shares unless the institutions have paid all accrued, unpaid dividends (in the case of non-cumulative shares, the full dividend for the latest completed dividend period). However, participating institutions can repurchase junior preferred shares or common shares in connection with a benefit plan in the ordinary course of business and consistent with past practice.
Warrants. In addition to preferred shares, the Treasury must also receive warrants to purchase common stock, in an amount equal to 15% of the Treasury’s investment in senior preferred shares.
- The exercise price of the warrants will be the market price of the common stock at the time the preferred shares were issued, calculated according to a 20-day trailing average.
- As an incentive to participating institutions to raise private capital, the number of shares the Treasury can buy using warrants will be reduced by half if the institution receives the full purchase price of the preferred shares from an offering of other shares by December 31, 2009.
- The warrants will be immediately exercisable and have a 10-year term.
- They will be fully transferable, except that the Treasury may transfer no more than half of its warrants pertaining to a particular institution before December 31, 2009, or earlier if the institution has received the full purchase price of the preferred shares from an offering of other stock.
- The warrants must prohibit the Treasury from voting.
- The CPP’s terms include remedies for the Treasury if the warrants cannot be filled when exercised.