Pursuant to the Emergency Economic Stabilization Act of 2008 (the “Act”), the Secretary of the Treasury (“Treasury” or the “Secretary”) has been authorized to establish the Troubled Asset Relief Program (“TARP”) to purchase troubled assets from any financial institution in an amount up to $250 billion outstanding at any one time (subject to increase to $350 billion upon Presidential notification). Pursuant to that general grant of authority, the Secretary has been authorized to take such actions as he deems necessary to carry out the grants of authorities under the Act.
On October 14, 2008, pursuant to this grant of authority, Treasury announced a voluntary Capital Purchase Program (the “Program”) under which Treasury intends to purchase up to $250 billion of senior preferred stock and warrants on standardized terms. The Program is available to qualifying U.S. controlled banks, savings associations, and certain bank savings and loan holding companies engaged only in financial activities that elect to participate and submit an application to their primary federal regulators no later than 5:00 p.m. (EDT) on November 14, 20081. At the same time, Treasury announced that nine major financial institutions2 had “voluntarily” agreed to investments totaling $125 billion under the Program.
Under the published standardized terms and conditions of the Program (the “Terms and Conditions”), the senior preferred stock will have the following terms:
- Qualify as Tier 1 capital.
- Rank pari passu with any existing preferred shares (other than preferred shares, which by their terms rank junior to other existing preferred shares).
- Pay a cumulative dividend3 at a rate of 5% per annum for the first five years and 9% per annum thereafter.
- Callable at par after three years. Prior to such time, the preferred stock may also be redeemed at par with the proceeds of a qualifying equity offering of any Tier 1 perpetual preferred or common stock of not less than 25% of the issue price of the preferred stock.
- Nonvoting (except for class voting rights on (i) authorization or issuance of senior stock, (ii) amendments to the preferred stock and (iii) any merger, exchange or similar transaction that would adversely affect the rights of the preferred stock).
- Treasury has the right to appoint two directors if dividends are not paid in full for six dividend periods (whether or not consecutive).
- Treasury consent required for any increase in per share common stock dividends for three years.
- Treasury consent required for any share repurchases for three years other than in connection with any benefit plan in the ordinary course of business consistent with past practice.
- Transferable by Treasury at any time.
- Institution required to register preferred stock for resale and to grant certain piggyback registration rights.
In connection with the purchase of preferred stock, Treasury will receive warrants to purchase shares of common stock having an aggregate market value equal to 15% of the amount invested in the preferred stock. The warrants will have the following additional terms:
- 10-year term.
- Initial exercise price (and price for determining the number of shares covered by the warrants) will be the market price for the common stock on the date of the investment (calculated on a 20-trading day trailing average).
- If the institution receives aggregate gross proceeds from a qualifying equity investment of not less than 100% of the issue price of the preferred stock on or prior to December 31, 2009, the number of shares covered by the warrants will be reduced by one-half.
- Immediately transferrable, subject to a 50% limitation prior to the earlier of (i) receipt of a qualifying equity investment equal to 100% of the issue price of the preferred stock and (ii) December 31, 2009.
- Treasury will not vote any shares of common stock acquired upon exercise of the warrants.
- Institution required to register the warrants and the underlying common stock for resale and to grant certain piggyback registration rights.
- If institution has insufficient authorized shares or stockholder approval is required under applicable stock exchange rules, institution must call a stockholders meeting as soon as practicable. The initial exercise price decreases by 15% of the initial exercise price on each six-month anniversary of the issue date if stockholder approval has not been received prior to that time, subject to a maximum reduction of 45%.
- If the institution is no longer publicly traded or any required stockholder consent is not received within 18 months after the issue date, the warrants are exchangeable at Treasury’s option for senior term debt or another economic instrument or security to adequately compensate Treasury for the value of the warrant, as determined by Treasury.
A financial institution that participates in the Program must adopt Treasury’s standards for executive compensation and corporate governance for the period during which Treasury holds its equity under the Program. In addition, participating institutions must meet certain standards, including:
- Ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the institution.
- Required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate.
- Prohibition on the institution from making any “golden parachute payment” to a senior executive.
- Agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive.
A participating institution must issue preferred stock in an amount not less than 1% of its risk-weighted assets and not more than the lesser of (i) $25 billion and (ii) 3% of its risk-weighted assets.
On October 20, 2008, the Secretary issued a statement providing additional information about the Program and additional guidelines were published on Treasury’s website. In his remarks, the Secretary indicated that interested institutions should consult with their primary federal regulators about participating in the Program. After that consultation, qualifying institutions should submit a short two-page application to their primary federal regulators (the application is now available on Treasury’s website at http://www.treas.gov/press/releases/reports/applicationguidelines.pdf and will be available on each regulator’s website by the end of the day). The primary federal regulators will evaluate applications pursuant to a “streamlined” and “standardized” process designed to “ensure consistency.” Once the regulator has reviewed an application, it will forward the application to Treasury along with its recommendation. Treasury will review the application and the regulator’s recommendation (which will be accorded “considerable weight”) and then Treasury will decide whether to approve the investment. Upon such approval, the institution will have 30 days to submit completed purchase agreements and related documents. According to the FAQs accompanying Treasury’s new guidance, Treasury will provide preliminary acceptances “as expeditiously as possible.” However, the FAQ indicates that response times may vary from institution to institution.
According to the Secretary’s statement, application approvals will be publicly announced within 48 hours. Conversely, no public announcement will be made of any application that is withdrawn or denied. Institutions that apply for, but do not receive, an investment under the Program are likely to face difficult disclosure issues as analysts and other interested parties are sure to seek to determine whether a particular institution submitted an application and why an application that was submitted was denied.
As of October 20, 2008, Treasury had yet to publicly disclose the criteria that will be used to evaluate applications. Speculation has indicated that Treasury intends to invest only in qualifying institutions that it believes are strong enough to survive the current financial crisis. This speculation seems to be supported by the Secretary’s statement, which indicated that the purpose of the Program is to increase confidence in banks and increase confidence of banks so that they will “deploy, not hoard, their capital.”
The application form published on October 20, 2008 asks the applicant to indicate “any condition... the institution believes it cannot comply with by November 14, 2008 and provide a timeline for reaching compliance.” Treasury’s guidance also gives an applicant 30 days after receipt of approval to submit executed purchase agreements and related documents. Although nearly all institutions should have authorized perpetual preferred stock, some institutions may not. It is unclear whether the inability to immediately issue the preferred stock will disqualify an institution from participating in the Program. The FAQs indicate that an institution “must robustly explain any limitations to executing the final documentation or meeting the required conditions on its application form.” This language could be an indication that Treasury would be open to approving an investment in an institution that does not have currently authorized preferred stock to issue.
Although investments in nine institutions have been announced, none of the investments had been consummated as of October 20, 2008 and Treasury had not made publicly available the agreements and instruments that will actually be used to implement the Program, although Treasury is indicating that the forms will be available “soon.” As a result, we do not know at this time whether the terms summarized above, or other terms, will be included in the final terms of the investment.