1. New Treasury Capital Purchase Program Offers Capital to U.S. Banks and Thrifts, With Strings Attached; Enrollment Action Needed By November 14
Following the lead of several European central banks, the U.S. Treasury announced on October 14 a capital purchase program (the "Program") pursuant to which it will purchase up to $250 billion of preferred stock to be issued by U.S. banks, savings associations and their holding companies. However, prompt action must be taken in order to participate. Qualifying financial institutions that wish to participate in the Program must elect to do so by 5:00 pm EDT on November 14, 2008. Treasury will determine eligibility and capital allocations for interested applicants in consultation with the appropriate federal banking agency.
Foreign-Controlled Institutions Not Eligible. Significantly, U.S. banks and U.S. bank holding companies that are controlled by a foreign bank or bank holding company are NOT eligible to participate in the Program. Additionally, bank holding companies and savings and loan holding companies will not be eligible if they engage in non-financial activities (that is, activities other than those permitted for financial holding companies under Section 4(k) of the Bank Holding Company Act).
Basic Terms For Capital Purchase
Treasury's Program is outlined in a term sheet, available here. The minimum amount of preferred stock that may be issued by a participating financial institution under the Plan will be one percent (1%) of such institution's risk-weighted assets. The maximum amount of preferred stock that may be issued by a participating financial institution under the Plan will be the lesser of $25 billion or three percent (3%) of such institution's risk-weighted assets. The issuance of (and payment for) such preferred stock would occur by year-end 2008.
The most significant terms of the securities to be issued under the Program are:
- Type: Senior Perpetual Preferred Stock, qualifying as Tier 1 capital ("Preferred Stock").
- Priority: Senior to common stock and pari passu with existing senior preferred stock.
- Dividends: Cumulative dividend of five percent (5%) per annum for the first five years and nine percent (9%) per annum thereafter (non-cumulative for banks that are not subsidiaries of bank holding companies), payable quarterly.
- Voting: Non-voting, other than certain, limited class voting rights.
- Call Feature: Callable at par after three years, subject to regulatory approval. Prior to three years, the Preferred Stock may be redeemed with the cash proceeds of the issuance of common stock or Tier 1 qualifying perpetual preferred stock.
- Transfer: Treasury may transfer the Preferred Stock to a third party at any time.
- Warrants: Along with the Preferred Stock, Treasury will receive 10-year warrants to purchase common stock equal to 15 percent of the amount of its investment in Preferred Stock. The exercise price on the warrants will be the market price of the institution's common stock at the time of issuance, calculated on a 20-trading day trailing average.
General Reaction – Positive but Watch for the Strings Attached
Many eligible financial institutions will find Treasury's Program very attractive, particularly under current market conditions in which the cost of private capital (if available at all) is quite high. However, the Program has significant conditions that institutions should examine with care in deciding whether to apply to participate in the Program.
Executive Compensation Limitations Are Very Restrictive. During the time period Treasury holds any securities of a financial institution under the Program, the financial institution must comply with the following compensation rules with regard to the five most highly compensated executive officers of the institution: (1) their incentive compensation must not "encourage unnecessary and excessive risks that threaten the value of the financial institution"; (2) any of their bonus or incentive compensation based on materially inaccurate financial statements or other performance metrics are subject to "clawback" (and misconduct is not a requirement for clawback to occur); (3) they cannot receive any golden parachute payments within the meaning of the new Internal Revenue Code provision that expands the traditional definition of change of control payments to include payments made upon involuntary termination, bankruptcy filing, insolvency, or receivership; and (4) no compensation in excess of $500,000 (including performance-based and deferred compensation) for each senior executive may be deducted for tax purposes. In advance of selling the Preferred Stock to Treasury, the participating financial institution and its executive officers will be required to modify or terminate all benefit plans, arrangements and agreements to the extent inconsistent with the restrictions provided above and to waive potential claims against Treasury regarding such amendments, terminations or restrictions. Treasury has issued interim executive compensation rules to guide financial institutions participating in the Program.
Restrictions on Increase of Common Stock Dividends/Stock Repurchases. The Program requires that Treasury approve any increases in dividends on the institution's common stock during the first three years of the Preferred Stock investment. In addition, within three years of issuance of the Preferred Stock, any share repurchases (except in connection with benefit plans in the ordinary course in accordance with prior practice) require Treasury's consent.
Dilutive Effect of the Warrants; Potential Transfers to Third Parties. Any institution that participates in the Program also will be required to issue warrants in favor of Treasury having an exercise price based on the market value of the issuer's common stock (without premium) on the date of issuance, calculated on a 20-trading day trailing average. Institutions with thinly traded common stock might bear an additional risk, since the market price of such common stock may be less reflective of actual or fair market value than for more actively traded institutions. Even institutions with actively traded common stock may experience significant dilution since the 20-trading day trailing average will likely reflect the depressed price of financial institutions' stock with no premium to limit exercise of the warrants when the market recovers. Treasury has indicated that the warrants will contain customary anti-dilution provisions, and may be transferred without contractual restrictions. As such, transferees may be permitted to exercise voting rights with respect to common shares they acquire pursuant to the warrants. Note that Treasury's Program is structured to encourage early redemption of the Preferred Stock out of the proceeds of an issuance of common stock or Tier 1 qualifying perpetual preferred stock because the Preferred Stock can be redeemed in such an offering and after such offering/redemption the warrants may be repurchased at fair market value.
Requirements for Shelf Registration and Exchange Listing of Warrants Might Leave Out Some Institutions. The Program requires an institution to file a shelf registration for the Preferred Stock and the warrants "as promptly as practicable after the investment" and to grant Treasury piggyback registration rights. Further, if Treasury requests, the institution must use reasonable efforts to list the Preferred Stock and the warrants on a national securities exchange. Some community banks and/or privately held financial institutions may find these requirements difficult or even impossible to satisfy.
Potential Restrictions on Use of Capital Purchase Proceeds. Treasury's Term Sheet does not dictate how the proceeds of the Preferred Stock offering may be used; however, it is anticipated that pressure may be applied to ensure that proceeds are used to fund loans. Some analysts believe the use of proceeds will not be dictated in the end, since Treasury may want recipients of the capital to use certain proceeds to acquire weaker institutions and shore up the banking system in the process.
Each Institution Needing Capital Should Consider Participation
For institutions that were struggling to raise capital, Treasury's Program might present an opportunity to benefit from the government's stabilization efforts. In spite of the strings attached to the Treasury investment, the boards of financial institutions might find the Treasury's offer compelling, even as potential bridge financing pending a turnaround in the capital markets. At the very least, each institution needs to promptly consider whether to participate in this Program, before the November 14 deadline.
2. Other Stabilization Measures From the Federal Reserve and FDIC, to Guarantee New Bank Debt and to Strengthen Commercial Paper and Deposit Insurance
In addition to the Treasury's Program outlined above, the U.S. Government concurrently announced three significant related stabilization actions pursuant to the Secretary of the Treasury's historic invocation of the "systemic risk" power in the FDIC Improvement Act of 1991 and under the "exigent circumstances" clause of the Federal Reserve Act.
Guarantee New Bank Debt. First, the FDIC has been authorized to guarantee new senior unsecured debt issued by "Eligible Entities" (basically U.S. banks and bank holding companies not engaged in non-financial activities). To qualify for this new guarantee the debt must be newly-issued between October 14, 2008 and June 30, 2009. This guarantee would extend to promissory notes, commercial paper, and other forms of inter-bank funding, as well as any unsecured portion of secured debt. Guaranteed debt is also limited to 125% of an Eligible Entity's total debt outstanding as of September 30, 2008 and scheduled to mature before June 30, 2009. The guarantee of eligible debt issued on or before June 30, 2009 expires in June of 2012, even if the debt matures thereafter. A fee of 75 basis points of the newly-issued debt would apply. The fee is waived for the first 30 days of the program, and, prior to the end of this period, banks must inform the FDIC if they elect to opt out of this guarantee program.
Increased Deposit Insurance for Non-Interest Bearing Accounts. Second, the FDIC will, at the option of an FDIC-insured bank, guarantee customer funds in non-interest-bearing transaction accounts held in FDIC-insured banks until December 31, 2009. A 10 basis point surcharge fee, as to deposits not otherwise covered by the new deposit insurance limit of $250,000, would be added to each bank's FDIC premium for participating in this program. It is believed that corporate payroll and other expense payment accounts will benefit from this guarantee. As with the debt guarantee program, the surcharge fee is waived for the first 30 days of the program, and, prior to the end of this period, banks must inform the FDIC if they elect to opt out of this deposit guarantee program. The FDIC's release did not mention whether depositors would have to be notified of the bank's opting out of the deposit guarantee program.
Funding Backstop for Commercial Paper. Third, the Federal Reserve provided the operative details of the Commercial Paper Funding Facility ("CPFF") that the Federal Reserve Board of Governors had authorized on October 7, 2008. The CPFF will provide a credit facility to a special purpose vehicle (SPV) which will serve as a funding backstop to facilitate the issuance of unsecured and asset-backed term commercial paper by eligible issuers. The Federal Reserve Bank of New York will commit to lend to the SPV on a recourse basis, and those loans will be secured by all the assets of the SPV. The SPV will purchase from eligible issuers three-month U.S. dollar-dominated commercial paper through the New York Fed's primary dealers. Eligible issuers include U.S. issuers of commercial paper, including U.S. issuers with a foreign parent company. The SPV will only purchase U.S. dollar-dominated commercial paper (including asset-backed commercial paper (ABCP)) that is rated at least A-1/P-1/F1 by two or more major rating agencies. User limits apply, and pricing will be based on the then-current 3-month overnight index swap (OIS) rate plus fixed spreads. Registration opens on October 20, 2008, funding is currently scheduled to begin on October 27, 2008, and unless extended the program would end on April 30, 2009.