<p><em>&ldquo;There is nothing so permanent as a temporary government program&rdquo; -Milton Friedman</em></p> <p>Dr. Friedman&rsquo;s quote still rings true, perhaps more than ever. To date, hundreds of institutions have been approved to participate in Treasury&rsquo;s TARP Capital Purchase Program (the CPP). Despite commitments and funding involving billions of dollars in CPP funds to date, conditions in the market have continued to increase the need for bank capital since introduction of the CPP in late 2008.</p> <p>With the new administration now in place, for better or for worse, certain of the previous &ldquo;unknowns&rdquo; are being clarified and certain of the &ldquo;strings attached&rdquo; have blossomed into what some recipients may perceive as chains. Ongoing changes to the program, including industry &ldquo;stress testing&rdquo; as a factor in further Treasury capital funding and potential Treasury participation in shares of common stock, have thrown additional unknowns into the mix that will impact markets and public perception of participating institutions.</p> <p>Increased disclosure, reporting and examination requirements for CPP recipients; conflicting restrictions and/or directions on permissible/mandatory use of CPP funds by recipients; dividend restrictions; significant compensation restrictions on recipient executives and employees; retroactive compensation redemption requirements; and a host of other actual and proposed &ldquo;strings&rdquo; have become more clear and must be taken into account by institutions considering applying for, taking down or retaining CPP funding. Acceptance of CPP funding brings with it unprecedented federal government involvement in the business of banking and severely restricts or eliminates many organizational options and tools otherwise available to bank management and boards in running their institutions. In light of the developments surrounding CPP funding it is clear that CPP funding is not the same as public or private equity capital funding, and it should not be analyzed and approached in the same manner.</p> <p>The CPP strings announced to date, the televised Congressional grilling of industry executives and the CPP-related provisions of the federal stimulus package may also be indicative of what to expect going forward as institutions become more subject to public scrutiny and criticism, increased reporting and increased federal control as a result of participation in the CPP program. And with talk of &ldquo;nationalizing&rdquo; banking institutions, particularly those that are CPP participants, query the impact of participation on existing bank shareholders if &ldquo;nationalization&rdquo; is determined to be the outgrowth of that action. Already a number of CPP recipients have publicly announced that they are looking at early-out refinancing and recap opportunities in light of these developments and further unknowns of the program. Additional issues arising from unintended and unforeseen consequences of CPP participation are likely to continue to emerge.</p> <p>Based on what has happened to date, there is a significant likelihood of further Congressional as well as &ldquo;activist&rdquo; (shareholder, community, labor unions, etc.) involvement with participating institutions, increased public and media scrutiny, a sense of &ldquo;public utility&rdquo; status for participating institutions, the prospect of further &ldquo;demonizing&rdquo; of industry participants, boards and executives, and continued uncertainty as to &ldquo;what&rsquo;s next?&rdquo; All of which can make participation in the program far more expensive, from a number of perspectives, than just the stated rate on the preferred shares and warrants. And it makes participation in the program, including pricing, impossible to compare to other traditional forms of bank equity capital.</p> <p>In short, it remains extremely difficult for management and boards of institutions to accurately gauge and predict the consequences of CPP participation on individual participating institutions and the industry as a whole&ndash;and on the shareholders, communities, and other stakeholders of participating institutions.</p> <p>That being said, it may well be that for some institutions access to CPP equity, even with all the known and unknown &ldquo;strings,&rdquo; may be the best (and perhaps only) alternative. With limited practical ability to use CPP funding for lending opportunities given the present market, recipients need to make certain that the intended use of CPP funding is going to be acceptable to the agencies. Traditional capital continues to be hard to come by for banks, and with the uncertainty in the industry it is hard to tell when public and PE capital markets will open up. Nonetheless, it may be that the market will react to the issues induced by CPP and provide other less restrictive capital opportunities. Only time will tell.</p> <p>Political and reputation risk issues also combine to make the true &ldquo;cost&rdquo; of CPP funding difficult to ascertain and difficult to analyze and compare with the cost of other non-governmental equity funding sources.</p> <p><strong>Conclusions</strong></p> <p>Whether participation in CPP equity funding is appropriate remains an issue for each institution to analyze and consider on an independent and objective basis, based upon its own unique current and prospective needs, plans and circumstances. Uncertainty in the market in general, coupled with the special uncertainty that accompanies acceptance of CPP funding by an institution, makes the task of directors in analyzing the impact of participation on the organization and its constituencies a daunting one. Issues pertaining to true direct and indirect cost, off-balance sheet risk, impact on executive retention and recruitment and the general unknowns remain important factors to be considered. For some, the attached &ldquo;strings&rdquo; and &ldquo;unknowns&rdquo; may mitigate in favor of other sources of capital when analyzing the impact on the institution and its constituencies. For some there may be no alternative and for some existing CPP participants, a take-out scenario for ridding themselves of CPP funding now or in the future may be an important strategy.</p> <p>As always, management and boards of institutions must take care to assess the opportunity on the basis of their own specific current and anticipated needs and future plans and to analyze the opportunity in light of what is in and the best interests of their constituencies. And in doing so, they must take care to carefully document their analysis and the decision-making process.</p>