Last night the U.S. Treasury released the TARP Capital Purchase Program Preferred Securities Term Sheet applicable to non-publicly traded Qualifying Financial Institutions (other than S-corporations and mutual organizations) as well as the related Private Bank Program Q&A. The deadline for applications to the private Capital Purchase Program is December 8, 2008. According to the Q&A, the program for S-corporations and mutual organizations is “still under consideration.”

In many respects, the private company term sheet is similar to the previously disseminated public company term sheet, but there are important differences. The key points in the term sheet and Q&A are as follows:

  • Definition of a “Qualifying Financial Institution” (QFI) parallels the definition in the public company term sheet, but covers institutions that are not “publicly traded” – a “publicly traded” QFI is (consistent with prior Treasury guidance) “a company (1) whose securities are traded on a national securities exchange and (2) required to file, under the federal securities laws, periodic reports such as the annual (Form 10-K) and quarterly (Form 10-Q) reports with either the Securities and Exchange Commission or its primary federal bank regulator.” Note that this definition encompasses both non-reporting companies (classic private companies) and reporting companies whose shares are not traded on a national securities exchange (i.e., reporting companies whose shares are not traded or only trade through the pink sheets).
  • The amount of Treasury’s preferred stock investment, the preferred stock’s liquidation preference, ranking, Tier 1 capital treatment, voting, and dividend terms, and the required limitations on executive compensation are all consistent with the publicly traded QFI term sheet.
  • Like publicly traded QFIs, for the first three years, a non-publicly traded QFI is prohibited from increasing dividends paid on its common stock or other parity or junior stock. Unlike publicly traded QFIs, from year four until year ten, a non-publicly traded QFI may increase common stock dividends up to 3% per year, but must obtain Treasury approval to increase more than 3%. Limitations on stock repurchases by non-publicly traded QFIs also extend through year ten and also apply to repurchases of trust preferred securities. Unlike publicly traded QFIs, from and after year ten, a non-publicly traded QFI cannot pay dividends on parity or junior stock or repurchase any equity securities or trust preferred securities until all equity securities held by Treasury are redeemed in whole or Treasury has transferred all of its equity securities to third parties. This provides a strong incentive to redeem Treasury’s preferred before the end of year ten.
  • The preferred stock issuable to Treasury will not be subject to any contractual restrictions on transfer or the restrictions of any stockholders’ agreement or similar arrangement that may be in effect among the QFI and its stockholders at the time of Treasury’s preferred stock investment or thereafter; provided that Treasury and its transferees agree not to effect any transfer of the preferred stock which would require the QFI to become subject to the periodic reporting requirements of Section 13 or 15(d) of the Exchange Act.
  • If the QFI otherwise becomes subject to public company reporting requirements, it will file and cause to be declared effective a shelf registration statement covering the preferred stock issued to Treasury. In addition, Treasury and its transferees will have piggyback registration rights and the QFI will further agree to take all steps that may be reasonably requested to facilitate the transfer of the preferred stock.
  • Private company QFIs will be subjected to limitations on related-party transactions akin to those typically applicable to public companies in that, so long as Treasury holds any equity securities of the QFI, the QFI and its subsidiaries will not enter into any transactions with related persons (within the meaning of Item 404 under the SEC’s Regulation S-K) unless (i) such transactions are on terms no less favorable to the QFI and its subsidiaries than could be obtained from an unaffiliated third party, and (ii) have been approved by the audit committee or comparable body of independent directors.
  • The warrant for non-publicly traded QFIs is very different from the warrant issued by publicly traded QFIs. In the publicly traded structure, Treasury receives a warrant to purchase shares of common stock having an aggregate market price equal to 15% of Treasury’s preferred stock investment, at a per share exercise price equal to the 20-day average closing price of the QFI’s common stock. In the non-publicly traded structure, the QFI will issue a warrant to purchase (for a nominal purchase price) additional shares of preferred stock having an aggregate liquidation preference equal to 5% of Treasury’s initial preferred stock investment. The warrant preferred stock will be identical to the preferred stock initially issued to Treasury, except the dividend will be 9% from the date of issuance and the shares may not be redeemed until the initial preferred stock is redeemed in full (i.e., the 9% warrant preferred stock is the last tranche of preferred stock that the company can redeem). Although the warrant has a ten-year term, Treasury has indicated its intent to immediately exercise the warrant. This non-publicly traded QFI warrant structure does not offer the same potential appreciation as the publicly traded QFI warrant, but it does lock in an additional return for Treasury on its investment. Unlike the warrants issued by publicly traded QFIs, there is no opportunity for non-publicly traded QFIs to reduce the size of the warrant by raising new equity prior to the end of 2009.
  • The Treasury Department has indicated in its Q&A that it will not require a warrant to purchase additional preferred stock in the limited context of preferred issuances of $50 million or less by certified Community Development Financial Institutions.