The Treasury Department has released the terms for Subchapter S banks and mutual thrift institutions that desire to participate in the Administration’s Small Business Lending Fund (the SBLF) initiative. Under the new rules, Subchapter S and mutual thrifts institutions may issue unsecured subordinated debentures (Senior Securities) to the Treasury in exchange for an investment from the SBLF. The terms and restrictions for Subchapter S and mutual thrifts institutions are comparable to the terms provided for other banks and thrifts, except that the Senior Securities issued by Subchapter S banks and mutual thrifts institutions are only eligible for inclusion in an institution’s Tier 2 capital.

The new rules provide that an institution with $1 billion or less in total assets may issue a total amount of Senior Securities equal to not less than 1 percent and no more than 5 percent of its risk-weighted assets. An institution with more than $1 billion in total assets, but less than $10 billion, may issue a total amount of Senior Securities equal to not less than 1 percent and not more than 3 percent of its risk-weighted assets. An institution that qualifies for an investment from the SBLF in conjunction with a matching private investment must receive from one or more private investors an amount at least equal to the amount sought from the SBLF. For such private investments the SBLF’s investment will not exceed 3 percent of the institution’s risk-weighted assets. Institutions refinancing capital from the Capital Purchase Program (CPP) or Community Development Capital Initiative (CDCI) must redeem any outstanding CPP or CDCI senior securities prior to the SBLF’s investment.

The Treasury will calculate the interest rate payable, by an issuing institution, on the Senior Securities based on the amount of Qualified Small Business Lending the institution conducts. Qualified Small Business Lending includes loans of up to $10 million to businesses with up to $50 million in revenues, and the following types of loans: commercial and industrial loans; owner-occupied nonfarm, nonresidential real estate loans; loans to finance agricultural production and other loans to farmers; and loans secured by farmland.

The Treasury has adjusted the interest rates payable to reflect after-tax effective rates equivalent to the dividend rate paid by other classes of institutions participating in the SBLF through the issuance of preferred stock. The interest rate will be reduced as the participating institution increases its lending to small businesses. The initial interest rate for the first 10 quarters may range from 7.7 percent to 1.5 percent based on the institution’s percentage increase in Qualified Small Business Lending over the baseline. After the first 10 quarters and until the four-and-one-half year mark the interest rates will range from 10.8 percent to 1.5 percent. The rate adjustment based on increasing small business lending will expire at the four-and-one-half year mark and the interest rate payable on all Senior Securities will increase to 13.8 percent, at that point. The interest is payable quarterly in arrears.

Senior Securities issued by Subchapter S corporations will rank senior to common stock, and the Senior Securities issued by mutual thrifts institutions will rank senior to mutual capital certificates. The Senior Securities will mature 10 years from the date of the SBLF’s investment, at which time the institution must repay to the Treasury the principal amount and any accrued and unpaid interest. However, an institution may redeem its Senior Securities at any time, subject to the approval of the appropriate federal banking agency. All redemptions must be made at 100 percent of the issue price, plus any accrued and unpaid interest as of the date of redemption. An institution must redeem its Senior Securities in allotments of at least 25 percent of the originally issued amount.

An institution with outstanding Senior Securities will have the right to pay dividends and repurchase shares as long as its total risk-based capital would be at least 90 percent of the amount existing at the time immediately following the SBLF’s investment. However, when the interest payable on Senior Securities has not been paid for any quarterly interest period no repurchases or dividends may be declared or paid until after the accrued interest has been paid in full. After four quarters of missed interest payments, whether consecutive or not, the board of directors of the institution must certify that it used its best efforts to pay the interest due. After five quarters of missed interest payments the Treasury has the right to appoint a representative to serve as an observer on the institution’s board of directors, and after six missed payments the Treasury may elect up to two directors to the institution’s board of directors.

Institutions on the Federal Deposit Insurance Corporation problem bank list, or that have been removed from the list within the last 90 days are not eligible to participate in the SBLF. In addition, institutions that participated in the CPP or CDCI but missed more than one interest payment due to the Treasury are ineligible. Institutions that participated in the CPP or CDCI and repaid, or applied to repay, the CPP or CDCI must be in compliance with all of the terms of the CPP and CDCI and pay, in immediately available funds, any accrued and unpaid interest.

Applications to participate in the SBLF are due to the Treasury by June 6, 2011. An institution that desires to participate in the SBLF must also submit a small business lending plan to the appropriate federal banking agency and state regulator, if applicable. The Treasury will make its funding decisions on a rolling-basis. For your convenience, a complete overview of the terms and restrictions, forms and instructions for participating in the SBLF is available on the Treasury’s website at http://www.treasury.gov/resource-center/sb-programs/Pages/Overview-for-S-Corporation-Banks-and-Mutual-Institutions.aspx.