The U.S. Department of the Treasury has released three term sheets addressing participation by mutual holding companies (MHCs) in its Capital Purchase Program. Two of the term sheets relate to MHCs that have a subsidiary (mid-tier) holding company, but differ depending upon whether the MHC’s mid-tier holding company is publicly traded or not. A third term sheet has been created for entities that are in the mutual holding company structure but do not have a mid-tier holding company. The deadline for applying under the mutual holding company term sheets is May 7, 2009. Institutions that have previously applied to participate in the program do not need to reapply. Mutual organizations not in the holding company structure are not covered by the new term sheets and this deadline will not apply to those organizations. The terms of the Capital Purchase Program for these institutions are still under consideration by Treasury.
For purposes of the term sheets, “publicly traded” means a company whose securities are traded on a national securities exchange – such as NYSE, AMEX or NASDAQ – and that is required to file periodic reports with either the Securities and Exchange Commission (“SEC”) or its primary federal bank regulator. Companies that file periodic reports but that are quoted on the OTC-Bulletin Board or Pink Sheets are considered not publicly traded and are eligible to participate in the Capital Purchase Program on the terms for non-public companies.
All MHCs that participate in the program must agree to comply with the rules, regulations and guidance of the Treasury Department for executive compensation, transparency, accountability and monitoring.
Terms for MHCs with Mid-Tier Holding Companies
Treasury previously indicated that the investment through the Capital Purchase Program would occur at the MHC level. This presented difficulties in down-streaming the funds to the bank through a mid-tier holding company that had stockholders other than the MHC. The term sheets resolve this problem by having Treasury make the investment at the mid-tier holding company level.
The structure of the investment for public companies – preferred stock with common stock warrants – is substantially identical to the investment in publicly traded bank and savings and loan holding companies. Please click here for our alert describing those terms: Treasury Announces Capital Purchase Program
The structure of the investment for non-public companies – preferred stock with preferred stock warrants – is substantially identical to the investment in non-public bank and savings and loan holding companies. Please click here for our alert describing those terms: Treasury Announces Capital Purchase Program Terms for Non-Public Companies
Terms for MHCs without Mid-Tier Holding Companies
For MHCs without a mid-tier holding company, the security to be issued will be subordinated debentures of the MHC with a maturity of 30 years. The debentures will pay a rate of interest of 7.7% per annum for the first five years (which equates to 5% on an after-tax basis using a 35% tax rate) and will reset to a rate of 13.8% per annum after year five (which equates to 9% on an after-tax basis using a 35% tax rate).
It is expected that, before the date of the Treasury’s investment, Federal bank regulators will adopt a rule to make the debentures eligible for Tier 1 capital treatment. The securities rank senior to mutual capital certificates and other capital instruments and subordinate to senior indebtedness, unless such debt obligations are explicitly made pari passu or subordinated to the debentures.
Other terms include:
Interest on the debentures may be deferred for up to 20 quarters; however, any unpaid interest cumulates and compounds at the interest rate in effect. For so long as the interest deferral is in effect, no dividends may be paid on shares of equity, mutual capital certificates or other capital instruments or other trust preferred securities.
- Interest on the debentures may be deferred for up to 20 quarters; however, any unpaid interest cumulates and compounds at the interest rate in effect. For so long as the interest deferral is in effect, no dividends may be paid on shares of equity, mutual capital certificates or other capital instruments or other trust preferred securities.
- The debentures will be non-voting, other than class voting rights on matters that could adversely affect the debentures and the right to elect two directors if interest is not paid in full for six interest periods.
- Treasury may transfer the debentures to a third party at any time, unless the transfer of the debentures would require the institution to file periodic reports with the SEC. However, if the institution otherwise becomes a public reporting institution, it must file a shelf registration covering the debentures, provided the institution is eligible to use Form S-3.
Warrants. MHCs will provide Treasury a warrant to purchase additional debentures equal to 5% of the investment amount. The exercise price will be $0.01 per note representing a warrant security. According to the term sheet, Treasury intends to exercise the warrant immediately. The debentures issued upon the exercise of the warrant will be identical to the debentures purchased at full price except that the debentures will pay interest at a rate of 13.8% from inception and may not be redeemed until all the debentures purchased at full price have been redeemed. If the participating institution completes one or more qualifying equity offerings (meaning the sale of economic investments or securities qualifying as capital of at least equivalent rank as the debentures) before December 31, 2009 that raise gross proceeds equal to or more than the aggregate purchase price of the debentures, the number of warrant securities will be reduced by 50%.
Dividend and Repurchase Restrictions. MHCs participating in the program will be subject to restrictions on dividends and repurchases. For as long as any debentures are outstanding, no dividends may be paid on any shares of equity, mutual capital certificates, other capital certificates or trust preferred securities unless all accrued and unpaid interest is fully paid. Treasury’s consent will be required for any increase in regularly paid dividends for the first three years. After the third anniversary of the investment date and before the tenth anniversary, Treasury approval is required for any extraordinary dividends on deposit accounts or to increase aggregate dividends per share or certificate more than 3% over the prior year. The dividend restrictions will cease to apply after the subordinated debentures and the warrant securities have been redeemed in whole or Treasury has transferred the securities to third parties.
Treasury’s consent also will be required for any repurchases of equity securities, mutual capital certificates, other capital certificates or trust preferred securities until the tenth anniversary of the investment date, other than repurchases in connection with any benefit plan in the ordinary course of business consistent with past practice or relevant income tax laws, unless before that time the debentures and warrant securities have been redeemed in whole or Treasury has transferred the securities to third parties. After the tenth anniversary of the investment date, the participating institution cannot pay any dividends or repurchase any equity securities, capital certificates, other capital instruments or trust preferred securities until all debentures and warrant securities held by Treasury have been redeemed or Treasury has transferred the securities to third parties.
Important Open Issues Remain
While Treasury has taken important first steps in making this program available to institutions in the MHC form of organization, important issues remain open.
First, Office of Thrift Supervision rules applicable to mutual holding companies provide that if a subsidiary of a mutual holding company issues shares of common stock or preferred stock, it is required to obtain the approval of the Office of Thrift Supervision and to structure the offering in a manner similar to a standard mutual to stock conversion, with stock purchase priorities given to members of the MHC (i.e., depositors of the bank), unless the institution demonstrates to the satisfaction of the OTS that a non-conforming issuance would be more beneficial to the institution. The term sheet does not address those regulatory requirements or indicate whether the OTS intends to grant a blanket waiver to MHCs participating in the Capital Purchase Program.
Second, OTS regulations require that an MHC always hold more than 50% of the outstanding common stock of a subsidiary bank or holding company. In the case of MHCs with publicly traded mid-tier holding companies, the number of shares of common stock to be issued pursuant to the warrant may cause the number of shares of common stock held by persons other than the MHC to exceed 50%, which would be prohibited under applicable OTS regulations. The term sheet does not indicate whether, in such instances, the applicant is prohibited from participating in the Capital Purchase Program or if there is some method by which the number of shares to be issued under the warrant can be reduced and replaced with another instrument providing equivalent value.
Finally, consideration needs to be given as to how an MHC without a subsidiary holding company that owns less 100% of the subsidiary bank would downstream funds into the bank. The bank could issue additional shares of common stock to the MHC, but this would dilute minority stockholders and present issues for upstreaming funds to make interest and principal payments. Alternatively, the MHC could loan the funds to the bank, but this would have to be structured to obtain the desired capital treatment by the bank.