This morning, Treasury Secretary Paulson, FDIC Chairman Bair and Federal Reserve Chairman Bernanke jointly announced a series of coordinated actions “to protect the U.S. economy, to strengthen public confidence in our financial institutions, and to foster the robust functioning of our credit markets.” This past weekend, the United States and the other G7 nations announced a five-point action plan to “stabilize financial markets and restore the flow of credit to support global economic growth.”
The actions announced today include three main components, each of which is based on extraordinary legal authority of Treasury, the FDIC, and the Federal Reserve:
Treasury Voluntary Capital Purchase Program – Treasury will use its authority under section 101(a) of the Emergency Economic Stabilization Act of 2008 (EESA) to purchase non-voting senior preferred stock in U.S. financial institutions, together with warrants to purchase common stock.
FDIC Temporary Liquidity Guarantee Program – The FDIC will temporarily guarantee newly issued senior debt of FDIC-insured institutions and their holding companies, as well as deposits in non-interest-bearing transaction accounts.
Federal Reserve Commercial Paper Funding Facility – The Federal Reserve has issued additional details about its Commercial Paper Funding Facility, which it announced last Monday.
Treasury also announced that nine major financial institutions (Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman, Morgan Stanley, Bank of New York Mellon and State Street) have already agreed to participate in the capital purchase program and the FDIC’s new guarantee program.
Treasury Voluntary Capital Purchase Program
Under section 3(9)(B) of EESA, Treasury’s authority to purchase “troubled assets” specifically includes “any other financial instrument that the Secretary of the Treasury, after consultation with the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability....” This language is broad enough for Treasury to justify treating capital stock of financial institutions as “troubled assets” if the Secretary concludes that purchases are “necessary to promote financial stability.”
Treasury has issued a public term sheet setting forth the terms on which eligible financial institutions may participate in the capital purchase program. Key components are the following:
- Qualifying financial institutions (QFIs) – generally include any U.S. bank, savings association, bank holding company, and savings and loan holding company that is not controlled by a foreign bank or company.
- Participation – QFIs must elect to participate before 5:00 p.m. EDT on November 14, 2008, and enrollment is through the organization’s primary federal regulator, rather than through the Treasury.
- Subscription Amount – Minimum subscription is 1% of risk-weighted assets; maximum subscription is 3% of risk-weighted assets (or $25 billion, whichever is less). Existing regulatory capital rules may prevent a QFI from issuing the maximum number of shares.
- Security Purchased – Treasury is purchasing perpetual preferred stock, which will be senior to common and junior preferred stock and pari passu with any existing senior preferred stock.
- Dividends – The senior preferred stock will bear dividends of 5% for the first five years and 9% thereafter. So long as the preferred stock is outstanding, the QFI may not pay other dividends or repurchase shares, unless it is current on the payment of dividends on the senior preferred stock. In addition, Treasury’s consent will be required for any increase in common stock dividends and any stock repurchases until the earlier of three years or redemption or transfer of all of the senior preferred stock.
- Voting Rights – The senior preferred stock will be non-voting, except on class-specific matters on which preferred stock typically votes (including the right to elect two directors if dividends are unpaid for six dividend periods).
- Transfer of Shares – Treasury may transfer shares to any third party at any time, and will receive registration rights to facilitate transfers.
- Redemption – Shares are callable at par any time after three years. Shares may also be redeemed during the first three years only with the proceeds of a qualifying equity offering of Tier 1 perpetual preferred or common. Following the redemption in whole of the senior preferred stock held by Treasury, the QFI may repurchase any other equity security of the QFI held by Treasury (including presumably any unexercised warrant) at fair market value.
- Warrants – To comply with EESA requirements that Treasury obtain warrants or other contingent consideration when purchasing troubled assets, Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15% of the senior preferred investment. The warrants will have a ten-year term and a per share exercise price equal to the market price of the QFI’s common stock at the time of issuance (calculated on a 20-trading day trailing average). If the QFI has raised Tier 1 capital at least equal to the full amount of the preferred stock before December 31, 2009, the number of warrants will be cut in half.
- Executive Compensation Limitations – Also consistent with EESA requirements, so long as Treasury is an equity holder, the QFI must comply with Treasury’s announced executive compensation and corporate governance requirements, including amending existing employment agreements and benefit arrangements to comply with those requirements. Separately, today Treasury also issued its executive compensation rules under TARP and the capital purchase program.
FDIC Temporary Liquidity Guarantee Program
Under the FDIC’s new Temporary Liquidity Guarantee Program, for those institutions that choose to participate, the FDIC will guarantee their newly issued senior unsecured debt, including promissory notes, commercial paper, inter-bank funding, and any unsecured portion of secured debt. The amount of debt covered by the guarantee may not exceed 125 percent of debt that was outstanding as of September 30, 2008 that was scheduled to mature before June 30, 2009. Also, to be guaranteed, the debt must be issued on or before June 30, 2009, but in any event the guarantee will expire on June 30, 2012, even if the debt matures at a later date.
In addition, until December 31, 2009, any participating depository institution will be able to provide full deposit insurance coverage for non-interest bearing deposit transaction accounts, regardless of dollar amount, which the FDIC states are mainly payment-processing accounts, such as payroll accounts used by businesses. Participants in the program will be charged a 75-basis point fee for guarantees on debt issuances, and a 10-basis point surcharge will be added to a participating institution's current insurance assessment to cover the non-interest bearing deposit transaction accounts.
All FDIC-insured institutions are automatically covered under the program for the first 30 days without having to pay any fees. Thereafter, however, institutions must either opt out or they be assessed fees for future participation. If an institution opts out, the guarantees will expire after the first 30 days.
Federal Reserve Commercial Paper Funding Facility
Today, the Federal Reserve issued detailed terms and conditions for the program, including information about issuer qualification requirements (generally, domestic issuers rated at least A-1/P-1/F1), purchase limits (not more than the greatest amount of U.S. dollar-denominated commercial paper the issuer had outstanding on any day between January 1 and August 31, 2008) and pricing terms for both unsecured and asset backed commercial paper.
The Federal Reserve also issued a set of responses to frequently asked questions. The registration period will begin on October 20, 2008, and purchases will commence on October 27.