Last week, “breaking news” heralded a U.S. Treasury Department ruling that insurers are eligible for TARP participation. Characterized by the media and insurance industry sources as a new and positive development, Treasury’s ruling yesterday on AIG merely confirmed the scope of insurer and insurance holding company eligibility under Treasury’s existing framework for participation in the TARP Capital Purchase Program (“CPP”).
TARP Funds for AIG
Yesterday’s joint announcement by Treasury and the Board of Governors of the Federal Reserve System of the restructuring of the government’s financial support of AIG did not otherwise extend TARP’s coverage to the insurance industry. Interim Assistant Secretary of the Treasury for Financial Stability Neel Kashkari stated that the coordinated action regarding AIG was a “one-off event”, and was taken by the Treasury and the Fed due to the systemic importance of AIG. Thus, as has been the case since mid- September, AIG continues to be a category of its own. The announced restructuring is Treasury’s first purchase of troubled assets under the TARP (as opposed to the CPP), although the asset being purchased consists of $40 billion of newly issued preferred shares of AIG. In effect, the Treasury’s purchase of AIG preferred stock is virtually identical to its purchase of preferred shares of banks and bank holding companies in the CPP, although Treasury has been very careful to characterize the AIG action as a troubled asset purchase and not a purchase under CPP. In connection with the Treasury’s investment, the Fed also announced the modification of the terms of the existing credit facility and the establishment of new residential mortgagebacked securities and collateralized debt obligations facilities for AIG.
The terms of the Treasury’s investment in AIG are similar, but not exactly the same, as investments under the CPP. As is the case with CPP investments, Treasury will purchase senior perpetual preferred stock of AIG. The shares will have no voting rights, unless the dividend has not been paid for four periods (regardless of whether the periods are consecutive) and then the Treasury may elect the greater of 2 directors or 20 percent of the number of members on the Board. The proceeds from the sale of the preferred shares will be used to repay the senior secured revolving credit facility between AIG and the Federal Reserve Bank of New York. The dividend will be 10 percent per annum, as opposed to CPP investments which carry a 5 percent coupon for the first five years and 9 percent thereafter. AIG’s senior preferred shares may be redeemed only if the AIG Credit Facility Trust (established as part of the initial assistance provided to AIG) owns less than 30 percent of the aggregate voting power of AIG’s voting securities and no holder of the preferred shares controls AIG. In this regard then, so long as Treasury has the ability to control the AIG Board of Directors, AIG cannot redeem the preferred shares. AIG may not pay dividends on its common shares so long as the preferred shares are outstanding, nor may AIG repurchase or redeem any shares unless all dividends with respect of the preferred shares have been fully paid and then only after the fifth anniversary of the investment, unless the preferred shares have been redeemed or transferred to a third party prior to such fifth anniversary. Treasury’s consent is required for any increase in common dividends per share until the fifth anniversary of the investment, unless prior thereto, the preferred shares have been redeemed or the Treasury has transferred the shares to a third party.
Similar to agreements under the CPP, AIG must comply with the corporate governance requirements of the Emergency Economic Stabilization Act of 2008 (“EESA”) and its senior executives must comply with the limitations on compensation and on golden parachutes. Unlike CPP participants however, the Treasury has added a new restriction in the form of a freeze on the size of the annual bonus pool for AIG’s top 70 executives. The bonus pool paid by AIG in 2008 and 2009 cannot exceed the average of the annual bonus pool paid in 2006 and 2007 (exclusive of AIG’s historic quarterly bonus program). Additionally, AIG must continue to maintain and enforce newly adopted restrictions put in place by the new management on corporate expenses and lobbying as well as corporate governance requirements, including formation of a risk management committee under the board of directors.
AIG also issued a warrant to the Treasury in connection with the Treasury’s purchase of the preferred stock. The warrant is equal to 2 percent of the issued and outstanding common stock of AIG on the date of investment. The initial exercise price is $2.50 per share, the current par value of AIG’s common stock, and shall be adjusted to the par value of the common stock after AIG amends its Certificate of Incorporation as contemplated by the terms of the preferred stock. The warrant has a term of 10 years, is immediately exercisable and transferable and contains standard anti-dilution terms.
Insurance Company Participation in CPP
Our Client Alert of October 29, 2008 advised that CPP participation is already available to insurers and insurance holding companies which are bank-related Qualified Financial Institutions ("QFIs") or affiliates of bank-related QFIs. As you may recall, QFIs are bank or thrift holding companies, banks or thrifts.
As to insurance company affiliates of QFIs, what Treasury has now made clear is not that these are eligible for TARP participation – it was already clear to those following this issue closely – but that the existing CPP framework will not be expanded to include insurance companies that are not QFI affiliates. Therefore, for the moment non-affiliated insurers are foreclosed from TARP participation.
There had been some thought to encourage insurers to organize affiliates that could apply for a bank or a savings and loan status as a jurisdictional basis for CPP participation. Treasury, however, has stepped back from this idea at the moment. It is reported that Treasury is hesitant to extend the CPP program to insurers over which Federal authorities do not currently exercise regulatory authority. Also, Treasury has not yet found an easy solution to how it could participate in and eventually divest itself of equity interests in institutions which are not publicly traded. Those who wish to participate in the CPP program should evaluate this option quickly. The CPP application deadline, November 14, 2008, applies to insurers that are QFI’s or affiliates of QFIs.