1. The FDIC’s Debt Guarantee Program

On Wednesday, October 29, 2008, the FDIC issued an interim rule with request for comments on its Debt Guarantee Program (“DGP”) which was announced as part of the Temporary Liquidity Guarantee Program (“TLGP”). 73 Federal Register 64179. While most of the discussion has centered around the Capital Purchase Plan (“CPP”), the DGP is a program that offers substantial benefits to banks and savings and loans and their holding companies. The DGP is designed to offer liquidity to eligible institutions by guaranteeing in full their unsecured senior debt issued on or after October 14, 2008 and before June 30, 2009. More importantly, the DGP in effect allows qualifying institutions to indirectly issue Treasury securities. This program has significant advantages over the CPP in that it is automatic (there is no application to be filed and approved) and unlike the TARP, there are no executive compensation restrictions to participants in the DGP. Although the amount of senior unsecured debt is limited, as described below, the FDIC rule contemplates waivers that would allow companies to apply for and receive permission to issue the guaranteed debt in excess of the prescribed limits. The terms of the DGP are summarized below:

Eligible Entities

Only U.S. banks and thrifts or their holding companies are eligible to participate. For savings and loan holding companies, only those that engage in activities permissible for financial holding companies under 12 U.S.C. 1843(k) are eligible (i.e., savings and loan holding companies that engage in certain impermissible real estate activities would not be eligible). All eligible entities are automatically in the program unless they opt out on or before the newly extended deadline of December 5, 2008 (the original deadline was November 12, 2008). Participation in the DGP requires all entities in a holding company group to participate. The advantage is that all senior debt will be included in calculating the prescribed limit but the negative is that the same amount will be used for purposes of calculating the 75 basis points charge described below.

Senior Unsecured Debt

The FDIC will guarantee only the senior unsecured debt of an eligible entity. Senior unsecured debt means unsecured borrowings that are evidenced by a written agreement, has a specified and fixed principal amount to be paid in full on demand or on a date certain, is not contingent and is not subordinate to any other liability. It includes for example, federal funds purchased, promissory notes, commercial paper, certificates of deposit standing to the credit of a bank, bank deposits in an international banking facility of an insured depository institution and Eurodollar deposits standing to the credit of a bank. Senior unsecured debt does not include obligations from guarantees or other contingent liabilities, derivatives, convertible debt, capital notes, the unsecured portion of secured debt, negotiable CDs and loans to affiliates, parents, subsidiaries and institution affiliated parties.

Maximum Limitation

Under the DGP, the FDIC will guarantee Newly Issued Senior Unsecured Debt in an amount up to 125 percent of the par value of the senior unsecured debt outstanding as of September 30, 2008 that was scheduled to mature on or before June 30, 2009. For holding companies, the 125 percent limit is based on the consolidated senior unsecured debt of the holding company group. Newly Issued Senior Unsecured Debt is Senior Unsecured Debt that was issued on or after October 14, 2008 and before December 5, 2008 for eligible entities that opt-out of the DGP or June 30, 2009, for eligible entities that do not opt out of the DGP.

Each institution must report to the FDIC the amount of senior unsecured debt outstanding as of September 30, 2008, even if such amount is zero. The institution will be required to file subsequent reports each time that the institution issues guaranteed senior unsecured debt, which shall be certified by the CFO.

Waivers, Exceptions

The FDIC may grant an exception to the 125 percent limitation or may limit certain institutions to amounts less than the 125 percent amount. In addition, eligible institutions that had no senior unsecured debt as of September 30, 2008 may apply to the FDIC to have some amount of senior unsecured debt guaranteed under the DGP.

Guarantee Period

For those entities that opt out of the DGP, the debt will be guaranteed through December 5, 2008. For those eligible entities that do not opt out of the DGP, the Newly Issued Senior Unsecured Debt will be guaranteed through the earlier of the maturity of the debt or June 30, 2012. Participating entities may issue guaranteed debt with maturities beyond June 30, 2012, however, the guarantee will expire on June 30, 2012.

Opt-Out Deadline, Procedures, Publications

The deadline to opt out of the DGP is 11:59 p.m EST on December 5, 2008. The election to opt-out or affirmatively opt-in is irrevocable for all eligible entities in a holding company group. The FDIC will provide procedures for opting out or opting in using its secure e-business website FDICconnect. The forms for opting in or out will be available beginning November 12, 2008. The FDIC will publish the names of those institutions that have opted out of the DGP. Institutions that have not opted out of the DGP must clearly disclose to lenders whether or not the debt is guaranteed.

Use of Proceeds

The senior unsecured debt guaranteed by the FDIC cannot be used to repay non-FDIC guaranteed debt. In addition, the FDIC will not guarantee debt if the institution previously opted out of the DGP, the FDIC terminated the institution’s participation in the DGP, the amount exceeded the 125 percent limit, the debt was extended to an affiliate or an insider without FDIC prior approval or the debt does not otherwise qualify.

Assessments

No fee will be assessed for participation through December 5, 2008. Eligible entities that do not opt out will be assessed an amount equal to the amount of the guaranteed debt times the term of the debt times an annualized 75 basis points. No reduction of assessments will be granted for the early retirement of the debt. If the amount of the assessment is not sufficient to cover the costs of the program, the FDIC may impose an emergency special assessment on depository institutions. In the event an institution issues debt “guaranteed by the FDIC” in excess of the limit, the assessment rate for all outstanding guaranteed debt shall be increased to 150 basis points.

Payment of Claims

In the event of receivership (in the case of an insured depository institution eligible entity) or the filing of bankruptcy (in the case of a holding company eligible entity), the holder of the debt must file a proof of claim with the FDIC within 90 days. The FDIC will make payment on the principal and contract interest up to the date of receivership/ bankruptcy filing. The FDIC will pay interest at the 90 day T-Bill rate in the event of delay in payment beyond the next business day following the receivership/bankruptcy. Certain creditors and potential investors have raised concerns that the procedure for the payment of claims may result in undue delay in payments by the FDIC, and thereby make the DGP less attractive.

2. Treasury’s Capital Purchase Program

The Treasury Department recently issued additional guidance on the CPP authorized by the Emergency Economic Stabilization Act of 2008 (“EESA”). Of particular note is Treasury’s announcement that it will post an application form and term sheet for eligible privately/closely held, Subchapter S and mutual institutions at a later date and establish a reasonable deadline for such institutions to apply. Previously, the Treasury has encouraged private institutions to apply using the form designed more appropriately for public companies. It looks by this announcement, however, that Treasury is rethinking this approach and will design a new program tailored to private companies. The good news for nonqualified applicants that had been advised to file in anticipation of qualification is that the November deadline has been extended; the bad news is that Treasury has yet to adopt a program which will qualify them.

Regarding publicly held companies, the Treasury issued the documents that will be required to be signed as part of the CPP. The additional documents include:

  • Securities Purchase Agreement: This document describes the terms of the financial institution's agreement to issue senior preferred shares and fulfill other requirements in exchange for Treasury's investment.
  • Form of Letter Agreement: This contractual agreement describes the firm-specific information necessary to implement the securities purchase agreement and represents the financial institution's commitment to the terms of the Securities Purchase Agreement.
  • Certificate of Designations: This document creates the preferred shares.
  • Form of Warrant – Stockholder Approval Not Required: This document describes the terms of the warrants Treasury receives when stockholder approval is not required.
  • Form of Warrant – Stockholder Approval Required: This document describes the terms of the warrants Treasury receives when stockholder approval is required.
  • Term Sheet
  • SEC, FASB Letter on Warrant Accounting

After a financial institution is granted preliminary approval, the institution must complete and submit the securities purchase agreement, letter agreement, certificate of designations and warrant. Financial institutions that are granted preliminary approval will receive a letter from the Treasury Department with instructions regarding filing the documents and completing the process.

Once the investment agreements are complete and the investment is authorized, within two business days Treasury will publicly disclose the name and capital purchase amount for the financial institution. The information will be posted at http://www.treasury.gov/initiatives/eesa/  and updated daily at 4:30 p.m. (EST) as needed.

All publicly traded eligible institutions wishing to participate should submit their applications no later than 5:00 p.m. (EST), November 14, 2008.

The terms of the Securities Purchase Agreement are summarized below:

The Securities Purchase Agreement

The Securities Purchase Agreement (“SPA”) is the primary document in the CPP. The SPA contains the basic terms of the Treasury’s purchase of senior preferred shares. The SPA contains a number of standard representations, warranties and covenants and includes the registration rights and piggyback rights that must be granted by the issuer. In addition, the SPA requires the issuer and certain executive officers to agree to limitations on compensation as required by TARP.

Representations and Warranties

Under the SPA, the Issuer must represent and warrant that:

i.) The Issuer is duly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation and has the authority to issues the shares;

ii.) The preferred shares will rank pari passu with or senior to all other series or classes of preferred stock;

iii.) No approval of any governmental entity is required for the issuance of the shares, other than as may be required under “blue sky laws,” the filing of the certificate of designation with the Secretary of State of the state of incorporation or pursuant to a shareholder vote, if required. NOTE: This representation may present a problem for banks or thrifts that must seek the approval of the primary federal regulator to amend the charter in order to establish or increase the number of preferred or common shares necessary to effect the transaction;

iv.) The issuance of the shares and the Warrant will be exempt from any anti-takeover provision in the Issuer’s charter, including any “moratorium,” “control share,” “fair price” and “interested stockholder” limitations. In addition, the Board of Directors will take such actions necessary to exempt the shares from trigger provisions in any Poison Pill;

v.) The Issuer has not experienced any material adverse effect, as defined in the SPA, and that the financial statements and regulatory reports did not contain a material misstatement or omission;

vi.) The offer and sale of the shares will not be integrated with any other offering of the Issuer;

vii.) Any “risk management instruments,” including all derivative instruments, swaps, caps, floors and option agreements, have been made with counterparties believed to be financially responsible at the time.

Covenants

The SPA requires the Issuer to covenant to the following:

i.) If necessary, the Issuer shall call a special meeting of shareholders as promptly as possible to approve the issuance of shares under the warrant or increase the number of preferred and/or common stock to be issued to the Treasury;

ii.) The Issuer shall reserve sufficient authorized but unissued common shares for exercise of the warrant and shall cause the common shares issued upon exercise of the warrant (the “warrant shares”) to be listed on a national securities exchange;

iii.) Until the Treasury holds an amount of preferred shares equal to less than 10 percent of the original purchase price, the Issuer shall permit the Treasury, its agents, consultants, contractors and advisors, including the primary Federal regulator, to examine the corporate books, make copies thereof and to discuss the affairs of the Issuer with the principal officers, all upon reasonable notice and at reasonable times, and to review all information material to the Treasury’s investment. This covenant shall not require disclosure of any information prohibited by law or that would violate any agreement or that would cause the risk of loss of privilege, provided that the Issuer uses commercially reasonable efforts to provide substitute information. The Treasury shall use its best efforts to keep all such information confidential. NOTE: Participants in the CPP should understand that the confidentiality of information gathered pursuant to this provision of the SPA is not necessarily the same as typically afforded to information transmitted to a bank’s primary federal regulator. For instance, reports of examination are routinely held to be confidential and carry criminal penalties for their disclosure. Under the SPA, however, Treasury is acting as investor, rather than regulator, and in that regard, it is unknown whether the courts would grant the same level of confidentiality to nonpublic information obtained pursuant to the SPA as compared with information obtained in the examination process.

Transfers of Preferred Shares and Warrant Shares

Under the SPA, the Treasury may transfer the preferred shares or the warrant shares, except that the Treasury may not transfer the warrant or exercise the warrant for more than one-half of the warrant shares, until the earlier of the date the Issuer receives gross proceeds from a qualified equity offering equal to at least the purchase price of the preferred shares or December 31, 2009. If, prior to December 31, 2009, the Issuer receives gross proceeds equal to the aggregate liquidation amount of the preferred shares in one or more qualified offerings, then the number of common shares issuable upon exercise of the warrant shall be reduce by 50 percent.

Restrictions on Certain Transactions

An Issuer may not merge, consolidate or sell all or substantially all of its properties or assets to another company unless that company assumes the obligations of the Issuer under the SPA and related documents. NOTE: Companies that acquire a CPP Participant will not have the Target’s CPP funds counted against the Acquirer for purposes of determining whether the company has met the $300 million TARP auction of bad assets limit which triggers executive compensation restrictions.

Registration Rights

No later than 30 days following the issuance of the preferred shares, the Issuer shall prepare and file a shelf registration statement with the SEC covering the preferred shares, the warrant and the warrant shares. The shelf registration statement must continue to be effective until there are no remaining securities held by the Treasury. An Issuer with an effective shelf registration may designate such shelf registration for purposes of the registrable shares. If the Issuer is not qualified to file a shelf registration, then it need not file a resale registration statement until requested by the Treasury. If the Issuer does not qualify for a shelf registration, then in the event it proposes to file a registration statement for an offering, it must offer to include in such registration the preferred shares, the warrant and the warrant shares (“Piggyback Registration Rights”). Treasury and subsequent holders can require the Issuer to register and facilitate the offering of the shares (“Registration Demand Rights”), provided that the expected gross proceeds exceeds: i) 2 percent of the initial aggregate liquidation preference of the preferred shares if such initial aggregate liquidation preference is less than $2.0 billion; and ii) $200 million if the initial aggregate liquidation preference of the preferred shares is more than $2.0 billion. Holders of a majority of the shares may select the lead underwriter, however, if the Issuer has a broker-dealer affiliate, consideration must be given to the qualification of such affiliate as the lead underwriter. In an underwritten offering, the Issuer may not effect any other registration during the period beginning 10 days prior and up to 90 days after the underwritten offering. The Issuer’s officers and directors must agree to customary lock-up agreements for a period of up to 90 days, as requested by the managing underwriter.

Voting of Warrant Shares and Restrictions on Dividends and Repurchases

The Treasury will not vote any common shares issued upon exercise of the warrant. In addition, prior to the earlier of the third anniversary of the issuance of the preferred shares or the date on which the Treasury has transferred all of the preferred shares or the preferred shares have been redeemed, neither the Issuer nor any Subsidiary of the Issuer may declare and pay a dividend or make any distribution on its common stock, other than i) regular quarterly cash dividends in an amount not more than the last quarterly cash dividend per share or ii) dividends payable solely in shares of common stock. Further, an Issuer may not redeem, repurchase or acquire any shares of stock other than redemption and purchases of the preferred shares or redemptions and purchases of common or junior preferred stock: in connection with the administration of an employee benefit plan; by a broker dealer subsidiary of the Issuer solely for the purpose of market stabilization; in connection with an underwritten public offering; or in connection with a shareholder rights plan.

The restrictions on the payment of dividends by a subsidiary of a holding company may create an issue for participants in the CPP. For instance, if the subsidiary is wholly-owned by the issuing holding company, it would seem that Treasury would want the subsidiary to be able to dividend additional funds to the holding company since that is the entity that is the source for the payment of dividends to the Treasury on the preferred shares. If the subsidiary is not wholly-owned, it is unclear how Treasury could enforce this type of restriction. In addition, this type of restriction could present significant problems to Subchapter S companies.

Executive Compensation

Until such time as the Treasury ceases to hold any debt or equity of the Issuer, the Issuer must ensure that its benefit plans comply with the executive compensation requirements of Section 111(b) of EESA, and shall not adopt any new plan that does not comply with that section. In addition, the senior executive officers must deliver to the Treasury a waiver of claims they may have as a result of the Issuer’s compliance with Section 111(b). It should be noted that this provision makes applicable the executive compensation restrictions in the event Treasury holds any debt of a company, even though the CPP does not contemplate the purchase by Treasury of debt. This could be foreshadowing by Treasury of future changes to the TARP. Further, the executive compensation restrictions of EESA continue to be an issue for senior executives that are not inclined to waive contractual rights they may have under benefit plans. This tension between an executive’s contract rights and fiduciary duty will continue to be an issue as companies consider participation in the CPP.