On Monday, October 20, 2008, Secretary of the Treasury Henry Paulson announced additional details on the Capital Purchase Plan (“CPP”) under the TARP. Last week, the Treasury announced the CPP as a $250 billion program designed to invest in preferred stock of financial institutions and U.S. holding companies. (Nine of the largest institutions have already been allocated $125 billion under the CPP.) The Secretary stressed that the CPP is an investment, not an expenditure, and there is no reason to expect that this program will cost taxpayers anything. The CPP features the purchase by the Treasury of senior preferred shares with warrants for common shares. The Secretary further stated that the Treasury expects all participating banks to continue to strengthen their efforts to help struggling homeowners who can afford their homes avoid foreclosure. In today’s announcement, the Secretary stated that the CPP is designed to attract broad participation by healthy institutions. The Treasury has clarified that foreign banks may not participate in the CPP. The purpose of the CPP is to increase confidence in the U.S. banks so that they will deploy, not hoard, their capital through increased lending which will benefit the U.S. economy.
In today’s announcement, the Treasury laid out a streamlined, systematic process for all banks wishing to access this program. The process includes:
- A single application form that qualified and interested publicly-held financial institutions will use to submit to their primary regulator – the Federal Reserve, the FDIC, the OCC or the OTS. This form is available on the regulators’ websites.
- The terms for this program are the same for all institutions that apply before the CPP deadline of 5:00 p.m. (EST) on November 14, 2008. The amount allocated to the CPP equals approximately 3 percent of the riskweighted assets of the industry, and therefore all qualifying banks will be able to participate. The program is not being implemented on a first-comefirst- served basis.
- To apply for the CPP, banks must review the program information on the Treasury website and consult with their primary federal regulator. After this consultation, institutions desiring to access capital should submit an application to that same primary federal regulator.
- Treasury has worked with the regulators to establish streamlined evaluations; meaning all regulators will use a standardized process to review all applications to ensure consistency.
- The application form requires the institution to submit basic information about the institution, the amount of the perpetual preferred stock investment that the financial institution is requesting from Treasury, as well as information regarding the amount of authorized but unissued preferred stock and common stock that the institution currently has available for purchase.
- Once a regulator has reviewed an application, it will send the application along with its recommendation to the Office of Financial Stability (“OFS”) at the Treasury Department.
- Once Treasury receives the application with the regulator's recommendation, the OFS will review it and decide whether or not to make the capital purchase. The Treasury will give considerable weight to the primary federal regulator’s recommendations.
- All transactions will be publicly announced within 48 hours of execution. Treasury will not make public announcement of any applications that are withdrawn or denied, although in the application, applicants must indicate whether any part of the application should be deemed confidential and the basis for that determination under the Freedom of Information Act.
- An institution that has received preliminary approval to participate in the CPP will have 30 days in which to submit final documentation and fulfill any outstanding requirements, such as shareholder or board approvals.
- As previously discussed in our Client Alerts, a participating bank must agree to certain corporate governance and executive compensation requirements. These terms and conditions as well as additional representations and warranties will be described in various agreements which will be prepared by the Treasury and available on Treasury’s website. A summary term sheet is currently available on Treasury’s website and a detailed investment agreement and associated documentation will be posted soon. Each applicant must obtain and review a copy of these agreements and agree to all of the terms and conditions, including representations and warranties, contained in these agreements.
Separately, the regulators have announced that the perpetual senior preferred shares issued under the CPP will qualify as Tier 1 Capital. The Treasury along with the SEC are addressing potential negative capital affects resulting from the issuance of warrants under the CPP. In addition, the Treasury has made clear that institutions that do not meet the CPP qualifications may still be able to participate in other programs offered under TARP. Thus, institutions of less than $1.0 billion in assets and who serve low- to moderate- income areas may be able to participate in other programs offered by the TARP.
Additionally, Treasury is working to resolve legal issues to facilitate the government’s capital infusion in mutually owned, Subchapter S and privately held institutions (about 5,000 institutions). The Treasury also is open to the idea of using the capital to help with the acquisition of weak banks by stronger banks.
The CPP, as well as the larger TARP, is a work in progress and we expect more details on each of these programs on a daily basis. Some of our thoughts on the progress to date include:
- How many institutions are likely to participate? A recent survey suggests little appetite among community bankers for the CPP. However, this attitude may change and banks may reconsider participating in the program as the details become clear and the attempts by Treasury to encourage participation take hold. Indeed, a joint press release issued today by the federal banking agencies are encouraging banks to participate in the CPP and the FDIC’s temporary liquidity guarantee program. Further, we question whether banks that do not participate will be marked with the “reverse scarlet letter”. That is, the Treasury has stated that the CPP is designed for “healthy banks”. Will participation then be the mark of a healthy bank while a non-participating bank will be viewed as not qualifying and therefore not healthy?
- What about banks in danger of failing? Treasury has previously stated its intention to establish a third program designed to address failing banks that are “systemically significant” on a case by case basis. No details have yet been proffered by the Treasury on this third program. Those banks that are not “systemically significant” presumably will be dealt with in the normal supervisory process.
- What will happen to privately held and mutual banks? The Treasury has stated its commitment to include these institutions in the CPP, however, to date, the CPP has been modeled solely for publicly held banks. Treasury acknowledges some work needs to be done in order to include all institutions in the CPP.
- What happens to banks that pass on participating in the CPP and later experience financial problems? A question has arisen as to whether the regulators will be less inclined to provide assistance in the future for banks that passed on the CPP.
- To date, Treasury has not placed limits on the use of proceeds from the sale of the senior preferred shares. Presumably, the proceeds can be used to repurchase trust preferred securities or to repay FHL Bank advances.
- The amendments to IRC 162(m) are more restrictive than initially believed. Under 162(m) prior to the passage of EESA, executive compensation in excess of $1 million was not deductible for tax purposes. Excluded from the $1 million threshold was performance based compensation under plans approved by shareholders. However, under EESA, banks that participate in the TARP may not deduct compensation paid to executives if the W-2 compensation exceeds $500,000, regardless of whether such compensation is made pursuant to a shareholder approved plan, for the period that the bank is in the program. Bank boards of directors are cautioned to carefully consider the full after tax effects of participating in the TARP program.
- Yet to be determined is the extent that Treasury will impose foreclosure forbearance and mortgage modification requirements under Section 103(3) of EESA.