U.S. Treasury Troubled Asset Relief Program: Recent Developments
On Oct. 14, 2008, the United States Department of Treasury announced the Troubled Asset Relief Program, or TARP Program, which is one of several recent government initiatives to improve the strength of financial institutions and enhance market liquidity. We summarized the highlights of the program in an advisory bulletin in October. On Nov. 17, 2008, the Treasury released the term sheet and frequently asked questions for certain privately held financial institutions applying for the TARP Program.1 This bulletin will briefly summarize the recent developments with respect to the TARP Program.
Non-Public Qualifying Financial Institutions
On Nov. 17, 2008, the Treasury released the term sheet and frequently asked questions for certain privately held financial institutions applying for the TARP Program. The term sheet is generally available to the following “Non-Public Qualified Financial Institutions”: (i) any top-tier bank holding company (“BHC”) or top-tier savings and loan holding company (“SLHC”) that engages solely or predominantly in activities permissible for financial holding companies under relevant law, that in either case is not publicly traded; (ii) any U.S. bank or U.S. savings association in a stock form that is neither publicly traded nor controlled by a BHC or SLHC; and (iii) any U.S. bank or U.S. savings association that is not publicly traded and is controlled by an SLHC that is not publicly traded, other than S Corporations and Mutual Depository Institutions. Such institutions will be qualified to participate only if they elect to participate on or before Dec. 8, 2008. The Treasury will then determine the eligibility and allocation for Qualified Financial Institutions after consultation with the appropriate federal banking agency.
In addition, institutions that have filed a bank or thrift holding company application on or before Dec. 8, 2008, may apply to the TARP Program through their federal banking regulator on a conditional basis by the applicable deadline. In order to qualify for the TARP Program, final approval of the application must be granted by Jan. 15, 2009. Funding will not be provided prior to consummation of the transaction for which bank or thrift holding company status was necessary. In addition, any bank or thrift holding company that receives funds under the TARP Program must maintain its status as a bank or thrift holding company for as long as the Treasury holds Senior Preferred stock or warrants in the company.
The Treasury has also made it clear that the term sheet and deadline for non-public institutions do not apply to S-Corporations and mutuals, as these structures are still under consideration.
Corporate Governance Requirements for Non-Public Qualifying Financial Institutions
Non-public institutions participating in the TARP Program will be required to adopt the Treasury's standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP Program. These standards generally apply to the chief executive officer, chief financial officer, and the next three most highly compensated executive officers. Non-Public Qualifying Institutions must meet certain standards, including: (i) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (ii) requiring claw back of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (iii) prohibiting on the financial institution from making any golden parachute payment to a senior executive based on the Internal Revenue Code provision; and (iv) agreeing not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. Treasury has issued interim final rules for these executive compensation standards.
For as long as the Treasury holds any equity securities of the Non-Public Qualifying Institution, such institution and its subsidiaries may not enter transactions with related persons2 unless such transactions (i) are on terms no less favorable to the Non-Public Qualifying Institution and its subsidiaries than could be obtained from an unaffiliated third party; and (ii) have been approved by the audit committee or comparable body of independent directors of such Non-Public Qualifying Institution.
Terms of the Senior Preferred stock
The terms of the Senior Preferred stock will be substantially the same as the Senior Preferred stock issued by publicly traded institutions that participate in the TARP Program. In addition to the terms detailed in our previous release, the new term sheet adds that the Senior Preferred stock issued by non-public institutions will not be subject to any contractual restrictions on transfer or the restrictions of any stockholders' agreement or similar arrangement that may be in effect among the institution and its stockholders at the time of the Treasury's investment; provided that the Treasury shall not effect any transfer of the Senior Preferred stock which would require the Non-Public Qualifying Institution to become subject to the periodic reporting requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”). If the Non-Public Qualifying Institution otherwise becomes subject to such reporting requirements, the Non-Public Qualifying Institution will be required to file a shelf registration statement covering the Senior Preferred stock as promptly as practicable.
In addition to the Senior Preferred stock, the Treasury will receive warrants to purchase a number of net shares of preferred stock having an aggregate liquidation preference equal to 5 percent of the amount of Senior Preferred stock purchased on the date of investment. The warrants will have a term of 10 years and will be immediately exercisable. The shares of preferred stock issued upon exercise of the warrants (“Warrant Preferred”) will have the same rights, preferences, privileges, voting rights and other terms as the Senior Preferred stock, except that (i) the Warrant Preferred will pay dividends at a rate of 9 percent per annum and (ii) the Warrant Preferred may not be redeemed until all the Senior Preferred stock has been redeemed.
Like the Senior Preferred stock, the warrants will not be subject to any contractual restrictions on transfer or the restrictions of any stockholders' agreement or similar arrangement that may be in effect among the institution and its stockholders at the time of the Treasury's investment; provided that the Treasury shall not effect any transfer of the Preferred stock which would require the Non-Public Qualifying Institutions to become subject to the periodic reporting requirements of Section 13 or 15(d) of the Exchange Act. If the Non-Public Qualifying Institution otherwise becomes subject to such reporting requirements, the Non-Public Qualifying Institution will be required to file a shelf registration statement covering the warrants and the Warrant Preferred underlying the warrants as promptly as practicable.
The Treasury has discretion to exempt certain investments from the warrant requirements.3 The Treasury has determined not to require a warrant to purchase additional Preferred stock for a limited class of qualifying institutions which meet the following requirements: the size of the investment must be $50 million or less and the qualifying institution must be a certified Community Development Financial Institution (“CDFI”).4 In order to qualify for the exemption, the company must have completed an application to be a CDFI at the time such company's application is filed for the TARP Program.
Non-Public Qualifying Financial Institutions will have until Dec. 8, 2008, to apply for participation in the TARP Program. Non-Public Qualifying Financial Institutions will be required to adopt the Treasury's standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP Program. In addition, participation in the TARP Program will result in restrictions on dividends, stock repurchases and redemptions. Further, because the securities issued to the Treasury will not be subject to any contractual limitations on transfer, including any restrictions of any stockholders' agreement or similar arrangement that may be in effect among the institution and its stockholders at the time of the Treasury's investment, Non-Public Qualifying Institutions wishing to participate in the TARP Program may need to obtain the consent or waiver of any stockholders that are party to such agreements.
1 The publicly available term sheet and the frequently asked questions are available at http://www.treasury.gov/press-center/press-releases/Pages/hp1277.aspx.
2 The term “related person” means any officer or director of the Non-Public Qualifying Institution, any immediate family member of a director or executive officer of the participating institution, or any person who was the beneficial holder of more than 5 percent of the Non-Public Qualifying Institution's securities when such transaction took place, or an immediate family member of such beneficial holder.
3 See Sec. 113(d)(3) of the Emergency Economic Stabilization Act of 2008.
4 A Community Development Financial Institution is a specialized financial institution that works in market niches that are underserved by traditional financial institutions. CDFIs provide a unique range of financial products and services in economically distressed markets, such as mortgage financing for low-income and first-time home buyers and not-for-profit developers, flexible underwriting and risk capital for needed community facilities, and technical assistance, commercial loans and investments to small start-up or expanding businesses in low-income areas.