On October 14, 2008, Secretary of the Treasury Henry Paulson, FRB Chairman Benjamin Bernanke and FDIC Chairman Sheila Bair formally announced and provided further detail on two new programs, the TARP Capital Purchase Program (the “Capital Purchase Program”) and the Temporary Liquidity Guarantee Program (the “Liquidity Program”), designed to strengthen public confidence in the U.S. financial system and address the crisis in the credit markets. The Treasury announced that through voluntary participation in the Capital Purchase Program, financial institutions may sell preferred shares to the U.S. government. The Treasury further announced that it is seeking comments on a program that would guarantee the principal of, and interest on, troubled assets originated or issued prior to March 14, 2008. The FDIC also announced that under the Liquidity Program it will temporarily (i) guarantee newly issued senior unsecured debt of any FDIC-insured depository institution and certain bank and savings and loan holding companies engaged only in financial activities, and (ii) offer full deposit insurance coverage of non-interest bearing deposit transaction accounts, regardless of dollar amount.
These actions were taken to implement the comprehensive global strategy outlined by the Group of Seven nations to address the current instability in the financial markets and to mitigate the risks such instability poses to the broader economy. Following the G-7 meeting, the FRB announced that it will provide unlimited dollar funds to the Bank of England, the Swiss National Bank and the European Central Bank. The Treasury and FRB have previously announced plans to purchase certain illiquid mortgage-backed assets held by financial institutions and commercial paper. The Capital Purchase Program expands the scope of the Troubled Asset Relief Program (“TARP”) from buying such illiquid mortgage-backed assets to directly capitalizing financial institutions. The Treasury announced that it will initially invest $125 billion in nine large financial institutions under the Capital Purchase Program. In addition, the FRB provided further detail concerning the previously announced Commercial Paper Funding Facility. Please see our discussion of the FRB’s Commercial Paper Funding Facility in the article below.
I. Treasury Action: TARP Capital Purchase Program
Under the authority of the Emergency Economic Stabilization Act of 2008 (the “EESA”), the Treasury will make available $250 billion of capital to U.S. financial institutions through the Capital Purchase Program. This $250 billion is part of the $700 billion authorized by Congress for the TARP. Under the Capital Purchase Program, the Treasury will purchase up to $250 billion of senior preferred shares on standardized terms as described in the Capital Purchase Program’s term sheet (the “Senior Preferred Shares”). The Capital Purchase Program will be available to qualifying U.S.-controlled banks, savings associations, and certain bank and savings and loan holding companies engaged only in financial activities that elect to participate before 5:00 pm (EDT) on November 14, 2008. The Treasury will determine eligibility and allocations for interested financial institutions after consultation with the appropriate federal banking regulator. Financial institutions interested in participating in the Capital Purchase Program are requested to contact their primary federal regulator for specific enrollment details.
Senior Preferred Shares
Size and Security. The minimum subscription amount available to a participating financial institution will be one percent of its risk-weighted assets. The maximum subscription amount will be the lesser of $25 billion or three percent of risk-weighted assets. The Treasury will fund the Senior Preferred Shares purchased under the Capital Purchase Program by year-end 2008. The Senior Preferred Shares will have a liquidation preference of $1,000 per share; however, the Treasury may agree to a higher liquidation preference per share depending upon the participating financial institution’s available authorized preferred shares.
Ranking, Term and Dividend. The Senior Preferred Shares will qualify as Tier 1 capital and will rank senior to common stock and pari passu with existing preferred shares, other than preferred shares which by their terms rank junior to any other existing preferred shares. The Senior Preferred Shares will have a perpetual life. The Senior Preferred Shares will pay cumulative dividends at a rate of five percent per year for the first five years and will reset to a rate of nine percent per year after the fifth year. For Senior Preferred Shares issued by banks which are not subsidiaries of holding companies, the Senior Preferred Shares will pay non-cumulative dividends at a rate of five percent per year for the first five years and will reset to a rate of nine percent per year after the fifth year. The dividends of Senior Preferred Shares will be payable quarterly in arrears on February 15, May 15, August 15 and November 15 of each year.
Redemption. The Senior Preferred Shares will be callable at par after three years, including any accrued and unpaid dividends for the cumulative Senior Preferred Shares or any accrued and unpaid dividends for the then current dividend period for the non-cumulative Senior Preferred Shares (regardless of whether any dividends are actually declared for such dividend period). Redemptions of Senior Preferred Shares will be subject to the approval of the participating financial institution’s primary federal bank regulator. Prior to the end of three years, the Senior Preferred Shares may be redeemed with the proceeds from a qualifying equity offering of any Tier 1 perpetual preferred or common stock (“Qualifying Equity Offering”) which results in aggregate gross proceeds to the participating financial institution of not less than 25 percent of the issue price of the Senior Preferred Shares.
Dividend Restrictions. For as long as any Senior Preferred Shares are outstanding, no dividend may be declared or paid on any junior preferred shares, preferred shares ranking pari passu with the Senior Preferred Shares, or common shares unless all the accrued and unpaid dividends for the cumulative Senior Preferred Shares are fully paid or all the full dividend for the latest completed dividend period for the non-cumulative Senior Preferred Shares has been declared and paid in full. Dividends may be declared on pari passu preferred shares on a pro rata basis with the Senior Preferred Shares. Participating financial institutions also may not repurchase or redeem any junior preferred shares, preferred shares ranking pari passu with the Senior Preferred Shares or common shares unless all the accrued and unpaid dividends for the cumulative Senior Preferred Shares are fully paid or all the full dividend for the latest completed dividend period for the non-cumulative Senior Preferred Shares has been declared and paid in full. Consent of the Treasury will be required for any increase in common dividends per share for the first three years, unless prior to the end of three years the Senior Preferred Shares have been redeemed in full or the Treasury has transferred all of the Senior Preferred Shares to third parties.
Repurchases. The consent of the Treasury will be required for any share repurchases, other than repurchases of the Senior Preferred Shares or junior preferred shares or common shares in connection with any benefit plan in the ordinary course of business consistent with past practice, for the first three years, unless prior to the end of three years the Senior Preferred Shares have been redeemed in full or the Treasury has transferred all of the Senior Preferred Shares to third parties. No repurchases of junior preferred shares, preferred shares ranking pari passu with the Senior Preferred Shares or common shares will be allowed if such repurchase is prohibited by a restriction on dividends.
Voting Rights. The Senior Preferred Shares will be non-voting, except for class voting rights on matters that could adversely affect the shares, such as an issuance of senior ranking shares, any amendment to the rights of the Senior Preferred Shares, or any merger, exchange or similar transaction. If dividends on the Senior Preferred Shares are not paid in full for six dividend periods, whether or not consecutive, the Senior Preferred Shares will have the right to elect 2 directors. This right to elect directors will end when full dividends have been paid for four consecutive dividend periods.
Transferability. The Treasury may also transfer the Senior Preferred Shares to a third party at any time. The participating financial institution must promptly file a shelf registration statement covering the Senior Preferred Shares and shall take all action to cause such shelf registration to be declared effective as soon as possible. The participating financial institution must also grant the Treasury piggyback registration rights for the Senior Preferred Shares and will take such other steps as reasonably requested to facilitate the transfer of the Senior Preferred Shares, including, if requested, reasonable efforts to list the Senior Preferred shares on a national securities exchange. At the request of the Treasury, the participating financial institution will appoint a depository to hold the Senior Preferred Shares and issue depository receipts.
In conjunction with the purchase of Senior Preferred Shares, the Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15 percent of its investment in Senior Preferred Shares. The exercise price on the warrants will be the market price of the participating financial institution’s common stock at the time of issuance, calculated on a 20‑trading day trailing average. The warrants will have a term of 10 years and will be immediately exercisable, in whole or in part. The warrants will be freely transferable, however, the Treasury may only transfer or exercise an aggregate of one-half of the warrants prior to the earlier of (i) the date on which the participating financial institution has received aggregate gross proceeds of at least one hundred percent of the issue price of the Senior Preferred Shares from one or more Qualifying Equity Offerings or (ii) December 31, 2009. The participating financial institution must promptly file a shelf registration statement covering the warrants and the underlying common stock and shall take all action to cause such shelf registration to be declared effective as soon as possible. The participating financial institution must also grant the Treasury piggyback registration rights for the warrants and underlying common stock and will take such other steps as reasonably requested to facilitate the transfer of the warrants and underlying common stock. The participating financial institution shall list the underlying common stock on the same national securities exchange on which its common shares are traded. The Treasury will not exercise the voting rights of any common stock issued to it upon exercise of the warrants.
In the event that the participating financial institution has received aggregate gross proceeds of at least one hundred percent of the issue price of the Senior Preferred Shares from one or more Qualifying Equity Offerings on or prior to December 31, 2009, the number of shares of common stock underlying the warrants then held by the Treasury shall be reduced by a number of shares equal to the product of (i) the number of shares originally underlying the warrants (taking into account all adjustments) and (ii) 0.5. In the event that the participating financial institution does not have sufficient available authorized shares of common stock to reserve for issuance upon exercise of the warrants and/or stockholder approval is required for such issuance under applicable stock exchange rules, the participating financial institution will call a meeting of its stockholders as soon as possible after the investment to increase the number of authorized shares of common stock and/or comply with such exchange rules, and take any other measures the Treasury deems necessary to allow the exercise of warrants into common stock. In the event the participating financial institution is no longer listed or traded on a national securities exchange or securities association, or the required consent of the institution’s stockholders has not been obtained within 18 months after the issuance date of the warrants, the warrants will be exchangeable, at the option of the Treasury, for senior term debt or another economic instrument or security of the institution such that the Treasury is appropriately compensated for the value of the warrant, at its so determines.
Executive Compensation and Corporate Governance Restrictions
Any financial institution participating in the Capital Purchase Program will be subject to stringent executive compensation and corporate governance rules for the period during which Treasury holds equity or debt issued under the Capital Purchase Program. A participating financial institution must meet certain standards, including: (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) requiring “clawback” 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; (3) prohibiting the financial institution from making any golden parachute payment to a senior executive based on the Internal Revenue Code provision; and (4) agreeing not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. These standards generally apply to the chief executive officer, chief financial officer, plus the next three most highly compensated executive officers. As a condition of closing an investment, participating financial institutions shall modify or terminate all benefit plans, arrangements and agreements to the extent necessary to be in compliance with such standards. The institution and any officers covered by the standards shall grant the Treasury a waiver releasing the Treasury from any claims that the institution or such officer may otherwise have as a result of the issuance of any regulation which modify the terms of benefits plans, arrangement and agreements to eliminate any provisions that would not be in compliance with the executive compensation and corporate governance standards. The Treasury has issued interim final rules for these executive compensation standards.
Nine large financial institutions have already agreed to participate in the Capital Purchase Program. In an investment totaling $125 billion, the Treasury will buy $25 billion each in Senior Preferred Shares of Citigroup, J.P. Morgan Chase and Wells Fargo (including Wachovia); $10 billion each in Senior Preferred Shares of Goldman Sachs and Morgan Stanley; $3 billion in Senior Preferred Shares of The Bank of New York Mellon; and approximately $2 billion in Senior Preferred Shares of State Street. These institutions have voluntarily agreed to participate on the same terms that will be available to small and medium-sized banks and thrifts across the nation. The remaining $125 billion of the Capital Purchase Program will be allocated among thousands of small and midsize financial institutions. Such institutions will be eligible for government investments reflecting a similar proportion of their assets.
II. Request for Comment on Guarantee Program for Troubled Assets
The Treasury has requested comment on establishing a program under the EESA to guarantee the principal of, and interest on, troubled assets originated or issued prior to March 14, 2008. Such program may take any form and may vary by asset class, but must be voluntary and self-funding. Premiums may be set to reflect the credit risk characteristics of the insured assets so as to ensure that taxpayers are fully protected. The Treasury invites comment on how the program should be structured to minimize adverse selection, including how premiums should be calculated, what events should trigger insurance payout, what form that payout should take, and which institutions and assets should be eligible. The Treasury also asks for public comment on technical considerations, including what legal, accounting, or regulatory issues would arise and what administrative challenges the program will create. Comments are due by Friday, October 28, 2008.
III. FDIC Action: Temporary Liquidity Guarantee Program
Under its authority to prevent systemic risk, the FDIC announced the Liquidity Program to strengthen confidence and encourage liquidity in the banking system. The Liquidity Program has two components: (i) a guarantee of newly issued senior unsecured debt of any FDIC-insured depository institution and certain bank and savings and loan holding companies engaged only in financial activities, and (ii) full deposit insurance coverage of non-interest bearing deposit transaction accounts, regardless of dollar amount.
Guarantee of Newly Issued Senior Unsecured Debt
Under the Liquidity Program, certain newly issued senior unsecured debt issued on or before June 30, 2009, will be fully protected in the event the issuing institution subsequently fails, or its holding company files for bankruptcy. This includes promissory notes, commercial paper, inter-bank funding, and any unsecured portion of secured debt. The amount of debt of the issuing institution covered by the guarantee may not exceed 125% of its debt that was outstanding as of September 30, 2008 and that was scheduled to mature before June 30, 2009. Coverage will be limited to June 30, 2012, even if the maturity of the debt extends beyond that date. The FDIC will not provide protection to “troubled” institutions. The FDIC stated that it will issue further guidance specifying the process for utilizing the Liquidity Program.
Full Deposit Insurance Coverage of Non-Interest Bearing Deposit Transaction Accounts
In addition, any participating depository institution will be able to provide full deposit insurance coverage for non-interest bearing deposit transaction accounts, regardless of dollar amount. These include payment-processing accounts, such as payroll accounts used by businesses. Frequently, the balance of such accounts exceeds the current deposit insurance limit of $250,000. This increased deposit insurance coverage will expire on December 31, 2009.
Liquidity Program Fees
The Liquidity Program will not be funded with taxpayer funds or through the Deposit Insurance Fund. Rather, financial institutions participating in the Liquidity Program will be charged a 75 basis point fee on the amount of debt guaranteed by the Liquidity Program and a 10 basis point surcharge will be applied to non-interest bearing transaction accounts that would not otherwise be covered by the existing deposit limit of $250,000 and added to the participating institution’s current insurance assessment.
Liquidity Program CoverageAll FDIC-insured institutions will be covered immediately under the program for the first 30 days without incurring any costs. After that initial period, however, institutions no longer wishing to participate must opt out or be assessed for future participation. If an institution opts out, the guarantees will only cover the initial 30 day period. All opt outs are final; once an institution opts out, it cannot re‑enter the Liquidity Program. Financial institutions participating in the Liquidity Program will be subject to enhanced supervisory oversight to prevent rapid growth or excessive risk taking. The FDIC will maintain control over eligibility in consultation with the participating institution’s primary federal regulator. Participation in the Liquidity Program will not trigger executive compensation restrictions. The FDIC will issue rules for the Liquidity Program in the upcoming weeks, including what form of customer notification is necessary for newly insured deposits under the Liquidity Program or when a financial institution opts out of the Liquidity Program.