Alert November 18, 2008

Recent Developments in the Treasury’s Troubled Asset Relief Program

The deadline for participation in the Treasury’s Capital Purchase Program (“CPP”) expired on November 14, 2008 for public banks.  In the most recently issued CPP FAQs, the Treasury addressed which banks are deemed “public” banks for purposes of this deadline.  For the purposes of the CPP, a “public” bank, savings association, bank holding company, or savings and loan holding company is a company (1) whose securities are traded on a national securities exchange and (2) that is required to file, under the federal securities laws, periodic reports such as annual and quarterly reports on Forms 10-Q and 10-K with either the SEC or its primary federal bank regulator.

CPP Investments for Private Banking Organizations

On November 17, 2008, the Treasury released the term sheet for private institutions, which have until December 8, 2008 to apply for CPP investments.  This term sheet and deadline do not apply to mutual banking organizations or S corporations.  The Treasury is continuing to work on structures for mutual banking organization and S corporations, and will release a term sheet and deadline for those institutions in the future.  Many of the terms of the preferred securities issued by private banking organizations  to the Treasury (the “Preferred Securities”), such as the investment size, dividend rate, redemption restrictions, voting rights, and executive compensation requirements, are identical to those for public banks.  Please see the October 14, 2008 Alert for further discussion of the terms for preferred securities issued under the CPP by public banks. 

The dividend and repurchase restrictions for private banking organizations differ from those for public banks.  The Treasury’s consent for share repurchases is required for ten years instead of three years.  Further, from the third anniversary date until the tenth anniversary date, the Treasury must consent to any increase in dividends on common shares greater than 3 percent per year.  In addition, after ten years, private banking organizations participating in the CPP are prohibited from paying common dividends or repurchasing any equity securities or trust preferred securities until all Preferred Securities held by the Treasury are redeemed or have been transferred by the Treasury to a third party.  The Preferred Securities will not be subject to any contractual restrictions on transfer or the restrictions of any stockholders’ agreement or similar arrangement; however, the Treasury and any subsequent holders of the Preferred Securities will not effect any transfer of the Preferred Securities which would require the private bank to become subject to securities reporting requirements.  For as long as the Treasury holds Preferred Securities, private banking organizations participating in the CPP are barred from entering into transactions with related persons unless such transactions are on arms length terms and have been approved by the organization’s audit committee or a comparable body of independent directors.

The Treasury will also receive warrants to purchase, upon net settlement, a number of net shares having an aggregate liquidation preference equal to 5% of the Preferred Securities amount on the date of investment (the “Warrant Preferred”).  The initial exercise price of the warrants will be $0.01 per share unless the participating banking organization’s charter requires a greater par value per share.  The Treasury intends to immediately exercise the warrants.  The warrants will have the same rights, preferences, privileges, voting rights and other terms as the Preferred Securities, except that the Warrant Preferred will pay a 9% annual dividend and the Warrant Preferred may not be redeemed until all of the Preferred Securities have been redeemed.

The Treasury has discretion to exempt certain investments from the warrant requirements and has determined not to require a warrant to purchase Warrant Preferred for a limited class of qualifying institutions.  The Treasury will not require the issuance of Warrant Preferred shares if the size of the investment is less than $50 million and the banking organization is a certified Community Development Financial Institution (“CDFI”).  Institutions must file an application for certification as a CDFI by December 8, 2008.  If an institution has applied for CDFI certification, and it is eligible for funding under the CPP, it will receive conditional approval contingent on receiving the CDFI certification, which must be approved by January 15, 2009.

Treasury Secretary Paulson Outlines Three Priorities for Use of Remaining TARP Funds

On November 12, 2008, Treasury Secretary Henry Paulson outlined three priorities for the use of the remaining Troubled Asset Relief Program (“TARP”) funds and abandoned the plan to use TARP funds for the purchase of troubled mortgage assets. 

New Capital Purchase Programs.  The Treasury is designing new capital purchase programs for financial institutions.  The Treasury is evaluating programs that will attract private capital to financial institutions, potentially through matching investments (see the November 12, 2008 Alert for further discussion of private equity matching investments).  The Treasury is also considering investments in non-bank financial institutions that are not currently eligible under the CPP.  This may include insurance companies (four insurance companies recently acquired thrifts to access the CPP).  In addition, there have been efforts by members of Congress to make automotive companies eligible for TARP funds. 

Support for the Asset-Backed Securitization Markets.  The Treasury is looking for ways to support the asset-backed securitization market in order to increase the availability of consumer finance such as car loans, student loans and credit cards.  With the FRB, the Treasury is exploring the development of a potential liquidity facility for highly-rated AAA asset-backed securities, which may include providing federal financing to private investors.  Secretary Paulson indicated that such a program would be targeted at consumer financing, but that it may also be used to support new commercial and residential mortgage-backed securities lending. 

Mortgage Loan Modifications.  The Treasury is exploring ways to mitigate mortgage foreclosures and achieve more aggressive mortgage modification standards.  Secretary Paulson cited as a model the mortgage modification protocol developed by the FDIC through IndyMac Bank.  Secretary Paulson also highlighted the modification program announced by the Treasury, the FHFA, the GSEs, HUD and the Hope Now alliance, which adopts an explicit affordability target similar to the FDIC’s model.  However, in an interview on November 17, 2008, Secretary Paulson stated that he does not intend to use the remaining $410 billion of unallocated TARP funds unless it is absolutely necessary.  Secretary Paulson further stated that he wishes to preserve the funds and the flexibility of the TARP for the incoming administration.

Proposed FDIC Loan Modification Program

The FDIC has separately proposed a loan modification program that is targeted at homeowners who have missed at least three monthly payments on their mortgage, but have not filed for bankruptcy.  Under the program, the homeowner’s mortgage payments would be reduced to no more than 38 percent of the household’s monthly income.  The FDIC has proposed using government guarantees in conjunction with loan modifications.  Under the plan, up to half of a modified loan’s losses would be guaranteed in the event of default.  Mortgage servicers would be paid $1,000 per modified loan to cover the costs of modification.

Meeting the Needs of Creditworthy Borrowers

The FRB, the FDIC, the OCC and the OTS underscored Secretary Paulson’s remarks by issuing a joint statement on meeting the needs of creditworthy borrowers.  The statement encourages financial institutions to lend prudently and responsibly to creditworthy borrowers, work with borrowers to preserve homeownership and avoid preventable foreclosures, adjust dividend policies to preserve capital and lending capacity and employ compensation structures that encourage prudent lending.  The federal banking agencies noted that financial institutions’ adherence to these expectations will be reflected in examination ratings for safety and soundness, compliance with laws and regulations, and Community Reinvestment Act performance.