Alert February 11, 2009

Treasury Secretary Geithner Announces Financial Stability Plan

Yesterday U.S. Treasury Secretary Timothy Geithner announced a broad, multi-faceted program, the Financial Stability Plan (the "FSP"), designed to strengthen the financial system through additional capital injections to banks, creation of a public/private investment fund to buy troubled assets, establishment of guidelines for mortgage modification, and expansion of a Federal Reserve lending program aimed at small businesses and communities.

Initial market reaction and financial commentary was negative, largely based on uncertainty regarding the details of the FSP and therefore its implications for affected financial institutions, businesses and consumers going forward. In these circumstances, the Administration can be expected to move rapidly to flesh out the details of the FSP. Set forth below are some areas which financial institutions will likely focus on as the details of the FSP are made known.

Capital Assistance Plan ("CAP"). U.S. banking organizations with assets of $100 billion or more (the top twenty or so firms) will be required to undergo a regulatory review, including a comprehensive balance sheet "stress test." If the results show that capital and reserves are inadequate, these organizations will have access to "buffer" capital in the form of convertible preferred stock investments by the newly created "Financial Stability Trust."

Going forward, organizations in this group, and smaller financial institutions which are considering whether to opt into the CAP, will focus on the scope and other features of the stress test to assess its impact on capital planning, and the potential that such testing will necessitate (in response to pressures from regulators and outside auditors) unplanned additions to loan loss and other reserves, over and above what might be required under GAAP.

In the event that capital deficiencies are identified, affected banking organizations will be forced to raise additional capital, in the current environment most likely from the Financial Stability Trust. Regardless of the stated cost to the institution of mandatory capital injections, government ownership may well be deemed unfavorable overall, particularly given its dilutive impact on current shareholders, the associated requirement to increase lending in a recession of uncertain depth and duration, the prescribed limitations on dividends, stock repurchases, executive compensation, acquisitions, and the increased reporting and disclosure requirements. The FSP and other more recently proposed executive compensation limitations are considerably more stringent than applicable under the TARP/CPP regime, and will be discussed in next week’s Alert.

Public Private Investment Fund. Another key aspect of the FSP is the creation of a fund to provide U.S. government financing and capital to purchase "toxic assets." The fund is expected to initially have $500 billion in assets and could grow to $1 trillion. Very little detail has been provided to date. From the standpoint of the selling banking organizations, the matters to be clarified include the pricing mechanism for the assets to be sold, the accounting impact of such transactions on capital levels, the other terms of the sale, and any residual obligations with respect to the assets sold or additional regulation associated with participation in this aspect of the FSP. From the standpoint of potential investors in the fund, details to be provided, among others, relate to opportunities to manage risk through due diligence on the assets to be acquired, the terms of the investment, including any government provided downside protection or provisions for upside opportunity, as well as arrangements for management of the assets and the plan for ultimately disposing of or otherwise resolving the assets of the fund.

Consumer and Business Lending Initiative . The FSP also contemplates expanding the not yet implemented Term Asset-Backed Securities Loan Facility ("TALF"). This program was initially designed to provide financing for private investors to acquire auto, small business, and credit card related instruments. It has now been expanded to include credit support for eligible borrowers who purchase AAA-rated commercial mortgage-backed securities ("CMBS"). It remains to be seen what eligibility criteria will apply to the underlying collateral of the CMBS. The Treasury has indicated that it may further expand the TALF to include non-Agency residential mortgage-backed securities and assets collateralized by corporate debt. Loans will be non-recourse to the private investor borrowers. Sponsors of eligible ABS are required to comply with the executive compensation restrictions of the Emergency Economic Stability Act of 2008.

Mortgage Loan Modification Program. The FSP includes a proposal to reduce mortgage rates through Treasury and Federal Reserve purchases of up to $600 billion of GSE mortgage-backed securities and GSE debt. In addition, the FSP calls for the issuance of formal loan modification guidelines and standards applicable to government and private programs. It is unclear whether financial institutions (other than participants in the CAP and other aspects of the FSP) will be required to engage in mortgage foreclosure mitigation efforts.

Small Business and Community Bank Lending Initiative . The FSP references incentives to increase small business lending through expansion of government financing under TALF to purchase high grade SBA loans in the secondary market, as well as proposals to increase the SBA guaranteed portion of loans under the relevant statutory provisions. It remains to be seen what measures, if any, in addition to SBA related initiatives, will be taken to encourage community banks to increase lending in their local market areas.

Conclusion

Given the breadth of Treasury’s proposals and initiatives, as well as the expansive scope of the financial stimulus package making its way through Congress, it is clear that numerous pronouncements from a host of government sources will be made over the coming weeks. We intend to monitor legislative and regulatory developments which clarify and set forth additional FSP details through the weekly Alert as well as special Alerts as appropriate.