U.S. Department of the Treasury Announces Terms For Private Company Preferred

November 24, 2008

Sub-S and Mutuals Still Under Review; Costs of Funds Generally 6%-7% with Issuance of Warrant Preferred; Applications Due December 8.

On November 17, 2008, the U.S. Department of the Treasury ("Treasury") announced the terms of the TARP Capital Purchase Program for privately held qualifying financial institutions ("Private QFIs"). Private QFIs do not include subchapter S corporations or mutual depository institutions at this time. Included with the announcement were a term sheet and answers to frequently asked questions. Participation in the Capital Purchase Program is voluntary. Applications to participate must be filed with the financial institution's federal banking regulators by December 8, 2008.

In general, the terms for public and Private QFIs are very similar; however, Private QFIs should be alerted to some significant differences. Unlike the public company program, Private QFIs require permission from the Treasury to increase common dividends more the 3% per year after the third year of the issuance of Preferred Stock. Private QFIs are also prohibited from entering into transactions with related persons subject to very limited exceptions.

The major difference between the public company and private company programs, however, are the terms of the Warrant Preferred. Rather than issuing warrants for common shares of the Private QFI, as is the case under the public company program, the Treasury will receive warrants exercisable for additional Warrant Preferred, which the Treasury intends to exercise immediately. The structure of the warrants increases the initial cost of funds to Private QFIs, generally, to between 6% and 7% (instead of 5%). The Warrant Preferred carry a 9% dividend rate. This structure effectively makes the cost of capital significantly higher than under the public company program. For some Private QFIs, the higher cost of funds could be a deciding factor in determining whether to participate in the Capital Purchase Program. Private QFIs that are certified "community development financial institutions" by January 15, 2009, and where the Treasury's investment is $50 million or less, will not be required to issue warrants or Warrant Preferred to the Treasury.

The following is a summary of the key elements of the Capital Purchase Program for privately held qualifying financial institutions:

PRIVATELY HELD QUALIFYING FINANCIAL INSTITUTIONS

Private QFIs include the following: (1) non-publicly traded top-tier bank holding companies or savings and loan holding companies, (2) non-publicly traded U.S. banks or U.S. savings associations organized in a stock form that are not controlled by holding companies, or (3) non-publicly traded U.S. banks or U.S. savings associations that are controlled by non-publicly traded savings and loan holding companies. Private QFIs do not include subchapter S corporations, mutual depository institutions or any institution controlled by a foreign bank or company.

PREFERRED STOCK, GENERALLY

Private QFIs may issue cumulative or, if issued by a bank with no holding company, noncumulative preferred stock ("Preferred Stock") in amounts that are not less than 1% of the Private QFI's risk-weighted assets and not more than the lesser of: (i) $25 billion and (ii) 3% of the Private QFI's risk weighted assets. The Preferred Stock is perpetual and will be senior to common stock and pari passu with existing preferred stock, other than preferred stock which ranks junior to existing preferred stock. The Preferred Stock will have a liquidation preference of $1,000 per share, although the Treasury may agree to purchase the Preferred Stock with a higher liquidation preference. The Preferred Stock will be classified as Tier 1 capital for regulatory capital purposes. The Preferred Stock will have the following additional terms:


WARRANTS

With the purchase of Preferred Stock, the Treasury will receive warrants to purchase net shares of additional Preferred Stock of the Private QFI ("Warrant Preferred"). The initial exercise price will be $0.01 per share or greater as required by the Private QFI's charter. The Warrant Preferred are immediately exercisable and the Treasury intends to immediately exercise the warrants. The terms of the Warrant Preferred include:


EXECUTIVE COMPENSATION RESTRICTIONS

As a condition of the Treasury's investment in any Preferred Stock of a Private QFI, the Private QFI and its senior executive officers (which include the chief executive officer, chief financial officer, and the next three highest compensated executive officers) must modify or terminate all benefits plans, arrangements and agreements (including golden parachute agreements) to the extent necessary to be in compliance with, and agree to be bound by, the compensation and corporate governance standards of Section 111 of the Emergency Economic Stability Act of 2008 ("EESA"), and any guidance or regulations issued by the Secretary of the Treasury. The Private QFI and its senior executive officers must also grant the Treasury a waiver releasing the Treasury from any claims that the Private QFI and its senior executive officers may have as a result of the issuance of any regulations that modify the terms of the benefits plans, arrangements and agreements.

The executive compensation and corporate governance standards of Section 111 of the EESA that must be adopted by a Private QFI include the following: 

Frost Brown Todd will continue to monitor developments related to this advisory and any upcoming guidance on S corporations and mutual depository institutions.

The Treasury application documents are available online.

For more information or assistance, please contact one of the members of our Financial Institutions practice listed below:

R. James Straus (502-568-0221; jstraus@fbtlaw.com)
Nathan L. Berger (502-779-8168; nberger@fbtlaw.com)
Dawn R. Franklin (502-779-8500; drfranklin@fbtlaw.com)

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