Archive for January, 2009
In a recent financial institution newsletter (the Letter), the FDIC announced its “expectation” that state nonmember institutions institute a process to monitor “their use of capital injections, liquidity support and/or financing guarantees obtained through recent financial stability programs.” (A copy of the letter is available here.) The stated purpose of the monitoring requirement is to help measure the impact of recent financial stability programs on the lending practices of participating institutions. Here’s a quick overview of the Letter:
- Which institutions are covered by the Letter? The Letter applies to all state nonmember institutions that have (1) received funds under the TARP Capital Purchase Program, (2) issued FDIC-guaranteed debt, or (3) received funding from the Federal Reserve’s expanded borrowing facilities.
- What activities should be monitored? Covered institutions should document how funds obtained from or guaranteed by federal liquidity-enhancement programs are used to promote lending activities, as described in the November 10, 2008, Interagency Statement on Responsible Lending (see FIL-128- 2008).
- Why does the FDIC want to monitor the conduct of these institutions? According to the Letter, the FDIC expects the results of the monitoring programs to illustrate whether federal programs are supporting credit markets and strengthening bank capital. In addition, the FDIC anticipates results of the monitoring processes should demonstrate whether participation in these federal programs has reduced unnecessary foreclosures.
- How will a covered institution report the results of its monitoring program? Covered institutions should be prepared to describe their use of federal programs during bank examinations. The Letter also encourages covered institutions to summarize such information in published annual reports and financial statements.
This Letter probably represents the first of many reporting/monitoring requirements for institutions that participate in federal liquidity-enhancement programs like TARP or the Temporary Liquidity Guarantee Program. Like all reporting requirements, covered institutions should begin implementing a compliance monitoring system now, so that all relevant information is available during examinations.
Yesterday, the United States Treasury issued the much-anticipated Term Sheet setting forth the terms for financial institutions operating under Subchapter S of the Internal Revenue Code (S-Corps) to participate in the TARP Capital Purchase Program (CPP). The application deadline is February 13, 2009. To review the Term Sheet in its entirety, click here. To review the Treasury’s Frequently Asked Questions about the Term Sheet, click here. Here’s an overview of the Term Sheet:
- Security Type: Unlike previous CPP transactions, S-Corps will not sell preferred stock to Treasury. Instead, participating S-Corps will issue subordinated debentures, referred to in the Term Sheet as “Senior Securities.”
- Amount: A participating financial institution will issue Senior Securities in an aggregate principal amount that equals at least 1% of the institution’s risk-weighted assets and does not exceed 3% of risk-weighted assets or $25 billion, whichever is less.
- Key Terms: Each debenture representing a Senior Security will be issued in the principal amount of $1000, will require quarterly interest payments at a rate of 7.7% per annum for the first five years the securities are outstanding and 13.8% thereafter and will carry a maturity date of 30 years. (These interest rates are higher than the dividend rates payable under previous CPP transactions. Treasury increased the rate for S-Corps to offset the fact that interest payments are tax-deductible but dividends are not.)
- Capital Treatment: The Senior Securities will be treated as Tier 1 capital for holding companies and Tier 2 capital for banks or other associations.
- Interest Deferral: Holding companies may defer interest payments on the Senior Securities for up to 20 quarters. Unpaid interest will accrue and compound during any deferral period.
- Dividend Restrictions: No dividends on shares of equity or trust preferred securities may be paid while an interest deferral is in effect. For the first three years of participation, Treasury must consent to any increase in the participant’s regularly paid common dividends. After the third year, Treasury must consent to any dividend increase that exceeds an amount equal to 103% of the prior year’s dividend. However, Treasury’s consent is not required for any dividend increase if the increase is proportionate to the increase in the financial institution’s income, and the increased dividends are distributed to shareholders to pay increased income tax liabilities.
- Voting: The Senior Securities will be non-voting, except that they will have class voting rights on (1) the issuance of equity securities purporting to rank senior to the Senior Securities, (2) amendments to the rights of the Senior Securities, and (3) any merger, exchange or similar transaction that would adversely affect the Senior Securities’ rights. Further, if interest is not paid in full for six interest periods, consecutive or non-consecutive, Treasury will be able to elect two directors until all interest payments are current.
- Executive Compensation: The senior executive officers of S-Corps participating in CPP will be subject to the executive compensation provisions in EESA and its implementing regulations.
- Affiliate Transactions: For as long as the Treasury holds its Senior Securities, a financial institution may not enter into a transaction with a related person unless the transaction is on terms no less favorable than could be obtained from an unaffiliated third party.
Just like other federal programs aimed at alleviating stress in the financial sector during the current economic downturn, the S-Corp CPP has advantages and disadvantages. We strongly urge all S-Corps to weigh those benefits and costs in deciding whether to apply for this particular program before the February 13th application deadline.