Treasury Extends the TARP to Cover S-Corporations

January 15, 2009 at 3:42 pm Leave a comment

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.

Entry filed under: Client Alerts, Financial Institutions, TARP.

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