TARP Application Deadline Looms for S-Corporations

February 9, 2009 at 5:09 pm Leave a comment

On January 16, 2009, the U.S. Treasury issued a term sheet (Term Sheet) setting forth terms for financial institutions operating under Subchapter S of the Internal Revenue Code (S-Corps) to participate in the TARP Capital Purchase
Program (CPP). S-Corps desiring to participate in the CPP must file their applications by Friday February 13, 2009. A copy of the application can be downloaded. (Ignore the application deadline date printed on the form).

Here is a quick overview of how the CPP works for S-Corps:

  • 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.”
  • 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.)
  • 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.
  • 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.Review the S-Corp Term Sheet in its entirety.

Review the Treasury’s Frequently Asked Questions about the Term Sheet.

Because Treasury will be issuing debt instead of equity under this program, many S-Corps have questions about the true costs of participating. Here is an estimate of the effective cost of this debt for the first five years, assuming repayment at the end of that period:

Coupon 7.7%
Warrant Debt Issuance (OID)
(5% over 5 years)
1.0%
Interest on Warrant Debt .05 (13.8) .69%
Effective Approx. Annual Interest Rate 9.39%

Entry filed under: Client Alerts, TARP.

Now We have Teeth—Additional Restrictions on Executive Compensation Under TARP Economic Stimulus Legislation Adds to Executive Compensation Restrictions for TARP Participants

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