On October 14, 2008, the U.S. Department of the Treasury announced a program to purchase troubled assets from qualified United States financial institutions in exchange for preferred stock. Known as the Troubled Asset Relief Program, or TARP, the program is designed to inject up to $250 billion of capital in these "Qualified Financial Institutions".
What follows is a summary of the TARP term sheet, as published by the Treasury. Although the term sheet answers many questions about TARP, it leaves others unanswered. For instance, as written, the term sheet could lead one to believe that access to capital under TARP is limited to publicly held and troubled financial institutions. However, many industry experts believe that, despite the lack of a formal pronouncement, financial institutions that are not publicly held and which are fiscally sound will be eligible, and indeed, encouraged, to participate in the program.
"Qualified Financial Institutions" may generally take advantage of the TARP Program. Qualified Financial Institutions are defined as:
any U.S. bank or savings associations not controlled by a bank holding company ("BHC") or savings and loan holding company ("SLHC"); and any U.S. BHC, or any U.S. SLHC that engages in activities that are financial in nature or complementary to a financial activity and do not pose a risk to the safety and soundness of the financial system; and any U.S. bank or U.S. savings association controlled by a qualifying U.S. BHC or SLHC.
Although the Treasury is said to be considering allowing BHC's, SLHC's, bank or savings associations controlled by a foreign bank or company to participate in TARP, they currently are not encompassed by the term "Qualified Financial Institution".
The Treasury will be purchasing senior preferred stock from participating Qualifying Financial Institution (a "Participant"), as well as warrants to purchase common stock from the Participant.
Terms of the Preferred Stock
Each Participant may issue an amount of senior preferred stock equal to not less than 1% ots risk-weighted assets and not more 3% ots risk-weighted assets. The terms of the senior preferred stock are as follows:
Senior to common stock and pari passu with existing preferred shares, other than preferred shares which by their terms rank junior to any existing preferred shares; Not subject to any contractual restrictions on transfer; Non-voting other than certain class voting rights; Will be cumulative, except in the case of stand-alone banks, in which case, will be non-cumulative
5% pannum dividend rate, payable quarterly until the fifth anniversary of the issuance and at a rate of 9% pannum thereafter; No dividends may be declared or paid on junior preferred shares, preferred share ranking pari passu with the senior preferred stock, or common shares until no shares of senior preferred stock are outstanding; No junior preferred shares, preferred share ranking pari passu with the senior preferred stock, or common shares may be redeemed or repurchased unless all accrued and unpaid dividends are fully paid; Dividends on common stock may not be increased prior to three years after the senior preferred stock has been issued, without prior consent of the Treasury (unless all the senior preferred stock has been redeemed or transferred by the Treasury). Voting Rights: Non-voting, except with regard to any proposed changes in the terms of the senior preferred stock, including transactions that would adversely affect the rights of the Treasury (or other senior preferred stock holders), or the authorization of stock senior to the senior preferred stock.
Cannot be redeemed during the first three years from the date of issuance, except with proceeds from the sale of Tier 1 qualifying perpetual preferred stock or common stock for cash; Following the first three years, redeemable at the Qualifying Financial Institution's election, subject to approval of the primary federal bank regulator; Redemptions shall occur at a price equal to the issue price plus any accrued and unpaid dividends.
In addition, the Participant may be required to list the senior preferred stock on a national securities exchange upon the request of the Treasury.
Terms of the Warrants
The number of shares of common stock authorized under the warrants shall have an aggregate market price equal to 15% ohe original senior preferred stock issue price, subject to a 15% rction on each sixth-month anniversary of issuance, with a maximum reduction of 45%. following additional terms apply to the warrants:
Term: Ten years Exercise Period: Immediately exercisable, in whole or in part Exercise Price: The average trading price of the Participant's common stock on the 20 trading days preceding the issuance of the senior preferred stock. Voting: Treasury agrees not to exercise voting rights with respect to shares of common stock issued upon exercise of the warrants Restrictions on Transfer: Not subject to any contractual restriction on transfer. The Treasury may only transfer or exercise up to an aggregate of one-half of the warrants prior to the earlier of (i) the date the Participant has received aggregate gross proceeds of not less than 100% ohe senior preferred stock issue price and (ii) December 31, 2009. Shares of Common Stock: If the Participant does not have sufficient authorized shares of common stock available to reserve for issuance upon exercise of the warrants, it must convene a shareholders' meeting as soon as practicable after the issuance of the warrants to increase the number of authorized shares of common stock Substitution: If the common stock of the Participant is no longer listed or traded on a national securities exchange or securities association or where shareholder approval has not been received within 18 months after the issuance of the warrants, the warrants will be exchangeable, at the Treasury's election, for senior debt or another economic instrument or security to appropriately compensate the Treasury, as it may determine, for the value of the warrants.
Heightened Corporate Governance
Participating in TARP does not come without cost to a Participant. During the period that the Treasury holds equity or debt securities in a Participant, that Participant and its "senior executive officers" must revise or terminate all benefit plans such that they meet the Treasury's standards for executive compensation and corporate governance. "Senior executive officers" means the five highest compensated executives (generally, in other words, the chief executive officer, chief financial officer and the next three most highly compensated executive officers.)
Among other things, the Treasury standards require a Participant to:
Claw back of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; Ensure that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the Participant. Prohibit making any "golden parachute" payment to a senior executive based on Internal Revenue Code Section 280G(e). Agree not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive under Internal Revenue Code Section 162(m)(5). Grant, along with each senior executive, a waiver releasing the Treasury from any claims that the Participant and such senior executive officer may otherwise have as a result of the issuance of any regulations that modify the terms of benefit plans not in compliance with the Treasury standards.
The deadline for submitting the application for participation in the TARP Program is 5:00 p.m. Eastern Standard Time on November 14, 2008. Because the Treasury has identified the Qualifying Financial Institutions' primary federal bank regulators as the gateway for entry into the TARP Program, Qualifying Financial Institutions interested in participating in the program should communicate with their respective primary federal bank regulator in completing the application.
Despite the length of the TARP legislation, significant questions remain about TARP, including questions about the eligibility of companies that are not publicly held or are ineligible for shelf registration statements and about the interplay between TARP and the existing bank regulatory capital rules. We are certain that we have not heard the last from the Treasury about the TARP Program, and anticipate that at least some of these questions and ambiguities will be resolved in the near future.
For further information regarding the TARP Program, please contact David A. Butcher at 317-684-5123, Matthew R. Macaluso at 317-684-5447 or Mark J. Wuellner at 317-684-5459.