Treasury Issues Guidance For Publicly Traded Financial Institutions Participating in TARP CPP

On October 31, 2008, the U.S. Department of the Treasury (the “Treasury”) provided additional information for publicly traded financial institutions seeking to participate in the Troubled Assets Relief Program (“TARP”) Capital Purchase Program (the “Program”) as authorized under the Emergency Economic Stabilization Act of 2008 (the “Act”). Specifically, the Treasury published form documentation for the issuance of preferred stock and warrants by such publicly traded financial institutions. [1] The form documents, which include a Securities Purchase Agreement, Certificate of Designations and Form of Warrant, clarify the terms and conditions under the Program and modify certain terms that were contained in the initial Term Sheet as published on October 14, 2008 by the Treasury. It appears that the Treasury intends for all qualifying financial institutions to enter into substantively identical agreements and will not agree to any changes or modifications. Therefore, each financial institution should consider whether it can comply with the terms and conditions under these form documents.
The application deadline for publicly traded financial institutions to participate in the Program is 5:00 PM (EDT) on November 14, 2008. The Treasury will post an application form and term sheet for privately held eligible institutions at a later date and establish a reasonable deadline for private institutions to apply.
This Client Alert provides a summary of the substantive changes from the initial Term Sheet and relevant issues that publicly traded financial institutions should consider prior to applying for the Program. For a more detailed overview of the Program, please see our Client Alert on the TARP Capital Purchase Program.[2]

Securities Purchase Agreement

The Securities Purchase Agreement (the “Agreement”) governs the basic terms of the Treasury’s investment in each qualifying financial institution. The Agreement sets forth conditions to the investment, various representations, warranties and covenants of the parties and registration rights covering the securities acquired by the Treasury, among other provisions. The following is a summary of key provisions of the Agreement.

Executive Compensation

At or prior to closing, the financial institution must take all necessary action to ensure that its employee compensation and benefit plans with respect to its senior executive officers comply with Section 111(b) of the Act on executive compensation standards. Senior executive officers include the principal executive officer, the principal financial officer and the three other most highly compensated executive officers of the financial institution. Also, each of the financial institution’s senior executive officers must deliver a written waiver releasing the Treasury from any claims that he or she may otherwise have with respect to the modification of his or her compensation and benefit plans to comply with Section 111(b) of the Act.

Anti-takeover Provisions and Rights Plans

The financial institution must ensure that the transactions contemplated under the Agreement will be exempt from any anti-takeover or similar provisions of the institution’s charter and bylaws or other anti-takeover laws and regulations of any jurisdiction. The financial institution also must ensure that any stockholders’ rights plan (or “poison pill”) does not apply to the securities issued under the Agreement.

Exchange Listing

Upon the request of the Treasury, the financial institution must use its reasonable best efforts to cause the shares of preferred stock issued to the Treasury to be approved for listing on a national securities exchange as promptly as possible.

Registration and Piggyback Registration Rights

The financial institution agrees to file a Shelf Registration Statement covering all the preferred stock, warrants and underlying common shares and use its reasonable best efforts to cause such Shelf Registration Statement to become effective and useable for resales until there are no such securities remaining. Notwithstanding the foregoing, the financial institution will not be obligated to file a Shelf Registration Statement if it is not eligible to file a registration statement on Form S-3, unless requested to do so by the Treasury. To the extent that a Shelf Registration Statement is not available and the financial institution proposes to file a registration statement for a subsequent offering, all holders of securities issued pursuant to the Program will have piggyback registration rights to include their securities in a registration statement.

Restrictions on Repurchases

The redemption or repurchase of any equity securities, including trust preferred securities, within the first three years (unless the Treasury’s preferred stock has been redeemed in whole or transferred to a third party) is subject to restrictions under the Agreement. Certain carve-outs are available, including a carve-out for the exchange or conversion of junior stock, parity stock or trust preferred securities for other parity or junior stock as required under certain contractual agreements.

Unilateral Amendments by the Treasury

Section 5.3 of the Agreement permits the Treasury to unilaterally amend any provision of the Agreement to the extent required to comply with any future changes in applicable federal laws. This grants significant power to Congress, and the Treasury has not announced any modifications to this section. Therefore, a financial institution should carefully weigh the potential impact of this section when it considers the advantages and disadvantages of the Program.

Certificate of Designations

The form Certificate of Designations establishes the terms of the preferred stock to be issued by a financial institution under the Program. Under the form Certificate, dividends on the preferred stock will be cumulative and compounding if unpaid on the quarterly dividend payment dates.[3] With the consent of the Treasury, the dividend payment dates may be changed from the dates specified in the Term Sheet. If the dividends are not fully paid for an aggregate of six fiscal quarters, all the holders of the preferred stock (together with the holders of shares of any other voting parity preferred stock) have a right to elect two members of the board of directors of the financial institution. This right continues until all accrued and unpaid dividends for all past dividend periods have been declared and paid in full. Previously, the initial Term Sheet indicated that this right terminated when full dividends were paid for four consecutive dividend periods.

A financial institution must raise at least 25% of the issue price of the preferred stock before the preferred stock can be redeemed within the first three years. The form Certificate clarifies that, with respect to redeeming preferred stock within the first three years, one or more qualified equity offerings may be considered in calculating the minimum amount of gross proceeds received by the financial institution. However, this may not include any offerings made pursuant to any arrangements publicly announced before October 13, 2008. The initial Term Sheet suggested that only one qualified equity offering could be used to meet the gross proceeds minimum. Further, a financial institution may repurchase any other equity securities (other than preferred stock) held by the Treasury after the Treasury’s preferred stock is redeemed in whole or is transferred to a third party. Previously, the right to repurchase under the Term Sheet was only triggered upon the redemption of the Treasury’s preferred stock. Finally, the form Certificate provides additional exceptions to the limitation on the repurchase of shares by the financial institution.

The Certificate of Designations prepared by a financial institution may need to be modified to comply with state specific requirements under the laws of the financial institution’s state of incorporation. We are available to assist you with reviewing applicable state laws to ensure your documents comply with such laws.

Warrant

The form of warrant modifies the date for determining the initial exercise price of the warrant and the market price for determining the number of underlying shares to the date the Treasury accepts the financial institution’s application to participate under the Program. Previously, the initial Term Sheet used the closing date of the transaction. In addition, the form of warrant clarifies that the exercisability of the warrant is subject to the restriction that the number of shares underlying the warrant may be reduced by half if the financial institution receives aggregate gross proceeds of 100% of the issue price of the preferred stock before December 31, 2009. The Treasury may only exercise or transfer a portion of the warrant with respect to up to half of the initial underlying shares before this date.

Based on a letter on warrant accounting from the U.S. Securities and Exchange Commission and the Financial Accounting Standards Board, the warrant will be classified as permanent equity under U.S. GAAP, as long as the issuer of such warrants has sufficient authorized but unissued shares of the underlying stock and has obtained any other necessary stockholder approvals prior to the end of the fiscal quarter in which such warrants are issued.

The form of warrant also provides that in the event the financial institution is no longer listed or traded on a national securities exchange or if stockholders’ consent authorizing a sufficient number of shares underlying the warrants has not been received within 18 months after the issuance of the warrant, the warrant will be exchangeable at the option of the Treasury for an economic interest of the financial institution that is classified as permanent equity under U.S. GAAP having a fair market value of the portion of the warrant exchanged.
The form of warrant also contains anti-dilution adjustment provisions. Significantly, within the first three years (unless the Treasury no longer holds any portion of its warrants), the exercise price and number of shares underlying the warrant will be adjusted if the financial institution issues common stock or convertible securities for consideration (including non-cash consideration) that is less than 90% of the then current market value of the common stock.

 

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[1] The press release and form documents are available on the Treasury’s website at http://www.ustreas.gov/press/releases/hp1247.htm.

[2] The referenced Client Alert and Term Sheet are available at http://www.troutmansanders.com/united-states-treasury-announces-tarp-capital-purchase-program-10-17-2008.

[3] The dividends for preferred stock issued by banks which are not subsidiaries of holding companies will be non-cumulative.