- Deadlines for Financial Market Initiatives Are Approaching
- January 14, 2009 | Author: David B. Miller
- Law Firm: Faegre & Benson LLP - Minneapolis Office
The federal government has created numerous programs to bolster financial markets. This update discusses two programs with imminent participation deadlines: the FDIC's Temporary Liquidity Guarantee Program (TLGP) and the portion of the U.S. Department of the Treasury's Capital Purchase Program (CPP) designed for non-publicly traded financial institutions.
The TLGP is an opt-out program with an opt-out deadline of December 5. The CPP is an opt-in program—and the deadline for non-publicly traded financial institutions to apply is December 8.
FDIC Temporary Liquidity Guarantee Program: Should you Opt-out?
On November 21, the FDIC adopted a final rule to implement the TLGP. Pursuant to the final rule, FDIC-insured depository institutions, bank and financial holding companies, and certain savings and loan holding companies are eligible to participate. The TLGP, which became effective on October 14, has two components: 1) a debt guarantee program; and 2) a transaction account guarantee program. Initially, all eligible entities were deemed to be participants in the TLGP. However, eligible entities may opt-out of one or both programs no later than December 5.
Who Is Eligible?
Eligible entities include FDIC-insured depository institutions, any U.S. bank holding company or financial holding company, and any U.S. savings and loan holding company that either engages only in activities that are permissible for financial holding companies to conduct under Section 4(k) (12 USC 1843(k)) of the Bank Holding Company Act of 1956 (BHCA) or has at least one insured depository institution subsidiary that is the subject of an application that was pending on October 13, 2008, pursuant to section 4(c)(8) of the BHCA, or any affiliate of these entities approved by the FDIC after a written request made by, and the positive recommendation of, the appropriate federal banking agency.
Debt Guarantee Program
The debt guarantee program will temporarily guarantee all newly-issued senior unsecured debt up to prescribed limits that is issued by participating entities on or after October 14, through and including June 30, 2009. The program guarantees timely payment of principal and interest of covered debt and the FDIC has made clear that the debt is backed by the full faith and credit of the United States. Accordingly, the FDIC's duty to pay holders of guaranteed debt will arise upon the uncured failure of an issuer of debt to make a timely payment of principal or interest.
Senior Unsecured Debt
By definition, eligible debt is unsecured borrowing that:
- Is evidenced by a written agreement or trade confirmation
- Has a specified and fixed principal
- Is noncontingent and contains no embedded options, forwards, swaps, or other derivatives
- Is not, by its terms, subordinated to any other liability
- Has a stated maturity of more than 30 days
Senior unsecured debt includes obligations such as federal funds purchased and U.S. dollar denominated certificates of deposit owed to an insured depository institution, an insured credit union as defined in the Federal Credit Union Act, or a foreign bank. Eligible debt must be issued on or before June 30, 2009. For eligible debt issued by that date, the FDIC will provide guarantee coverage until the earlier of the maturity date of the debt or until June 30, 2012 (regardless of whether the liability has matured at that time).
The FDIC will temporarily guarantee newly issued unsubordinated debt in a total amount up to 125 percent of the par or face value of senior unsecured debt outstanding, excluding debt extended to affiliates, as of September 30, and that was scheduled to mature on or before June 30, 2009. This maximum guaranteed amount will be calculated for each individual participating entity within a holding company structure.
If a participating entity that is an insured depository institution had either no senior unsecured debt as of September 30, or only federal funds purchased, its debt guarantee limit is 2 percent of its consolidated total liabilities as of September 30. If a participating entity, other than an insured depository institution, had no senior unsecured debt as of September 30, it may make a request to the FDIC to have some amount of debt covered by the TLGP. The FDIC, after consultation with the appropriate Federal banking agency, will decide whether, and to what extent, such requests will be granted on a case-by-case basis.
The FDIC's agreement arising from the debt guarantee program does not exempt any participating entity from complying with federal and state securities laws and with any other applicable laws. However, the FDIC submitted a request for interpretive guidance to, and received a favorable response from, the SEC to the effect that senior unsecured debt of eligible institutions that is fully and unconditionally guaranteed by the FDIC under the program will be considered guaranteed by an instrumentality of the United States for purposes of Section 3(a)(2) of the Securities Act of 1933 and therefore exempt from the registration provisions of that act.
Transaction Account Guarantee Program
Through this component of the program, the FDIC is guarantying all deposits held at insured banks in noninterest-bearing transaction accounts. So, unless an insured bank opts out of this component of the FDIC's program, any amount in excess of existing deposit insurance limits will be insured through December 31, 2009.
The transaction account component of the program applies to "noninterest-bearing transaction accounts." A "noninterest-bearing transaction account" is defined as a transaction account with respect to which interest is neither accrued nor paid and on which the insured depository institution does not reserve the right to require advance notice of an intended withdrawal.
The definition covers traditional demand deposit checking accounts that allow for an unlimited number of deposits and withdrawals at any time. It does not encompass interest-bearing money market deposit accounts. However, for purposes of the transaction account guarantee program, the FDIC is including in the definition of a noninterest-bearing transaction account:
- Accounts commonly known as Interest on Lawyers Trust Accounts (IOLTAs) and functionally equivalent accounts; and
- Negotiable order of withdrawal accounts (NOW accounts) with interest rates no higher than 0.50 percent for which the insured depository institution at which the account is held has committed to maintain the interest rate at or below 0.50 percent.
Effective November 13, any eligible entity that does not choose to opt out of the debt guarantee component of the program will be assessed fees determined by multiplying the amount of FDIC-guaranteed debt times the term of the debt (expressed in years) times an annualized assessment rate. The assessment rate is: 50 basis points for debt with a maturity of 180 days or less; 75 basis points for debt with a maturity of 181 to 364 days; and 100 basis points for debt with a maturity exceeding 364 days. Under certain circumstances, the rate can be increased by 10 basis points.
For noninterest-bearing transaction deposit accounts, a 10 basis point annual rate surcharge will be applied to noninterest-bearing transaction deposit amounts over $250,000. Banks will not be assessed on amounts that are otherwise insured. This surcharge will be collected through the normal assessment cycle.
If fees are not enough to cover costs of the program, the difference will be made up through a special assessment on all insured institutions, whether or not they participate in the FDIC's program.
Should You Participate in the TLGP?
All eligible entities must file the FDIC Temporary Liquidity Guarantee Program Election Form, using FDIConnect, no later than 11:59 p.m. (Eastern Standard Time) on December 5.
Insured banks may elect to opt out of either program component, or both. Other eligible entities may elect to opt out of the debt guarantee program and will not be covered by the transaction account guarantee program. So, what should you do?
Decisions Are Final
The decision to participate generally cannot be changed. So, an entity that opts out of either component can not later reverse the decision, and an entity that does not opt out cannot opt out at a later date.
An insured bank that opts out of the transaction account guarantee program will likely lose deposits to participating banks. The FDIC will maintain and post on its Web site a list of eligible entities that opt out of the transaction account guarantee program.
Beginning December 19, every insured depository institution that offers noninterest-bearing transaction accounts must post a prominent notice in the lobby of its main office and each branch, and, if it offers Internet services, on its Web site, clearly indicating whether it is participating in the transaction account guarantee program. If the institution is participating in the transaction account guarantee program, the notice must also state that funds held in noninterest-bearing transactions accounts at the entity are insured in full by the FDIC.
If you do not opt out, there are no fees if a program component is not used. However, if the assessments on participating entities are not adequate to cover the costs of the program all insured institutions will be assessed.
Few Benefits in Opting Out
While a bank could choose to opt out, there is little upside to doing so. A bank that opts out would not have to pay a 10 basis point surcharge on any noninterest bearing transaction accounts with balances exceeding $250,000 but at what cost to its deposit base? Even if a bank does opt out, it may still be assessed if the FDIC is required to impose a special assessment. For eligible non-banks, fees are only imposed if covered debt is issued.
For institutions for which additional debt capital is an appropriate element of the capital structure, government-guaranteed unsecured debt is expected to be an attractive financing option. Debt of participating institutions is expected to be viewed as a form of synthetic Treasury security, trading at a premium to Treasuries, but at a discount to current yields for the issuing institution's debt. Goldman Sachs Group, JPMorgan Chase and Morgan Stanley completed last week successful issues aggregating $17.25 billion of FDIC-guaranteed debt under the debt guarantee program. Many financial firms are expected to follow with similar issues.
The Capital Purchase Program: Is It Right for Your Non-publicly Traded Financial Institution?
On November 17, the Treasury published a summary term sheet for Treasury investments under the CPP in non-publicly traded qualifying financial institutions. While a form of securities purchase agreement is not yet available as there is for publicly traded financial institutions, the private company term sheet gives a good indication of the principal differences private institutions can expect should they apply for CPP funds. And while there are more similarities than differences when comparing the terms of the Treasury's investment regime between public and private institutions, the differences can be significant and , in some cases, even the similarities can have materially different consequences for private entities.
These considerations will be important in determining whether to apply for participation in the CPP by the extended deadline for private entities of December 8.
Who Is Eligible?
As with the publicly traded participants, eligible qualifying financial institutions are limited to top-tier bank holding companies or savings and loan holding companies or , where not owned by a holding company, U.S. banks and savings associations. The additional qualification is that the entity not be "publicly traded." To be "publicly traded" , a financial institution must be both traded on a national securities exchange and required to file periodic reports under the federal securities laws. So, for example, neither companies with securities trading on the NASDAQ OTC Bulletin Board, nor companies that voluntarily file reports under the Securities Exchange Act of 1934, would be deemed "publicly traded." Further, the entity must not be organized in a mutual form or have elected taxation under Subchapter S of the Internal Revenue Code. the Treasury hopes to have issues relating to participation by these entities resolved soon.
What's Different for Private Companies?
Many of the changes in terms in the private company term sheet have their origin in the relative illiquidity of the Treasury's investment. Without a well-regulated, transparent trading market for its securities and readily available public information on the issuer, an investment in private company securities presents fundamental differences in terms of value and risk. Other changes in terms appear to stem from the relative lack of corporate governance discipline imposed on private companies. Still other changes arise from the Treasury's willingness to respect the typical private company's closely held ownership of voting securities.
The principal differences are summarized below:
Restrictions on common dividends. Until the third anniversary from issuance, both a public and private entity may not increase the common stock dividends it pays, without the consent of the Treasury, unless the securities acquired by the Treasury have been redeemed or transferred. Following the third anniversary, while a public company is no longer prohibited from increasing dividends, a private company may not increase aggregate common dividends greater than 3 percent per annum. Additionally, following the tent anniversary of issuance of the securities, a private company participant will be prohibited from paying any common dividends without Treasury approval, unless the securities acquired by the Treasury have been redeemed or transferred.
Restrictions on repurchases of equity securities. Generally privately held institutions will be prohibited from making any repurchases of common stock or other equity securities or trust preferred until the securities held by the Treasury are redeemed or transferred. However, prior to the tenth anniversary of issuance, private financial institutions will be allowed to repurchase junior preferred and common stock in connection with any benefit plan in the ordinary course of business consistent with past practice. Publicly traded companies are free to purchase junior securities after the third anniversary of issuance of the securities to the Treasury.
Voting rights of preferred stock. While both public and private company preferred stock investments are generally non-voting, the Treasury will have the right to vote as a class on any amendment to the rights of its preferred stock issued by a private company. In the case of a public company, the amendment must affect the class of preferred stock adversely in order for the Treasury to have a class vote.
Transferability. Both public and private entities are expected to issue the securities free of restrictions on transferability, except as may apply under the securities laws. So, for private companies, this means the Treasury will not agree to be a party to any stockholder or buy\sell agreement that otherwise would limit its rights. However, the Treasury will agree not to transfer its holdings in a private company in a way which would require the company to become subject to periodic reporting under the securities laws. If a private company otherwise becomes subject to the periodic reporting requirements, it must file a shelf registration under the Securities Act to permit resales of Treasury-owned securities, just as publicly traded companies are required to do.
Warrants. the Treasury will require the issuance of warrants from private companies, but for preferred stock, rather than common stock, as is the case for public companies. The preferred stock will bear a dividend rate of 9 percent per annum and may not be redeemed until all other preferred has been redeemed, but will otherwise be on terms identical to the initial preferred stock investment being made by the Treasury. Participants will be required to issue warrant preferred stock with a liquidation preference equal to 5 percent of the other preferred stock being issued to the Treasury. The exercise price of the private company warrants will be $.01 per preferred share and the Treasury has indicated its intent to exercise these warrants in full immediately. So, while there will be no voting common stock dilution or risk of becoming publicly held by reason of CPP participation for private companies, the preferred warrants will impose an economic cost on existing equity holders.
Executive compensation restrictions. Private companies are required to observe the same restrictions on executive compensation as are imposed under the CPP on publicly traded companies. In addition to the chief executive officer and the chief financial officer, a private company will need to determine the next three most highly compensated executive officers as calculated under rules applicable to compensation disclosure for public companies. Employee plans and agreement and compensation committee protocols will need to be reviewed to determine whether modifications are needed to accommodate the applicable restrictions imposed.
Interested party transaction limitations. While the Treasury holds its investment, private companies must observe a prohibition on transactions between the company and related persons, as defined by applicable public company disclosure rules, unless the transaction is on terms no less favorable to the company than could be obtained from unaffiliated third parties and is approved by the audit committee or comparable body of independent directors. Public companies have disclosure and corporate governance rules that are intended to have this effect, but are not subject to an express prohibition. It is not entirely clear at this time whether existing transactions are grandfathered and what other carve outs available to public companies will be available to private companies.
Should You Participate in the CPP?
Decisions to participate in the CPP should be based on unique characteristics of each privately held institution. However, the following considerations should be weighed.
Potential Benefits of Participation
- Is cost of capital too good to pass up? The answer to this question may vary, but when compared to what is available in the market, the price appears quite attractive.
- The capital is tier 1 capital. Could you be competitively disadvantaged versus peers which do participate and may be or appear to be better capitalized? Keep in mind that the regulatory agencies have historically based their capital evaluations on comparison with a bank's peers.
- Do you anticipate needs for capital, whether for growth, loss absorption or other uses?
- Are you concerned about public relations in an environment where not participating may signal that somehow the institution is "unhealthy?" Do you have a public relations plan in place?
- The program does not result in dilution of common stock.
- If you don't apply now, you are unlikely to get another opportunity to do so.
Potential Drawbacks of Participation
- The capital is relatively cheap, but it's not free.
- Can you live with the various restrictions to be imposed on compensation, dividends, repurchases and related party transactions, as well as the possibility those restrictions could be unilaterally enlarged by the Treasury if applicable law changes?
- Are you comfortable with the possible transfer of your equity by the Treasury?
- Do you have sufficient authorized capital, including preferred stock, to participate, or will it require potentially cumbersome shareholder action?
- Do you have a profitable use for the capital, or is your capital sufficient? If you don't anticipate increased loan demand or other profitable uses, even low cost capital may not be worth the "red tape" associated with the presence of the US Government as a stockholder and any other regulatory scrutiny?
- Are you concerned about public relations in an environment where participating may suggest to some that you "need" the capital? Do you have a public relations plan developed?
Because the Treasury and the banking regulators have been unwilling to divulge the criteria to be used in determining which banks can participate and which cannot, there's no sure way to know whether, even if eligible and interested in participating, a financial institution will get CPP approval. Interested institutions should contact their primary federal regulator as early as possible to begin a dialogue about possible participation.
Fresh Source of Capital for Private Companies
While the volume of available CPP dollars is much smaller than that available to publicly traded institutions, the extension of the CPP to private entities greatly expands the number of eligible participants and the opportunity to diversify the capital available to recapitalize the banking system. While different in certain material respects from the public company program, the CPP program for private institutions seems to be an equally inviting source of fresh capital for private companies at a time when private sources of capital are severely limited.