• U.S. Treasury Department Announces TARP Capital Purchase Program for S Corps
  • February 4, 2009 | Authors: Timothy M. Sullivan; Michael D. Morehead
  • Law Firms: Hinshaw & Culbertson LLP - Chicago Office; Hinshaw & Culbertson LLP - Springfield Office
  • General: On October 14, 2008, the United States Department of the Treasury (DOT) announced a voluntary Capital Purchase Program (CPP) as part of the Troubled Asset Relief Program (TARP).

    On January 14, 2009, the DOT posted a summary term sheet for S Corps that desire to participate in the CPP and indicated that the relevant investment documents would be available in a few weeks. Under this portion of the CPP, the DOT will purchase subordinated debentures and a warrant to acquire additional subordinated debentures from eligible participants (as defined below).

    The January 14th term sheet does not apply to mutual organizations. The DOT has indicated that it continues to work with the federal banking agencies on a solution for mutuals.

    Applications: Applications must be submitted by February 13, 2009. Institutions should consult with their primary bank regulator before filing an application.

    An S Corp that previously filed an application with its primary federal banking agency need not refile its application.

    Eligible Participants: The following S Corps may participate in this portion of the CPP:

    • A top tier bank holding company or top tier savings and loan holding company that engages solely or predominately in activities permissible for financial holding companies under relevant law;
       
    • A stand alone U.S. bank or U.S. savings association organized in a stock form; or
       
    • A U.S. bank or U.S. savings association that is a qualifying S Corp subsidiary which is controlled by a holding company which itself is an S Corp and which does not engage solely or predominately in activities that are permitted for financial holding companies under relevant law.

    The DOT will determine the eligibility and allocation for entities desiring to participate in the CPP after consultation with the appropriate federal banking agency.

    Summary of Subordinated Debenture Terms

    Size of Investment: One to three percent of the entity’s risk weighted assets.

    Security: The DOT will acquire Subordinated Debentures (Securities). Each note representing a Security shall be in the principal amount of $1,000.

    Ranking: The Securities will be senior to the issuer’s common stock (and any other class of equity, as applicable, such as if the S Corp converted to a C corporation).
    The Securities issued by a bank or savings association must be expressly subordinated to: (1) claims of depositors; and (2) to the issuer’s other debt obligations to its general and secured creditors, unless such debt obligations are explicitly made pari passu or subordinated to the Securities.

    Securities issued by a holding company must be subordinated to senior indebtedness of the issuer, in accordance with applicable holding company regulations, unless such debt obligations are explicitly made pari passu or subordinated to the Securities.

    Regulatory Capital Status: The Securities will be treated as Tier 2 at a bank or savings association.

    For a stand-alone bank, the amount of the subordinated debt that may be included in Tier 2 capital in combination with any other subordinated debt issued by the bank is limited to 50% of Tier 1 capital.

    The Securities will be treated as Tier 1 for a holding company. However, it will be necessary for the appropriate federal banking agency to issue an interim final rule designating the Securities as Tier 1 capital for holding companies. Previously, the Federal Reserve determined that preferred stock issued to the DOT under the CPP would be treated as Tier 1 capital for holding companies.

    Maturity: 30 years.

    Interest Rate: The Securities will pay interest at a rate of 7.7% per annum for the first five years and thereafter at a rate of 13.8% per annum. Interest will be payable quarterly in arrears.

    The Securities have 7.7% and 13.8% interest rates which equate to after-tax effective rates (assuming a 35% tax rate) of 5% and 9%, respectively; these are the same rates paid on securities issued by other institutions participating in the CPP.

    Interest Deferral For Holding Companies: A holding company may defer interest on the Securities for up to 20 quarters; however any unpaid interest shall cumulate and compound at the then applicable interest rate in effect.

    No dividends may be paid on shares of equity or trust preferred securities of the issuer for so long as any interest deferral is in effect.

    Redemption: The Securities may not be redeemed for a period of three years, except with and to the extent of the net proceeds from a Qualified Securities Offering (as defined below), which results in aggregate gross proceeds of not less than 25% of the issue price of the Securities. Such early redemptions will be limited to the amount raised in the Qualified Securities Offering.

    After the third anniversary, the Securities may be redeemed, in whole or in part, at any time and from time to time, at the option of the issuer.

    All redemptions shall be at 100% of their issue price, plus any accrued and unpaid interest.
    Redemptions must be approved by the issuer’s appropriate federal banking agency.

    “Qualified Securities Offering” means the sale by the issuer of capital which qualifies for at least the same tier or higher of regulatory capital as the Securities (Tier 1 in the case of a holding company and Tier 1 or 2 in the case of a bank or savings association) for cash (other than any sales made pursuant to agreements or arrangements entered into, or pursuant to financing plans which were approved by the issuer’s board of directors or, if applicable, publicly announced, on or prior to January 15, 2009).

    Restrictions on Dividends: Unless all accrued and unpaid interest for all past interest periods on the Securities is fully paid, no dividends may be declared or paid on any shares of equity or trust preferred securities nor may the issuer repurchase or redeem any shares of equity or trust preferred securities.

    The DOT’s consent shall be required for any increase in regularly paid common dividends per share until the third anniversary of the date.

    Between the third anniversary and the tenth anniversary, the DOT’s consent shall be required for any increase in aggregate common dividends per share where the resulting aggregate common dividend per share is greater than 103% of the prior year’s dividend rate per annum. Furthermore no increase in common dividends may be made as a result of any dividend paid in common shares, any stock split or similar transaction.

    The restrictions in the preceding three paragraphs will not apply once the Securities and Warrant Securities (as defined below) have been redeemed in whole or the DOT has transferred all of the Securities and Warrant Securities to unaffiliated third parties.

    Because most S Corps make distributions to shareholders to allow them to pay taxes on the S Corp’s income, the DOT’s consent shall not be required for any increase in dividends where such increase is solely proportionate to the increase in taxable income of the issuer and such increased dividends are distributed to shareholders in order to fund their individual tax payments on such allocable taxable income (Tax Distribution). The DOT (and subsequent investors who purchase the Securities) shall have the right to challenge the amount of the proposed Tax Distributions to the extent it believes they exceed the amount necessary for such shareholders to pay their allocable share of income taxes.

    After the 10th anniversary, the issuer may not pay common dividends or repurchase any equity securities or trust preferred securities until all Securities and Warrant Securities have been redeemed or repurchased in whole.

    Restriction on Acceleration: Principal and accrued interest will only be immediately due and payable: (1) in the case of a holding company, upon the bankruptcy or liquidation of the holding company, the receivership of a major bank subsidiary of the holding company, or deferral of interest on the Securities for more than 20 quarters; or (2) in the case of a bank or savings association, upon the receivership of the bank or savings association.

    Repurchases: The DOT’s consent is required for any repurchases of equity securities or trust preferred securities (other than repurchases of common shares in connection with any benefit plan in the ordinary course of business consistent with past practice or relevant income tax laws) until the 10th anniversary unless prior thereto the Securities and Warrant Securities are redeemed in whole or the DOT has transferred all of the Securities and Warrant Securities to third parties.

    In addition, there shall be no share repurchases of equity if prohibited as described above (see “Restrictions on Dividends,” above).

    After the 10th anniversary, the issuer may not pay common dividends or repurchase any equity securities or trust preferred securities until all Securities and Warrant Securities have been redeemed or repurchased in whole.

    Voting Rights: The Securities shall be nonvoting, other than class voting rights on: (1) any authorization or issuance of any equity securities which purport to rank senior to the Securities; (2) any amendment to the rights of Securities; or (3) any merger, exchange or similar transaction which would adversely affect the rights of the Securities.

    Election of Directors: If interest is not paid in full for six interest periods, whether or not consecutive, the holders of the Securities will have the right to elect two directors, which right will end when full interest has been paid for all prior interest periods.

    Transferability: The DOT and its transferees will not effect any transfer of the Securities which would require the issuer to become subject to the periodic reporting requirements of Section 13 or 15(d) of the Exchange Act.

    If the issuer otherwise becomes subject to such reporting requirements, it must file a shelf registration statement covering the Securities as promptly as practicable and shall take all action to cause such shelf registration statement to be declared effective as soon as possible. In addition, the DOT and its transferees shall have piggyback registration rights for the Securities.

    Executive Compensation: The issuer and its senior executive officers covered by the Emergency Economic Stabilization Act of 2008 (EESA) (the CEO, CFO and the next three most highly paid officers) must modify or terminate all benefit plans, arrangements and agreements (including golden parachute agreements) to the extent necessary to be in compliance with Section 111 of ESSA. For so long as DOT holds any equity or debt securities (including the Securities) of the issuer, the issuer shall be bound by the executive compensation and corporate governance requirements of Section 111 of the EESA and any guidance or regulations issued by the Secretary of the Treasury on or prior to the date of the investment.

    The issuer and its senior executive officers covered by the EESA must execute a waiver releasing the DOT from any claims that the issuer and such officers may otherwise have as a result of the issuance of any regulations which modify the terms of benefits plans, arrangements and agreements to eliminate any provisions that would not be in compliance with the executive compensation and corporate governance requirements of Section 111 of the EESA and any guidance or regulations issued by the Secretary of the Treasury on or prior to the date of the investment.

    A memo discussing the DOT executive compensation rules may be found at www.hinshawlaw.com/hinshaw-special-alert-10-17-2008.

    Affiliate Transactions: For as long as the DOT holds any debt or equity securities (including the Securities) of the issuer, the issuer and its subsidiaries may not enter into transactions with related persons (as defined in Item 404 under the SEC’s Regulation S-K – directors and executive officers and their family members and related businesses) unless such transactions are: (1) on terms no less favorable to the issuer and its subsidiaries than could be obtained from an unaffiliated third party; and (2) have been approved by the audit committee or a comparable body of independent directors of the issuer, or if there are no “independent directors,” of the issuer by the board of directors, but only if the board maintains written documentation supporting its determination that the transaction meets the requirements of (1) of this paragraph.

    Summary of Warrant Terms

    Warrant: The DOT will receive warrants to purchase Securities in an amount equal to 5% of the amount of its Securities investment (Warrant Securities), for an exercise price of $0.01 per $1,000 note.

    The DOT will immediately exercise the warrants.

    Term: 10 years for the Warrant, with the Warrant Securities having a maturity of 30 years.

    Warrant Securities: The Warrant Securities shall have the same rights, preferences, privileges, voting rights and other terms as the Securities, except that:

    • the Securities will pay interest at a rate of 13.8% per annum,
    • the Warrant Securities may not be redeemed until all the Securities have been redeemed.

    Transferability: The DOT will not effect any transfer of the warrants or underlying Warrant Securities which would require the issuer to become subject to the periodic reporting requirements of Section 13 or 15(d) of the Exchange Act.

    If the issuer otherwise becomes subject to the periodic reporting requirements of Section 13 or 15(d) of the Exchange Act, it must file a shelf registration statement covering the warrants and the Warrant Securities as promptly as practicable and take all action required to cause such shelf registration statement to be declared effective as soon as possible. In addition, the DOT and its transferees shall have piggyback registration rights for the warrants and the Warrant Securities.