On Wednesday, January 14, 2009, at approximately 5:00 p.m. eastern time, the Treasury Department released a Subchapter S term sheet under the TARP Capital Purchase Program (the “CPP”). This term sheet applies specifically to Subchapter S banks and bank holding companies and is the third such term sheet to be released under the CPP thus far; the first two being for publicly held and privately held C corporations, respectively. The deadline for submitting applications under the CPP for Subchapter S institutions is 5:00 p.m. eastern time on February 13, 2009.
The terms of the CPP for Subchapter S institutions are strikingly different from those for publicly and privately held C corporations and should be evaluated solely by reference to the Subchapter S term sheet and accompanying Q&A document. The term sheet authorizes qualifying financial institutions to issue subordinated debentures (called “Senior Securities”) to the Treasury Department in amounts between 1% and the lesser of $25 billion or 3% of the entity’s risk-weighted assets. These Senior Securities will have a maturity of 30 years and will bear interest at an annual rate of 7.7% for the first five years, then at an annual rate of 13.8% thereafter.[1]
For bank holding companies, the Senior Securities will be treated as Tier 1 capital (subject to the Federal Reserve issuing an interim final rule designating them as such for bank holding companies). For stand-alone banks not controlled by bank holding companies however, the Senior Securities will be treated as Tier 2 capital.[2]
Unless institutions have been certified by the Treasury Department as community development financial institutions,[3] Treasury will also receive immediately exercisable warrants to purchase additional Senior Securities (called “Warrant Securities”) in an amount equal to 5% of Treasury’s initial Senior Securities investment. These Warrant Securities will also have a maturity of 30 years and will bear interest at an annual rate of 13.8%. For example, an institution that issues $1,000,000 in Senior Securities will also grant Treasury an additional $50,000 in Warrant Securities. Upon maturity, redemption or repurchase, the institution will then have to repay any accrued and unpaid interest and $1,050,000 in combined principal.
Under certain circumstances, substantial restrictions may be placed on the payment of dividends. In general, as long as all accrued interest remains timely paid, institutions are permitted to pay common dividends, including dividends to cover shareholders’ portion of the entity’s tax liability. For the first three years however, prior consent from Treasury is required for any increase in common dividends over 103% of the prior year’s annual dividend rate. Treasury did make an exception to this restriction in the case of a dividend increase that is solely proportionate to an increase in the shareholders’ tax liability for Sub S income. If, at any time, the institution elects to defer interest payments, it will be prohibited from paying any dividends on equity shares or trust preferred securities for as long as any interest deferral remains in effect. This appears to include the payment of dividends to cover shareholders tax payments on Sub S income. Likewise, after ten years from the investment date, institutions can no longer pay common dividends until all Senior Securities and Warrant Securities have been completely redeemed or repurchased.
In addition to dividend restrictions, the term sheet also contains provisions on executive compensation requiring institutions to comply with the restrictions contained in the Emergency Economic Stabilization Act of 2008. There are also limitations on transactions with related persons (within the meaning of Item 404 under SEC Regulation S-K).
The following link is to the Treasury Department’s press release containing the Subchapter S term sheet and accompanying Q&A. http://www.treasury.gov/press/releases/hp1354.htm
If you have any questions about the Subchapter S term sheet under the TARP Capital Purchase Program, please feel free to contact us by telephone at (210) 228-9961 or by email at info@subsbanks.org.
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[1] According to the Treasury Department, the interest rates for the Subchapter S term sheet were adjusted upwards to reflect the tax deductibility of interest payments on the Senior Securities and equalize them with the interest rates on non-tax deductible preferred stock investments in C corporations.
[2] It may be possible for a bank that does not have a bank holding company today, to form a bank holding company before the February 13 deadline; alternatively it may be possible to negotiate with Treasury to allow the assumption of the bank’s Senior Securities by the newly formed bank holding company so that they could be treated as Tier 1 capital. The Association intends to raise these issues promptly with the Treasury Department.
[3] A “community development financial institution” is defined under 12 U.S.C. § 4702(5)(a) as “a person (other than an individual) that—(i) has a primary mission of promoting community development; (ii) serves an investment area or target population; (iii) provides development services in conjunction with equity investments or loans, directly or through a subsidiary or affiliate; (iv) maintains, through representation on its governing board or otherwise, accountability to residents of its investment area or targeted population; and (v) is not an agency or instrumentality of the United States, or of any State or political subdivision of a State.”
