By Beth Vessel

On Wednesday, June 17, President Obama announced a plan for financial regulatory reform, available at this link.

The plan will require action by Congress.  It is divided into the following five sections:

• Promote robust supervision and regulation of financial firms.

This section of the plan proposes forming a Financial Services Oversight Council, consisting of the heads of various financial regulatory agencies, to identify systemic risks and improve interagency cooperation.  The plan would also give new authority for the Federal Reserve to supervise all firms that could pose a threat to financial stability, event those that do not own banks.  The plan specifically grants the Federal Reserve the authority to supervise all firms that could pose a threat to financial stability based on their size, leverage and interconnectedness to the financial system (calling such firms “Tier 1 Financial Holding Companies”).  It would impose strong capital standards for all financial firms and even higher standards Tier 1 Financial Holding Companies.  It would set up a National Bank Supervisor to supervise all federally chartered banks, taking over such duties from the Office of the Comptroller of the Currency.  The Office of Thrift Supervision would be rolled into the National Bank Supervisor.  In addition, the plan would require advisers of hedge funds and other private pools of capital of any significant size to register with the SEC.  The plan would also close loopholes in current regulations by requiring industrial loan companies to become bank holding companies and therefore be regulated by the Federal Reserve.  The Federal Reserve and the Federal Deposit Insurance Corporation would maintain their respective roles in the supervision and regulation of state-chartered banks.

• Establish comprehensive supervision of financial markets.

The plan proposes enhanced regulation of securitization markets, including new requirements for market transparency, stronger regulation of credit rating agencies and a requirement that issuers and originators retain a financial interest in securitized loans.  The plan would regulate all over-the–counter derivatives.  The plan does not merge the Securities and Exchange Commission and the Commodities Futures Trading Commission, but requires that they make recommendations to Congress on how to eliminate differences in their statutes for similar financial products if such differences are not essential to achieving investor protection.  The plan would also grant the Federal Reserve authority to oversee certain payment, clearing and settlement systems. 

• Protect consumers and investors from financial abuse.

This section of the plan would institute a new Consumer Financial Protection Agency to protect consumers from unfair, deceptive and abusive practices by providers of credit, savings, payment and other financial products and services.  It proposes stronger regulations to improve the transparency, fairness and appropriateness of consumer and investor products and services.  The plan makes it clear that rules enacted by the new agency would not pre-empt tougher state consumer laws.

• Provide the government with the tools it needs to manage financial crises.

This section proposes a new regime, modeled on the existing Federal Deposit Insurance Company authority, to address the potential failure of a bank holding company or other nonbank financial firm when the stability of the financial system is at risk.  It also proposes revisions to the Federal Reserve’s emergency lending authority to improve accountability, requiring that the Federal Reserve Board receive prior written approval from the Secretary of the Treasury for emergency lending under its “unusual and exigent circumstances” authority.

• Raise international regulatory standards and improve international cooperation.

The plan proposes international reforms, including strengthening the capital framework, improving oversight of global financial markets, coordinating supervision of internationally active firms and enhancing crisis management tools.  The United States is paying a leadership role in efforts to coordinate international financial policy through the G-20, the Financial Stability Board and the Basel Committee on Banking Supervision, and the plan contemplates using this position to promote the foregoing initiatives.

By Beth Vessel

The U.S. Treasury Department has released the form of securities purchase agreement for privately held financial institutions applying for the capital purchase program.  You can review the securities purchase agreement at this link.  This form of securities purchase agreement does not apply to S corporations. 

Other than differences previously identified in the term sheet for privately held institutions (see our previous post here) and provisions that work better for institutions that are publicly held, such as registration rights provisions, terms of the securities purchase agreement are similar to the terms of the securities purchase agreement for publicly held companies.  A comparison of the new private company securities purchase agreement to the version being used by public companies is available at this link.

By Beth Vessel

The U.S. Treasury Department released the term sheet and answers to frequently asked questions for privately held financial institutions applying for the capital purchase program.  You can see the term sheet at this link and the frequently asked questions here.

The application deadline for privately held institutions is Monday, Dec. 8, 2008.  The term sheet does not cover S-corporations.  Treasury has indicated that the structure for such entities is still under consideration, and the December 8 deadline will therefore not apply to S-corporations. 

The new term sheet provides that Treasury shall not effect any transfer of the preferred securities that would require the financial institution to become subject to periodic reporting requirements.  If the financial institution becomes subject to these requirements, it will be required to file a shelf registration statement covering the preferred stock, the warrants and the shares of preferred stock issuable upon exercise of the warrants.

The terms of the preferred securities are otherwise similar to the terms previously applied to publicly held financial institutions, with a few exceptions.  You can find a comparison of the two term sheets by clicking here.

• Common Dividends:  In addition to the consent requirement for any increase in common dividends for the first three years of the investment, the new term sheet requires Treasury’s consent for any increase in common dividends per share greater than 3 percent per annum between the third and tenth anniversary of the date of the investment.
• Repurchases:  The private company term sheet generally requires Treasury’s consent to the repurchase of equity or trust preferred securities until the tenth anniversary of the date of investment, while the term sheet for public institutions had such a restriction for only three years.
• Other Dividend and Repurchase Restrictions: The private company term sheet prohibits the financial institution from paying common dividends or repurchasing securities during the first 10 years after the investment.
• Related Party Transactions:  The private company term sheet provides that the financial institution may not enter into transactions with related persons unless the transactions are on terms no less favorable than could be obtained from an unaffiliated third party and have been approved by the institution’s audit committee or comparable body.
• Warrant Terms: The private company term sheet provides for warrants to purchase preferred stock (rather than common stock, as was the case with the public company term sheet) having a liquidation preference equal to 5 percent of the preferred stock (rather than 15 percent, as was the case for public companies).  The initial exercise price for the warrants is set at $0.01 per share or such greater amount as the company’s charter may require as the par value per share.  There is no reduction in the number of warrants based on receipt of proceeds from qualified equity offerings, and the private company term sheet provides that Treasury intends to exercise the warrants immediately.  The preferred shares received upon exercise of the warrants will pay dividends at a rate of 9 percent per year.

The frequently asked questions indicate that Treasury will exempt investments from the warrant requirements if:

• the size of the investment is $50 million or less; and
• the financial institution is a certified Community Development Financial Institution.

CDFIs are specialized financial institutions that work in market niches that are underserved by traditional financial institutions, providing services in economically distressed target markets, such as mortgage financing for low-income and first-time homebuyers and not-for-profit developers, flexible underwriting and risk capital for needed community facilities and technical assistance, commercial loans and investments to small start-up or expanding businesses in low income areas.  In order to qualify for this exemption, a financial institution must have a completed application to be a CDFI at the time the CPP application is filed, and the CDFI application must be approved at the time of the closing of the investment.  You can find additional information about becoming a CDFI here.

By Beth Vessel

Treasury Secretary Henry Paulson announced Wednesday that the TARP program will likely not be used to purchase troubled assets as originally planned.  He said that the purchase of illiquid mortgage-related assets, the original purpose of the TARP legislation, is not the most effective way to use TARP funds.  He said that the administration will continue to use the program to purchase stock in banks as a way to bolster their balance sheets and encourage them to resume more normal lending.  He listed three critical priorities for remaining TARP funds:

• Reinforcing the stability of the financial system, so that banks and other institutions providing credit will be able to support economic recovery and growth;
• Supporting markets for securitizing credit outside of the banking system, including areas such as credit card debt, auto loans and student loans; and
• Exploring ways to reduce the risk of foreclosure.

The full transcript of Secretary Paulson’s remarks can be found at this link.

By James Bristol

The FDIC announced yesterday that the deadline to opt out of the liquidity guarantee program (discussed here) has been extended. All FDIC eligible entities are automatically covered until Dec. 5, 2008. Thereafter, participation fees will apply unless the entity opts out of the program. The FDIC announcement and application forms are available at this link.
 
While no decision has to be made today, we are not currently seeing a rush to opt out of the program. Industry sources tell us that the liquidity guarantee program is perceived as inexpensive and potentially effective for attracting deposits.

By Beth Vessel

The Treasury Department issued additional documents for publicly traded financial institutions applying for the capital purchase program this afternoon. The documents, with links provided, include:

Securities Purchase Agreement
This document describes the terms of the financial institution's agreement to issue shares and fulfill other requirements in exchange for Treasury's investment.

Form of Letter Agreement
This contractual agreement describes the firm-specific information necessary to implement the securities purchase agreement and represents the financial institution's commitment to the terms of the Securities Purchase Agreement.

Certificate of Designations
This document creates the preferred shares.

Form of Warrant – Stockholder Approval Not Required
This document describes the terms of the warrants Treasury receives when stockholder approval is not required.  

Form of Warrant – Stockholder Approval Required
This document describes the terms of the warrants Treasury receives when stockholder approval is required.

After a financial institution is granted preliminary approval, the institution must complete and submit the securities purchase agreement, letter agreement, certificate of designations and warrant. Financial institutions that are granted preliminary approval will receive a letter from the Treasury Department with instructions regarding filing the documents and completing the process.

Once the investment agreements are complete and the investment is authorized, within two business days Treasury will publicly disclose the name and capital purchase amount for the financial institution. The information will be posted at Treasury's web site updated daily at 4:30 p.m. (EDT) as needed.

Treasury also confirmed that it 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.

By Beth Vessel

• Bank of America Corporation
• The Bank of New York Mellon Corporation
• Citigroup Inc.
• JP Morgan Chase & Co.
• Morgan Stanley
• Wells Fargo & Company
• Merrill Lynch & Co., Inc.

 With some notable exceptions, these documents generally match the term sheet published by Treasury on Oct. 14, 2008. 

Preferred Stock

The original term sheet indicated that Treasury’s right to elect directors would terminate once the issuer had paid full dividends for four consecutive quarters. The Citigroup, however, filing indicates that Treasury will retain this right until all accrued and unpaid dividends for all past dividend periods have been declared and paid in full. This is contained in Citigroup’s certificate of designation.

Warrant Terms

The warrant issued with the preferred stock provides for conversion of the warrant in the event of a business combination or reclassification of common stock. There are restrictions on the ability to redeem common stock acquired through the warrant, as indicated in the Citigroup warrant.

Purchase Agreement Terms

The issuer is required to make extensive representations and warranties to Treasury, the purchaser, as would be typical in a stock purchase and merger agreements. These representations survive the closing of the CPP transaction. One notable item is a representation that derivative instruments, including swaps, caps, floors and option agreements, were prudent and believed to be financially responsible when entered into, and that there are no breaches of such obligations (subject to material adverse effect qualifier). One of the more significant terms is that Treasury gets permission to examine and make copies of corporate books and to review and discuss with the officers affairs, finances and accounts and all material information that was provided to the issuer’s federal banking agency in the CPP investment. The terms from the Citigroup filing are available at this link. 

By James Bristol

News evolves daily on the Capital Purchase Program (CPP).  Here are updates from what we have learned today.

Nov. 14, 2008 Application Deadline is Only for Publicly Traded Financial Institutions
On Tuesday, Treasury officials met with representatives of the American Bankers Association and said that the CPP term sheet and Nov. 14, 2008 deadline only apply to publicly traded banks and bank holding companies. A separate term sheet and deadline will apply to other types of institutions.

Special Meeting to Authorize Preferred Stock
A number of potential applicants do not have authorization to issue preferred stock needed to participate in the program. Treasury says these institutions can apply by Nov. 14, 2008 but should hold a special shareholders meeting as soon as possible. At least six bank holding companies have already announced special shareholder meetings to authorize preferred stock.

No Intent to Change SEC Reporting Obligations
Treasury does not intend to alter SEC reporting obligations. It is working on a solution for privately held participants that issue warrants to Treasury and obtain more than 500 shareholders of record in a subsequent sale by Treasury.

Shelf-Registration Eligibility
Treasury expects to have a solution soon for banks that are not exchange-traded and are ineligible to file a shelf registration for the preferred stock and warrants as required under the CPP.

Congress Further Scrutinizes Executive Pay
Rep. Henry Waxman (D-Calif.) said Tuesday that the House Committee on Oversight and Government Reform is investigating compensation practices at the nine financial institutions that were identified as participants in the CPP at the time Treasury announced the program. Waxman said he is concerned that the capital infusion not be used to pay “billions” in bonuses. By Nov. 10, 2008, these institutions must provide full compensation details, including all employees who earned more than $500,000 in each of the last two years.

The Treasury Department has announced three programs under the Emergency Economic Stabilization Act passed by Congress on Oct. 3, 2008. The first is the TARP Capital Purchase Program (CPP). The CPP is intended to be available generally to any U.S. bank or savings association and certain U.S. bank holding companies and savings and loan holding companies. Two additional programs are being developed for institutions with "troubled" assets, including a program for systematically significant failed institutions (PSSFI) and the troubled asset auction program (TAAP).
 
The details of the CPP and executive compensation restrictions are summarized below. Treasury's announcement encourages participation and instructs applicants to work with their federal banking agency (FDIC, OTS, OCC, FRB). The development of approval criteria is moving at breakneck speed with new informal guidance being provided almost daily. One regional office of the FDIC has intimated in the last few days that healthy institutions are the most likely to be approved. Some in the industry believe that banks will be judged by their CAMELS score, and that those with poor scores may not be able to use the CPP to improve their capital position. Although CAMELS scores are confidential and not subject to disclosure, some industry players have been told that a denied application will be treated as an indication of a low score. Treasury will not disclose who it turned down, so an institution may want to consider carefully announcing that it is applying for the CPP, which means weighing in SEC disclosure obligations for reporting companies. Some also are hearing from their regulators that the intended use of the funds will be considered, which was not evident in the announcement from Treasury. We have heard informally that at least one regional office of the FDIC has told applicants that funds can be used for acquisitions as long as the target is identified in the application. This seems impractical, given the Nov. 14, 2008 deadline for application. All of these reports combine to underscore the rapidly evolving nature of the program and raise concerns over the potential inconsistencies in the application and approval process.