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). Under the CPP, the DOT could purchase up to $250 billion in shares of preferred shares and warrants convertible into common stock from banks and bank holding companies.

Following below is an analysis of the CPP’s provisions.

Size of Investment: One to three percent of risk weighted assets

Security: Senior preferred pari passu with current any current preferred shares issuance. The DOT will also receive warrants.

Dividends: Dividends are cumulative on preferred shares issued by bank holding companies. Dividends on preferred shares issued by banks (that are not part of a bank holding company) are noncumulative.

Rate: Five percent per annum until year five, then nine percent per annum.

Redemption: May not be redeemed for a period of three years; after three years may be redeemed at 100% of issue price plus any accrued or unpaid dividends. May be redeemed earlier if the company sells common stock or qualifying perpetual preferred shares for cash with a value equal to 25% of the price paid by the DOT for the company's preferred shares.

Common Dividends: Common dividends may be increased during the first three years only with DOT approval. This restriction ceases if the shares are redeemed of if they are sold by the DOT.

If dividends are not paid on the preferred shares, they may not be paid on the common shares.

Repurchases: The DOT's consent is required for any share repurchases. However share repurchases can be made to fund employee benefit plans. This restriction ceases at the end of three years but may end sooner if the securities are redeemed before the end of the three years or if the DOT transfers the preferred shares to someone else.

Voting Rights: Preferred stock is nonvoting. If dividends are not paid for six quarters – the preferred security holders elect two directors who serve until dividends have been paid for four consecutive quarters.

Holders of the securities will also have voting rights if the issuing company does anything that materially adversely affects their interests.

Shelf Registration:  The issuing company would have to file a shelf registration statement with the United States Securities and Exchange Commission for the new securities and a shelf registration statement for the warrants and the common stock to be acquired upon the exercise of the warrants. The DOT will be free to sell these shares and the warrants to whomever it pleases. The company would also have to give the DOT piggyback registration rights.

Executive Compensation: Senior executives will have to modify or terminate all executive arrangements and agreements (including golden parachutes and benefit plans) to the extent necessary to be in compliance of Section 111 of the Emergency Economic Stabilization Act (EESA) (the bailout legislation recently passed by Congress) and any guidance or regulations issued by the Secretary of the Treasury on or prior to the date of the investment.

Section 111 provides that the DOT will promulgate executive compensation rules governing financial institutions. Where the DOT buys assets directly, the institution must observe standards limiting incentives, allowing clawback and prohibiting golden parachutes. When the DOT buys assets at auction, an institution that has sold more than $300 million in assets is subject to additional taxes, including a 20% excise tax on golden parachute payments triggered by events other than retirement, and tax deduction limits for compensation limits above $500,000.

Under United States Internal Revenue Service rules, companies currently operate under a $1 million cap that denies deductibility to yearly compensation payments in excess of $1 million.

Although the rules under Section 111 were designed to apply to financial institutions that sell troubled assets, the DOT has stated that these rules will apply to any financial institution that participates in the CPP.

The TARP indicates that each executive officer covered by the ESSA will have to sign a waiver of claims with respect to any modification of benefits imposed by this provision. These givebacks end once the securities are no longer held by the DOT – either due to the sale by the DOT of the securities or due to redemption of the preferred securities.

Warrants: The DOT will receive warrants to purchase common stock equal to 15% of the investment, with an exercise price based on a 20-day trailing average price (calculated when the DOT approves an entity's participation in the CPP). If the shareholder approval discussed in the next paragraph is not received within six months of the date of the issuance of the warrant, the exercise price will be reduced by 15% on each six-month anniversary subject to a maximum reduction of 45%.

The warrants have a 10-year life and are immediately exercisable. The number of shares covered by the warrant will be reduced by 50% provided the company completes a qualified public offering (a public sale of securities equal in value to the value of the securities bought by the DOT) before December 31, 2009. If there are not enough common shares to cover the warrant, a shareholders' meeting will have to be called.

FDIC Adopts Temporary Liquidity Guarantee Program

On October 14, 2008, the Federal Deposit Insurance Corporation (FDIC) adopted the Temporary Liquidity Guarantee Program (TLGP), under which:

• the FDIC will guarantee newly issued senior unsecured debt of banks, thrifts, and certain holding companies, and
• the FDIC will provide full coverage of noninterest bearing deposit transaction accounts, regardless of the dollar amount.

Eligible Institutions
Eligible Institutions under the TLGP include:

• FDIC-insured depository institutions
• U.S. bank holding companies
• U.S. financial holding companies
• U.S. savings and loan holding companies that engage only in activities that are permissible for financial holding companies to conduct under Section 4(k) of the Bank Holding Company Act.

Guarantee of Debt
Under the TLGP, certain newly issued senior unsecured debt issued on or before June 30, 2009, would be fully protected in the event the issuing institution subsequently fails, or its holding company files for bankruptcy.

The TLGP would cover all newly issued senior unsecured debt issued by Eligible Institutions on or before June 30, 2009. This would include promissory notes, commercial paper, interbank funding and any unsecured portion of secured debt. The amount of debt covered by the guarantee is limited to 125% of debt that was outstanding as of September 30, 2008 that was scheduled to mature before June 30, 2009.

The guarantee will terminate on June 30, 2012, even if the debt has not matured.

Deposit Insurance
Eligible Institutions will be able to provide full deposit insurance coverage for noninterest bearing deposit transaction accounts, regardless of dollar amount.

These are mainly payment processing accounts, such as payroll accounts used by businesses.

This guarantee expires on December 31, 2009.

Fees
Under the TLGP, there will be no fees for the first 30 days. Thereafter, a fee would be imposed as follows:

• For all newly issued senior unsecured debt, an annualized fee equal to 75 basis points multiplied by the amount of guaranteed debt.
• For noninterest-bearing transaction deposit accounts, a 10 basis point surcharge would be applied to noninterest-bearing transaction deposit accounts not otherwise covered by the existing deposit insurance limit of $250,000. This surcharge will be added to the participating bank’s existing risk-based deposit insurance premium paid on those deposits.

Duration
All Eligible Institutions will be covered under the TLGP for a period of 30 days. Prior to the end of this period, Eligible Institutions must inform the FDIC whether they will opt out of the guarantee program. If an Eligible Institution opts out of the TLGP, the guarantee on newly issued senior unsecured debt and noninterest-bearing transaction deposit accounts will expire at the end of the 30-day period.

Supervisory Enhancement
Eligible Institutions availing themselves of the TLGP will be subject to enhanced supervisory oversight to prevent rapid growth or excessive risk taking.

For further information, please contact Timothy M. Sullivan or your regular Hinshaw attorney.

This alert has been prepared by Hinshaw & Culbertson LLP to provide information on recent legal developments of interest to our readers. It is not intended to provide legal advice for a specific situation or to create an attorney-client relationship.