On October 14, the U.S. Treasury Department (“Treasury”) announced the establishment of a Capital Purchase Program (“CPP”) as part of Treasury’s Troubled Asset Relief Program (“TARP”) under the provisions of the Emergency Economic Stabilization Act of 2008 (“Act”), to enhance the overall capital bases of domestic financial institutions.  CPP participation contemplates financial institution access to TARP funds upon Treasury’s approval of the institution’s application and the institution’s acceptance of the terms of Treasury’s corresponding investment in the institution.  Under the CPP, Treasury purchases an institution’s preferred stock (“Preferred Stock”) and warrants (subject to various terms and restrictions) in exchange for TARP funds.

As of mid-October, only a publicly tradedⁱ qualifying financial institution (“PQFI”) was eligible for CPP participation.  PQFIs include (i) any U.S. bank or U.S. savings association not controlled by a bank holding company (“BHC”) or a savings and loan holding company (“SLHC”), (ii) any top-tier U.S. BHC, (iii) any top-tier U.S. SLHC engaging solely or primarily in financial holding company (“FHC”) permitted activities, and (iv) any U.S. bank or U.S. savings association controlled by a SLHC that does not engage solely or primarily in FHC permitted activities.

On November 17, Treasury invited any non-publicly traded qualifying financial institution (“NPQFI”) to become a CPP participant.  NPQFIs include (i) any privately held top-tier BHC or top-tier SLHC engaging solely or predominantly in FHC permitted activities, (ii) any privately held U.S. bank or U.S. savings association organized in stock form and not controlled by a BHC or SLHC, and (iii) any U.S. Bank or U.S. savings association not publicly traded and controlled by a privately held SLHC that does not engage solely or primarily in FHC permitted activities.  Excluded from qualification as a NPQFI (at least for now) are Subchapter S corporations and mutually owned thrifts or mutual holding companies.

Links to the term sheets for Treasury investments in Preferred Stock of PQFIs and NPQFIs (together “QFIs”) can be found at the end of this notice.  The terms of Treasury’s investments in QFIs share a number of similarities but also several differences, the more notable of which are set forth below.

The major similarities include:

1. Treasury will be the initial holder of securities issued by QFIs.
2. The amount of a QFI’s Preferred Stock issued shall equal not less than one percent (1%) of a QFI’s risk-weighted assets.
3. The amount of a QFI’s Preferred Stock issued shall equal no more than the lesser of (a) $25 billion and (b) three percent (3%) of the QFI’s risk-weighted assets.
4. A QFI’s Preferred Stock shall be non-voting perpetual preferred stock with a liquidation preference of $1,000 per share and receive Tier 1 capital treatment.
5. A QFI’s Preferred Stock shall rank senior to common stock and pari passu with existing QFI preferred shares, other than preferred shares already ranking junior to any existing QFI preferred shares.
6. A QFI’s Preferred Stock shall pay cumulative dividends of five percent (5%) per year (payable quarterly in arrears) until the fifth anniversary of Treasury’s investment, and thereafter at nine percent (9%) per year, provided that for Preferred Stock issued by U.S. banks that are not subsidiaries of holding companies, the Preferred Stock will pay noncumulative dividends of five percent (5%) per year until the fifth anniversary of Treasury’s investment, and thereafter at nine percent (9%) per year.  For Preferred Stock issued by QFIs that are U.S. banks and not subsidiaries of holding companies, such Preferred Stock shall pay noncumulative dividends on the same terms.
7. If a QFI does not pay Preferred Stock dividends in full for six dividend periods (whether consecutive or not), Treasury shall have the right to elect 2 QFI directors.
8. A QFI’s Preferred Stock shall not be redeemable for three years from the date of Treasury’s investment, except where redeemed with the proceeds of a qualified equity offering of either Tier 1 perpetual preferred stock or common stock for cash that results in aggregate gross proceeds to the QFI in an amount not less than twenty five percent (25%) of the Preferred Stock’s issue price.  After three years, the QFI’s Preferred Stock may be redeemed, in whole or in part, at any time, subject to the approval of the QFI’s primary banking regulator.
9. A QFI’s Preferred Stock and warrants (see below) issued to Treasury shall not be subject to any contractual restrictions on transfer and a QFI shall grant Treasury piggyback registration rights for such Preferred Stock and warrants.
10. A QFI must obtain Treasury’s consent for any increase in dividends on a QFI’s common stock prior to the third anniversary of Treasury’s investment.
11. A QFI must obtain Treasury’s consent for the repurchase of its equity securities prior to the third anniversary of Treasury’s investment.
12. All of a QFI’s benefit plans, agreements and other arrangements (e.g., “golden parachutes,” etc.) shall be modified or terminated so as to comply with executive compensation and governance requirements of Section 111 of the Act.

The noteworthy differences include:

1. Treasury’s NPQFI term sheet provides that a NPQFI will grant Treasury warrants (10-year term) to purchase, upon net settlement, a number of net shares of preferred stock having an aggregate liquidation preference equal to five percent (5%) of the NPQFI Preferred Stock on the date of Treasury’s investment, with an initial exercise price of $0.01 per share, to be exercised immediately.  In contrast, Treasury’s PQFI term sheet provides that a PQFI will grant Treasury warrants (10-year term) to purchase a number of PQFI common shares with an aggregate market price equal to fifteen percent (15%) of the PQFI Preferred Stock amount on the date of Treasury’s investment, with an exercise price equal to the market price for PQFI common stock on the date of Treasury’s investment (calculated on a 20-trading day trailing average), subject to customary anti-dilution adjustments (and other contingent deductions).  Furthermore, Treasury may only transfer or exercise an aggregate of one-half of PQFI warrants prior to the earlier of (a) date on which PQFI received aggregate gross proceeds of not less than one hundred percent (100%) of the issue price of the PQFI’s Preferred Stock from a qualified equity offering and (b) December 31, 2009.
2. Treasury’s NPQFI term sheet provides that Treasury’s consent is required for an NPQFI’s repurchase of its equity securities and trust preferred securities and such consent is required until the tenth anniversary of Treasury’s investment (as opposed to the third anniversary for PQFIs), and thereafter may not redeem such securities until all NPQFI securities held by Treasury are redeemed in their entirety or Treasury has transferred all such securities to third parties.
3. Treasury’s NPQFI term sheet provides that, from the third anniversary to the tenth anniversary of Treasury’s investment, Treasury’s consent is required to increase in the aggregate common stock dividends per share greater than three percent (3%) per year.
4. Treasury’s NPQFI term sheet provides that, from the third anniversary to the tenth anniversary of Treasury’s investment, no dividends on commons stock may be paid until all NPQFI equity securities held by Treasury are redeemed in their entirety or Treasury has transferred all such securities to third parties.
5. Treasury’s NPQFI term sheet provides that the right to elect NPQFI directors ends when Preferred Stock dividends are paid in full for all prior dividend periods (for cumulative Preferred Stock) or four consecutive dividend periods (for noncumulative Preferred Stock), whereas the PQFI term sheet does not provide for such right to expire when dividends have been in full for all prior periods (for cumulative Preferred Stock).
6. Treasury’s NPQFI term sheet provides that NPQFI Preferred Stock and warrants issued to Treasury shall not be subject to the restrictions of any stockholders’ or similar agreement in existence at the time of Treasury’s investment or thereafter.
7. Treasury’s NPQFI term sheet provides that an NPQFI is only required to file a shelf registration statement to cover NPQFI Preferred Stock and warrants issued to Treasury if such NPQFI becomes subject to periodic reporting under the federal securities laws, whereas Treasury’s PQFI term sheet provides that any PQFI must file a shelf registration statement to cover PQFI Preferred Stock and warrants issued to Treasury, and take any action required to cause it to be declared effective as soon as possible.
8. Treasury’s NPQFI term sheet provides that as long as Treasury holds any NPQFI equity securities, the NPQFI and its subsidiaries shall not enter into related party transactionsⁱⁱ unless (a) such transactions are on an arm’s length basis and are approved by the NPQFI’s audit committee or comparable body of NPQFI independent directors, whereas such a condition does not appear in Treasury’s PQFI term sheet.

Should you have any questions regarding the Act or the CPP, please contact one of our BRST team members.

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ⁱ For purposes of CPP participation, a company is “publicly traded” if either (1) its securities trade on a national securities exchange, or (2) it is required to file periodic reports under federal securities laws with the Securities and Exchange Commission or its primary federal banking regulator.

ⁱⁱ For purposes of CPP participation, a related party is a person within the meaning of Item 404 under the Securities and Exchange Commission’s Regulation S-K.