Bank Bailout Ball: Using Federal TARP Funds for Acquisition Financing

My reserarch assistant, Sandra Gonzalez del Pilar, has kindly provided a summary of the terms of the bank bailout portion of the federal government's efforts to control the effects fo the current financial crisis.

After the enactment of EESA on October 3, 2008 the Bush administration’s implementation of the Troubled Asset Purchase Program (TARP) under EESA has taken a different approach. There are now three initiatives under the Troubled Asset Relief Program: the Trouble Asset Auction Program, the Capital Purchase Program, and a program being developed by the Secretary on Systemically Significant Failing Institutions. This summary deals with the Capital Purchase Program, which was announced by President Bush and the Treasury Secretary on October 14, 2008. The program intends to inject capital into the banking system, which mirrors recent actions in Europe.

She provided a summary of the program as prepared by the U.S. Department of Treasury Department, which itself is redolent with understatement:

Under the program, Treasury will purchase up to $250 billion of senior preferred shares on standardized terms as described in the program's term sheet. The program will be available to qualifying U.S. controlled banks, savings associations, and certain bank and savings and loan holding companies engaged only in financial activities that elect to participate before 5:00 pm (EDT) on November 14, 2008. Treasury will determine eligibility and allocations for interested parties after consultation with the appropriate federal banking agency.

The minimum subscription amount available to a participating institution is 1 percent of risk-weighted assets. The maximum subscription amount is the lesser of $25 billion or 3 percent of risk-weighted assets. Treasury will fund the senior preferred shares purchased under the program by year-end 2008. Institutions interested in participating in the program should contact their primary federal regulator for specific enrollment details.

The senior preferred shares will qualify as Tier 1 capital and will rank senior to common stock and pari passu, which is at an equal level in the capital structure, with existing preferred shares, other than preferred shares which by their terms rank junior to any other existing preferred shares. The senior preferred shares will pay a cumulative dividend rate of 5 percent per annum for the first five years and will reset to a rate of 9 percent per annum after year five. The senior preferred shares will be non-voting, other than class voting rights on matters that could adversely affect the shares. The senior preferred shares will be callable at par after three years. Prior to the end of three years, the senior preferred may be redeemed with the proceeds from a qualifying equity offering of any Tier 1 perpetual preferred or common stock. Treasury may also transfer the senior preferred shares to a third party at any time. In conjunction with the purchase of senior preferred shares, Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15 percent of the senior preferred investment. The exercise price on the warrants will be the market price of the participating institution's common stock at the time of issuance, calculated on a 20-trading day trailing average.

Companies participating in the program must adopt the Treasury Department's standards for executive compensation and corporate governance, for the period during which Treasury holds equity issued under this program. These standards generally apply to the chief executive officer, chief financial officer, plus the next three most highly compensated executive officers.

The financial institution must meet certain standards, including: (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on the financial institution from making any golden parachute payment to a senior executive based on the Internal Revenue Code provision; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. Treasury has issued interim final rules for these executive compensation standards.

According to announcements by the US Department of Treasury, nine large financial organizations have agreed to participate in the program and it has received indications of interest from a broad group of banks of all sizes.

The US government has now issued the following documents for the Capital Purchase Program:
-Term Sheet

-Application Guidelines

-Frequently Asked Questions documents for the program:

According to an October 14, 2009 press release by the US Department of Treasury, in addition to the bank capitalization, Secretary Paulson has triggered the systemic risk exception to the Federal Deposit Insurance Corporation (FDIC) Act, enabling the FDIC to temporarily guarantee the senior debt of all FDIC-insured institutions and their holding companies, as well as deposits in non-interest bearing deposit transaction accounts. The ability to use guarantee debt under the program would expire on June 30, 2009 and the full protection for deposits in noninterest bearing transaction deposit accounts would revert back to the statutory limits on December 31, 2009.

Furthermore, to increase access to funding for businesses in all sectors of the economy, the Federal Reserve has announced further details of its Commercial Paper Funding Facility (CPFF) program, which provides a broad backstop for the commercial paper market. Beginning October 27, 2008, the CPFF will be able to purchase commercial paper of 3 month maturity form high-quality issuers.

Well, the proof is in the pudding, so the English have taught us. And, this much ballyhooed bank bailout has begun to have effect. Two of the smaller fry receiving federal largess for the protection of the American banking system have taken the money and begun using it--for their own narrow best interests. It seems that PNC Financial Services Group is using its bailout goodies to attempt an acquisition of National City at a bargain price. See PNC and Valley National Get on the Dole Bailout Report, Oct. 25, 2008. Other banks have begun to use the promise of cash to negotiate equity deals with the Federal Treasury. All to the good--our banks and the integrity of the financial system have been saved by opening the federal coffers for state controlled or directed merger, acquisition and finance transactions of a common sort. Good times are likly just around the corner.