United States: Getting Out From Under The TARP

Last Updated: April 6 2009
Article by Robert K. Morris

To date, hundreds of public financial institutions have obtained capital infusions from the U.S. Treasury through the issuance of preferred stock and accompanying warrants to Treasury pursuant to its Capital Purchase Plan. Treasury's investment was originally contemplated to be a long-term one; the preferred stock by its terms may not be redeemed for a period of three years from the date of its issuance, other than from proceeds of the institution's offerings of qualifying equity securities, if such proceeds are at least 25 percent of the aggregate liquidation amount of the preferred issued by the institution.

The American Recovery and Reinvestment Act ("ARRA"), enacted Feb. 17, 2009, imposed significant executive compensation and corporate governance requirements on institutions that have issued this preferred stock, with such requirements to apply for as long as the preferred stock remains outstanding. However, ARRA also included a provision, 12 U.S.C. §5221(g), which requires Treasury, subject to consultation with the appropriate federal banking agency, to permit a Troubled Assets Relief Plan ("TARP") recipient to repay any assistance previously provided under TARP to such financial institution (which includes these investments in preferred stock), without regard to whether the financial institution has replaced such funds from any other source or to any waiting period. The statute also provides that when such assistance has been repaid, Treasury shall liquidate the associated warrants at the current market price.

Many institutions originally applied to participate in Treasury's plan, not because they had a need for capital, but because the capital offered under the plan was priced attractively, and because such institutions felt a sense of public obligation to participate in the economic recovery program. In the case of some participants, it has been reported government pressure was brought to bear to encourage their participation. Subsequently, some of such institutions have felt their reputations adversely affected by the perception that they were beneficiaries of taxpayer largesse. In addition, some institutions have been surprised to find that their participation in the plan has now subjected them to new executive compensation and corporate governance requirements that did not exist when they originally decided to participate.

On March 31, four institutions publicly announced their repurchase of the preferred stock they previously issued to Treasury, the first such transactions which have occurred. Treasury has posted on its website a form of letter agreement to be utilized for public institutions desiring to make such repurchases. Any such repurchase transaction must be approved by the institution's federal regulators. The letter agreement, to be entered into between the institution and Treasury, specifies a repurchase price for the preferred equal to its face amount, plus accrued and unpaid dividends through the date of repurchase. The agreement does not require that all of the institution's outstanding preferred be repurchased; partial repurchases are permitted. It is not clear from the form of agreement whether Treasury will impose some minimum requirement for partial repurchases of an institution's preferred. The executive compensation and corporate governance requirements that are applicable under ARRA for so long as the institution's preferred stock is outstanding would continue in force after any partial repurchase of the preferred stock.

The mechanism for dealing with the accompanying warrant held by Treasury with the preferred is as follows. If only a portion of the institution's preferred is repurchased, the existing warrant remains outstanding unchanged. If all of the institution's preferred stock is repurchased, first, the institution agrees that the warrant held by Treasury is now immediately exercisable for the full number of subject shares. (The original warrant may not be exercised for more than one-half of the subject shares until the earlier of (a) the date on which the institution receives proceeds from offerings of qualified equity securities in at least the initial aggregate face amount of the preferred; or (b) Dec. 31, 2009.)

Second, the institution agrees that within 15 calendar days (after repurchase of the preferred), it will either deliver to Treasury a notice of its intent to repurchase the warrant in accordance with Section 4.9(b) of the institution's existing Securities Purchase Agreement with Treasury (the agreement under which the original investment was made), or it will deliver a new warrant in substantially the form of the existing warrant, but with the deletion of the current warrant provision that reduces the number of shares represented by the warrant by 50 percent if the institution completes one or more offerings of qualified equity securities prior to Dec. 31, 2009, generating proceeds of at least 100 percent of the aggregate initial liquidation amount of the preferred issued by the institution.

If a notice of intent to repurchase is delivered, the current provisions of Section 4.9(b) will operate to ascertain the market value of the warrant, which is the price at which the warrant will be repurchased. These provisions require the institution to accompany its notice with a determination of the institution's Board of Directors of the fair market value of the warrant. Fair market value means the fair market value as determined by the Board, acting in good faith in reliance on an opinion of a nationally recognized independent investment banking firm retained by the institution for this purpose, and certified in a resolution to Treasury. If Treasury does not agree with the Board of Directors' determination, it may object within 10 days. An authorized representative of Treasury and the chief executive officer of the company would then promptly meet to resolve the objection and agree upon the fair market value. If they are unable to agree during the 10-day period following delivery of Treasury's objection, either party may invoke a specified appraisal procedure by notification not later than the 30th day after delivery of Treasury's objection.

Under the appraisal procedure, each party would within 10 days after the procedure is invoked, deliver a notice to the other appointing an appraiser chosen by it. If within 30 days after appointment the two appraisers are unable to agree on fair market value, they would select a third appraiser. Each appraiser within 30 days thereafter would provide its appraisal, and an averaging process would then be conducted.

Under the letter agreement, if the institution determines to revoke its warrant repurchase notice, it is required to deliver a substitute warrant in substantially the form of the existing warrant (but excluding the provision for reduction of the number of warrant shares).

Treasury in the letter agreement provides notice of its intention to sell any substitute warrant delivered to it.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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