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Commentary: Demonstrating a Bank is Using TARP Capital to Lend

One issue that seems to be gaining traction is the need for banks to show how they are using TARP Capital, with a strong preference for the banks to be using TARP Capital to make loans.  While the fungibility of bank capital makes it virtually impossible to directly tie any particular dollar of capital with any particular dollar lent, that fungibility also gives great leeway to community banks to demonstrate the lending impact of TARP Capital.  Despite the political hot potato, we expect very few, if any, community banks to be criticized for their use of TARP Capital funds.

We do not believe that TARP Capital should fundamentally change the way in which bankers run their banks.  Solely because they have TARP Capital, banks should not approve loans that they otherwise would turn down.  However, any bank with additional capital, which TARP Capital provides, is in a better position to make or renew loans than that same bank would have been without TARP Capital.

A bank should be able to show that TARP Capital is “working” so long as its total loans are higher than they would have been without the TARP Capital infusion.  In recognition of the current economic environment and capital restraints, we believe many banks would be actively attempting to shrink the size of the bank were they not to receive TARP Capital infusions.  As a result, merely maintaining the current levels of loans could, in reality, be the result of TARP Capital increasing bank lending activity.  Even Barney Frank’s proposed reform legislation acknowledges that TARP Capital may simply minimize the decline in lending that normally accompanies economic recessions.  While this metric may be difficult for the Congressional Oversight Committee to accept, anytime the question is asked whether a new program is working, you have to make assumptions about what the situation would look like without the program.

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Treasury Announces TARP Capital Terms for Subchapter S Institutions

On January 14, 2009, the Treasury published a Term Sheet for S Corporations and a Frequently Asked Questions for S Corporations.  In order to comply with the limitations on stock ownership for entities that elected to be taxed as S Corporations, the Treasury is planning to use subordinated debt as the investment vehicle.

The subordinated debt will pay interest at a rate of 7.7% per annum until the fifth anniversary, and then pay at a rate of 13.8% per annum.  This equates to after-tax effective rates of 5% and 9%, the same rates applied to public and private C corporations under the TARP Capital program.  Bank holding companies can defer interest for up to 20 quarters.

Like it did for private and public companies, the Treasury plans for the Federal Reserve to issue a special rule to permit the vehicle be treated as Tier 1 Capital for bank holding companies.  Stand-alone banks will only be able to treat the subordinated debt as Tier 2 capital (and only to the extent that all subordinated debt does not exceed 50% of Tier 1).

The subordinated debt will have a maturity of 30 years, and cannot be redeemed within the first three years unless a “Qualified Securities Offering” raises at least 25% of the amount of the investment.  All redemptions are subject to regulatory approval, and are at 100% of the issue price (plus any accrued and unpaid interest).

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Kashkari Comments on Use of TARP Capital Funds

In a speech to the Georgetown Business School on January 13, 2009, Treasury Assistant Secretary Kashkari made several comments regarding how banks were using TARP Capital funds, and why the Treasury does not believe that further requirements are necessary.  In light of continued political pressure to force banks to increase lending (or otherwise specify how to use the TARP Capital funds), we provide the highlights of Kashkari’s remarks on this matter.

Specifically, Kashkari noted that banks have strong economic incentives to deploy any TARP Capital received by the institution.  “Banks are in the business of lending and they will provide credit to sound borrowers whenever possible.  If a bank doesn’t put the new capital to work earning a profit or reducing a loss, its returns for its shareholders will suffer.”  In other words, Treasury is relying on the fundamental tenant of capitalism that banks will act in their own self-interest to make creditworthy loans.

Kashkari notes that we are still at a point of low confidence, and that as long as confidence remains low, banks will remain cautious about making loans and consumers and businesses will remain cautious of taking on new loans.  Until confidence returns, we are unlikely to see significantly more credit extended.  “We must not attempt to force them to make loans whose risks they are not comfortable with.  Bad lending practices were at the root cause of this crisis.  Returning to those practices will not held end this financial turmoil.”

With regard to tracking lending activity, Kashkari indicated that Treasury intends to use the existing quarterly call reports to study changes in balance sheets (and to compare against institutions that did not receive TARP Capital).  Treasury also plans to supplement call report information with monthly data collection from the largest banks.

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Issuance of FDIC Guaranteed Debt

Issuance of FDIC Guaranteed Debt

January 14, 2009

Authored by: Robert Klingler

Over the last several weeks, we have had further conversations with clients and the FDIC regarding the details of the Debt Guarantee Program under the FDIC’s Temporary Liquidity Guarantee Program.  In the course of these conversations, we have noticed a misunderstanding of several key components of the program.

  • Lines of Credit are not Senior Unsecured Debt. Under the regulations, senior unsecured debt must have “a specified and fixed principal amount.”  (12 CFR 370.2(e)(1).)  As a result, lines of credit are not eligible for an FDIC guarantee, and should not be included in calculating the amount of senior unsecured debt outstanding at September 30, 2008.
  • 2% of Liabilities Test is Only Available for Depository Institutions. If a bank holding company had no “senior unsecured debt” outstanding at September 30, 2008 (and remember that lines of credit are not included), then its maximum amount of guaranteed debt that can be issued is zero.  Only depository institutions themselves (and not their parent entities) can take advantage of the alternative cap of 2% of the total liabilities outstanding as of September 30, 2008.
  • Approvals to Establish or Increase a Debt Guarantee Cap will be “Very Rare.” The regulations provide a process for entities to establish or increase a debt guarantee cap.  However, we understand that all applications go to the highest levels of the FDIC in Washington DC, and there face high levels of scrutiny.  No timeframe has been provided, but given the level of scrutiny and DC review, bottlenecks are virtually guaranteed to develop.  We understand that the FDIC has lots of applications currently in the system, but the FDIC believes that approvals will be “very rare.”
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Round 9 of TARP Capital Infusions

Round 9 of TARP Capital Infusions

January 13, 2009

Authored by: Bryan Cave

On January 13, 2009, the Treasury announced the completion of the ninth round of TARP Capital infusions.  The Treasury purchased a total of approximately $4.7 billion in securities from 42 financial institutions on Friday, January 9, 2009, and has now invested in 257 institutions, totaling $192.3 billion. 

The largest infusion went to American Express Corporation: $3.4 billion.  The smallest infusion went to Independence Bank of East Greenwich, Rhode Island: $1.07 million.

Of note in this ninth round, the first Hawaii-based financial institution received a TARP Capital infusion.  Central Pacific Financial Corp, of Honolulu, Hawaii, received $135 million.  In total, 42 states and 1 U.S. territory are home to institutions that have received TARP Capital infusions.

Also of note in this ninth round, Bank of America Corp. is listed as receiving $10 billion in TARP Capital; however, this sum was already accounted for in the first round as an investment in Merrill Lynch & Co.  The actual disbursement of the $10 billion was delayed until the successful closing of the Bank of America and Merrill Lynch merger, which occurred on January 1, 2009.

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Treasury Publishes Second Report to Congress

On January 6, 2008, the Treasury released its Second Report to Congress as required under Section 105(a) of the Emergency Economic Stabilization Act.  While the Second Report does not contain any new information, it does contain two nuggets of information that may be of interest to community bankers: (a) how Treasury believes the effectiveness of the TARP Capital program should be measured; and (b) confirmation that terms applicable to S corporations and mutuals are still in the works.

The Second Report begins with a note that Treasury has continued to make significant investments in financial institutions through the Capital Purchase program.  “These investments have improved the capitalization of these institutions, which is essential to improving the flow of credit to businesses and consumers and boosting the confidence of depositors, investors, and counterparties alike. With higher capital levels and restored confidence, banks can continue to play their vital role as lenders in our communities, a necessary requisite for economic recovery and a return to prosperity.”

In discussing the details of the Capital Purchase program, the Second Report notes that “terms applicable to S corporations and mutual organizations are still under consideration.”

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Sub S TARP Capital Terms to be Announced Wednesday

On January 13, 2009, Treasury Assistant Secretary Kashkari announced that the Treasury has completed a term sheet for Subchapter S corporations to participate in the TARP Capital Purchase Program. He stated that the term sheet for Subchapter S corporations will be posted on the Treasury website on Wednesday, January 14, 2009. The application period is expected to open at that time and remain open for 30 days.

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Request to Release Second Half of TARP Money

January 12, 2009

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On January 12, 2009, President Bush, at the request of President-elect Obama, formally requested that Congress release the second $350 billion under the Emergency Economic Stabilization Act.  This request can be seen as either: (a) an attempt to preserve executive branch flexibility in light of pending Congressional action; or (b) a political decision to have Bush rather than Obama veto any Congressional decision not to move forward.  (Under the Emergency Economic Stabilization Act, Congress is required to take affirmative action within 15 days or the request in order to deny the $350 billion, and that denial is subject to Presidential veto – which would require a 2/3 vote to overturn.)

Director-designate of the National Economic Council, Lawrence Summers, has provided a letter to the Congressional leadership explaining why Obama believes the release of the second $350 billion is needed now. The letter acknowledges that Obama believes “there has been too little transparency and accountability; too much upside for financial institutions and executives who acted irresponsibly without providing enough help for small business owners, families who are struggling to keep their jobs and make ends meet, and innocent homeowners.”  However, Obama believes that the “American people need to know that going forward the government has the resources to do whatever is necessary to stabilize our financial system and protect our economy.”

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FDIC and Open Bank Assistance

FDIC and Open Bank Assistance

January 12, 2009

Authored by: Robert Klingler

On January 2, 2009, the Wall Street Journal ran a story on the possibility of the FDIC agreeing to assume future losses on the troubled assets of a failed institutions.  The FDIC has used versions of the loss-sharing model several times last year, but with the exception of the initial attempt to rescue Wachovia, only as part of the receivership of a failed institution.

“It is something that we plan on doing in the future where it’s appropriate,” says Herb Held, assistant director in the FDIC’s division of resolutions and receiverships. “I think it’s a good deal for everybody: the FDIC, the acquiring bank and the borrowers. It keeps the assets where they were.”

This leaves open the question of whether the FDIC will begin using a loss-sharing approach to facilitate open bank transactions.  Some advisers believes that the FDIC will use this approach to effectively entice sound financial institutions to purchase struggling banks, or those which may be in imminent danger of failing.  While there is no existing precedent during this period of economic turmoil, open bank assistance was a well regarded and oft used solution in earlier troubled times.  Where FDIC does provide stop loss or other support, it comes ahead of shareholders in the troubled institution, so it does not help shareholders in most instances; however, it does prevent the extra disruption of a failure.  Traditionally, FDIC officials informally estimated the additional loss upon a failure was at least 15% higher than the loss where the troubled bank is acquired by a healthy bank in an open bank transaction.  As a result, properly structured stop loss or other assistance programs should save the deposit insurance fund real dollars.

For now, the FDIC appears tied to the position that it can only offer loss-sharing following receivership and a full auction of the troubled or failing institution in order to comply with its legal obligation to provide the least-costly solution.  If a tangible proposal for a loss sharing were presented to a regional FDIC office, such a proposal would be have to be structured to assure “least costly” status and would be forwarded to DC for review.

Accordingly, we recommend that neither acquiring banks, nor troubled institutions looking to be acquired, put too many eggs in the basket hoping for FDIC loss-sharing assistance.

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