January 14, 2009
Authored by: Robert Klingler
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).
The subordinated debt instrument contains comparable restrictions on common stock dividends, common stock and trust preferred repurchases, and executive compensation as contained in the terms for private C corporations participating in TARP Capital. No increase in common stock dividends for three years without approval. From years 4 through 10, participating companies can increase common dividends per share by 3% annually, and then no dividends after 10 years until the subordinated debt is redeemed (or the Treasury transfers the subordinated debt to a third party).
In exchange for purchasing subordinated debentures equal to between 1% and 3% of the risk-weighted assets, the Treasury will also receive additional subordinated debentures equal in amount to 5% of the Treasury’s investment. Like the private terms, these are being structured as immediately exercisable warrants, and thus are called “Warrant Securities.” The Warrant Securities will have the same terms as the other subordinated debentures, but will pay interest at a rate of 13.8% per annum from the beginning.
If a Sub S entity has already submitted an application for TARP Capital, then they do not need to re-apply. The deadline for Sub S corporations to apply is 5:00 p.m., Eastern Time, February 13, 2009. The TARP Capital application form is unchanged. Definitive investment agreements are expected to be available “within a few weeks.”
Treasury continued to work with the federal banking agencies on a solution for mutual companies.