On February 15, 2012, Broadway Financial Corporation announced that it had reached a definitive agreement with the Treasury Department pursuant to which Treasury will exchange preferred stock in the company for new common stock valued at a discount of 50% to the aggregate liquidation preference of the outstanding shares of preferred stock held by Treasury.  As previously noted, while Treasury is unwilling to consider a blanket discount on the repayment of TARP, it remains open to restructuring its investment to facilitate additional capital, so long as it is treated equitably with other investors.

Although exact terms of the agreement are not yet publicly available, the company’s press release indicates that Treasury has agreed to convert its TARP CPP investment in the company into common stock at 50% of its liquidation value and the accrued unpaid interest on such investment at 100% of the accrued amount.  The conversion is condition on a number of factors, including: (i) the exchange of the Company’s other preferred stock at the same 50% discount; and (ii) at least $5 million being raised in new common equity.

The company has previously announced that it had an agreement in principal with its senior bank lender to exchange a portion of its senior line of credit, which is in default, for common stock at 100% of the face amount to be exchanged and to forgive the accrued interest on the entire amount of the senior line of credit.  In the company’s 3rd Quarter Form 10-Q, the company indicated that these conversions would result in the issuance of approximately 7.5 million new shares of common stock, which in turn would constitute approximately 80% of the pro forma outstanding shares.

While the TARP CPP program has returned a financial profit, as the Treasury has recovered 103% of its investment in the form of dividends, repayments and gains on sale of warrants, about 350 banks remain in the TARP CPP program.  In this election year, it appears increasingly likely to us that Treasury is seeking means to eliminate the government’s continuing investment (and resulting entanglement) in financial institutions.

According to multiple sources, Treasury is looking to exit from the TARP CPP program in the “near-term” or by mid-year 2012.  As we’ve previously noted, Treasury has hired Houlihan Lokey to advise it on exit strategies, paying Houlihan Lokey $375,000 a month for advice.  We understand that Houlihan Lokey has now talked with about a third of the remaining banks, and is expected to talk to the remainder over the next several weeks.  These discussions have generally been cordial, and equal parts information sharing and information gathering.

We expect Houlihan Lokey to present Treasury with multiple options, including: individual auctions, pool sales, and potential restructurings.

Under the terms of the preferred stock investments, Treasury can’t require repayment, and institutions will still need regulatory approval to make a payment.  We’ve separately heard that the FDIC has inquired about repayment of TARP in reviewing a bank’s strategic plan, suggesting that the bank regulators may “force” repayment in connection with approving changes to business plans, etc.  Treasury has initiated off-site examination of TARP compliance programs of the remaining TARP participants, but we understand that this function is at least nominally separate from Treasury’s investment decision and not intended to motivate banks to repay the TARP funds.

In advance of releasing the “Stress Test” results (scheduled for 5:00pm on Thursday, May 7, 2009), the Treasury and the federal banking regulators released a joint statement about the Supervisory Capital Assistance Program on May 6, 2009.  The joint statement also includes information about the process that will be used for institutions desiring to redeem their TARP Capital Purchase Program Preferred stock.

A few key points about the Stress Test:

• The government intends to announce, for each of the 19 institutions individually and in the aggregate, estimates of: losses and loss rates across select categories of loans; resources available to absorb those losses; and the resulting necessary additions to the capital buffers.
• Any of the 19 needing to raise capital will be given until June 8, 2009 to develop a detailed capital plan, and until November 9, 2009 to implement that plan.
• As part of the capital plan, an institution may apply for Mandatory Convertible Preferred under the TARP Capital Assistance Program, and may convert its existing TARP Capital Purchase Program Preferred shares into the Capital Assistance Program Convertible Preferred shares.
• “Smaller financial institutions generally maintain capital levels, especially common equity, well above regulatory capital standards.”
• Accordingly, the government does not intend to expand the Stress Test beyond the initial 19 bank holding companies (at least officially).
• The Treasury reiterates that the TARP Capital Assistance Program is available to other institutions on the same terms and conditions applicable to the 19 Stress Tested banks.  The Treasury intends to process applications received “in an expedient manner.”  (No discussion is made of when or if term sheets will be made available for non-publicly traded institutions to participate in the Capital Assistance Program.

Despite the fact that no Subchapter S institution has yet received TARP Capital funds, and a term sheet for mutual organizations has not yet been announced, the Treasury has now provided documentation on how a TARP Capital recipient would redeem their investment, as permitted by the American Recovery and Reinvestment Act of 2009.  On March 25, 2009, the Treasury published TARP Capital Purchase Program repurchase documents for public and private TARP Capital recipients.

Both the public and private documents contemplate the repurchase of all, or a portion of, the Company’s TARP Capital investment.  Under the public company repurchase documents, if a Company repurchases 100% of the Treasury’s preferred stock, then the Company is also given 15 days to either repurchase the warrant for common stock at fair market value, or to issue a replacement warrant that does not contain the adjustment to reduce the number of shares covered by the warrant in the event of a qualified equity offering.  Under the private company repurchase documents, once a Company repurchases 100% of the primary preferred shares (the ones initially paying 5%), it can also repurchase up to 100% of the warrant preferred shares (paying 9%).