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Additional Clarity on TARP Approval Process & Standards

On August 6, 2009, the Office of the Special Inspector General for TARP (SIGTARP) published its report on whether external parties (i.e. politicians) unduly influenced TARP Capital Purchase Program decisions.  We will write more about that subject shortly, but the Report also provided the most detailed summary that we’ve seen of the factors considered by Treasury and the federal banking regulators in determining whether to approve a TARP application.

First, composite CAMELS ratings clearly played a significant role in determining the likelihood of success for any given institution.

  • 1-rated institutions were generally sent directly to Treasury for approval, and seemingly regularly approved for Capital Purchase Program funds.
  • 2-rated institutions with “acceptable performance ratios” were also sent directly to Treasury for approval, and again appear to have been regularly approved for funds.  2-rated institutions with “unacceptable performance ratios” were subject to further review by the interagency council, where at least three of the four federal banking regulators had to approve the application.  The Report states that the interagency council then analyzed “the viability of the institution based on the quantitative and qualitative  factors of the case” in determining whether to recommend approval to Treasury.
  • 3-rated institutions were originally treated like 2-rated institutions, but “relatively early in the CPP application review process,” Treasury decided that all 3-rated institutions needed to be reviewed by the interagency council.
  • 4- or 5-rated institutions were generally asked to withdraw, without the application being forwarded to the interagency council.

The Treasury would then make an independent evaluation of each application before making recommendations to the three-member Treasury Investment Committee.  The Treasury Investment Committee would then make a recommendation for final approval to the Assistant Secretary.  While only the Assistant Secretary can actually approve a TARP CPP application (all other actions are merely recommendations to approve), according to the Report, the Assistant Secretary had not rejected any recommendation forwarded by the Investment Committee for approval.

Performance Ratios

The Report also includes, as an Appendix, a copy of a “Case Decision Memo Template” that appears to have been the form used by the region/district level office of each federal banking regulator that reviewed TARP CPP applications.  The Memo provides further guidance on the specific performance ratios considered by the agencies.  In addition to CAMELS and CRA ratings, the  Memo called for an evaluation of the following performance ratios, both before and after a TARP infusion and both for the holding company and the largest bank subsidiary:

  • Tier 1 Risk-Based Capital
  • Total Risk-Based Capital
  • Tier 1 Leverage Ratio
  • Classified Assets/(Net Tier 1 Capital + ALLL)
  • (NPLs + OREO)/(Net Tier 1 Capital + ALLL)
  • Construction & Development Loans/Total Risk-Based Capital

While the first three performance ratios are consistent with the three historical measures of bank capitalization, the last three performance factors highlight the focus of the banking regulators on these ratios.

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Private Capital to Match TARP Capital?

We understand that several banks have been told that the bank needed to raise sufficient new private capital so that, following a TARP Capital infusion, the bank would:

  • have total non-performing assets that are less than 100% of the resulting capital;
  • have total classified assets that are less than 100% of the resulting capital; and
  • be in compliance with the Commercial Real Estate guidance (total Commercial Real Estate loans of less than 300% of resulting capital, and total Acquisition, Development and Construction loans of less than 100% of the resulting capital).

We don’t think this is exclusive or automatic, but we do find it logical for some banks, and a good argument for others to use.  For those banks that cannot satisfy the requirements of the Commercial Real Estate guidance, we believe that a tangible reduction schedule may suffice.

Yesterday’s New York Times article on whether banks are making loans (an interesting read if you haven’t already), also provides a graphic showing the Texas ratio of banks that received TARP Capital investments through December 31, 2008.  While there are certainly flaws in the Texas ratio, we believe it is informative that the worst September 30th Texas ratio of any bank that received TARP Capital through December 31, 2008 was 77.4%.

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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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Treasury Responds to Congressional Oversight Questions

On December 30, 2008, the Treasury responded to the ten questions raised by the Congressional Oversight Panel.  The Treasury has provided a measured and reasoned response to the questions raised, but has not provided any significant new information, but rather has done a good job assembling existing information for the Congressional Oversight Panel.

We have highlighted the Treasury’s response to three questions:  Why Capital Investments?  Has it Worked?  and What is the Application Process?  You can review all of the Treasury’s answers in its formal response.

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Commentary: Big Picture Thoughts on Applying for TARP Capital

Whether to apply for or accept TARP Capital is a decision that each bank needs to make individually depending on its own markets and circumstances.  However, as explained below, we believe each bank needs to prepare a realistic, worst-case scenario for the next three years.  Unless your bank’s capital will remain strong, we think you should apply for TARP Capital.

In three years, your bank will likely be in position to redeem the TARP Capital.  If that’s true, then the TARP Capital will have served as an inexpensive insurance policy that went unused, and you won’t be subject to any further government restrictions.

On the other hand, it is possible that, in three years, the financial condition of your bank makes you unable to redeem the TARP Capital.  In that event, it is very clear that you needed the TARP Capital.

With only these two scenarios, we believe almost every bank is better off applying for TARP Capital.

Where is the Economy Headed?

As the residential real estate market declined, all the contractors and subcontractors associated with that market began to suffer.  These contractors and subcontractors include our drywall installers, plumbers, painters, flooring specialists, lighting specialists, landscapers, pavers, pool installers, and numerous others – a vast group of construction and service-industry workers.  With new residential starts drying up, and with in-progress projects shutting down, many of the employees in those contracting and subcontracting fields began to lose their jobs.

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Timing of TARP Capital Infusions

Timing of TARP Capital Infusions

November 23, 2008

Authored by: Ken Achenbach

A representative of the Federal Reserve Bank of Atlanta has informed us that the Treasury does not intend to process any applications for private companies until all public company applications have been processed.  As a result, we expect (and the Federal Reserve did not deny) that a December 31 funding date is probably a realistic expectation only for public companies at this point.  We hope that Treasury will begin to realize some efficiencies in the processing of closing documents, but December 31 is approaching rapidly.

To the extent that any privately-held clients may be expecting a potential TARP infusion to keep them “well-capitalized” at December 31, 2008, they may need to also be working on Plan B.

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Commentary: Tightening of TARP Capital Standards

Conversations with each of the federal banking regulators over the last several days confirm what we have heard elsewhere: the distribution of TARP Capital that started out with a more liberal bias has now turned more conservative.  Regulators have recently indicated that institutions with a CAMELS rating of 1 and 2 are almost certainly likely to receive an investment, while 3-rated institutions are now described as “perhaps” receiving an investment.  4 and 5-rated banks are unlikely to receive any TARP Capital, absent unique circumstances.  (Just a few weeks ago, these same regulators were telling us that a 3-rated institution would be treated more like a 2-rated institution, and that 4-rated institutions would “perhaps” receive an investment.)  This shift is certainly an outgrowth of Treasury’s position that the main test of which institutions will receive capital investments is assured long term viability.

What does this mean for the thousands of banks that will not receive funding?  They certainly need to be considering a public relations initiative to manage or preempt the questions that will come at them from shareholders and the local media.  Perhaps the conversation could be along the following lines: “(i) the banking industry did not ask for this plan (which has changed dramatically since it was first proposed); (ii) an investment by the Treasury in a bank is not an automatic guarantee that a particular bank will be successful and neither is a decision not to invest some sort of condemnation; (iii) our loan portfolio reflects our community and the real estate lending which helped our community grow is suffering; and (iv) we are here for the long run and look forward to meeting the credit needs of our customers for years to come.  Together we will both survive the current economic challenges.”

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Do Private Companies Need to Amend their Applications?

In light of the new term sheet for non-public institutions, we have been asked by several clients whether they need to amend their application if they have already submitted applications to their federal regulators.

At this time, unless the regulator specifically asks that you file an amendment, we do NOT believe an amendment should be necessary.  The Treasury has not updated its application form (available online directly from the Treasury in PDF format, or from Powell Goldstein in Word format) and the application does not contain any information that would differ because the company is applying under the new non-public company term sheet.

We are aware of one instance in which the regulators specifically requested an amendment, but in that case the applicant also desired to increase the amount of TARP Capital they were applying for, which would seem to independently necessitate an amendment.

Update 11/20/2008 – An FDIC representative confirmed to one of our privately-held clients that they did NOT need to file a new application or amend their application, but that they should confirm to the regulators that they have reviewed the new Term Sheet.

Update #2 11/20/2008 – A Federal Reserve Bank of Atlanta representative stated that they expect that private banks WILL NEED to make some kind of amendment, but they don’t know what form that amendment will take.  They expect to receive guidance later this week from D.C., and will inform applicants accordingly.

Update #3 11/21/2008 – The representative of the Federal Reserve Bank of Atlanta has informed us that the staff at the Board of Governors has advised that there is NO need to amend the application to reflect the recent terms announced for private companies.  The documents the Treasury will require participants to sign in order to participate will incorporate all of the changes, terms, conditions, etc.

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New Term Sheet for Private Banks

New Term Sheet for Private Banks

November 17, 2008

Authored by: Robert Klingler

The Treasury has published a new Term Sheet and FAQ for banks that are not publicly traded.

We will provide additional analysis over the next several days, but here are some highlights:

  • The new Term Sheet applies to all non-public qualifying financial institutions, excluding S Corporations and mutual organizations.  The Treasury has NOT clarified its prior statement regarding the definition of “publicly traded” companies to clarify whether such companies must be traded on a national securities exchange or whether being obligated to file periodic reports is sufficient to constitute a publicly traded company.
  • Investment structures for S Corporations and mutual organizations are still “under consideration,” and the announced deadline does not apply to S Corporations or mutual organizations.
  • The deadline for applications for private C Corporations is Monday, December 8, 2008.
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Federal Reserve TARP Capital Review for Public Member Banks

We are beginning to receive some indication of how the Federal Reserve will be reviewing TARP Capital Applications for public member banks.  As institutions begin to file applications in greater numbers, we believe the review process is starting to gel from a methodological standpoint (although the regulators still say they receive new guidance daily).  We have not yet had any indication as to how consistent this review methodology may be between regulatory agencies.

We understand that the review will generally consist of a 3-part process:

  • First, the regional director of applications risk will serve as an initial point-of-contact person who will review the application and any follow-up materials that may be requested.  The plan is for this initial review period to take approximately 3 days, although this time period could be extended, depending on the circumstances of a particular application and the volume of applications being processed.
  • Second, the application will be passed along to a 5-member panel.  This panel will review the application and make the decision as to whether an “invest” recommendation should be made to Treasury.
  • Finally, Treasury will make its ultimate investment decision, based in large part on the recommendation of the regulators.

The review process, from the filing of an application to an ultimate decision by Treasury to fund, may be completed in as little as 5-7 days, although this process could be drawn out considerably, based on the circumstances.

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