United States: The Financial Stability Plan: Treasury Releases Terms Of The Capital Assistance Program

On February 10, 2009, Treasury Secretary Timothy Geithner introduced the Financial Stability Plan, a series of programs to be implemented by the U.S. Treasury Department, the Federal Reserve, and other regulatory authorities that are designed to strengthen financial institutions and stabilize financial markets. The Financial Stability Plan includes four principal elements: (1) the Capital Assistance Program to ensure that banks have adequate amounts of "high-quality" capital, (2) the Public-Private Investment Fund, established to purchase "legacy" assets (i.e. mortgage-backed and other collateralized securities that are declining in value and adversely affecting bank balance sheets) from financial institutions, (3) an increase in the size of the Federal Reserve's Term Asset-Backed Securities Lending Facility to $1 trillion from $200 billion, as well as the potential inclusion of real estate loans in eligible collateral, and (4) the Homeowner Affordability and Stability Plan, designed to help prevent residential foreclosures.

The Economic Crisis Response Group is closely monitoring new developments in response to the current turmoil affecting the world's financial markets and institutions and provides updates and analysis on key initiatives to address this crisis.

This update focuses on the Treasury Department's Capital Assistance Program, the details of which were released on February 25, 2009.

The Capital Assistance Program

The Capital Assistance Program ("CAP") is the core element of the Obama Administration's Financial Stability Plan and is designed to ensure that banks have adequate capital to function under worse than expected economic conditions. CAP consists of (1) a forward-looking capital assessment to determine whether a banking institution is sufficiently capitalized to withstand a difficult economic environment, and (2) a program for the Treasury to invest in U.S. banking institutions deemed to require additional capital through the purchase of convertible preferred stock as a bridge to private capital in the future.

If regulatory authorities determine that a bank is in need of additional capital, the qualifying banking institution may raise the additional capital from private sources within six months from the date of this determination or obtain additional capital under CAP. The additional capital required as a result of the capital assessment does not represent a new capital standard for banks and is not expected to be permanent. It is intended only to help banking institutions absorb larger than expected future losses, if any, and to support lending to creditworthy borrowers during the economic downturn. Any capital investments made by Treasury under the CAP will be placed in a separate trust set up to manage the government's investments in U.S. financial institutions.

Eligibility

CAP is currently available only to publicly traded U.S. Qualifying Financial Institutions ("QFIs"), which are defined as (i) any U.S. bank or U.S savings association not controlled by a Bank Holding Company ("BHC") or Savings and Loan Company ("SLHC"), (ii) any top-tier U.S. BHC, and (iii) any top-tier U.S. SLHC which engages solely or predominately in activities that are permitted for financial holding companies under relevant law. Financial institutions controlled by non-U. S. entities are not eligible. QFIs seeking CAP assistance must submit an application to the appropriate federal banking agency by May 25, 2009. The Treasury will release separate term sheets governing the eligibility of QFIs that are not publicly traded, organized as subchapter S corporations, or in mutual form.

Banking Institutions with Less than $100 Billion in Assets: Smaller QFIs that wish to apply for CAP assistance will be subject to the same eligibility requirements used in the Capital Purchase Plan ("CPP"), the program to purchase preferred shares of U.S. financial institutions implemented by the Treasury Department in October 2008.

Banking Institutions with Assets in Excess of $100 Billion: Bank regulatory authorities will conduct mandatory capital assessments of 19 publicly traded banking institutions with assets in excess of $100 billion, which in the aggregate comprise roughly two-thirds of U.S. Bank Holding Company assets. The capital assessment will test the capital adequacy of these banking institutions using two stress scenarios. The first is a "baseline" scenario that reflects, among other things, a 2% decline in GDP in 2009, followed by a GDP growth rate of 2.1% in 2010; an 8.4% unemployment rate in 2009, followed by an 8.8% unemployment rate in 2010; and a 14% decline in housing prices in 2009, followed by a 4% decline in housing prices in 2010. The second is a more "adverse" scenario, which assumes a 3.3% decline in GDP in 2009, followed by a GDP growth rate of 0.5% in 2010; an 8.9% unemployment rate in 2009, followed by a 10.3% unemployment rate in 2010; and a 22% decline in housing prices in 2009, followed by a 7% decline in housing prices in 2010.

Mandatorily Convertible Preferred Shares And Warrants

Convertible Preferred Shares. The Treasury will provide capital to QFIs under CAP by purchasing shares of mandatorily convertible preferred stock ("Convertible Preferred Shares") that are convertible into common equity. Convertible Preferred Shares are intended to serve as a source of contingent common capital for the bank. In addition, QFIs may exchange the preferred securities issued under CPP or the Treasury's Targeted Investment Program ("TIP") with new Convertible Preferred Shares, subject to prior supervisory approval. The Treasury's goal is to keep the period of government ownership under CAP as temporary as possible and, accordingly, the Convertible Preferred Shares are designed to give banks the incentive to redeem or replace government-provided capital with private capital when feasible.

A QFI may issue an amount equal to a minimum of 1% of its risk-weighted assets and a maximum of 2% of its risk-weighted assets, plus any additional amounts to the extent such proceeds are used to redeem preferred shares issued under the CPP or the TIP. QFIs may issue in excess of the maximum amount above upon the approval of the appropriate federal banking authority. QFIs that issue in excess of the maximum amount will be deemed as receiving "exceptional assistance" and may be subject to additional terms and conditions.

Warrants. In addition, participating QFIs will issue warrants ("Warrants") to the Treasury to purchase shares of common stock of the QFI having an aggregate market value (based on the applicable Conversion Price (as described below)) equal to 20% of the amount of Convertible Preferred Shares issued on the date of investment. The Warrants will be immediately exercisable, in whole or in part, at the Conversion Price and have a term of 10 years. QFIs shall have the right to repurchase the Warrants (and any common stock issued upon the exercise thereof) issued to the Treasury under CAP at fair market value upon the full repurchase of common stock acquired by the Treasury through the conversion of the Convertible Preferred Shares. In the event the common stock of the QFI is no longer listed or traded on a national securities exchange, the Warrants will be exchangeable for senior term debt or another economic instrument.

Voting Rights. No voting rights (other than certain class voting rights) will be attributable to the Convertible Preferred Shares. The Treasury will have the right to elect two directors if dividends on the Convertible Preferred Shares are not paid in full for any six dividend periods. The right to elect directors will terminate when the issuer pays four consecutive dividends on the Convertible Preferred Shares. Common stock issued upon the conversion of Convertible Preferred Shares will have all voting rights associated with the common shares issued by the QFI. The Treasury will agree not to exercise voting power with respect to any shares of QFI common stock of the QFI issued to it upon the exercise of the Warrants. The Treasury is expected to publish a set of principles governing its use of voting rights prior to closing any transactions.

Transferability. The CAP does not impose any contractual restrictions on the transfer of Convertible Preferred Shares, the Warrants or the underlying shares of common stock. The QFI is required to file a shelf registration statement, grant piggyback registration rights to the Treasury and take other steps that may be reasonably requested to facilitate the transfer of the Convertible Preferred Shares, the Warrants and the underlying shares of common stock, including efforts to list the Convertible Preferred Shares, Warrants and the shares of common stock on a national securities exchange.

Limits on Executive Compensation. QFIs and their covered officers and employees are required to comply with the rules, regulations and guidance of the Treasury with respect to executive compensation, transparency, accountability and monitoring, as published and in effect at the time of the investment closing to participate in CAP.

Key terms of the Convertible Preferred Shares are presented in the accompanying table:

Dividend:

Cumulative dividend at a rate of 9% per annum, compounding quarterly.

Mandatory Conversion Date

Mandatory conversion to common stock at the Conversion Price 7 years from the date of issuance.

Optional Conversion:

A QFI has the option to convert to common equity at any time, in whole or in part, subject to the approval of the appropriate federal banking authority.

The Treasury has the option to convert to common equity upon specified corporate events, including certain sales, mergers or changes of control of the QFI.

Conversion Price:

90% of the average closing price for the common stock for the 20trading day period ending February 9, 2009, plus any accrued and unpaid dividends (payable in cash or shares of common stock valued at the closing price on the second preceding trading day).

Redemption:

May be redeemed, in whole or in part, at any time at par plus accrued interest, subject to the approval of the QFI's primary federal banking agency, provided that the Convertible Preferred Shares must be redeemed solely with proceeds from the QFI's accumulated retained earnings or the issuance of common stock for cash the aggregate proceeds of which are in an amount equal to not less than 25% of the issue price of the Convertible Preferred Shares.

Following the redemption in whole of the Convertible Preferred Shares held by the Treasury, the QFI shall have the right to repurchase the Warrant and any common stock then held by the Treasury under CAP at fair market value.

Dividend Stopper:

No dividends may be declared or paid on junior preferred shares, preferred shares ranking pari passu with Convertible Preferred Shares, or common shares (other than in the case of pari passu preferred shares, dividends on a pro rata basis with the Convertible Preferred Shares) while any Convertible Preferred Shares are outstanding.

Restrictions on Repurchases:

QFIs may not repurchase or redeem any junior preferred shares, preferred shares ranking pari passu with the Convertible Preferred Shares or common shares, unless all accrued and unpaid dividends on the Convertible Preferred Shares are paid in full.

Share repurchases of common stock or trust preferred securities are prohibited without the prior consent of the Treasury, subject to certain exceptions similar to those under the CPP.

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