If you have Troubled Asset Relief Program preferred stock on your books, want to buy a bank that has Tarp on its books or seek to invest in an institution that that still has Tarp on its books, there are ten things that you should keep in mind as you attempt to structure a deal with Treasury.
Before reviewing those, let's consider the facts. There are some 300 financial institutions that still have Tarp on their books. Treasury wants it off the U.S. balance sheet, if for no other reason than to turn the page on the recent financial crisis. It has a team of talented financial and legal experts that are working on various transactions that involve redeeming Tarp securities, selling or restructuring them, sometimes in connection with recapitalizations by new investors of Tarp institutions.
Similarly, most financial institutions want to end the Tarp era so that they can extricate themselves from the increased government involvement that comes with Tarp. That is particularly true given the fact that according to the terms under which the Tarp securities were issued, dramatically higher dividend rates of 9% (versus 5%) will go into effect after five years. For the many companies that received Tarp beginning in 2008, that is right around the corner. Once those dividend rates are increased, it's likely to further increase government involvement. For example, companies' inability to honor the higher preferred stock dividend rates will trigger dividend payment defaults which will allow the government, among other things, to appoint up to two representatives on the board of directors.
Depending on what vantage point you have, some or all of the following considerations and issues will impact your Tarp transaction.
First, the Tarp world is divided into several different categories: very large Tarp recipients, failing Tarp recipients, Tarp banks that are trying to negotiate their own recapitalization and/or Tarp redemption and Tarp banks that will go into the auction pools that the Treasury has been selling to the public at a discount. You should know what category your bank fits in and where the Treasury has it slotted if you want to structure a successful deal.
Second, if the pending transaction anticipates the repayment of Treasury at less than par, financial issues will arise. For example, what Treasury accepts for redemption will be a function of several different factors: what the securities would likely fetch in an auction, what dilution other common and preferred shareholders have already experienced or are likely to experience in the redemption transaction, what Treasury is being offered for the securities, (i.e., how much of a discount Treasury will be asked to take), (what other securities are outstanding in the bank's capital structure how those other securities are likely to fare and how those other securities, such as Trups, may otherwise impact the transaction.
Third, companies should understand how the redemption of Tarp may continue to impact the executive compensation restrictions that came with it. For example, vested restricted stock given to bank executives during the Tarp period may need to be partially forfeited if the aggregate value of the dividends and redemption from Tarp do not make the Treasury 100% whole on its original investment.
Fourth, the involvement of new capital in a Tarp redemption can be structured several different ways. There are likely to be different accounting and regulatory results depending on whether an investor purchases the Tarp from the Treasury or invests in the bank, which then uses that new money to, among other things, redeem its Tarp.
Fifth, where Tarp has been restructured into other securities, and where favorable accounting results have already been booked, they have to be taken into consideration when structuring a takeout of those securities.
Sixth, in that regard, the Tier 1 capital treatment grandfathering Trups may enjoy under the Dodd-Frank Act has to be taken into consideration when determining whether a Tarp issuer will want a new investor to continue to hold the identical securities or restructure them to better reflect the economics the investor expects.
Seventh, at the end of the day, all creativity aside, institutions need to keep in mind they are doing a deal with the U.S. government, and especially in an election year, headline risk may play a role in the profile of the ultimate structure that is chosen.
Eighth, if a bank is considering repurchasing its Tarp, there may be clear economic benefits to redeeming it from an auction purchaser that bought it at a discount from the Treasury.
Ninth, Treasury has limited human resources stretched over a large number of transactions. Make sure your first approach is your best if you want to maintain credibility and get a slot in line.
Tenth, make sure you coordinate with your regulators, particularly if there is new capital coming into the bank to take out the Tarp which may end up in a position of control for purposes of bank regulation. These transactions can create complex multi-sided negotiations, since what satisfies the Treasury may not satisfy the Federal Reserve Board.
There will be some complex decisions for those involved in Tarp situations, particularly with regard to banks that are likely to fail if they are not acquired or recapitalized, where Treasury may receive nothing for its investment.
Thomas P. Vartanian is chairman of Dechert's Financial Institutions practice. He formerly served as general counsel of the Federal Home Loan Bank Board and the Federal Savings and Loan Insurance Corp., as well as a senior trial counsel at the Office of the Comptroller of the Currency.