Financial Markets in Crisis: The Capital Purchase Program Takes Shape

October 20, 2008

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets.

We are providing updates on key regulatory and legislative issues as well as information on legal issues that we believe could prove useful as firms and other entities navigate these challenging times.

Today, Treasury Secretary Henry Paulson delivered a statement addressing new details about the Capital Purchase Program ("CPP"), Treasury’s initiative to purchase $250 billion in preferred stock of American financial institutions under the Troubled Asset Relief Program ("TARP").[1]  This program is designed to inject capital into America’s financial institutions and increase available financing for U.S. businesses and consumers.    

As expected, Secretary Paulson announced that CPP participants will be required to accept corporate governance and executive compensation restrictions, such as a ban on golden parachutes and the implementation of a clawback provision.  Secretary Paulson stated that these taxpayer protections ensure that, “[t]his is an investment, not an expenditure.”  Further, he said that “there is no reason to expect this program will cost taxpayers anything.”  Secretary Paulson also stated that Treasury “expected” participating banks to help struggling homeowners avoid foreclosure. 

Treasury is seeking broad participation by financial institutions in the CPP.  Secretary Paulson emphasized that sufficient capital has been allocated so that all qualifying institutions may participate, and that participation is not on a first-come, first-served basis.  Among the key details of the CPP program are the following:

• The program is open to "Qualifying Financial Institutions," or "QFIs."  QFIs include (1) banks or savings institutions not controlled by a Bank Holding Company ("BHC") or Savings and Loan Holding Company ("SLHC") and (2) BHCs and SLHCs that engage "solely or predominately in activities that are permitted for financial holding companies under relevant law."  Financial institutions controlled by a foreign bank or other entity are not eligible to participate in the program.  We note that this definition is not the same as – and, indeed, is more restrictive than — those that determine eligibility for other aspects of the Troubled Asset Relief Program or for the FDIC’s Temporary Liquidity Guarantee Program.  Note also that the QFI definition appears to be a work in progress as there are discrepancies among the term’s descriptions in Treasury’s FAQs document, term sheet, and application guidelines.
• For BHCs and SLHCs, capital purchases will be made from the highest-tier holding company.
• Treasury’s application guidelines, application, and other materials can be found at the following web address (the application is the last two pages of the application guidelines document):  http://www.treas.gov/initiatiatives/eesa/
• Applications are due by 5:00 PM (EST), November 14, 2008.
• A QFI need not comply with all terms and conditions attendant to the program by that time.  Rather, once a QFI is granted preliminary approval, it will have 30 days in which to submit necessary investment agreements and documentation.
• Institutions should send their applications to their primary federal regulator.  Regulators then will send applications to Treasury along with their recommendation.
• Treasury will announce any transactions within 48 hours of their completion.
• The minimum subscription amount available to participating institutions is 1 percent of risk-weighted assets; the maximum amount is the lesser of $25 billion or 3 percent of risk-weighted assets. 
• Treasury will take non-voting senior preferred shares, which will pay a cumulative divided rate of 5 percent per annum for the first five years, and 9 percent per annum after the fifth year.  They will be callable at par after three years.  Treasury is reserving the right to transfer the shares to a third party at any time.
• As required by the terms of the rescue bill that created TARP, Treasury will obtain warrants from participating QFIs.  The warrants are to be convertible into common stock equal in value to 15 percent of the capital purchased from the QFI by Treasury.