Approximately 343 banks remain in TARP's Capital Purchase Program ("CPP"). If these banks remain in TARP into late 2013, they will start to face a steep increase in quarterly dividend payments as dividend rates increase to nine percent from five percent, five years after investments were made. Yet, for many of these banks, the prospect of raising sufficient capital to repay their TARP funds by the time the increased dividend rate begins is bleak. Those that can raise the capital for repayment will dilute their existing shareholders, in some cases substantially.
Meanwhile, the U.S. Treasury Department ("Treasury") appears anxious to wind down its remaining TARP bank investments. In November 2011, CPP participants received letters from Treasury stating that the government had hired the consulting firm of Houlihan Lokey Capital Inc. ("Houlihan") to explore options for the "management and ultimate recovery" of the Treasury's investments. Soon after, Houlihan began calling bank executives, asking about their plans to leave TARP and, in some cases, requesting (or demanding, when Treasury had an ability to do so) that the bank file a registration statement to allow Treasury to sell its TARP securities. Under the terms of their TARP agreements, many banks with securities registered with the Securities Exchange Commission ("SEC") must maintain a shelf registration statement with the SEC that permits the re-sale of the bank's preferred shares held by Treasury. However, banks with SEC registered stock that are not eligible to file a Form S-3 registration statement are not required to file a registration statement until requested to do so in writing by Treasury. And, in some cases, Treasury has waived the registration statement requirements even for banks that are eligible to file Form S-3 statements. However, Treasury's recent course suggests that exiting TARP is now its paramount interest.
For many of the remaining CPP participants, creating — and implementing — a TARP exit strategy is an extremely daunting task. Not surprisingly, the biggest U.S. banks — those holding $50 billion or more in assets — were the first to exit TARP. By the end of 2009, these banks had raised sufficient capital and met other conditions to exit CPP. The majority of banks holding assets of $10 billion to $50 billion followed suit, with less than 10 of these banks remaining in the program.
Smaller community banks have been less successful in leaving TARP because they were hit especially hard by turmoil in the financial industry, are under extreme regulatory pressure, and have little access to the capital markets. Last year, however, 137 community banks were able to leave TARP by refinancing through the government's Small Business Lending Fund ("SBLF"), which finished accepting participants on September 27, 2011. An analysis by the Special Inspector General for TARP ("SIGTARP") reveals that the banks that exited through SBLF were healthier than those that remain in TARP.
The banks remaining in TARP face significant challenges that impede their ability to exit TARP. According to the SIGTARP study, which was released on April 25, 2012, 163 of the banks remaining in TARP are not current in making dividend and interest payments on CPP funds. Many banks have missed six or more payments, giving Treasury the right to appoint directors to the delinquent banks' boards (although Treasury has not done so in every case). Additionally, about one-third of the banks remaining in CPP are operating under formal enforcement orders imposed by their federal regulators.
So what are these banks to do? On May 3, 2012, Treasury released details on its exit strategy for winding down its TARP investments, which entails employing a mix of the three basic approaches that have been used throughout TARP:
Understanding Treasury's approach to each of these options can help banks plan and execute their own TARP exit strategies.
Treasury believes many banks will be able to pay off their debts in full over the next 12-18 months and Treasury intends to continue holding those investments until they are paid off. Treasury acknowledges that expectations about repayment ability may change periodically based on market and other conditions, and it intends to be in frequent communication with banks that anticipate repayment in the next 12-18 months. At the same time, Treasury acknowledges that the majority of banks remaining in CPP do not fall into this category, and Treasury intends to move toward winding down these investments through restructurings and sales.
While only a small number of banks have successfully negotiated restructurings of their TARP debts, restructurings remain a possible exit strategy. Under limited circumstances, Treasury has agreed to restructure TARP investments, such as by exchanging preferred stock for money or another equity format, including, for example, trust preferred securities, convertible preferred stock, common stock or warrants. These restructurings typically occur in connection with mergers or capital raising plans. Treasury has participated in approximately 20 restructurings to date and will consider future restructurings so long as "the terms represent the best deal for taxpayers under the circumstances."
In March of this year, Treasury sold its preferred stock investments in six banks through auctions. While Treasury previously auctioned TARP bank warrants, this was the first auction of preferred stock investments, and the March 2012 auctions sparked interest from both CPP participants and a broad base of investors. These auctions were substantially oversubscribed, receiving eight times as many bids as the number of securities offered. Despite criticism that the auctions brought in less money than the original par value of investments, Treasury stated that the returns were in line with its budget projections and did not constitute a loss to the public. Treasury announced that it expects to auction additional preferred stock investments in the future and that it believes that these auctions may be beneficial to community banks because they increase the banks' access to the capital markets by attracting new private capital. Treasury will consider combining smaller investments into pools, which would likely attract more investors than individual sales would. Some CPP participants, who Treasury cannot require to file registration statements, have voluntarily filed statements in case the opportunity for an auction of their shares arises. Sales and auctions of TARP investments can also release the banks from some of TARP's restrictions, such as executive compensation, dividend and redemption restrictions, that apply only so long as the government holds the investment. However, the same underlying debt instrument is transferred in the sale, which means that many other conditions, such as the increased dividends in late 2013 and the ability of the investor to appoint directors to the bank's board after six missed payments, will remain.© 2013 Schiff Hardin LLP