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Treasury to Infuse $250 Billion of Capital into Nine Largest Banks

October 12–18, 2008

Financial Reform Watch

Financial Reform Watch is a Blank Rome Government Relations LLC series of alerts developed for our colleagues needing to keep current on Washington's response to the turmoil in the financial markets..

Friday, October 17—6:00 p.m. EDT
 

Many unresolved issues continue to surround the financial relief program as evidenced by a flurry of diverse actions today. The nation’s banking regulators — the Federal Reserve, the Federal Deposit Insurance Agency, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision — issued a joint release about tax relief for banking organizations that have suffered losses on their Fannie Mae and Freddie Mac holdings.  The regulators will allow banking organizations “to recognize the effect of the tax change enacted in Section 301 of the Emergency Economic Stabilization Act of 2008 (EESA) in their third quarter 2008 regulatory capital calculations.”  Without today’s decision, banking institutions would not have seen any tax benefit until the fourth quarter of 2008.

Also today, leaders of the Independent Community Bankers Association (ICBA) met with President Bush and Secretary Paulson to discuss the Treasury’s capital purchase program. The FDIC will be the main overseer of that program; however, institutions’ primary regulators (e.g. OCC or OTS) will assist the FDIC. The Treasury has released some details of the program, but according to an ICBA press release, more details are needed.  Association leaders urged Treasury to provide “details on how mutual, Subchapter S corporation, privately held and non-publicly traded community banks can participate.” 

The ICBA has offered suggestions for modifying the TARP Capital Purchase Program.  We understand the ICBA along with others are working with Treasury to make the needed changes and expect Treasury to release more detailed guidance next week.  Some of the ICBA suggestions include:

• IRS agreeing not to allow capital injection to alter S Corp status; this would not cost taxpayers
• Alter the dividend restrictions, which could be problematic for Subchapter S banks and privately held banks
• For community banks that are in mutual form and do not issue stock, the program should be adjusted so they can participate
• Some stock-holder owned community banks do not have an identified market value, which is a problem given the warrant requirements.  ICBA has proposed alternatives related to a national bank index.

In other news this afternoon, the Treasury Department released guidelines for small businesses that want to pursue procurement opportunities in the EESA program.  The guidelines contain a list of Web sites where small businesses can sign up for information alerts and input their capabilities.

Thursday, October 16—5:30 p.m. EDT
 

Tuesday, October 14—5:00 p.m. EDT

This afternoon, the U.S. Department of the Treasury announced its selection of the Bank of New York Mellon Corporation (BoNY Mellon) to serve as the custodian for implementing the Troubled Asset Relief Program (TARP), which was established by the Emergency Economic Stabilization Act of 2008.  This action paves the way for the contractor to begin providing a broad array of services that will almost certainly require the assistance of multiple subcontractors. 

Under the terms of the agreement, the Treasury may approve or reject any subcontractors to BoNY Mellon, however, BoNY Mellon will contract directly with, pay, and assume liability for any subcontractors. 

BoNY Mellon started working immediately “to help the Department with custodial, accounting, auction management, and other infrastructure services needed to administer the complex portfolio of troubled assets the Department will purchase.”  Here is a sampling of the responsibilities specified in the contract’s scope of work:

• Provide and supervise all accounts for the portfolio and for all asset anagers appointed by Treasury; Treasury plans to appoint multiple asset managers.
• Provide asset tagging in order to track unique attributes of assets in the portfolio such as warrants, executive compensation triggers, and tax law triggers linked to counterparty transactions.
• Manage and execute auctions and/or reverse auctions to acquire securities for the portfolio, including conducting multiple simultaneous auctions.
• Manage all the accounting and reporting requirements.
• Provide pricing, valuation, and market information for all debt and equity assets in the portfolio.
• Track, confirm, and maintain records for all operations of the portfolio.
• Provide a technology platform for executing the purchase, sale and holding of mortgage loans and loan portfolios; Treasury will appoint multiple whole loan asset managers who will need to use this platform.
• Provide physical storage for safekeeping of loan and legal documents.
  Act as master loan servicer, overseeing activities of primary servicers as Treasury directs; disseminate and monitor compliance with Treasury’s servicing guidelines and conduct on-site reviews of servicers.

The Financial Agency Agreement between the U.S. Department of the Treasury and the Bank Of New York Mellon for Custodian, Accounting, Auction Management and Other Infrastructure Services for a Portfolio of Troubled Mortgage-Related Assets can be downloaded here.

Tuesday, October 14—1:00 p.m. EDT

Treasury Department officials confirmed overnight their plan to allocate the first $250 billion of the $700 billion financial rescue package not for the purchase of troubled assets, as originally contemplated, but to inject capital into nine of the nation's largest banks in exchange for preferred shares. Calling it the TARP Capital Purchase Program, President Bush is expected to certify today that the next $100 million of the plan is required for release per the provisions of the Emergency Economic Stabilization Act of 2008.  

Here is how the funds will be distributed:

Citigroup                 $25 billion

JP Morgan Chase      $25 billion

Bank of America        $25 billion (including $5 billion for its Merrill Lynch acquisition)

Wells Fargo              $25 billion (including $5 billion for its Wachovia acquisition)

Goldman Sachs         $10 billion

Morgan Stanley        $10 billion

Bank of New York      $2-3 billion

Mellon Bank             $2-3 billion

State Street Bank     $2-3 billion

TOTAL                    $126 - 129 billion.

This leaves $221-224 billion unallocated from the funds available after the president's certification to release the next $100 million. While several reports indicate that smaller banks will soon be among those receiving funds from the program, there is no confirmation yet of how and when that would happen.  The Treasury-issued summary of the senior preferred stocks and warrants program says the department will “determine eligibility and allocation for QFIs (qualified financial institutions) after consultation with the appropriate federal banking agency.”  We anticipate the Office of Thrift Supervision and perhaps State Bank Supervisors may have roles in qualifying and running the program for smaller institutions, and we will continue to monitor for further developments related to "Main Street" banks.

The TARP Capital Purchase Program completes a pivot by the Bush Administration over the past four days in which they adopted an approach they had previously rejected.  Perhaps predictably, congressional Democrats reacted with some concern last night because no information was available on whether Treasury had exacted the price for equity investment that some Democrats have wanted. Among the concessions they had suggested Treasury should obtain for such investments were limits on executive pay, a cessation of dividend payments, and a commitment that recipient banks would not use "exotic" investment instruments. The program details released thus far do include executive compensation restrictions, dividend restrictions, and numerous other terms and restrictions. 

Also announced late Monday were two important actions by the Federal Deposit Insurance Corporation (FDIC). The FDIC’s Temporary Liquidity Guarantee Program will insure loans between banks for a three-year period and will lift limitations on the amount of insurance in non-interest bearing accounts many companies use to manage their short-term operations.  Not to be left out, the Federal Reserve announced it will begin its Commercial Paper Funding Facility Program (CPFF) on October 27, 2008.  The CPFF will “provide a liquidity backstop to U.S. issuers of commercial paper” by purchasing eligible, three-month, unsecured and asset-backed commercial paper “from eligible issuers” using financing from the Federal Reserve Bank of New York.   

More details of the CPFF and the TARP Capital Purchase Program can be downloaded here.

Monday, October 13—12:00 p.m. EDT  

World stock markets responded well this morning to the emerging consensus among European and US officials to focus on capitalizing banks with government funds in exchange for an ownership stake in them. Wednesday's announcement from UK Prime Minister Gordon Brown that he plans to inject capital directly into banks and to guarantee interbank lending accelerated momentum for similar moves by the United States and European central bankers. Meetings on Friday and over the weekend among the G-7 finance ministers and at the International Monetary Fund in Washington helped to bring these key players into alignment.

Meanwhile, the Treasury Department took further steps to implement the Troubled Asset Relief Program (TARP). In a speech this morning before the Institute of International Bankers, Acting Assistant Secretary of the Office of Financial Stability (OFS) Neel Kashkari outlined progress and the seven internal policy teams established to execute the TARP--

1. Mortgage-backed Securities Purchase Program - will examine which assets to purchase, from whom, and how
2. Whole Loan Purchase Program - will work with bank regulators to determine which loans to purchase first, how to value them, and how to purchase them
3. Insurance Program - on Friday, Treasury solicited public comments on how to insure troubled assets; comments are due within 14 days, at which point OFS will develop the program
4. Equity Purchase Program - will establish a standardized program to buy equity in a broad array of financial institutions; program will be voluntary with attractive terms so healthy institutions will participate and also raise private capital to complement public capital
5. Homeownership Preservation - will work with the Department of Housing and Urban Development to help homeowners when the Treasury purchases mortgages and mortgage backed securities
6. Executive Compensation Program - will define firms' participation requirements for three scenarios: auction purchase of troubled assets, broad equity or direct purchase program, and an intervention to prevent the failure of a systemically significant firm
7. Compliance Program - will set up the Oversight Board, the on-site participation of the General Accounting Office, the selection of a Special Inspector General, and all the reporting mechanisms

Kashkari also announced that the Financial Stability Oversight Board, comprised of the Chairman of the Federal Reserve, Treasury Secretary, Director of the Federal Housing Finance Agency, SEC Chairman, and Secretary of Housing and Urban Development held its first meeting and selected Bernanke to chair. In addition, Treasury has appointed five people to fulfill critical, albeit interim, roles--

1. Chief Financial Officer - Tom Bloom; CFO of the Comptroller of the Currency and former CFO of the Department of Commerce
2. Chief Risk Officer - Jonathan Fietcher; Deputy Director of the IMF Monetary and Capital Markets Department, former Board Member of both the Resolution Trust Corporation and the FDIC
3. Chief of Homeownership Preservation - Donna Gambrell; Director of the Community Development Financial Institutions Fund at the FDIC and former Resolution Trust Corporation official
4. Chief Compliance Officer - Don Hammond; Deputy Director of Federal Reserve Bank Operations and Payment Systems and former Treasury Fiscal Assistant Secretary
5. Chief Investment Officer - Reuben Jeffrey; Under Secretary of State for Economic Affairs and former Chairman of the Commodity Futures Trading Commission

Last week, Treasury solicited proposals from six specialist law firms to advise the department on structuring the equity program. Treasury selected Simpson Thatcher on Friday. Kashkari also announced the Saturday selection of Chicago-based Ennis Knupp as the Investment Management Consultant for the TARP. Three solicitations remain - the Master Custodian Firm, which Kashkari referred to as the prime contractor of the purchase program; the Securities Asset Manager; and the Whole Loan Asset Manager. Treasury plans to announce the selection of the Master Custodian Firm within the next twenty-four hours and will announce the remaining two firms in the next few days. We will keep you posted on these and other developments.
 

To view the Financial Reform Watch alerts from previous weeks:

• October 5–11, 2008
• Summary and Analysis of the EESA (October 7, 2008)
• September 28–October 4, 2008
• September 21–27, 2008

Notice: The purpose of this newsletter is to review the latest developments which are of interest to clients of Blank Rome. The information contained herein is abridged from legislation, court decisions, and administrative rulings and should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.