The most significant regulatory intervention in U.S. banking since the Great Depression was just launched in the form of the $700 billion Troubled Asset Resolution Program (TARP) and its $250 billion TARP Capital Purchase Program (CPP). Treasury is currently allocating funds in the TARP CPP and has spelled out its pricing and terms for participation. While the timing from initial announcement in mid-September to the Nov. 14 and Dec. 8 deadlines for application for TARP has been startlingly quick, banks that received TARP funding can catch their breath and begin to think through the strategies to best take advantage of this newfound capital.
To assist, this article will examine the TARP programs and the related FDIC debt guarantee programs. We will identify key benefits and risks of participating in TARP and review key banking strategies for 2009 and beyond.
Background and impact
As a historical note, from 1933 to 1935, the Reconstruction Finance Corp. (RFC) purchased more than $1.7 billion in preferred stock from 6,104 banks. By the program's end in 1935, RFC had a substantial voting interest in half of the nation's commercial banks. The terms for today's TARP Senior Preferred Stock ("TARP Preferred") and associated warrants are summarized in the box "TARP Preferred Terms," at the right.
The TARP Capital Purchase Program set aside $250 billion of funding for investments in banks and thrifts. The program was kicked-off by nine large institutions which committed to receive $125 billion of funds. Banks whose shares are traded on major exchanges were asked to submit their application by Nov. 14. Through Dec. 15, 203 publicly traded banks (including the original nine) had been given approval to receive about $246.8 billion in funding. About 3,110 private institutions were excluded from the public TARP program, but were later extended an invitation to apply for TARP funding by Dec. 8. The issuance terms were largely the same for private institutions, except that Treasury will receive warrants to purchase preferred stock with a liquidation value of 5% of the face amount of the TARP preferred, a dividend rate of 9%, and an initial exercise price of one cent.
The benefits of participating in TARP CPP are straightforward:
* Access to the least expensive form of equity capital currently available
* Anticipates potential guidance to higher capital levels
* Provides increased ability to fund growth, expansion, and acquisition opportunities
* Creates minimal dilution that can be offset with investment in interest-earning assets
* Provides a market perception of financial strength
The risks of participation in the TARP preferred program are more qualitative:
* Difficult to achieve reasonable return on "excess" capital.
* Restrictions on dividend increases or/and stock buybacks.
* Potential earnings per share dilution.
* Potential corporate governance impact.
* Vagaries of contract with regard to future lending and loan workouts.
* Risk of greater government involvement in the future.
In addition to the TARP preferred capital purchase program, the government, through FDIC, also authorized the Temporary Liquidity Guarantee Program (TLGP) and its Senior Unsecured Debt Guarantee Program on Nov. 21, 2008. The TLGP program will guarantee new senior, unsecured debt with maturities greater than 30 days issued on or before June 30, 2009. All FDIC-insured depository institutions are eligible to participate, along with bank and financial holding companies and certain savings and loan holding companies. The amount of debt which may be issued under the program is generally limited to 125% of the senior unsecured debt outstanding at Sept. 30, 2008, that is scheduled to mature by June 30, 2009. The limit for institutions without any senior unsecured debt outstanding at Sept. …