The American Recovery and Reinvestment Act of 2009 (the “Act”) contained a number of tax provisions that are likely to be of particular interest to and will directly impact most, if not all, of our bank and other financial institution clients. One of the tax provisions, the provision increasing the period that a net operating loss (“NOL”) can be carried back from two (2) to up to five (5) years, saw the addition of a provision that will substantially limit the number of taxpayers eligible to take advantage of the expanded carryback period. The new limitation makes it likely that only smaller financial institutions will be able to take advantage of the expanded carryback period allowed by the Act. The Act also repealed (with limited transitional protection) the relief provided in Notice 2008-83 issued by the Internal Revenue Service (“IRS”) in the fall of 2008 that exempted certain losses on loans and foreclosure property incurred by banks from the NOL limitation rules applicable to built-in losses.
Increase in the Net Operating Loss Carryback Period
Original provisions coming out of the tax writing committees of the House and Senate included a provision extending the period in which 2008 and 2009 NOLs could be carried back from two (2) to up to five (5) years. The provision also eliminated the 90% limitation on the use of AMT NOLs that were carried back from 2008 or 2009. The limitations in the original provisions were that the expanded carryback period did not apply (i) if the bank or other financial institution received any money under the Troubled Assets Relief Program (TARP) (ii) to Fannie Mae, Freddie Mac, or (iii) any corporation that is a member of the same affiliated group for income tax purposes as a bank or other financial institution that received TARP funds.
The Act retains the expanded carryback period for NOLs, but only for those generated in 2008 (or, at the election of the taxpayer, taxable years beginning in 2008). Further, only taxapayers that are “eligible small businesses” may take advantage of the expanded carryback period. An “eligible small business” that elects may carryback a 2008 NOL for up to five (5) years. An eligible small business is a taxpayer having less than $15,000,000 in average annual gross receipts for the three (3) years prior to the year in which the NOL occurs. Thus, the usefulness to most financial institutions of the expanded NOL carryback provisions appears to have been severely limited by the change in eligibility requirements.
Repeal of IRS Notice 2008-83
The Act retains the provisions repealing IRS Notice 2008-83 originally included in the House bill and subsequently added to the Senate bill. An explanation of these provisions is set forth below.
In addition to our regularly updated map of TARP Capital recipients, BankBryanCave.com will now also be regularly updating a list of TARP Capital recipients sorted by state. We believe this listing (a) shows how the TARP Capital is being distributed across the county, and not just to “Wall Street” and (b) allows community bankers to reference other community banks in their geographic area for an understanding of how the TARP Capital program is really affecting similarly-situated banks.
We have used the location of the headquarters for the bank or bank holding companies that have received TARP Capital to sort by state. While there are a couple short-comings of this methodology (namely ignoring that many regional and national banks operate in multiple states and that bank holding companies may have multiple bank subsidiaries), we believe this approach does a great job of showing the diversity of recipients and accurately reflects, on an aggregate basis, where the TARP Capital is being distributed. (Note: the accuracy is significantly diminished when looking at dollars invested because the shortcomings are most significant with the largest banks, and the size of the investments in these banks distort any aggregate analysis.)
Contrary to initial media reports, it currently appears that the majority, but not all, of the executive compensation restrictions for TARP recipients contained in the Senate version have survived the negotiations between the House and the Senate. According to published conference reports (which may be subject to further change until officially approved by the House and the Senate), the following restrictions on Executive Compensation are being included in the Economic Stimulus Legislation.
The new executive compensation restrictions are at last partially offset by an elimination of the three-year holding period before institutions can freely redeem the TARP Capital investment.
A summary of the final terms, as published in the conference reports, as well a note of certain changes from the Senate version, are included below.
Limits on Compensation
For so long as the Treasury holds preferred stock in an institution, the institution may not make a “golden parachute payment” of any amount to a senior executive officer or any of the next five most highly-compensated employees. A “golden parachute payment” is defined as any payment for departure from a company for any reason, except for payments for services performed or benefits accrued.
On February 10, 2009, Treasury Secretary Geithner laid out the preliminary aspects of how the Obama administration intends to move forward with the Troubled Asset Relief Program. As outlined by the Treasury’s Fact Sheet, there are six elements to the new “Financial Stability Plan.”
1. New Capital Investments - The Treasury will invest an indeterminate amount of preferred stock, to be held in a newly formed “Financial Stability Trust,” to provide a “capital buffer” to help absorb losses and serve as a bridge to private capital. The terms of the preferred stock were generally not announced, but will be convertible at a discount to the institution’s stock price as of February 9, 2009. It appears the capital plan, and the required “comprehensive stress test” is designed primarily for the largest institutions, however the Treasury states that the banking institutions with less than $100 billion “will also be eligible.” Recipients will be subject to the new additional restrictions addressed below.
2. A Public-Private “Bad Bank” – The Treasury plans to leverage public funds with private capital to form a bad bank to purchase “toxic assets.” Pricing, how assets will be chosen, and the structure of the private capital partnership have not been detailed.
On February 10, 2009, the Treasury announced the completion of the thirteenth round of TARP Capital infusions. The Treasury purchased a total of approximately $239 million in securities from 28 financial institutions on Friday, February 6, 2009, and has now invested in 389 institutions, totaling $195.6 billion.
Of note in this thirteenth round, two institutions received less than $1 million each: The Freeport State Bank, Harper, Kansas, received $301,000 and Banner County Bank Corporation, Harrisburg, Nebraska, received $795,000. Further, no institution received more than $60 million, with Lakeland Bancorp, Inc., Oak Ridge, New Jersey, receiving the largest infusion at $59 million. In this round, the average infusion was only $8.5 million.
One more state joined the group of states with an institution receiving TARP Capital — Alaska, with Alaska Pacific Bancshares, Inc. receiving a $4.8 million infusion. This leaves only Montana, New Mexico, Vermont, and Wyoming without an institution to have received TARP Capital.
Click here to view our updated TARP Map.
As a reminder, the deadline for Subchapter S institutions to apply for the TARP Capital Purchase Program is Friday, February 13, 2009. (Review the terms for Subchapter S institutions.)
The application form is unchanged from the initial application, and is available from the Treasury or as a Word document. The Treasury has also confirmed that Subchapter S institutions that applied prior to the announcement of the terms for Subchapter S institutions do not need to re-apply.
While there is significant uncertainty over the application of TARP 2.0 rules to the TARP Capital Purchase program, with over 2,000 applications in the hands of the banking regulators, there is likely to be significantly more clarity to the program before an institution has to make a final decision on whether to accept TARP Capital. Filing an application by the deadline preserves the institution’s flexibility to make a final decision, while declining to make an application effectively constitutes an irrevocable decision not to participate. (See our big picture thoughts on whether to apply for TARP Capital.)
On Friday, February 9, 2009, the TARP Congressional Oversight Panel released its February Oversight Report, with significant press coverage that the Treasury paid too much under TARP.
The Panel’s analysis revealed that in the ten largest transactions made with TARP funds, for every $100 spent by Treasury, it received assets worth, on average, only $66. This disparity translates into a $78 billion shortfall for the first $254 billion in TARP funds that were spent.
Extrapolation to Community Banks?
The Panel’s analysis explicitly extrapolates the value of the Treasury’s investments in 311 banks, including many private community banks will less than $1 billion in total assets, based solely on the individual risk characteristics of Bank of America, Citi, JPMorgan, Morgan Stanley, Goldman Sachs, PNC Financial, US Bancorp, and Wells Fargo. While criticizing the Treasury for using a “one-size-fits-all investment policy,” the Oversight Panel’s analysis uses a one-size-fits-all investment analysis. Other than a footnote acknowledging this extrapolation, the Congressional Oversight Panel’s report does not explain why it believes this extrapolation is appropriate.
On February 6, 2009, the Wall Street Journal ran a story indicating that the Treasury Department is shifting away from a “bad bank” concept and towards a second round of capital injections. This second round of capital injections, according to the Wall Street Journal, would carry stricter terms than the current TARP Capital Purchase program and would be targeted towards weaker banks.
Instead of buying preferred shares, as it did before, the government is discussing taking convertible preferred stakes that automatically convert into common shares in seven years.
To get money, banks would likely have to pay a higher dividend to the government than the 5% rate the government charged in the first round of infusions and agree to a host of new restrictions, such as lending above a baseline level, reporting frequently on their use of the money and curbing executive salaries. While Treasury wouldn’t preclude healthy banks from participating, the stricter terms would likely attract primarily weaker banks in need of capital.
Adding to the acronyms involved, on February 5, 2009, the Office of the Special Inspector General for the Troubled Asset Releief Program (SIGTARP) released its initial report to Congress. The report clocks in at 108 pages plus 77 pages of appendices, but appears to do an excellent job summarizing the Emergency Economic Stabilization Act, the overall TARP program, as well as the specific investments made under TARP.
Highlights include tables on page 47 and 48 that outline the basic terms of all of the TARP equity and debt investments and a complete list, as of January 23, 2009, of the warrants held by the Treasury under TARP, including the strike and market price, in Appendix D. (Most of the warrants held are very “out of the money.”)
TARP Capital Evaluation Process
The report includes a relatively useful summary of the evaluation process being used under the TARP Capital Purchase program. According to the report, all applicants are classified by their federal banking examiner into one of three categories:
- Category One
- CAMELS Composite 1
- CAMELS Composite 2 and for which the most recent examination rating is not more than 6 months old
- CAMELS Composite 2 or 3 and “acceptable performance ratios”
- Category Two
- CAMELS Composite 2 and for which the most recent rating is more than 6 months old
- CAMELS Composite 2 or 3 and “overall unacceptable performance ratios”
- Category Three
- CAMELS Composite 4 or 5
We correlated the Treasury’s official list of TARP Capital Recipients through February 2, 2009 with the FDIC’s Statistics on Depository Institutions (with data as of September 30, 2009) to identify the characteristics of community banks that have received TARP Capital funding.
In order to preserve comparability, we limited our search to stand-alone banks and one-bank holding companies with total assets of less than $1 billion. We identified 161 institutions that met this criteria and had received TARP Capital through February 2, 2009. The institutions ranged from $46.9 million in total assets (Mainstreet Bank in Ashland, Missouri) to $990.0 million (First Federal Savings Bank of Elizabethtown in Elizabethtown, Kentucky). The composite group included 87 state non-member banks, 37 state member banks, 29 national banks, and 8 federal thrifts. The group included representatives from 36 states.
Overall, the 161 institutions, prior to the receipt of TARP funding, generally had very strong capital positions, and were well reserved, but they do show higher concentrations in real estate than expected given today’s emphasis on concentrations.