On April 24, 2009, the Federal Reserve published a white paper describing the process and methodologies employed by the federal banking supervisory agencies in their forward-looking capital assessment of large U.S. bank holding companies. The white paper is thin on new details, but does provide a base for understanding the stress tests being undertaken of 19 bank holding companies with total assets in excess of $100 billion.
Purpose and Effect of the Stress Tests
The stress tests are designed as the first part of the Capital Assistance Program to demonstrate which institutions the government believes will need to raise additional capital. If a stress test demonstrates that an institution requires additional capital, the institution will be required to enter an agreement to issue convertible preferred securities to the U.S. Treasury in an amount sufficient to meet the capital shortfall under the TARP Capital Assistance Program. Each such institution will then be permitted up to six months to raise private capital in public markets to meet their capital needs, and would be able to cancel the obligation to the government without penalty. Participants would also be given the opportunity to convert their existing TARP Capital Purchase Program preferred stock into the convertible preferred stock to be issued under the TARP Capital Assistance Program (such a conversion would not affect the institution’s Tier 1 capital, but could affect the institution’s tangible common equity and their dividend obligations).
The Wall Street Journal Economics Blog has an excellent post by Jon Faust, the director of the Center for Financial Economics at Johns Hopkins University, criticizing Elizabeth Warren’s claim that the Treasury is only getting 66 cents in value for every TARP dollar spent.
Overall, the 66 cent myth is based on the assumption that markets were functioning normally, that the Treasury would pursue a panic sale, and that banks required no compensation due to risk of Congressional meddling.
These arguments are not revelations. Before Warren’s panel commissioned the market-value report, the Panel asked Treasury to perform this valuation. According to testimony, Treasury replied that the market valuation was not relevant. Indeed, Treasury agreed that the assets would be below par if valued at prevailing market prices but argued that the investments would be “at or near par” on a more reasonable basis.
Finally, Treasury reminded the panel that part of the value to the taxpayer was to come in “ensuring the stability of the financial system,” a factor that plays no role in market valuations.
Rather than evaluating these arguments, Warren complained that Treasury didn’t explain itself sufficiently well. Perhaps Treasury could have been clearer, but the basic ideas sketched above are not subtle. If Warren’s panel had insufficient expertise to understand these arguments, the investment bank it hired could easily have explained them.
In addition to these criticisms, as we’ve previously noted, Warren’s analysis uses a one-size-fits-all investment analysis, despite criticizing the Treasury for doing the same thing. The 66 cent figure is based on the value received by the Treasury under the TARP Capital Purchase Program exclusively for its investment in the first eight recipients of TARP Capital Purchase Program funds. While these entities have received the bulk of the TARP Capital Purchase Program funds, there have been over 500 additional recipients of these funds, many of which look virtually nothing like the original eight recipients, and about half of which have received TARP Capital Purchase funds under the private term sheet, resulting in a different investment vehicle.
On April 21, 2009, the Treasury announced the completion of the twenty-third round of TARP Capital infusions. The Treasury purchased a total of approximately $40.9 million in securities from 6 financial institutions on Friday, April 17, 2009, and has now invested in 554 institutions, totaling approximately $198.9 billion.
On April 21, 2009, Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program, released his quarterly report to Congress.
Survey Results
As we’ve previously discussed, Barofsky has issued letters to many TARP Capital Purchase Program recipients requesting information on how the institutions have used the TARP funds and how the institution was addressing the executive compensation limits. As clarified in the report to Congress, SIGTARP sent letters to all recipients of TARP funds through January 30, 2009, a total of 364 recipients. There is no indication that SIGTARP will be sending any letters to subsequent recipients. SIGTARP received responses from all 364 recipients, a 100% response rate. (It’s amazing how much more likely one is to respond to a survey when threatened with government action if one doesn’t respond.)
In testimony before the Senate Finance Committee on March 31, 2009, Barofsky had indicated that while his analysis was ongoing, he had concluded that one thing “was apparent from the responses – complaints that it was impracticable or impossible for banks to detail how they used TARP funds were unfounded.” Barofsky does not repeat this conclusion in the report to Congress, but rather notes that the responses “provided a broad range of answers to the two sets of questions.” While some banks identified detailed and specific uses of the funds, others provided more general responses.
On April 7, 2009, the Treasury published three term sheets for participation in the TARP Capital Purchase Program by mutual organizations with various holding company structures, and, on April 14, 2009, the Treasury published a separate term sheet for mutual depository institutions that do not have a holding company. The term sheets generally are as follows:
- Publicly Traded Subsidiary Holding Companies – Preferred Stock – Tier 1
- Non-publicly Traded Subsidiary Holding Companies – Preferred Stock – Tier 1
- Top-Tier Mutual Holding Companies without Subsidiary Holding Companies – Debt – Tier 1 (requiring a change in regulations)
- Mutual Banks without Holding Companies – Debt – Tier 2
The deadline for mutual holding companies to apply is 5:00 p.m., Eastern Time, May 7, 2009. The deadline for mutual banks without holding companies to apply is 5:00 p.m., Eastern Time, May 14, 2009. The application forms and process are unchanged from those previously provided, and no new application needs to be submitted if the entities applied before the term sheets were available.
The provided term sheets are generally comparable to the terms sheets previously provided to non mutual organizations, with one striking variation. The Treasury has not provided an opportunity for private or Sub S institutions to reduce the number of shares covered by the warrant in half by completing a qualified equity offering during 2009. Only publicly traded companies have the opportunity to cut the number of shares of common stock covered by the TARP warrant in half by completing a qualified equity offering during 2009. (This reduction is separate and distinct from the previous requirement to complete a qualified equity offering in order to redeem the TARP investment within three years. That requirement was eliminated by Congress when it passed the American Recovery and Reinvestment Act of 2009, and participants can now seek to redeem the TARP investment at any time.) The corresponding mutual term sheets, however, include a 50% reduction in warrants for private mutual organization. This variation may, however, merely be an oversight by Treasury, as it is not clear how the warrant would be reduced after it had already been exercised at the time of closing.
On April 14, 2009, the Treasury announced the completion of the twenty-second round of TARP Capital infusions. The Treasury purchased a total of approximately $22.8 million in securities from 5 financial institutions on Friday, April 10, 2009, and has now invested in 548 institutions, totaling approximately $198.8 billion.
On April 13, 2009, the Treasury Department published the standard agreements for Subchapter S institutions to participate in the TARP Capital Purchase Program. As previously discussed, the TARP Capital Purchase Program for Sub S institutions consists of a subordinated debt instrument paying interest at a rate of 7.7% per annum until the fifth anniversary, and then at 13.8% per annum, plus an immediately exercised warrant for additional subordinated debt equal to 5% of the investment, paying interest at a rate of 13.8% per annum. The investment has a 30 year term, and, like trust preferred securities, interest can be deferred for up to 20 consecutive quarterly periods.
Like the documents for public and private participants, the standard documents consist primarily of a letter agreement that incorporates the standard terms contained in a securities purchase agreement, as well as documents defining the investment instruments.
- Form of Letter Agreement
- Securities Purchase Agreement
- Form of Senior Subordinated Securities
- Form of Warrant Senior Subordinated Securities
- Form of Warrant
For some reason, the Securities Purchase Agreement defines the subordinated debt instrument to be the “Senior Notes,” presumably to be comparable to the “Senior Preferred” issued under the TARP Capital Purchase Program for public and private institutions. However, these “Senior Notes” are subordinated to virtually all other indebtedness, whether outstanding at the time of the investment or subsequently incurred. The TARP subordinated debt instruments are senior to any subordinated debt issued in connection with trust preferred securities.
SunTrust Robinson Humphrey has created a depressing slideshow of Atlanta’s residential and CRE properties in development (or in lack of development). From the SunTrust Robinson Humphrey report:
While the city’s residential real estate lot inventory woes are well known to the investment community, we believe the extent of inventory in CRE property types like office and retail centers is not fully appreciated. We took some photos of residential and CRE properties around Atlanta, which is admittedly a small sample. Based on our observations and the statistics, we believe there are significant and growing vacancies around the city, particularly in the outer suburban areas like Alpharetta and Cumming (North of Atlanta). We witnessed particularly high vacancy rates in numerous outer suburb strip and neighborhood retail centers. Atlanta’s retail vacancy rate was 9.9% at the end of 1Q09, compared to the national average rate of 7.2% and Atlanta’s 4Q08 level of 9.0%. This is the sixth highest level of retail vacancy among the 63 major U.S. retail markets. Moreover, Atlanta led all major U.S. markets in aggregate retail space delivered during 1Q09, with 1.7 million square feet hitting the market.
On April 7, 2009, the Treasury announced the completion of the twenty-first round of TARP Capital infusions. The Treasury purchased a total of approximately $54.8 million in securities from 10 financial institutions on Friday, April 3, 2009, and has now invested in 543 institutions, totaling approximately $198.8 billion.
Community First Bancshares, Inc, of Harrison, Arkansas, received the largest infusion, $12.7 million. BCB Holding Company, of Theodore, Alabama, received the smallest infusion, $1.7 million. (more…)
On Thursday, April 9, 2009, the FDIC held its second telephone conference call to discuss the PPIP Legacy Loans Program. The first such call (audio replay|transcript) was primarily for bankers, while today’s call was primarily for investors. A transcript of the investor call is also available on the FDIC site.
Investors wishing to participate in the Legacy Loans Program should complete the preliminary application. The Legacy Loans Program Summary, Fact Sheet, and FAQ are also available.
At the outset, the FDIC repeatedly advised that this call was for information and discussion purposes only and specifically “not for attribution” to the FDIC.
The FDIC Chairman, Sheila Bair, presented very brief opening remarks, and gave certain background information. She reminded callers that on March 23, 2009, Mr. Geitner announced the Legacy Loans Program, to be administered by the FDIC. The FDIC’s Proposed Term Sheet regarding the Legacy Loans Program is currently on the FDIC’s website, where the FDIC is currently still seeking comment and input, until tomorrow, April 10, 2009. The Term Sheet provides the FDIC’s 17 initial questions. Ms. Bair confirmed that the Legacy Loans Program is intended for all banks, large and small and that today’s call focuses on the investor perspective.