On August 14, 2009, Bryan Cave LLP submitted a comment letter on the Treasury Department’s Interim Final Rule on TARP Standards for Compensation and Corporate Governance.
In addition to several technical revisions, we have recommended that Treasury:
- permit TARP recipients to implement new commission compensation programs;
- treat single-trigger change in control payments as retention awards as opposed to golden parachute payments;
- add a $100,000 floor for consideration of an employee as a “most highly compensated employee;”
- permit smaller reporting companies to use the SEC’s smaller reporting company rules for determining their senior executive officers;
- modify its restrictions on tax gross-up payments;
- clarify that the say on pay provisions do not apply to private companies; and
- either clarify or eliminate the 162(m)(5) requirement.
The comment letter is currently being processed by the Treasury Department before being added to the public docket for the regulation, but you can read the complete comment letter here.
On August 6, 2009, the Office of the Special Inspector General for TARP (SIGTARP) published its report on whether external parties (i.e. politicians) unduly influenced TARP Capital Purchase Program decisions. We will write more about that subject shortly, but the Report also provided the most detailed summary that we’ve seen of the factors considered by Treasury and the federal banking regulators in determining whether to approve a TARP application.
First, composite CAMELS ratings clearly played a significant role in determining the likelihood of success for any given institution.
- 1-rated institutions were generally sent directly to Treasury for approval, and seemingly regularly approved for Capital Purchase Program funds.
- 2-rated institutions with “acceptable performance ratios” were also sent directly to Treasury for approval, and again appear to have been regularly approved for funds. 2-rated institutions with “unacceptable performance ratios” were subject to further review by the interagency council, where at least three of the four federal banking regulators had to approve the application. The Report states that the interagency council then analyzed “the viability of the institution based on the quantitative and qualitative factors of the case” in determining whether to recommend approval to Treasury.
- 3-rated institutions were originally treated like 2-rated institutions, but “relatively early in the CPP application review process,” Treasury decided that all 3-rated institutions needed to be reviewed by the interagency council.
- 4- or 5-rated institutions were generally asked to withdraw, without the application being forwarded to the interagency council.
The Treasury would then make an independent evaluation of each application before making recommendations to the three-member Treasury Investment Committee. The Treasury Investment Committee would then make a recommendation for final approval to the Assistant Secretary. While only the Assistant Secretary can actually approve a TARP CPP application (all other actions are merely recommendations to approve), according to the Report, the Assistant Secretary had not rejected any recommendation forwarded by the Investment Committee for approval.
Performance Ratios
The Report also includes, as an Appendix, a copy of a “Case Decision Memo Template” that appears to have been the form used by the region/district level office of each federal banking regulator that reviewed TARP CPP applications. The Memo provides further guidance on the specific performance ratios considered by the agencies. In addition to CAMELS and CRA ratings, the Memo called for an evaluation of the following performance ratios, both before and after a TARP infusion and both for the holding company and the largest bank subsidiary:
- Tier 1 Risk-Based Capital
- Total Risk-Based Capital
- Tier 1 Leverage Ratio
- Classified Assets/(Net Tier 1 Capital + ALLL)
- (NPLs + OREO)/(Net Tier 1 Capital + ALLL)
- Construction & Development Loans/Total Risk-Based Capital
While the first three performance ratios are consistent with the three historical measures of bank capitalization, the last three performance factors highlight the focus of the banking regulators on these ratios.
During the month of July, the Treasury completed rounds thirty-four, thirty-five, thirty-six, and thirty-seven of TARP Capital infusions. In these four rounds, which closed on July 10, July 17, July 24, and July 31, respectively, the Treasury purchased a total of approximately $1.2 billion in securities from 14 financial institutions. Through July, the Treasury had invested in 664 institutions, totaling approximately $204.3 billion.
In these four rounds, Lincoln National Corporation, Radnor, Pennsylvania, received the largest infusion, $950 million, and Plato Holdings, Inc., Saint Paul, Minnesota, received the smallest infusion, $2.5 million. Of note during the July closings, Yadkin Valley Financial Corporation received an additional $13.3 million investment after having received a $36 million investment on January 16, 2009.
During July, two financial institutions repaid their TARP capital investments: First Community Bankshares, Inc., Bluefield, Virginia ($41.5 million); and Old Line Bancshares, Inc., Bowie, Maryland ($7 million). As of the end of July, 34 financial institutions had re-paid all, or some portion, of their TARP Capital investment, bringing the total amount re-paid to approximately $70.2 billion. At the end of July, Treasury’s outstanding investment equaled approximately $134.2 billion.
At a conference on July 28, 2009, Neil Barofsky, the Special Inspector General for TARP, outlined the types of fraud that his office was investigating. He indicated that review of the Capital Purchase Program is his primary objective at this time, and that the office is investigating allegations of securities fraud, accounting fraud, falsified financial statements, criminal misrepresentations, and fraudulent practices involving mortgage modifications. Barofsky noted that his office is currently conducting “10 or 11” audits involving government spending that could lead to criminal fraud charges.
The focus appears to be on “application-stage” fraud, involving actions taken by entities when they were applying for Capital Purchase Program funds. Barofsky noted that “these are banks that are cooking their books, whether it’s false valuation of assets, whether it’s round-trip transactions — really whatever we’ve seen recently in large accounting fraud, we’re investigating, looking at institutions that did that in order to get TARP funds.”
On July 20, 2009, the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) published the results of the SIGTARP Survey of Initial TARP Capital Purchase Program Recipients. Despite the report’s flaws, some of which are discussed below, the results should be read by all TARP recipients. The report does a good job summarizing how banks use capital (see in particular Appendix B) and exploring the myriad of ways in which TARP funds have been used.
Report Conclusions
Titled “SIGTARP Survey Demonstrates that Banks Can Provide Meaningful Information on Their Use of TARP Funds,” the report recommends that Treasury require TARP Capital recipients to submit periodic reports to Treasury on the uses of TARP funds, including what actions they were able to take that they would not have taken otherwise.
The actual results of the survey, however, would seem equally to support a conclusion that, because TARP funds are capital, the specific uses of TARP funds cannot be specifically identified. Instead, the TARP Capital Purchase Program has provided additional capital to banks to allow them to continue to engage in all of the activities in which they engage in, including lending.
Disclosure of Individual Responses
The SIGTARP report aggregates the responses of the 360 bank recipients of TARP funds through January 31, 2009. (SIGTARP has not given any indication that it intends to survey subsequent recipients of TARP funds.) Although individual responses are not included in this report, SIGTARP indicates that it intends to post all responses, redacted as necessary, on its website within 30 days.
On June 23, 2009 and June 30, 2009, the Treasury announced the completion of the thirty-second and thirty-third rounds, respectively, of TARP Capital infusions. In these two rounds, which closed on June 19 and June 26, the Treasury purchased a total of approximately $3.7 billion in securities from 26 financial institutions. The Treasury has now invested in 650 institutions, totaling approximately $203.2 billion.
In these two rounds, Hartford Financial Services Group, Inc., Hartford, Connecticut, received the largest infusion, $3.4 billion. Gold Canyon Bank, Gold Canyon, Arizona, received the smallest infusion, $1.6 million.
Of note during the last two weeks of June, 2009, eleven institutions re-paid approximately $68.3 billion. The largest re-payments came from JPMorgan & Chase ($25 billion), The Goldman Sachs Group, Inc. ($10 billion), and Morgan Stanley ($10 billion). As of June 30, 2009, the total amount re-paid under the TARP Capital Purchase Program is approximately $70.1 billion, and Treasury’s outstanding investment equals approximately $133.1 billion.
Also of note, the Treasury provided the warrant disposition information for a number of institutions that had previously re-paid the Treasury (please click here for our discussion of the disposition process). The Treasury disposed of the additional investment of thirteen institutions (10 public (via warrants) and 3 private (via preferred stock)). The proceeds from these dispositions totaled approximately $19.4 million.
The Interim Final Rules regarding Executive Compensation for TARP recipients provide a number of corporate governance standards for Compensation Committees. While these standards currently only apply to financial institutions that have outstanding TARP investments, many of the standards are likely to be considered best practices for the compensation committees of all companies.
TARP recipients generally are required to have a compensation committee consisting solely of independent directors (with independence determined by reference to the federal securities laws). (Private TARP recipients who received a TARP investment of less than $25 million are not required to have a compensation committee, in which case the full Board of Directors is required to take the actions detailed below).
As noted by the Wall Street Journal (subscription required), a steady stream of small banks are still lining up for government money.
Since May 31, 20 small banks have received a total of $164.1 million in taxpayer-funded capital, according to the Treasury’s latest available figures. Half of those banks got the money in the same week that 10 big financial institutions gave theirs back.
Analysts see no end in sight to the trend. The recession and borrowers are squeezing most of the 8,200 federally insured commercial banks and savings institutions in the U.S., so even a dollop of TARP funds could make a difference. Some banks are turning to the government to fill a void left by investors who are leery about pouring money into the sector, despite the rebound by bank stocks since early March.
Meanwhile, the rules and stigma of TARP that turned some executives such as J.P. Morgan Chairman and CEO James Dimon against the program are irrelevant to small institutions.
Their employees usually don’t fly on corporate jets or collect hefty bonuses that trigger outrage from taxpayers, customers and Congress. And curbs on dividend payments are a modest price to pay for greater assurance that the banks can plow ahead with their core mission to gather local deposits, lend them nearby and support local charities, some recent TARP recipients said.
It’s certainly a stretch to say the executive compensation restrictions are “irrelevant” to small institutions, but community banks generally don’t have the excesses that have drawn public and congressional scorn. With the deadline for smaller community banks to apply to participate under the TARP Capital Purchase Program extended until November 9, 2009, many institutions are taking a fresh look as to whether to apply, even as larger institutions are making a decision as to whether to seek to redeem the TARP investment they’ve already received.
Even as five of the eight initial Capital Purchase Program recipients have redeemed their TARP investments with the Treasury, hundreds of applications are still being processed, as reported by the American Banker on June 26, 2009 (subscription required).
The Government Accountability Office said in a June 17 report that the Treasury had received more than 1,300 applications from federal regulators as of June 12, and that fewer than 100 were still awaiting a decision. The GAO also said bank regulators are reviewing another 220 applications that have not yet been forwarded to the Treasury.
Of the banking agencies, only the Office of Thrift Supervision details the Tarp application process. Of the roughly 800 companies it oversees, the OTS said 302 have applied for capital injections. Forty-nine have gotten the money and 140 have withdrawn their applications. Another 71 are in some state of review while 42 have yet to be considered.
The Treasury may emphasize that “fewer than 100 are still awaiting a decision,” but that excludes over 200 applications that are haven’t even made it to the Treasury yet. All told, there are probably 300 applicants that haven’t been told whether they are eligible to receive a TARP investment.
On June 26, 2009, the Treasury announced its policy with regard to the repurchase or other disposition of the warrants it received from exchange-traded companies under the TARP Capital Purchase Program.
Under the terms of the Capital Purchase Program contract, publicly-traded institutions that have repaid the Treasury’s TARP investment have 15 days following repayment to make a determination of the “fair market value” to repurchase the warrants as well. This determination is made by the institution’s Board of Directors, acting in good faith on the opinion of an independent banking firm. The Treasury then has 10 days to either accept the “fair market value” offered by the company, or will initate the three appraiser process established in the original contract to determine a final “fair market value.”
If a company decides not to repurchase the warrants, the Treasury intends to sell the warrants through an auction process over the next few months. The Treasury is in the process of establishing guidelines for these auctions. Treasury also has the authority to dispose of warrants held by companies that have not redeemed their TARP investment generally (subject to a requirement to retain half the warrants through December 31, 2009). Although the Treasury’s announcement of an upcoming auction does not specifically differentiate between companies that have and have not redeemed the TARP investment, presumably the upcoming auction is intended only for institutions that have elected not repurchase the warrants after redeeming the TARP investment.