On February 2, 2022, the U.S. Department of the Treasury ("Treasury")
released drafts of the definitive transaction documentation with respect to the
capital securities issuable by Community Development Financial Institutions ("CDFIs")
and Minority Depository Institutions ("MDIs") who have received
allocations under the Emergency Capital Investment Program ("ECIP"). These capital securities would be issued in
the form of noncumulative perpetual preferred stock for C corporation issuers
and as subordinated debt securities for S corporation issuers, and are
referenced collectively in this Alert as "ECIP Securities." The definitive transaction documents provided
by Treasury include a (1) Securities Purchase Agreement, (2) form of ECIP Security
instrument and (3) Letter Agreement. This
Alert summarizes and provides some preliminary analysis of the terms of these
definitive transaction documents and other issuer considerations in moving
forward with the issuance of ECIP Securities.
Securities Purchase Agreement
The Securities Purchase Agreement ("SPA") is the
agreement between the issuer and Treasury that sets forth the terms and
conditions of the purchase of ECIP Securities.
The SPA can be divided into four primary components: (1) the
closing-related provisions, (2) the representations and warranties section, (3)
the issuer's ongoing covenants and agreements, and (4) the provisions regarding
remedies for non-performance.
The SPA establishes
a number of conditions that must be satisfied before Treasury will purchase
ECIP Securities from an issuer, including the following:
- The issuer must deliver an officer's certificate
affirming, among other things, the accuracy of its representations and
warranties and the satisfaction of its pre-closing obligations, its eligibility
to issue ECIP Securities and the adoption of any required changes to its
corporate organizational documents to enable it to issue the ECIP Securities,
the continuing effectiveness of its ECIP Investment and Lending Plan, and its compliance
with certain other matters. The scope of
issuer representations, warranties, covenants and other obligations is discussed
- The issuer must deliver a written legal opinion
from counsel to the issuer, addressed to Treasury, that opines, among other
things, as to (1) certain organizational matters regarding the issuer, (2) the
due authorization and issuance of the ECIP Securities, (3) the authority of the
issuer to execute and deliver the SPA and carry out its obligations, (4) the
enforceability of the SPA and ECIP Securities, (5) certain matters relating to
the issuer's compliance with its corporate organizational documents, other
agreements and applicable judgments, decrees and orders, (6) the completion of
all necessary corporate and regulatory action, (7) compliance matters with
respect to federal securities laws and the Investment Company Act of 1940, and
(8) ECIP issuer eligibility. Given that
the transactional documents are governed by New York law, we would expect the
legal opinions to be given under federal law, New York law and the law of the
state in which the issuer is incorporated.
- The issuer must provide certified copies of its organizational
documents and authorizing resolutions.
While the closing condition is not specific, based on prior Treasury
programs, we would expect Treasury to require comprehensive authorizing
resolutions that approve the forms of documents (or expressly delegate the
approval authority to specified persons), authorize the execution and delivery
of the definitive transaction documents, designate officers authorized to
execute ECIP-related closing documents, and authorize the performance of the
issuer's obligations thereunder, including the issuance of the ECIP
Securities. Formal resolutions would
also be necessary to support the legal opinion to be delivered at closing.
- If applicable, the issuer must have adopted any
changes to its organizational documents necessary to enable it to issue the
ECIP Securities. C corporation issuers
would likely be required to amend their organizational documents to include the
preferred securities designation, which sets forth the terms and conditions of
the ECIP preferred stock, and an S corporation issuer's organizational
documents may need to be reviewed and amended to the extent that they limit the
issuer's ability to issue debt under certain circumstances. Further, a broadly drafted preemptive rights
provision in an issuer's organizational documents may impact its ability to
issue ECIP Securities without first considering the interests of other
constituencies. As a result, all issuers
should review their corporate organizational documents prior to issuing ECIP
Securities to evaluate the extent to which these documents may need to be
amended or additional steps may need to be taken to comply with their
- The issuer must deliver the ECIP Security,
generally in physical certificated form, which should contain the applicable
restricted securities legends.
- The issuer must have delivered a copy of any
applicable disclosure schedules, including any updates required for closing.
(See discussion below regarding representations and warranties).
- The issuer must have received any and all
approvals required to issue the ECIP Securities, and the issuance must not
violate any law, regulation or order.
For most issuers, the issuance of ECIP Securities will not require any
regulatory approvals. However, certain
issuers may have regulatory commitments relating to dividends or debt that may
need to be considered prior to issuing ECIP Securities.
- The issuer must provide a certificate from the
applicable state governmental authority with respect to the existence,
organization, and, if applicable, good standing of the issuer.
- The issuer must deliver an incumbency
certificate with respect to the persons authorized to execute any document
arising out of or relating to the transaction.
- The issuer must have delivered three years of consolidated
financial statements of the issuer, and quarterly financial statements for more
recent periods, if applicable. For
transactions closing before March 31, 2022, quarterly financials should not be
- The issuer must deliver its initial Supplement
Report, which is designed to establish the issuer's baseline calculation of
"qualified lending" for the annual period ended September 30, 2020. This report must be certified by the issuer's
principal executive or financial officer.
- The issuer must have delivered its ECIP Investment
and Lending Plan, which describes in detail how it will address the community
development needs targeted by the ECIP.
The closing would
occur, and Treasury would purchase the ECIP Securities, when Treasury
determines all of the closing conditions have been satisfied. If the closing conditions have not been
satisfied within 30 days after the issuer executes the SPA, Treasury or the
issuer may generally terminate the SPA.
If the closing has not occurred by June 30, 2022, the SPA will terminate
without further action by either party.
The SPA may also be
terminated prior to closing by mutual consent of the parties or, by either
party, if any order, decree or ruling enjoins or otherwise prohibits the transactions
contemplated by the SPA. The SPA will
terminate following the closing, and the issuer will have no further
obligations under the SPA, after the ECIP Securities have been fully repaid or redeemed
or, in the case of ECIP preferred stock, when those securities have been
transferred to third persons who are not affiliates of Treasury.
Representations and Warranties
The SPA contains a comprehensive set of issuer
representations and warranties, which are statements regarding the issuer and
its subsidiaries relating to a wide variety of matters, including, among other
things, organizational matters, capitalization, authorization and enforceability,
regulatory and legal compliance, lack of material adverse effect, ECIP
eligibility status, financial statements and other reports, employee benefits, undisclosed
liabilities, offering-related matters, insurance, intellectual property,
environmental matters, litigation and tax matters.
The representations and warranties made by the issuer in the
SPA must be true and correct as of the date that the SPA is executed and as of
the closing, and material inaccuracies with respect to those representations
and warranties can serve, among other things, as a basis for Treasury to
decline to purchase the ECIP securities.
Moreover, all representations and warranties survive the closing
indefinitely, which exposes the issuer to continuing liability with respect to
material inaccuracies. Accordingly,
issuers are advised to carefully review all of the representations and
warranties contained in Article III of the SPA.
To the extent that any representation or warranty contained
in the SPA is not true, correct and complete as written, the issuer may provide
separate disclosure through disclosure schedules delivered to Treasury in
advance of execution of the SPA. Those schedules would be further updated, as
necessary, prior to closing. The information
contained in the disclosure schedules is designed to correct any inaccuracy with
respect to a representation or warranty contained in the SPA. Disclosure schedules should be prepared
carefully and clearly indicate the applicable sections of the SPA to which the
disclosure exception relates, as the failure to do so may adversely affect the
issuer's ability to rely on the disclosures as exceptions to the applicable
representations and warranties.
Covenants and Other Agreements
The SPA also contains a number of covenants and other
agreements with which the issuer must comply prior to and following the
issuance of the ECIP Securities. Most of
the covenants are contained in Article IV, and certain of them require affirmative
action on the part of the issuer, including the following:
- The issuer must notify Treasury between the date
that the SPA is executed and the closing date regarding any changes to its representations
and warranties, as well as any matter that would reasonably be expected to have
a material adverse effect on the business, financial condition or operating
results of the issuer and its subsidiaries, taken as a whole.
- The issuer and its subsidiaries must generally
provide Treasury with broad access to their respective books and records, with certain
exceptions. This right of access also
includes the right of Treasury to discuss matters regarding the books and
records with personnel of the issuer and its subsidiaries. This right generally applies for as long as
Treasury or its affiliates own the ECIP Securities.
- The issuer must submit a quarterly Supplemental
Report, which sets forth the issuer's qualified lending activities under the
ECIP. The information in this report is utilized to set the applicable rate on
the ECIP Securities.
- The issuer must provide to Treasury certain
financial and other reports, including (1) its annual consolidated financial
statements within 90 days after the end of its fiscal year, which generally
should be audited, (2) a copy of any reports or other communications provided
to the issuer's shareholders, (3) a copy of any internal controls assessment
received by the issuer, (4) a copy of any amendments to the charter, bylaws or
other organizational documents of the issuer, (5) an annual certification
within 120 days after the end of its fiscal year with respect to certain
processes and controls used to generate ECIP Supplemental Reports, (6) an
annual certification as to compliance with respect to ECIP restrictions with
respect to excessive compensation, severance pay, luxury expenditures and
capital distributions, and (7) certifications with respect to the information
contained in the issuer's Supplemental Reports.
- The issuer must adopt an excessive or luxury
expenditures policy, deliver a copy of that policy to Treasury and post the
text of the policy on its website.
- The issuer must provide prior notice to Treasury
in the event of its decision not to declare dividends or pay interest on the
ECIP Securities in any particular period.
- During any period in which the ECIP Securities
are "restricted securities" within the meaning of Rule 144 under the Securities
Act of 1933, as amended, at the request of a holder of ECIP Securities, the
issuer must use its reasonable best efforts to make certain current financial
information available so as to permit resales of ECIP Securities under Rule
- In the case of S corporation issuers, the issuer
must defer interest if, as of any applicable interest payment date, the issuer
is not "well capitalized" under applicable regulatory guidelines, has not
achieved positive net income for the most recently completed quarter, is
subject to distribution limitations under applicable capital rules or
determines that the payment would be detrimental to its financial health.
- To the extent that the issuer is or becomes subject to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the issuer must provide registration rights to Treasury. Because this covenant only applies to issuers who are or later become subject to public company reporting obligations, this covenant is unlikely to apply to most issuers.
In addition to affirmative actions required by the issuer under the SPA, the SPA also contains several negative covenants, which generally restrict an issuer from activities that would otherwise be permitted in the absence of the ECIP Securities, including the following:
- The issuer may not merge or consolidate with, or
sell all or substantially all of its assets to any other party unless the
successor entity agrees to assume the issuer's obligations with respect to the
SPA and ECIP Securities. In addition, the
successor entity must also be a CDFI or MDI, except with the prior approval of
- The issuer may generally not pay dividends to its shareholders, or repurchase or otherwise redeem its securities, if the issuer is not current with respect to dividends or interest with respect to its outstanding ECIP Securities, with certain exceptions in the case of S corporations for reasonable tax distributions.
- If the issuer is a CDFI, it may not revoke or otherwise change its status as a CDFI.
- If the issuer is an S corporation, it may not
revoke or otherwise change its status as an S corporation.
The SPA provides that ECIP Securities are generally
transferable by Treasury to one or more third parties, and the issuer agrees
generally to take the steps required to facilitate the sale of the ECIP
Securities. However, the issuer is not
required to permit a transfer that would subject it to any public company
reporting obligations, and Treasury must provide the issuer with a right of
first refusal prior to the sale of ECIP Securities. Moreover, prior to the 10th
anniversary of the issuance of the ECIP Securities, subject to certain
exceptions, there are additional restrictions on the sale of ECIP Securities by
Treasury to third parties, and advance notice to the issuer will be required.
Non-Payments and Certain Remedies
Because ECIP Securities issued as preferred stock do not
include a contractual obligation to pay dividends, only those ECIP Securities
issued as subordinated debt securities have traditional default related
provisions. Accordingly, if an issuer of
ECIP debt securities fails to make a payment of interest or principal on such
securities, a holder thereof would be entitled to seek specific performance of
that payment obligation. However, except
in the case of bankruptcy-related events involving the issuer or its banking
subsidiary, the holder of the ECIP debt securities has no right or ability to
accelerate the principal or any installment of interest on the securities that
is not otherwise due.
Moreover, under the terms of the SPA, during any period in
which any interest or dividends are not paid or are in deferral, the issuer may
not declare or pay any dividends, repurchase any shares of its equity
securities, or make any discretionary payments on any debt that ranks equal
with or subordinate to the ECIP Securities, except that an S corporation issuer
may make capital distributions, or purchase or redeem senior securities, to the
extent required to cover the tax obligations of its owners.
Under certain circumstances involving the continuing
deferral or failure to pay dividends or interest on the ECIP Securities, the
holders of the ECIP Securities will have the right to appoint representation to
the issuer's board of directors.
Accordingly, upon the failure to pay dividends or interest on ECIP
Securities for five or more periods, whether or not consecutive, the holders
have the right to appoint a nonvoting observer to the board of directors of the
issuer. Upon the failure to pay
dividends or interest on ECIP Securities for six or more periods, whether or
not consecutive, the holders have the right to appoint up to two individuals to
serve on the board of directors of the issuer.
These rights would generally terminate after timely payments over four
Further, in the event that Treasury determines that an issuer
has breached, violated or defaulted on any of its obligations under the SPA or
the ECIP Securities, regardless of whether issued as preferred stock or
subordinated debt securities, Treasury can determine that the issuer is not eligible
for a rate reduction otherwise provided under the ECIP Securities, which would
have the effect of increasing the rate payable on those securities to the
maximum amount permitted for such securities.
Treasury is also authorized to report such noncompliance to the CDFI
Fund, and such noncompliance may adversely impact the issuer's eligibility for
future awards. Finally, the SPA contains
a mechanism whereby Treasury may specify other alternative remedies in the
event of noncompliance.
Form of ECIP Security
The other primary transaction document applicable to the
issuance of the ECIP Securities is the form of security instrument. As discussed above, the instrument takes the
form of noncumulative perpetual preferred stock for C corporation issuers, the
terms of which are contained in a certificate of designation or similar
document that would be adopted by the issuer.
Noncumulative perpetual preferred stock is a type of
preferred stock that has no maturity date and that does not provide for the
accumulation of unpaid dividends over time.
Accordingly, the issuer is under no legal obligation to declare preferred
stock dividends in any particular period, and holders lose any rights with
respect in such dividends for any period in which the board fails to declare
Subordinated debt securities are contractual obligations of
the issuer that rank subordinate to all of the issuer's existing and future
senior indebtedness. Unlike ECIP
preferred stock, however, interest on ECIP debt securities will continue to
accrue on any outstanding principal, regardless of whether such interest
payment is timely made, whether as a result of deferral or otherwise. Also, unlike the ECIP preferred stock, ECIP
subordinated debt securities have a stated term, which would be 15 or 30 years at the option of the issuer.
The following paragraphs discuss some of the material
provisions of the ECIP Securities, some of which are wholly contained in the
ECIP Security instrument, while others are covered through the SPA.
The applicable dividend or
interest rate on ECIP Securities will be 0% from the issue date to the second
anniversary thereof. Thereafter, and
until the tenth anniversary of issuance, the applicable rate will be based on
the increase in the issuer's "qualified lending," with a maximum rate of
2.0%. Thereafter, the applicable rate
will be fixed at a rate based on the increase in the issuer's "qualified
lending" as of the last reset date.
Notwithstanding the foregoing, if the issuer is in breach, violation or
default of any of its obligations under the SPA or the ECIP Securities or any
of the rules or regulations relating to the ECIP program, the applicable rate
will be set at the maximum rate permitted for the ECIP Securities.
ECIP Securities are not
subject to redemption prior to the 5th anniversary of the date of
issuance, subject to limited exceptions.
From and following the 5th anniversary date, the issuer may
redeem the ECIP Securities in whole or in part at any time or from time to
time. However, partial redemptions must
be equal to the lesser of 20% of the original amount of ECIP Securities issued
or 100% of the outstanding remaining balance.
ECIP Securities are redeemable at their outstanding principal balance or
liquidation amount, as applicable, without any prepayment penalty or premium,
plus any accrued but unpaid interest, or declared but unpaid dividends, as
applicable, through the redemption date.
The redemption of ECIP securities is subject to regulatory approval to
the extent required under capital rules applicable to the issuer; however,
under prior Treasury capital programs, regulatory approval presented no real
impediment, unless the redemption would cause the issuer's regulatory capital
to fall to an unsafe or unsound level. The ECIP Securities are not subject to
redemption at the option of the Treasury.
The ECIP Securities provide for notice of redemption to be mailed at
least 30 and not more than 60 days before the date fixed for redemption.
The holders of ECIP
Securities generally have no voting rights.
However, in the case of ECIP preferred stock, holders have the right
under the preferred stock designation to appoint an observer to the board of
directors and up to two directors upon the failure of the issuer to declare or
pay dividends for a certain number of periods, whether or not consecutive, as
discussed above. Holders of ECIP
preferred stock also have the right to vote as a class in connection with (1)
the creation of any class of capital stock of the issuer that would rank senior
to the ECIP Securities, (2) any amendment to the terms of the ECIP preferred
stock, (3) certain mergers or consolidations where the ECIP Securities are
adversely affected, or (4) certain holding company formation transactions. Holders of subordinated debt securities have
no voting rights as equityholders of the issuer. However, the SPA requires the issuer to take
certain steps to appoint board observers or directors and support their
re-election under circumstances where the issuer has failed to pay interest for
a certain number of periods, whether or not consecutive, as discussed
In the event of any
liquidation, dissolution or winding up of the affairs of the issuer, the
holders of ECIP Securities would be entitled to payment with respect to their
securities before the issuer would be permitted to make payments on junior
securities, such as its common stock.
Holders of ECIP preferred stock would be entitled to the liquidation
amount per share of preferred stock, together with any declared but unpaid
dividends, while holders of ECIP subordinated debt securities would be entitled
to the outstanding principal amount of the securities, plus any accrued but
unpaid interest. If the liquidation
payment has been made on the ECIP Securities, the holders thereof will have no
further right to any remaining assets of the issuer.
Form of Letter Agreement
The Letter Agreement is designed to confirm the terms and
conditions of the issuance by the issuer of the ECIP Securities and generally
incorporates the terms and conditions contained in the SPA. The Letter Agreement also incorporates
additional information regarding the amount and nature of the purchase of ECIP
Securities by Treasury, closing information, capitalization data and certain
disclosure exceptions. The execution of
the Letter Agreement will represent the acceptance by the issuer of the terms
and conditions of the SPA and the ECIP Securities.
Analysis and Considerations
The draft definitive transaction documents circulated by
Treasury were consistent, in all material respects, with the term sheets
previously provided by Treasury during the ECIP application phase. Accordingly, the draft transaction documents
did not meaningfully shift the assessment of the benefits and drawbacks of ECIP
Low Cost Capital
The most compelling benefit of ECIP relates to access to
low-cost capital. ECIP Securities carry
an interest or dividend rate of 0.0% for the first two years, and thereafter,
through the 10th anniversary, the interest or dividend rate would be
determined based on the increase in qualified lending by the issuer, as
compared to a baseline, with a maximum rate of up to 2.0%. From and following the 10th
anniversary, the applicable rate through redemption or maturity, in the case of
ECIP debt securities, would be fixed based on the increase in qualified lending
by the issuer as of the end of the last reset period. Payment rates on ECIP Securities were
competitive at the time that the term sheet was originally issued in August 2021,
and given interest rate trends, those rates appear even more attractive.
Unlike senior debt instruments, such as a traditional bank
stock loan, ECIP debt securities represent unsecured indebtedness. Accordingly, the issuer would not be required
to pledge any assets, including stock of its subsidiary, to Treasury as
security for the loan, rendering those assets available for pledge against any
indebtedness that the issuer might seek to secure at any point in the future.
Deferral Rights and Implications
ECIP Securities are also structured to permit an issuer to
defer payments due on such securities.
In the case of ECIP preferred stock, the issuer has legal obligation to
pay dividends, which are payable only upon declaration by the board of
directors. In the case of ECIP debt
securities, interest would be deferred in the event the issuer is not "well
capitalized," fails to achieve positive net income for the most recently completed
fiscal quarter and in certain other situations.
This interest deferral feature is not typical for market-based
subordinated debt instruments issued outside of ECIP or senior debt
obligations. However, under the terms of
the ECIP, during any period in which any interest or dividends are not paid or
in deferral, the issuer may not declare or pay any dividends, repurchase any
shares of its equity securities, or make any discretionary payments on any debt
that ranks equal with or subordinate to the ECIP Securities. Notably, however, an S corporation participating
in the ECIP may make capital distributions, or purchase or redeem senior
securities, to the extent required to cover the tax obligations of its
owners. Although the dividend and share
repurchase restrictions during periods where interest is past due or in
deferral is a feature of most market-based senior and subordinated debt
securities instruments, the ability of S corporations to make tax distributions
to its shareholders during such a period is a substantive change and mitigates
a material risk to S corporations evaluating participation in ECIP.
The terms of the ECIP Securities also permit Treasury to
appoint a nonvoting observer to the issuer's board of directors if payments on
the ECIP Securities are not made for five quarters, regardless of whether or
not consecutive. Treasury's appointment
right would increase to two director representatives if payments are not made
for six quarters. The appointment right
terminates when the issuer has become current on its payment obligations for
four consecutive quarters.
Covenants/Restrictions Against Additional Indebtedness
ECIP Securities contain no meaningful financial or other
operational covenants, such as minimum debt/equity ratios, minimum regulatory
capital ratios, asset quality metrics or the like. In addition, the terms of the ECIP Securities
do not restrict in any way the ability of the issuer to incur additional
indebtedness in the future.
Acceleration of Principal and/or Interest
The terms of the ECIP debt securities do not permit the
acceleration of outstanding principal or interest upon an event of default with
respect to the securities, except in the event of a receivership or liquidation
event. Accordingly, if the issuer fails
to timely pay an installment of interest on ECIP debt securities, or fails to
comply with any other obligation with respect thereto, Treasury's recourse
would be to seek relief with respect to the payment of the single installment
of interest then due, or compliance with any such other relevant obligation,
but it would have no ability to declare the remaining outstanding principal
balance and unpaid interest due and payable.
Limited Voting Rights
The ECIP Securities would be non-voting, except that
Treasury would generally have consent rights with respect to any amendments to
the terms of the ECIP Securities and with respect to any merger transaction
that would affect the rights of the ECIP Securities. In practice, this means that Treasury would
generally have no right to vote in the election of directors or other matters
brought for a vote of the shareholders, with limited exceptions in the event of
continued failure of the issuer to make interest or dividend payments for
extended periods. Accordingly, if the issuer
was seeking to enter into a merger transaction with another entity, and the issuer
was the surviving/acquiring entity, Treasury would have no right to vote with
respect to the merger if the ECIP Securities would remain outstanding and
unaffected by the merger. If the issuer was
being acquired by another financial institution in a transaction in which the
ECIP Securities were being repaid in full, Treasury likewise should have no
input in such a transaction.
institutions in a holding company structure with less than $3.0 billion in
consolidated assets, ECIP Securities will effectively be treated as tier 1
common equity for regulatory capital purposes to the extent that the
proceeds of the issuance are pushed down to the bank. For financial institutions with $3.0 billion
or more in consolidated assets, ECIP Securities issued in the form of preferred
stock would be treated as tier 1 capital at the holding company level and those
issued in the form of debt securities would be treated as tier 2 capital at the
holding company level.
The SPA contains material merger-related restrictions affecting
buyers and sellers that issuers should carefully consider before issuing ECIP
Securities. First, the SPA contains a covenant
that requires a CDFI issuer to maintain its status as a CDFI during the term
that the ECIP Securities are outstanding.
Accordingly, an issuer seeking to acquire another financial institution
will need to assess, on a pro forma basis, whether any prospective acquisition
would impair its ability to continue to qualify as a CDFI, and an issuer may
not be permitted to complete an acquisition under circumstances where the
combined entity would not remain qualified as a CDFI. While this risk may be manageable to CDFI
issuers looking grow through acquisitions within nearby markets that may have
similar demographic profiles, it nonetheless may impact an issuer's acquisition
strategy. However, perhaps more
importantly, the SPA contains a covenant that prohibits an issuer from selling
its institution to an acquiror that is not a CDFI or MDI. While the SPA contains an exception that
permits Treasury to consent to such a transaction, Treasury has issued no
guidance regarding the exercise of its discretion on that matter. Further, given Treasury's decision to limit
the favorable rate structure to institutions focused on certain underserved
markets, and the other policy objectives sought by the ECIP, there exist
compelling reasons to believe that consent may not be granted to permit the
acquisition of an issuer by a non-CDFI or MDI.
As a result, these restrictions may have the effect of placing
significant limitations on the ability of an issuer to buy another institution
or sell its institution for a period of five years. From and following the fifth anniversary of
the date of issuance, the issuer could seek to redeem the ECIP Securities to
facilitate such a purchase or sale transaction.
Restrictions on Capital Distributions
Treasury regulations adopted in connection with the ECIP
place certain limitations on the ability of an issuer to make capital
distributions without Treasury approval.
Accordingly, an issuer will generally be required to obtain Treasury
approval prior to making any capital distribution, if the total amount of
capital distributions made during the calendar year, including the proposed
distribution, exceeds the issuer's "eligible distributable income," which is
defined as the issuer's year-to-date income as of the end of the most recently
completed quarter, plus net income for the two preceding calendar years, less
any amounts previously distributed. For
purposes of the rule, capital distributions generally include issuer dividends
and stock repurchases. The rule also
contains an exception to the restrictions on capital distributions for reasonable
tax distributions to S corporation shareholders.
Debt Limitations for Small Bank Holding
time, ECIP Securities issued by S corporations with less than $3.0 billion in
total assets would be treated as debt for purposes of calculating the BHC's
debt-to-equity ratio under the Small Bank Holding Company Policy
Statement. Under the Policy Statement,
small bank holding companies with a debt-to-equity ratio that exceeds 1.0:1 may
be subject to certain dividend restrictions under the Policy Statement, which
would apply notwithstanding that the issuer is an S corporation. Moreover, small bank holding companies are
required to achieve a parent company debt-to-equity ratio of 0.3:1 or less
within 12 years of incurring the debt.
also worth mentioning that the Federal Reserve will also look at a bank holding
company's double-leverage ratio as part of its overall safety and soundness
supervisory review of the organization. The double-leverage ratio is generally
computed by dividing the bank holding company's investment in the banking
subsidiary by its total equity capital. A double-leverage ratio will be
considered by the Federal Reserve to be high once it exceeds 120%. At this
point, the bank holding company may become subject to additional regulatory
scrutiny by the Federal Reserve's supervision and regulation team.
Treasury's interim final rule states that an ECIP
participant must ensure that total compensation paid to senior executive
officers is appropriate and "not excessive."
These requirements will be deemed to be satisfied if the issuer
"maintains compliance with the guidelines or standards established by its
primary Federal regulator that address excessive compensation, corporate
practices, and operations." 12 C.F.R
Part 364 (Interagency Guidelines Establishing Standards for Safety and
Soundness) sets forth the standard for compensation practices by federally
insured depository institutions. In
practice, we expect that restrictions on compensation practices will have
little impact on most community banks, whose compensation practices tend to be
more consistent with market-based practices for similarly-situated institutions. ECIP contains none of the more specific
limitations on compensation included in TARP, such as limitations on cash
bonuses and deductibility of senior executive officer compensation in excess of
Treasury's interim final rule requires ECIP recipients to
establish and maintain policies designed to eliminate "excessive or luxury
expenditures," and defines these expenditures to include any of the following
to the extent that such expenditures are not reasonable expenditures for staff
development, reasonable performance incentives, or other similar reasonable
measures conducted in the ordinary course of business operations: (1)
entertainment or events; (2) office and facility renovations; (3) aviation or
other transportation services; (4) tax gross-ups (i.e., reimbursement of
taxes owed with respect to any compensation; and (5) other similar items,
activities, or events for which the ECIP recipient may reasonably anticipate
incurring expenses, or reimbursing an employee for incurring expenses. This excessive expenditure requirement also
mandates that an ECIP participant must adopt a policy that sets forth written
standards addressing these categories.
Capital investments, including investments in technology, equipment, and
similar items that expand the long-term capability of the issuer to provide
products and services to its customers and community are not considered to be
excessive or luxury expenditures. The
interim final rule does not, in and of itself, specifically characterize any
particular type of expenditure as a luxury expenditure, but it does require the
issuer to develop a policy and framework for identifying and managing
them. Material changes to the policy
would require Treasury approval. The
luxury expenditure policy requirement was also a feature of TARP and presented
few issues for community banks, who generally adopted a standardized form of
Status as S
corporation or CDFI
An issuer participating in the ECIP as an S corporation or
CDFI must generally maintain its status as such during the terms that the ECIP
Securities are outstanding, which should be expected to be a minimum of 5 years
from issuance. The requirement to maintain
a S corporation tax election or CDFI status may have the impact of limiting
opportunities that may be available to the issuer. In addition, there may be circumstances
beyond the issuer's control that impact its status as an S corporation or CDFI.
The sale of ECIP Securities to Treasury results in an investment
by the federal government in the securities of the issuer, and the stigma
associated with participating in a federal program may be a concern. Given the general overall condition of the
banking industry, and the express purpose of the ECIP to enhance lending to the
low- and moderate- income served by CDFIs and MDIs, it is unclear the extent to
which reputational risk may be enhanced; however, it remains a consideration
for those financial institutions evaluating a decision to participate.
There also exists the risk that the rules established for
participating institutions will evolve and be applied in a manner that
adversely impacts an ECIP issuer, after the institution has issued securities,
thus potentially exposing the issuer to a change in the terms of its
participation. Given that the design of
ECIP is largely based off of the structure developed for the Small Business
Lending Fund program, which experienced little change following inception, it
would not be unreasonable to expect some consistency in the manner in which the
ECIP is administered. However, as with
any program administered by the federal government, there can be no guarantees
in that regard.
Reporting Requirements and Treasury Access
The issuance of ECIP Securities will subject the issuer to
ongoing reporting requirements. The issuer
would be required to submit an initial report establishing its "qualified
lending" baseline and, for every quarter thereafter, to submit a supplement
report detailing the changes in its "qualified lending," which would be
utilized to set the payment rate on the ECIP Securities. The issuer would also be periodically
required to submit certifications relating to the accuracy of the information
contained in each supplemental report, to the processes and procedures used to
produce the supplemental reports, and to compliance with customer
identification program requirements, as well as other ECIP requirements. During the term of its investment, Treasury
would have inspection rights to review the corporate books and records of the issuer
related to the ECIP investment.
ECIP presents a unique opportunity for CDFIs and
MDIs who have received allocations under the program. For many issuers, the access to low-cost
capital creates organic and acquisitive growth opportunities that would
otherwise not be available and that would allow it to more effectively serve
its markets and enhance long-term shareholder value. However, ECIP also presents meaningful
trade-offs for those considering the issuance of ECIP Securities, whether under
the terms of the ECIP Securities themselves or the definitive transaction
documents required to complete such an issuance. Issuers and their board of directors should
be fully aware of the terms of the SPA and the ECIP Securities, and the
potential impact of the issuance of ECIP Securities, on their strategic plans
before electing to issue ECIP Securities, as issuers will generally be unable
to redeem or otherwise repay the ECIP Securities for a period of five years
following issuance and will remain subject to the benefits and the costs of
participation for at least that period.