Emergency Capital Investment Program Issues Draft Transaction Documents

Posted February 08, 2022

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.

Closing-Related Provisions

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 below.
  • 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 underlying provisions.
  • 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 required.
  • 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 144.
  • 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 Treasury.
  • 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 consecutive periods.

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 Instrument

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 them.

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.

Dividend/Interest Rate

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.

Voting Rights

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 above.

Liquidation Rights

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 participation.

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.

Unsecured Indebtedness

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.

No Financial 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.

No 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.

Regulatory Capital Treatment

For financial 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.

Restrictions on Mergers

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 Companies

At this 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.

It is 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.

Compensation Restrictions

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 $500,000.

Luxury Expenditure Restrictions

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 policy.

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.

Federal Government Participation

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.

Ongoing 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.