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Financial Institutions Update

October 15, 2008

TARP CAPITAL PURCHASE PROGRAM: HOW SHOULD YOUR BANK RESPOND?

Yesterday, the U.S. Treasury Department released a summary of its TARP ("Troubled Asset Relief Program") Capital Purchase Program for Senior Preferred Stock and Warrants. The Capital Program is in furtherance of the recently-enacted Emergency Economic Stabilization Act of 2008 ("EESA"). In this Update, Godfrey & Kahn provides some insights into the TARP Capital Purchase Program that should be of interest to our members.

EXECUTIVE SUMMARY

Under the TARP Capital Purchase Program, the Treasury proposes to purchase non-voting senior preferred stock from "Qualifying Financial Institutions" in an amount between 1 percent and 3 percent of the institution's risk-weighted assets (up to a maximum of $25 billion per institution). A "Qualifying Financial Institution" is any bank or thrift holding company and any state or federally chartered bank or thrift not controlled by a holding company. Yesterday's Treasury Department summary sets forth in detail the terms of the preferred stock ("TARP Preferred") the Treasury will buy. The deadline to apply to Treasury for participation in the Capital Program is November 14.

Terms of the TARP Preferred

The TARP Preferred is perpetual and therefore counts as Tier 1 capital. It will be redeemable at the institution's election during the first 3 years only with proceeds from an equity offering (of either more perpetual preferred or common stock) and thereafter at any time in whole or in part at the issuer's discretion. The TARP Preferred will have an annual dividend rate of 5% on its stated value for the first five years, increasing to 9% thereafter. Where a holding company is the issuer, preferred dividends are cumulative, but if TARP Preferred is issued by a bank, dividends will be non-cumulative. Dividends can be deferred but if more than six quarterly dividends are missed (consecutively or not) Treasury will have the right to elect two directors to the holding company or bank board. Dividends on common or junior preferred stock cannot be paid unless dividends on the TARP Preferred are current. As with any series of preferred stock, the TARP Preferred will have a dividend and liquidation preference over both common stock and any junior classes of preferred stock, but will nevertheless rank behind the bank's or holding company's other indebtedness. One key limitation is that, as a condition to the Treasury's purchase, the bank or holding company will have to modify or terminate all executive employment and benefit plans and arrangements that do not qualify under Section 111 of EESA, under which the institution must meet certain standards, including: (i) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the institution; (ii) requiring clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (iii) prohibiting the institution from making any golden parachute payment to a senior executive based on the Internal Revenue Code provision; and (iv) agreeing not to deduct executive compensation in excess of $500,000 for each senior executive.

TARP Warrants

The Treasury's purchase of TARP Preferred will be conditioned upon the issuance of a warrant to purchase common stock of the issuing bank or holding company having a market value of 15 percent of the stated value of the TARP Preferred being purchased. The warrant exercise price will be the market price at the time of the investment. The Treasury's October 14 Summary addresses the valuation methodology for publicly-traded stock but is silent on how stock of non-public banks and holding companies will be valued. The issuer will also be required to register (with the SEC) the common stock issuable pursuant to the Warrant, which will make it publicly tradable by Treasury if the Warrant is exercised.

To us, it seems that the issuance of TARP Preferred can provide a source of relatively inexpensive capital. Therefore, whether the terms of the TARP Preferred suit your bank's capital needs and its capital and cost structure are issues you will certainly want to explore.

OBSERVATIONS AND CONCERNS

Although EESA is essentially enabling legislation and thus not very specific on the various features of the bailout plan, and the Summary is only
the first published outline of the Program, we have some initial observations and concerns. We hope to see these addressed as the Program details are developed or refined by Treasury over the next several days or weeks.

• One question that is not addressed, either in EESA or the Summary, is the criteria by which Treasury will decide which financial institutions are eligible for a capital injection. We, along with many commentators, think it likely that the Treasury will either require certain minimum capital levels or will somehow heavily favor stronger institutions in determining eligibility for the Capital Program.

• We also believe that the very short application deadline - November 14 - may put pressure on banks and holding companies to act quickly in seeking a capital injection through the issuance of TARP Preferred, and that the Program will thus necessarily tend to favor those institutions with the resources to do so.

• While the Summary provides detail about how the Capital Program will apply to publiclytraded holding companies, almost nothing is said about non-public institutions. Among other things, stock valuation and SEC registration issues may be particularly challenging issues for private companies.

• Similarly, the specific features of the Capital Program seem to make it impossible for a Subchapter S institution or a thrift mutual holding company to participate.

These and other factors lead to our concern about the ability of smaller banks - especially statechartered banks - to adjust their structure to meet the requirements of the Capital Program, especially when one considers that laws regarding corporate organization, the issuance of preferred shares and the issuance of warrants, can vary from jurisdiction to jurisdiction.

HOW CAN YOU BE READY?

The details of the Capital Program clearly have to be fleshed out in the next several days and weeks and your interest in obtaining capital through the Capital Program may change as more guidance becomes available. While there is no indication that eligibility will be determined on a first come-first serve basis, the tight deadlines make it essential to act now. The most important advice we can give you is STAY INFORMED AND BE PREPARED TO MOVE QUICKLY.

Godfrey & Kahn has developed a preliminary action plan for smaller banks and holding companies to position themselves to take advantage of the Capital Program.

Make sure your bank or holding company has the ability to issue preferred stock.

One thing the Capital Program cannot do is "trump" the basic provisions of state banking and corporate law. Like most states, the Wisconsin Banking Statute and the Wisconsin Business Corporation Law do not allow any class of stock to be issued unless it is authorized by the Articles of Incorporation, and require shareholder approval for an amendment to the Articles. Given the November 14 deadline, if you need to amend your Articles, you will have to move quickly to give your shareholders notice of a special shareholders' meeting to approve the amendment. Under both the corporate and banking statutes, the minimum notice for a corporate or bank special shareholder meeting is 10 days, and most By-Laws provide the same. Both the banking and corporate statutes provide that a notice of special shareholder meeting must include a description of each purpose for which the meeting is called. For Wisconsin corporations, assuming a quorum exists, a majority of the votes present is necessary to approve the amendment. However, state-chartered banks face two significant hurdles: First, an amendment to the Articles of Incorporation must be approved by a majority of the outstanding shares (rather than a majority of the quorum); Second, an amendment to a state-chartered bank's Articles of Incorporation is not effective until approved by the DFI Division of Banking.

Make sure your bank or holding company can issue warrants.

On its face, there is no specific authority in Ch. 221 for Wisconsin-chartered banks to issue stock warrants and we are not aware of any banks that have issued warrants. In contrast, Section 180.0624 allows the board of a Wisconsin corporation to issue stock warrants without share-holder approval provided there are sufficient shares available for issuance upon exercise of the warrants. Thus, if your holding company does not have sufficient common shares authorized, your Articles would need to be amended on the same basis as discussed above for authorizing TARP Preferred.

Review your benefit programs and employment agreements.

If you are considering pursuing capital through the Capital Program, we recommend you review your compensation and benefit agreements and arrangements to determine whether they are compliant with EESA Section 111. This may largely be precautionary, since there isn't much likelihood that a community bank will cross the thresholds under Section 111.

Review your other commitments.

In some cases, debt and other agreements - possibly even indentures for Trust Preferred Securities - may restrict a company's ability to issue securities unless they are junior to the debt (as noted above, TARP Preferred would rank "behind" debt, but ahead of common stock, if the bank or company is
liquidated), or unless the debtholders' consent to the issuance.

IF YOU HAVE ANY QUESTIONS ABOUT THIS FINANCIAL INSTITUTIONS UPDATE, PLEASE CALL ANDY
GUZIKOWSKI AT (414) 287-9686 OR E-MAIL HIM AT aguzikowski@gklaw.com, OR CONTACT JIM SHERIFF
AT (414) 287-9390 OR BY E-MAIL AT jsheriff@gklaw.com.

This Financial Institutions Update is published to provide our friends and clients with current information
that may affect their businesses. This information is not intended to serve as specific legal
advice or as a solicitation for business. The information in this Update is not intended to create
a lawyer-client relationship.

Media Contact 

If you have a media request or need an attorney with particular knowledge for comment, please contact Susan Steberl, Director of Marketing, at 414.287.9556 or ssteberl@gklaw.com.

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