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Congress Passes Small Business Jobs and Credit Act of 2010

September 24, 2010

On September 23, 2010 Congress passed the much-anticipated Small Business Jobs Act of 2010 and sent the Legislation to President Obama for signature. President Obama plans to sign this legislation on Monday. This Alert will focus on the $30 billion Small Business Fund Program established under the Act. The Program establishes a $30 billion fund to be administered by the United States Department of Treasury designed to stimulate lending to small businesses by America's community banks through the investment in preferred stock or other financial instruments of such institutions. Raising capital in today's turbulent capital markets is both difficult and expensive for many smaller financial institutions. This Program is designed to enable smaller financial institutions to raise badly needed capital on favorable pricing terms, while supporting the administration's goal of stimulating small business lending.

What institutions are eligible to participate?
The Program is available to banks, bank holding companies, savings banks and savings and loan holding companies with total consolidated assets of under $10 billion. The Treasury is authorized to purchase preferred stock or other financial instruments (presumably subordinated debt for Subchapter S and mutual institutions) from the top tier holding company or from the bank or savings bank for stand-alone institutions. Institutions on or recently removed from the FDIC's problem bank list (i.e. 4- or 5-composite CAMEL-rated institutions) are ineligible to participate in the Program. It is unclear at this time whether multi-bank holding companies with both problem bank subsidiaries and non-problem bank subsidiaries will be able to participate with respect to the non-problem bank subsidiaries. Treasury will consult with the applying institution's primary federal regulator for recommendations on participation in the Program. If the regulator would not otherwise recommend that the institution participate in the Program, Treasury may consider whether participation would be appropriate if the institution were to match Treasury's investment with a like amount of private capital. In such instances, the private capital investment would need to be subordinated to Treasury's investment.

How much can an institution receive under the Program?
Eligible institutions with assets of $1 billion or less as reflected on their fourth quarter 2009 Call Report may receive up to 5% of risk-weighted asset as reflected on the Call Report immediately preceding the date of application. For eligible institutions with total assets of over $1 billion but less than $10 billion, the percentage drops to 3% of risk-weighted assets. For example, if your institution reported total assets of $200 million on its fourth quarter 2009 Call Report and had risk-weighted assets of $170 million reported on its Call Report immediately preceding the date of application, you would be eligible to receive up to $8.5 million.

What are the terms of the preferred stock issued under the Program?
The initial coupon rate on preferred stock will be 5% per annum, adjustable within the first two years of the Program based upon the participating institution's increase in small business lending over such period. The base against which increases will be measured is the institution's average amount of small business lending over the four full quarters immediately preceding the date of enactment of the Act, less the amount of such net small business loans charged off, plus any adjustments resulting from mergers, acquisitions or purchases of loans after origination and syndication. Generally, "small business lending" is determined as reported on the institution's quarterly Call Reports and is limited to loans of under $10 million to businesses with $50 million or less in annual revenues. The initial 5% coupon rate may be reduced as follows:

  • increases in small business lending during the first two years of at least 2.5%, but less than 5.0%, will result in a coupon rate of 4%;
  • increases in small business lending during the first two years of at least 5.0%, but less than 7.5%, will result in a coupon rate of 3%;
  • increases in small business lending during the first two years of at least 7.5%, but less than 10.0%, will result in a coupon rate of 2%; and
  • increases in small business lending during the first two years of at least 10.0% will result in a coupon rate of 1%.

NOTE: The reduced rate shall not apply to that dollar amount of investment in excess of the actual dollar amount increase in small business lending realized during the period. For example, if your institution qualified for an investment of $2,000,000 and the amount of your small business lending increased from $20 million to $21.2 million for the period (i.e. an increase of 6%), the preferred stock would bear a coupon rate of 3% applicable to the first $1.2 million of the investment and 5% to the remaining $0.8 million. Alternatively, the Secretary of Treasury is authorized to issues guidelines limiting the amount of investments which eligible institutions may receive in order to be consistent with these limitations.

The initial coupon rate shall be determined in reference to the institution's Call Report data published in the quarter immediately preceding its participation in the Program, as measured against the base level of small business lending described above. Adjustments to the rate will be made quarterly based upon Call Report data published in that quarter for activity in the previous quarter, payable in the next successive calendar quarter. For example if the Call Report published during the third quarter of 2010 reflects a cumulative increase in small business lending of 6%, the rate on the preferred stock would adjust to 3% for the third quarter of 2010, payable beginning in the fourth quarter of 2010. For S Corporations or mutual institutions, the rates described above would be adjusted to reflect any differential tax treatment applicable to interest payments versus dividend payments, similar to the treatment implemented under the TARP Capital Purchase Program.

The coupon rate in place at the end of the initial 2-year period (i.e. the eighth calendar quarter after the date of investment), will continue to apply until the end of the 4 1/2-year period beginning on the date of investment. If the amount of small business lending has remained unchanged or has decreased as of the end of the initial 2-year period, the rate will increase to 7% until the end of the 4 1/2-year period beginning on the date of investment. After the initial 4 1/2-year period, the rate will automatically increase on all investments to 9%. The preferred stock or subordinated debt will mature not later than 10 years from the date of investment.

May an institution refinance its TARP Capital Purchase Program obligations with securities issued under this Program?
Yes, as long as the institution has not missed more than one dividend payment on its TARP preferred stock. A payment that is more than 60 days late is considered to be missed for purposes of this analysis.

Are there any conditions to issuing preferred stock in the Program?
While none of the warrant requirements or executive compensation limitations imposed on officers of TARP Capital Purchase Program recipients are implicated by this Program, there are still a few conditions that apply, including:

  • any institution receiving a capital investment under the Program will need to provide "linguistically and culturally appropriate outreach and advertising" targeting minorities, women and veterans that describes the application process to obtain loans from the institution made possible by the Program; and
  • the appropriate federal bank regulator for the institution is tasked with issuing guidance within 60 days regarding prudent underwriting standards applicable to loans made with funds received from the Program.

Unlike the TARP Capital Purchase Program, any modifications that are made to the Program can only be applicable to "new capital investments." Presumably, this means that retroactive modifications to the Program are not permissible, alleviating concerns that Treasury will "change the rules" after the institution accepts the Treasury's investment.

How do I apply?
It is unclear whether applications will be submitted directly to the Treasury Department or rather to the institution's primary federal regulator first, as was the case with respect to the TARP Capital Purchase Program. At the time of application, however, the applicant will need to submit a small business lending plan that describes how the applicant's "business strategy and operating goals will allow it to address the needs of small businesses in the areas it serves, as well as a plan to provide linguistically and culturally appropriate outreach, where appropriate."

What should I do now if I am interested in pursuing this?
While there are no formal steps that need to be taken with Treasury or your banking regulator as of yet, there are a few things that you could be doing behind the scenes to make sure that your institution is positioned to take advantage of the Program if it is interested. Keep in mind that the Program is limited to $30 billion and it will be in your institution's best interest to act quickly if you choose to participate.

First, since the investment vehicle involved here is preferred stock, you should check your institution's Articles of Incorporation to determine if preferred shares are authorized. If not, now may be the time to consider an amendment to your Articles to authorize a class of "blank check" preferred stock. Such an amendment will require shareholder approval, so a special meeting of shareholders must be convened for that purpose. Since this takes time, the sooner you begin this process the better. Second, as discussed earlier, each institution will be required to submit a small business lending plan along with its application. Now may be a good time to start formulating a plan. Such a plan can always be revised prior to applying once more details emerge regarding Treasury's expectations.

Please contact Patrick Murphy, Thomas Homberg or John Reichert of the Godfrey & Kahn Financial Institutions team if you are interested in receiving additional details and/or a term sheet as they become available.

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