TARP II Terms: The New Bank Bailout Program

Treasury today issued the terms for its new Capital Assistance Program (CAP) for handing out TARP funds.  There are some very interesting wrinkles.  First, the government will purchase funny convertible preferred stock instead of preferred stock and warrants (on common).  The conversion ratio is based on a 10% discount from the price of the common stock on Feb. 9th.  Second, the preferred pays 9% for seven years rather than 5% for five and 10% for the second five (that some banks received).  On the seventh year the government can force redemption of the new convertible preferred.  Third, the preferred is convertible into voting common at the option of the issuer (not the holder, the government) with the approval of the government. Previously the warrants were for non-voting common only.  Fourth, banks are encouraged to exchange the new convertible preferred for the old TARP preferred.  The wrinkles are designed to allow banks to convert preferred into common to aid with TCE ratios (Total Common Equity ratios) that are the rage now for assessing bank health.  But to get the issuer conversion flexibility an issuer must sacrifice some short term dividends and give up, potentially, voting stock to the government.  Banks that need the more have no choice but to sell the convertible preferred but should hold on to the old non-convertible preferred issued under TARP I unless pressured by the government to exchange it to the new convertible preferred.  Then there are the new executive compensation caps that apply retroactively.  The stock market rose a bit on the terms and then tanked again after the President appeared on television at about 4:00 to warn of "heavy oversight."  This new cash is going to come with plenty of strings.  At some point bank boards should think about whether they will get more money to shareholders by voluntarily winding up than accepting government cash and government "oversight."  Indeed, the boards have a fiduciary duty to make the calculation and wind the bank up if the calculation favors the process.

Citigroup, of course, is getting a special deal. The government with exchange up to $25B of the old preferred for new convertible preferred (with an 8% rate) if the private shareholders also participate for the same amount. If it works out the government would have potential voting rights on close to 40% of Citigroups common.  The offer hit the markets hard as Citigroup shares broke trading volume records and fell close to 40% on the announcement.