[JPRT, 111th Congress]
[From the U.S. Government Publishing Office]
CONGRESSIONAL OVERSIGHT PANEL
FEBRUARY OVERSIGHT REPORT *
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VALUING TREASURY'S ACQUISITIONS
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February 6, 2009.--Ordered to be printed
* Submitted under Section 125(b)(1) of Title I of the Emergency
Economic Stabilization Act of 2008, Pub. L. No. 110-343
CONGRESSIONAL OVERSIGHT PANEL FEBRUARY OVERSIGHT REPORT
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CONGRESSIONAL OVERSIGHT PANEL
FEBRUARY OVERSIGHT REPORT *
__________
VALUING TREASURY'S ACQUISITIONS
[GRAPHIC] [TIFF OMITTED] TONGRESS.#13
February 6, 2009.--Ordered to be printed
* Submitted under Section 125(b)(1) of Title I of the Emergency
Economic Stabilization Act of 2008, Pub. L. No. 110-343
CONGRESSIONAL OVERSIGHT PANEL
Panel Members
Elizabeth Warren, Chair
Sen. John Sununu
Rep. Jeb Hensarling
Richard H. Neiman
Damon Silvers
C O N T E N T S
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Page
Executive Summary................................................ 1
Valuing TARP Acquisitions........................................ 4
Treasury Department Updates Since Prior Report................... 11
Oversight Activities............................................. 14
Future Oversight Activities...................................... 15
About the Congressional Oversight Panel.......................... 16
Appendix I: Letter from Mr. Lawrence Summers to Congressional
Leadership, dated January 15, 2009............................. 17
Appendix II: Letter from Congressional Oversight Panel Chair
Elizabeth Warren to Treasury Secretary Mr. Timothy Geithner,
dated January 28, 2009......................................... 20
Appendix III: Report of the Advisory Committee on Finance and
Valuation to the Congressional Oversight Panel................. 22
Appendix IV: Summary of the Legal Report to the Congressional
Oversight Panel for Economic Stabilization concerning the TARP
Investments in Financial Institutions.......................... 34
Appendix V: Link to Valuation Report of Duff & Phelps to the
Congressional Oversight Panel.................................. 45
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FEBRUARY OVERSIGHT REPORT
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February 6, 2009.--Ordered to be printed
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EXECUTIVE SUMMARY
A central question surrounding the Troubled Asset Relief
Program (TARP) is whether the U.S. Department of the Treasury's
(Treasury) policy of injecting cash into financial institutions
has resulted in a fair deal for taxpayers. The focus of this
report is a financial valuation study of the terms of
Treasury's program to invest capital in financial institutions.
The report was commissioned as part of the Congressional
Oversight Panel's continuing investigation into the terms of
the TARP. The report was conducted for the Panel by its
Advisory Committee on Finance and Valuation (Advisory
Committee) and by the international valuation firm, Duff &
Phelps Corporation; the Advisory Committee's report is attached
to this report and the longer complete Duff & Phelps valuation
report is posted on the Panel's website.\1\ The valuation
report was enhanced by an accompanying legal analysis of the
terms of the TARP transactions, which is also attached to this
report.
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\1\ Congressional Oversight Panel (online at cop.senate.gov).
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The valuation report concludes that Treasury paid
substantially more for the assets it purchased under the TARP
than their then-current market value. The use of a one-size-
fits-all investment policy,\2\ rather than the use of risk-
based pricing more commonly used in market transactions,
underlies the magnitude of the discount. A number of reasons
for this result have been suggested. The Panel has not
determined whether these reasons are valid or whether they
justify the large subsidy that was created. In addition, the
Panel has not made judgments about whether the decision-making
underlying these investments was sound. The rationale for the
Treasury's approach and the impact of this disparity will be
subjects for the Panel's continued study and consideration. It
is important, however, for the public to understand that in
many cases Treasury received far less value in stocks and
warrants than the money it injected into financial
institutions.
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\2\ That policy includes creation of a uniform capital infusion
program, acceptance of a limit on the marketability of the securities
Treasury received, and terms that encourage institutions to replenish
their private capital.
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The legal analysis concludes that the documentation for the
investments was standardized. The use of standardized documents
likely contributed to Treasury's ability to obtain speed of
execution and wide participation, but it meant Treasury could
not address differences in credit quality among various capital
infusion recipients through variations in contractual terms
governing the investments or impose specific requirements on a
particular recipient that might help insure stability and
soundness.
The February report also provides an update on the Panel's
previous work, as well as a review of the key actions and
changes at Treasury regarding the TARP since the Panel's last
report. In its initial report, on December 10, 2008, the Panel
asked ten questions about the TARP and a series of sub-
questions on the strategy, goals, methods, and operations of
the program. In its next report, issued on January 9, 2009, the
Panel analyzed Treasury's response to the Panel's questions and
highlighted four specific areas where Treasury most needed to
provide additional information:
(1) Bank Accountability. The Panel pressed Treasury to
collect and disclose additional information about how TARP-
recipient banks are using taxpayer funds and to establish
reporting requirements, formal usage guidelines, or additional
benchmarks for the conduct of TARP recipients as a condition of
taxpayer support.
(2) Transparency and Asset Evaluation. The Panel emphasized
the need for Treasury to ensure transparency both in the
process of selecting TARP recipients and the relationship
between an institution's receipt of TARP funds and the value of
its assets in order to increase TARP accountability and
confidence in the markets.
(3) Foreclosures. The Panel pressed Treasury to follow
Congress's express mandate in Sec. Sec. 109-110 of the
Emergency Economic Stabilization Act of 2008 (EESA) to increase
federal assistance to homeowners in danger of losing their
homes and make further efforts to reduce foreclosures.
(4) Strategy. The Panel repeated its concern about
Treasury's shifting explanations of its strategy for using TARP
funds and called for Treasury to develop and follow a coherent
strategy for the future use of TARP funds.
The Panel remains committed to its ongoing oversight role
and will continue to seek answers to the questions presented in
its previous reports. While the Panel recognizes that Treasury
is in the midst of a transition of personnel and policies, it
believes that the Panel's initial questions and areas of
concern maintain their importance and will help Treasury as it
reshapes its policies and continues to administer the TARP.
To that end, the Panel wrote a letter to Treasury on
January 28, 2009, reiterating its requests for answers and
asking for further response by February 18, 2009.\3\ The Panel
expects to discuss Treasury's responses in its March report to
Congress.
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\3\ See Appendix II, infra.
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In addition to following the issues raised thus far, the
Panel will focus on home mortgage foreclosures in its next
report. We will continue to engage the public through hearings
and a public participation and comment process, as well as
required monthly reports.
VALUING TARP ACQUISITIONS
In October 2008, Treasury abandoned its original strategy
of purchasing ``troubled'' mortgage and other assets from the
nation's financial institutions, deciding instead to invest
money directly into those institutions.\4\ The Panel made clear
in its first report to Congress and the public, on December 10,
2008, that it wanted to know if ``the public is receiving a
fair deal'' under the TARP in general and for those investments
in particular. It explained that:
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\4\ U.S. Department of the Treasury, Statement by Secretary Henry
M. Paulson, Jr. on Actions to Protect the U.S. Economy (Oct. 14, 2008)
(online at www.treasury.gov/press/releases/hp1205.htm).
[A] critical aspect of [the Panel's] mission is to
determine whether the United States government has
received assets comparable to its expenditures under
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the Emergency Economic Stabilization Act of 2008.
The Panel's review of the ten largest TARP investments the
Treasury made during 2008 raises substantial doubts about
whether the government received assets comparable to its
expenditures.\5\ The Panel's analysis does not explore whether
these investments were the best means of achieving broader
policy goals.
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\5\ This valuation analysis does not include the approximately $24
billion in loans to General Motors, Chrysler, Chrysler Financial, and
GMAC made as part of the Automotive Industry Finance Program.
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Valuation of the transactions is critical because then-
Treasury Secretary Henry Paulson assured the public that the
investments of TARP money were sound, given in return for full
value: ``This is an investment, not an expenditure, and there
is no reason to expect this program will cost taxpayers
anything.'' \6\ In December, he reiterated the point, ``When
measured on an accrual basis, the value of the preferred stock
is at or near par.'' \7\ This means, in effect, that for every
$100 Treasury invested in these companies, it received stock
and warrants valued at about $100.
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\6\ U.S. Department of the Treasury, Statement by Secretary Henry
M. Paulson, Jr. on Capital Purchase Program (Oct. 20, 2008) (online at
www.treas.gov/press/releases/hp1223.htm).
\7\ U.S. Department of the Treasury, Responses to Questions of the
First Report of the Congressional Oversight Panel for Economic
Stabilization (Dec. 30, 2008).
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As discussed in greater detail in the remainder of this
section, an extensive valuation analysis of the ten
transactions that was commissioned by the Panel concluded that:
In the eight transactions which were made under
the investment program for healthy banks, for each $100 spent,
Treasury received assets worth approximately $78.
In the two transactions which were made under
programs for riskier banks, for each $100 spent, the Treasury
received assets worth approximately $41.
Overall, in the ten transactions, for each $100
spent, the Treasury received assets worth approximately $66.
Extrapolating these results using appropriate
weighting to all capital purchases made in 2008 under TARP,
Treasury paid $254 billion, for which it received assets worth
approximately $176 billion, a shortfall of $78 billion.
Three programs have been used by the Treasury to infuse
capital directly into American financial institutions under
TARP. The Capital Purchase Program (CPP), created in October
2008 has the most widespread bank participation.\8\ This
program was intended for healthy banks: those that are sound
and not in need of government subsidization. While a total of
317 financial institutions have received a total of $194
billion under the CPP as of January 23, 2009, eight large early
investments represent $124 billion, or 64 percent of the total.
The eight were: Bank of America Corporation, Citigroup, Inc.,
JPMorgan Chase & Co., Morgan Stanley, Goldman Sachs Group,
Inc., PNC Financial Services Group, U.S. Bancorp, and Wells
Fargo & Company. In addition, the Systemically Significant
Failing Institutions Program (SSFI Program), launched in
November 2008,\9\ and the Targeted Investment Program (TIP),
launched in January 2009,\10\ were created to deal with
financial institutions that were in financial distress. Only
American International Group (AIG) received money under the
SSFI Program. After receiving money as a ``healthy bank,'' six
weeks later Citigroup received a second infusion of TARP funds,
an infusion that was ultimately included as part of the as yet
uncreated TIP.\11\
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\8\ U.S. Department of the Treasury, Treasury Announces TARP
Capital Purchase Program Description (Oct. 14, 2008) (online at
www.treas.gov/press/releases/hp1207.htm).
\9\ U.S. Department of the Treasury, Treasury to Invest in AIG
Restructuring Under the Emergency Economic Stabilization Act (Nov. 10,
2008) (online at www.treasury.gov/press/releases/hp1261.htm).
\10\ U.S. Department of the Treasury, Treasury Releases Guidelines
for Targeted Investment Program (Jan. 2, 2009) (online at
www.treasury.gov/press/releases/hp1338.htm).
\11\ Id. Treasury made it clear retroactively when it announced the
TIP guidelines that its November 23 investment in Citigroup fell under
TIP. Id. See also U.S. Department of the Treasury, Joint Statement by
Treasury, Federal Reserve and the FDIC on Citigroup (Nov. 23, 2008)
(online at www.treasury.gov/press/releases/hp1287.htm). Treasury used
TIP again in January 2009 to make additional investments in Bank of
America. U.S. Department of the Treasury, Treasury, Federal Reserve and
the FDIC Provide Assistance to Bank of America (Jan. 16, 2008) (online
at www.treas.gov/press/releases/hp1356.htm).
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Under these three programs, Treasury made cash investments
in designated financial institutions in return for a
combination of preferred stock \12\ and warrants \13\ to
purchase common stock of those institutions. The terms differed
for each of the three programs--CPP, SSFI, and TIP--but they
all involved the purchase of portions of the institutions.
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\12\ The preferred stock in the CPP investments paid a dividend of
5 percent for five years and 9 percent thereafter; it was so-called
``perpetual preferred'' (that is, it did not have a fixed term),
although it could be redeemed by the issuer under certain conditions.
Preferred stock is a form of security that lies halfway between a
corporation's common stock and its formal debt. The preferred stock
bears a fixed dividend rate that is payable out of earnings, it must
receive its dividend before any dividends can be paid to common
shareholders, and its dividend rights are often cumulative (as was the
case with the Treasury investments), which means that if a dividend is
missed, the holder of the preferred stock has a right to receive the
missed dividend as part of its payment in future years. In a
liquidation, the preferred shareholders must be paid before any amount
can be paid to the common shareholders, but preferred shareholders
themselves cannot receive any funds if there is not enough first to pay
all of the corporation's creditors.
\13\ The warrants allowed the Treasury to buy common stock of each
institution for an additional amount--called the ``exercise price''--
that was calculated so that Treasury benefit if the value of the common
stock increased. The exercise price for the Treasury warrants is the
average trading price of a share of the institution's stock for the 20
days prior to the selection of the institution for the CPP, and the
shares that could be purchased were set at 15 percent of the face value
of the Treasury's preferred stock investment. (So that if the Treasury
made a $100 billion investment, the warrants would permit it to
purchase $15 billion of common stock.) The warrant values differed for
the other two programs, but the principle remained the same.
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To determine whether the Treasury received its money's
worth in these transactions, the Panel commissioned a detailed
valuation project in December 2008. The project and its
methodology were designed by an Advisory Committee on Finance
and Valuation, composed of Adam M. Blumenthal, a former First
Deputy Comptroller of the City of New York, Professor William
N. Goetzmann of Yale University and Professor Deborah J. Lucas
of Northwestern University.\14\ After a competitive bidding
process, the Committee recommended the international valuation
firm Duff & Phelps to work with it to implement the project
design and to perform the actual valuation.
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\14\ Mr. Blumenthal is now the Managing General Partner of Blue
Wolf Capital Management in New York. Professor Goetzmann is Edwin J.
Beinecke Professor of Finance and Management Studies and Director of
the International Center for Finance at the Yale School of Management.
Professor Lucas is Donald C. Clarke HSBC Professor of Consumer Finance
at the Kellogg School of Management at Northwestern University. Both
Professor Goetzmann and Professor Lucas are Research Associates of the
National Bureau of Economic Research.
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To reach a conclusion about each of Treasury's investments,
it is necessary to compare the amount of the government
investment with the value of the preferred stock and the
warrants it received in return in each transaction. The task is
made more difficult because none of the securities is publicly-
traded. Instead, the valuation analysis assumed that
``securities similar to those issued under the TARP were
trading in the capital markets at fair values.'' \15\ The
valuations employed multiple approaches in order to cross-check
and validate the results.\16\ Value was estimated for each
security as of the time immediately following the announcement
by Treasury of its purchase. This valuation approach takes into
account investors' perceptions about how the TARP investment
and other government programs announced concurrently affected
the value of the institutions. The valuation report itself was
based solely on publicly available information.
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\15\ Adam M. Blumenthal, William N. Goetzmann, and Deborah J.
Lucas, Report to the Congressional Oversight Panel on the Emergency
Economic Stabilization Act of 2008, at 7 (Feb. 4, 2009) (hereinafter
``Advisory Committee Report''). The Advisory Committee Report is
attached as Appendix III to this report.
\16\ The valuation methods are summarized on pages 7-10 of the
Advisory Committee Report. The complete valuation report conducted by
Duff & Phelps, which runs to some 697 pages, has been posted on the
Panel's web site, www.cop.senate.gov, and a link to the report is
attached as Appendix V to this report.
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The ten largest investment transactions made under the
three programs through November 2008 are listed in the
following table.\17\
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\17\ Advisory Committee Report, supra note 15, at 2.
SUMMARY OF ESTIMATED VALUE CONCLUSIONS
[Dollars in billions]
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Total estimated value
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Purchase program participant Valuation Face Subsidy
date value Value ---------------------------------
Percent $
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Capital Purchase Program:
Bank of America Corporation............ 10/14/08 $15.0 $12.5 17 $2.6
Citigroup, Inc......................... 10/14/08 25.0 15.5 38 9.5
JPMorgan Chase & Co.................... 10/14/08 25.0 20.6 18 4.4
Morgan Stanley......................... 10/14/08 10.0 5.8 42 4.2
The Goldman Sachs Group, Inc........... 10/14/08 10.0 7.5 25 2.5
The PNC Financial Services Group....... 10/24/08 7.6 5.5 27 2.1
U.S. Bancorp........................... 11/03/08 6.6 6.3 5 0.3
Wells Fargo & Company.................. 10/14/08 25.0 23.2 7 1.8
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Subtotal........................... ........... 124.2 96.9 22 27.3
311 Other Transactions\1\.......... ........... 70.0 54.6 22 15.4
SSFI & TIP:
American International Group, Inc...... 11/10/08 40.0 14.8 63 25.2
Citigroup, Inc......................... 11/24/08 20.0 10.0 50 10.0
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Subtotal........................... ........... 60.0 24.8 59 35.2
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Total.......................... ........... 254.2 176.2 31 78.0
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\1\ Extrapolates 22% subsidy rate from 8 studied CPP investments. See discussion in Part II.
This valuation analysis bears some similarities to an
earlier valuation by the Congressional Budget Office (CBO). The
report, titled The Troubled Asset Relief Program: Report on
Transactions Through December 31, 2008, was released in January
2009. The CBO report focused on utilizing procedures similar to
the Federal Credit Reform Act (FCRA) to assess the budgetary
impact of all TARP transactions on the federal debt and
deficit, which can be interpreted as a cost and thus a subsidy
rate. By comparison, the Duff & Phelps report provides
extensive, detailed company-by-company information for all
major CPP participants. While both reports conclude that the
fair market value of the securities received by Treasury was
less than what was paid, the much deeper focus in the Duff &
Phelps report provides the detailed information necessary to
inform the public policy debate surrounding the future of the
TARP. The Duff & Phelps report includes multiple valuation
methods, an evaluation of similar private transactions, and an
exploration of some of the reasoning behind the varied
subsidies, including between the different programs and even
between CPP participants. While the report itself does not draw
any conclusions as to the validity of Treasury's decisions or
any particular goals, the information will be extremely
valuable to policy makers in drawing their own conclusions.\18\
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\18\ Like the Duff & Phelps report, the CBO report uses only
publicly available information to value capital purchases. Advisory
Committee Report, supra note 15, at 7-10; Congressional Budget Office,
The Troubled Asset Relief Program: Report on Transactions Through
December 31, 2008, at 4-5 (Jan. 16, 2009).
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In addition to a direct investigation of the market value
of the transactions, the Panel's earlier reports suggested that
additional information about the value of the TARP transactions
could be derived by comparing those transactions to three large
transactions involving private sector investors that were
undertaken in the same time period: the purchase by Berkshire
Hathaway of an interest in Goldman Sachs, announced in
September 2008, the investment by Mitsubishi in Morgan Stanley,
also announced in September 2008, and an investment by Qatar
Holding LLC and entities representing the beneficial interests
of HH Sheik Mansour Bin Zayed Al Nahyan, a member of the Royal
Family of Abu Dhabi (Abu Dhabi) in Barclays PLC, announced in
late October 2008.\19\ The Advisory Committee and Duff & Phelps
concluded that these transactions could not be used to make a
direct comparison with the TARP investments. But by applying
the same methodology to three major investments by private
investors in financial institutions which occurred near the
same time as the Treasury investments (the $5 billion
investment by Berkshire Hathaway in Goldman Sachs, the $9
billion investment by Mitsubishi in Morgan Stanley and the K7
billion investment by Qatar Holding and Abu Dhabi and in
Barclays), the valuation report concludes that, unlike
Treasury, private investors received securities with a fair
market value as of the valuation dates of at least as much as
they invested, and in some cases, worth substantially more.
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\19\ Advisory Committee Report, supra note 15, at 10.
For each $100 Berkshire Hathaway invested in
Goldman Sachs, it received securities with a fair market value
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of $110.
For each $100 Qatar Holding and Abu Dhabi invested
in Barclays, they received securities with a fair market value
of $123.
For each $100 Mitsubishi invested in Morgan
Stanley, it received securities with a fair market value of
$91.
The way Treasury structured the CPP, SSFI Program, and TIP
transactions was certain to create significant subsidies.
Treasury's emphasis on uniformity, marketability, and use of
call options in structuring TARP investments helped produce a
situation in which Treasury paid substantially more for its
TARP investments than their then-current market value. The
decision to model the far riskier investments under the TIP and
SSFI Program closely on the CPP transactions also effectively
guaranteed that a substantial subsidy would exist for these
riskier institutions. Because Treasury decided to make all
healthy bank purchases on precisely the same terms, stronger
institutions received a smaller subsidy, while weaker
institutions received more substantial subsidies.
Two other structural factors contributed to the discount
factor. First, companies have the ability to call the preferred
stock at par; this option, which is not typical of publicly
traded preferreds, decreased the value of the securities
received by Treasury, particularly in the stronger
institutions; this call feature may have reflected an attempt
to limit the amount of time taxpayer funds are outstanding.\20\
In addition, while the preferred stock and warrants could be
registered for resale at the Treasury's request, liquidating
such a large position would entail substantial cost. The likely
costs inherent in such a liquidation also contributed to the
discount.
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\20\ The ability of a recipient of TARP assistance to call at par
the preferred stock it has issued to Treasury accounts for slightly
less than one-third of the total subsidy involved in the TARP
transactions valued and slightly less than one-half of the subsidy in
the CPP transactions alone. The liquidation costs associated with the
preferred stock and warrants Treasury received accounted for about 20
percent of the total subsidy, or about a quarter of the subsidy in the
CPP transactions alone. Looking at the benchmark transactions, private
sector investors were, in those cases, able to offset this discount
through a combination of higher interest rate, by taking more shares,
or by insisting on other terms that balanced the impact of the market
overhang.
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In addition, the legal analysis \21\ prepared for the Panel
noted that for the CPP transactions: (i) Treasury will receive
no premium if the issuer optionally redeems the preferred
shares, (ii) the warrants and common stock held by Treasury can
be repurchased, albeit at their then-fair market value, if the
preferred stock is either redeemed or transferred, and (iii)
the number of warrants held by Treasury are subject to an
automatic 50 percent reduction if the subject institution sells
equity equal in amount to Treasury's investment and qualifying
as Tier I capital. Treasury appears to have decided to be a
passive investor in each of the institutions in which it
invests, choosing not to receive either voting rights or seats
on an institution's board of directors if it converts its
warrants to common stock, and with a few exceptions no special
covenants are imposed on the institutions that receive capital
infusions. This can be contrasted with the more activist
approach taken by the U.K. government in its investments in
banks. (The legal analysis does note that, in some respects,
Treasury did obtain better terms than were reflected in the
Berkshire Hathaway investment in Goldman Sachs, but that those
more favorable terms did not affect value.)
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\21\ The legal analysis was prepared by Timothy G. Massad, Esq., a
New York City corporate lawyer with close to 25 years' experience, who
took an unpaid leave of absence from his law firm to serve as special
legal advisor to the Panel on a pro bono basis. Catherina Celosse, Esq.
acted as counsel for the Panel in the development of the legal
analysis.
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Additional observations in the legal analysis are also
important. The analysis notes that the standard terms of the
investments used in the CPP were generally within the range of
what would be customary in a commercial transaction between a
large financial institution and a large investor. The terms of
the documents include a number of provisions that appear to be
designed to encourage replacement of the Treasury investment
with private capital quickly. In addition, there were no
provisions in the CPP investment that restricted operations or
business practices of the recipients, restricted or required
reporting of use of funds,\22\ or were directed at specific
public policy objectives of EESA.\23\ (The CPP, SSFI Program,
and TIP forms do contain a ``highly unusual provision . . .
favorable to Treasury'' that allow Treasury unilaterally to
amend any provision of the relevant agreements if necessary to
comply with any new or amended federal statutes; the impact of
this provision is not included in the valuations in any way and
is, in any event, extremely difficult to assess.) \24\
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\22\ The lack of such reporting requirements is especially hard to
understand.
\23\ Timothy G. Massad, Summary of the Legal Report to the
Congressional Oversight Panel for Economic Stabilization Concerning the
TARP Investments in Financial Institutions, at 8 (Feb. 4, 2009)
(hereinafter ``Legal Analysis''). The Legal Analysis is attached as
Appendix IV to this report.
\24\ Id. at 11.
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By paying the same price, regardless of the financial
condition of the bank, Treasury ensured that weaker
institutions would necessarily be subsidized more heavily. It
may have wished to avoid the risk that more stringent CPP terms
for some institutions would signal Treasury knowledge of
adverse circumstances at those institutions. It is also
possible that Treasury wanted to avoid the risk that failure of
a weak bank could bring down stronger banks. The Panel has not
determined whether these objectives have been met or whether
they justified the large subsidy that was created. The Panel
expects to address these broader policy objectives in its
future work.
Investments in AIG under the SSFI Program and the second
Citigroup investment involved significantly larger subsidy
levels than were seen in the CPP institutions. The reason is
that, despite the higher risk, Treasury modeled these
investments closely on the CPP investments that had been
designed for healthy banks. In the AIG transaction, Treasury
already held warrants for 79.9 percent of the equity of AIG as
the result of a loan provided to AIG by the Federal Reserve
Bank of New York earlier in 2008; the proceeds of the TARP
investment in AIG were used to repay part of that loan. The
multiple loans and investments by parts of the federal
government in AIG have helped keep it out of bankruptcy. The
Advisory Committee and Duff & Phelps looked only at the
discount to face value that the Treasury took as a result of
its TARP investment, although they recognize that that
investment was part of a broader strategy by the government to
prop up the company. Even in the AIG case, however, the then-
Treasury Secretary insisted that the transactions were
accompanied by ``significant taxpayer protections and
conditions.'' \25\
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\25\ U.S. Department of the Treasury, Remarks by Secretary Henry M.
Paulson, Jr. on Financial Rescue Package and Economic Update (Nov. 12,
2008) (online at www.treas.gov/press/releases/hp1265.htm).
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Similarly, while the first investment in Citigroup was made
as part of the CPP for healthy banks, the second investment was
made after the markets recognized that Citigroup was subject to
a significantly increased level of risk. The second investment
was originally made outside any particular TARP program, on a
freestanding basis; when the TIP was subsequently created, on
January 2, 2009, the second Citigroup investment was
reclassified as part of the TIP, aimed at riskier institutions,
in connection with other government interventions. The analysis
in the valuation report and its appendices does not evaluate
those other interventions (i.e., interventions other than the
purchase of preferred stock and warrants). It focuses only on
the value gap between the amount of capital provided by the
Treasury in the second Citigroup investment, and the value of
the securities the Treasury received in exchange.
It is possible that the value of the investments made by
Treasury may someday be worth more than the amount Treasury
paid. It is also possible that they may be worth much less.
This assessment demonstrates that the value received--including
the market's estimate of its future worth--was considerably
less at the time of the transaction than the amount paid by
Treasury. It also demonstrates that the value on an
institution-by-institution basis varied substantially.
Treasury may have determined that granting the subsidies
described above to a group of banks, regardless of their
condition, on essentially the same terms was necessary, for one
or more reasons, to preserve the integrity of the financial
system. Whether the subsidy provided by Treasury to financial
institutions represents a fair deal for the taxpayers is a
subject for policy debate and judgment, not one that can be
answered in a purely quantitative way.
In its public statements about its TARP expenditures,
Treasury did not describe the program in terms of
subsidization, nor did it explain why some banks should be
subsidized more than others. Instead, Treasury repeatedly
described investments ``at or near par.'' The Panel recognizes
that the prudence of spending taxpayer dollars in this way may
be the subject of disagreement among both experts and the
public, but the Panel believes that if TARP is to garner
credibility and public support, a clear explanation of the
economic transaction and the reasoning behind any such
expenditure of funds must be made clear to the public.
The Panel will continue to investigate how Treasury spends
taxpayer funds and whether these expenditures are helping the
economy.
TREASURY DEPARTMENT UPDATES SINCE PRIOR REPORT
In the month since the Panel's last report, the second half
of the TARP funds have been released, a new Administration has
taken office, and a new Treasury Secretary, Timothy Geithner,
has been sworn in. Since the new Administration began, Treasury
has also extended additional assistance to financial
institutions and announced new rules governing the conduct of
recipients of TARP money.\26\ The Panel will continue to
evaluate the terms and conditions of the new programs and will
provide updates on the effectiveness of these efforts.
---------------------------------------------------------------------------
\26\ The Panel appreciates the new administration's responsiveness
to the concerns raised in its oversight reports as evidenced by
National Economic Council Director Lawrence H. Summers' January 15,
2009 letter to the Congressional leadership, see Appendix I infra, and
its recent TARP initiatives discussed in this report.
Second Tranche of TARP Funds Released. On January
15, 2009, Congress voted to approve the release of the second
$350 billion available from the October 2008 Emergency Economic
Stabilization Act.\27\ As such, Treasury now has access to the
full $700 billion spending authority contemplated in EESA.\28\
---------------------------------------------------------------------------
\27\ Lori Montgomery and Paul Kane, Senate Votes to Release Bailout
Funds to Obama, Washington Post (Jan. 16, 2009) (online at
www.washingtonpost.com/wp-dyn/content/article/2009/01/15/
AR2009011504253.html).
\28\ Emergency Economic Stabilization Act of 2008 (EESA), Pub. L.
No. 110-343 at Sec. 115(a).
New Transparency Initiatives. Treasury has
announced new regulations governing disclosure and mitigation
of conflicts of interest in its TARP contracting.\29\ In
addition, Treasury has made public assurances that it will
``publish a detailed description'' of its criteria and process
for selecting TARP recipients.\30\ Treasury has also issued new
guidelines that restrict contact between lobbyists and the
Treasury officials who decide how to allocate TARP funds.\31\
Finally, Treasury has announced a new policy of publishing
investment contracts within five to ten business days of all
future TARP transactions,\32\ in addition to publishing
additional information about past TARP transactions with
financial institutions.\33\
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\29\ TARP Conflicts of Interest, Interim Rule, 74 Fed. Reg. 3431-
3436 (Jan. 21, 2009) (codified at 31 C.F.R. Sec. Sec. 31.200-31.218).
\30\ Brady Dennis, Treasury Moves to Restrict Lobbyists from
Influencing Bailout Program, Washington Post (Jan. 28, 2009) (online at
www.washingtonpost.com/wp-dyn/content/article/2009/01/27/
AR2009012703500.html); U.S. Department of the Treasury, Treasury
Secretary Opens Term with New Rules To Bolster Transparency, Limit
Lobbyist Influence in Federal investment Decisions (Jan. 27, 2009)
(online at www.ustreas.gov/press/releases/tg02.htm).
\31\ Id.
\32\ U.S. Department of the Treasury, Treasury Announces New Policy
to Increase Transparency in Financial Stability Program (Jan. 28, 2009)
(online at www.ustreas.gov/press/releases/ tg04.htm).
\33\ See, e.g., David Enrich and Damian Paletta, Agreement Boosts
Citi Oversight, Wall Street Journal (Jan. 29, 2009) (online at
online.wsj.com/article/SB123318955291026821.html).
Changing TARP Strategy. Secretary Geithner has
indicated that future TARP strategy will incorporate additional
conditions and an emphasis on homeowner assistance and
unfreezing credit markets. New TARP funding will have ``tough
conditions to protect the taxpayer and the necessary
transparency to allow the American people to see how and where
their money is being spent and the results those investments
are delivering.'' \34\ Furthermore, Treasury will increase its
emphasis on preventing foreclosures and freeing up credit for
homeowners and small businesses.\35\
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\34\ Senate Committee on Finance, Testimony of Timothy F. Geithner,
Hearing To Consider the Nomination of Timothy F. Geithner To Be
Secretary of the Treasury, 111th Cong. (Jan. 21, 2009) (online at
finance.senate.gov/hearings/testimony/2009test/012109tgtest.pdf).
\35\ Id. See also Rebecca Christie, Summers Says TARP To Be `Very
Different' Under Obama, Bloomberg (Jan. 25, 2009) (online at
www.bloomberg.com/apps/news?pid= 20601068&sid=ayehJsUpnfGg); Andrew
Ross Sorkin, Geithner Says TARP Would Force Banks To Lend More (Jan.
23, 2009) (online at dealbook.blogs.nytimes.com/2009/01/23/geithner-
says-tarp-will-force-banks-to-lend-more/).
Term Sheet for CPP investments in Subchapter S-
Corporations. On January 14, 2009, Treasury released a Summary
of Terms under which S-Corporation financial institutions--
generally small, private banks--can apply for TARP capital
infusions.\36\ Under these terms, Treasury limits dividend
repayments and receives 7.7 percent interest for the first five
years and then 13.8 percent interest for the next 25 years. In
exchange for capital, Treasury will receive debt senior to any
stock in the company.
---------------------------------------------------------------------------
\36\ U.S. Department of the Treasury, TARP Capital Purchase Program
(Jan. 14, 2009) (online at www.treas.gov/initiatives/eesa/docs/scorp-
term-sheet.pdf).
Additional Executive Compensation Rules. On
January 16, 2009, Treasury issued interim final rules for
reporting and recordkeeping requirements under the executive
compensation standards of the CPP.\37\ Treasury originally
published executive compensation standards for CPP in October
2008. The new rules require the CEOs of firms receiving funds
under CPP to certify to TARP's Chief Compliance Officer on a
regular basis that the institutions are complying with the
applicable TARP rules governing executive compensation.
Financial institutions are also required to maintain records to
substantiate these certifications for at least six years
following each certification and provide these records to the
TARP Chief Compliance Officer upon request. Treasury made
similar revisions to the executive compensation guidelines
applicable to financial institutions participating in the SSFI
Program. On February 4, 2009, Treasury issued stringent new
guidelines governing executive compensation for future TARP
recipients.\38\
---------------------------------------------------------------------------
\37\ U.S. Department of the Treasury, Treasury Issues Additional
Executive Compensation Rules Under TARP (Jan. 16, 2009) (online at
www.treas.gov/press/releases/hp1364.htm).
\38\ U.S. Department of the Treasury, Treasury Announces New
Restrictions On Executive Compensation (Feb. 4, 2009) (online at http:/
/www.ustreas.gov/press/releases/tg15.htm).
Investment in Chrysler Financial. In addition to
the $22.4 billion already loaned out as part of TARP's
Automotive Industry Financing Program (AIFP) in December 2008,
on January 16, 2009, Treasury announced a plan to make a $1.5
billion loan under the AIFP to a special purpose entity created
by Chrysler Financial.\39\ The money will provide liquidity to
Chrysler Financial's program to extend new consumer auto loans
to Chrysler customers. The five-year loan will require Chrysler
to pay Treasury interest equal to one month LIBOR plus 100
basis points in the first year, and then one month LIBOR plus
150 basis points in years two to five. The loan will be secured
by a senior secured interest in a pool of newly originated
consumer auto loans, and Chrysler Holding will serve as a
guarantor for certain covenants of Chrysler Financial.
---------------------------------------------------------------------------
\39\ U.S. Department of the Treasury, Treasury Announces TARP
Investments in Chrysler Financial (Jan. 16, 2009) (online at
www.treas.gov/press/releases/hp1362.htm); U.S. Department of the
Treasury, Treasury Announces TARP Investment in GMAC (Dec. 29, 2008)
(online at www.treasury.gov/press/releases/hp1335.htm); U.S. Department
of the Treasury, Indicative Summary of Terms for Secured Term Loan
Facility (Dec. 19, 2008) (Chrysler Term Sheet); U.S. Department of the
Treasury, Indicative Summary of Terms for Secured Term Loan Facility
(Dec. 19, 2008) (GM Term Sheet).
Finalized Terms of Citigroup Guarantee Agreement.
On January 16, 2009, Treasury, in conjunction with the Federal
Reserve and the Federal Deposit Insurance Corporation (FDIC),
finalized the terms of a guarantee agreement with
Citigroup.\40\ The guarantee agreement was initially announced
by Treasury on November 23, 2008. The agreement guarantees
Citigroup against unusually large losses on an asset pool of
$301 billion of loans and securities backed by residential and
commercial real estate assets, which will remain on Citigroup's
balance sheet.
The guarantee is in place for ten years for residential
assets and five years for nonresidential assets.\41\ Should
there be losses on the pool, Citigroup will be responsible for
up to the first $29 billion. Any additional losses will be
split between Citigroup and the government, with Citigroup
bearing 10 percent of the losses and the government bearing 90
percent.
---------------------------------------------------------------------------
\40\ U.S. Department of the Treasury, U.S. Government Finalizes
Terms of Citi Guarantee Announced in November (Jan. 16, 2009) (online
at www.treas.gov/press/releases/hp1358.htm).
\41\ U.S. Department of the Treasury, Summary of Terms, (Nov. 23,
2008) (online at www.treasury.gov/press/releases/reports/
cititermsheet_112308.pdf).
Additional Assistance to Bank of America. On
January 16, 2009, Treasury announced an agreement to provide
Bank of America with a package of assistance in the form of
guarantees, liquidity access, and capital under the TARP.\42\
Treasury and FDIC agreed to provide Bank of America protection
against the possibility of unusually large losses on an asset
pool of approximately $118 billion primarily composed of
securities backed by residential and commercial real estate
loans. The majority of these assets, which will remain on Bank
of America's balance sheet, were acquired as the result of its
merger with Merrill Lynch.
---------------------------------------------------------------------------
\42\ U.S. Department of the Treasury, Treasury, Federal Reserve and
the FDIC Provide Assistance to Bank of America (Jan. 16, 2009) (online
at www.treas.gov/press/releases/hp1356.htm).
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In addition, Treasury announced it will invest $20 billion
in Bank of America under the TIP. TIP was created to maintain
investor confidence in financial institutions at risk of a loss
due to market volatility. In exchange for its investment, Bank
of America will issue Treasury preferred shares with an 8
percent dividend.
OVERSIGHT ACTIVITIES
The Congressional Oversight Panel was established as part
of EESA and formed on November 26, 2008. Since its
establishment, the Panel has issued two oversight reports, as
well as its Special Report on Regulatory Reform, which was
issued on January 29, 2009.
Since the release of the Panel's January oversight report,
the following developments pertaining to the Panel's oversight
of the TARP took place:
In late January, the Panel received reports from
experts it engaged to estimate the fair market value of the
securities purchased by Treasury in its eight largest purchases
under the CPP, and its investments in AIG and Citigroup outside
the CPP. This report includes a discussion of their findings
above and a more detailed summary in Appendix III and on the
Panel's website.
On January 28, 2009, Elizabeth Warren, Chair of
the Panel, sent a letter to newly sworn-in Treasury Secretary
Timothy Geithner requesting more complete answers to the
questions the Panel posed regarding Treasury's TARP strategy
and implementation.
The Panel has received and reviewed more than
3,500 messages with stories, comments, or suggestions through
cop.senate.gov.
FUTURE OVERSIGHT ACTIVITIES
PUBLIC HEARINGS
Following two successful public hearings, one in Clark
County, Nevada in December on the housing crisis and one in
Washington, DC in January on regulatory reform, the Panel will
continue to hold hearings to shine light on the causes of the
financial crisis, the administration of TARP, and the anxieties
and challenges of ordinary Americans.
UPCOMING REPORTS
In March 2009, the Panel will release its fourth TARP
oversight report. The EESA aimed to stabilize the economy both
through direct support of financial institutions and through
encouraging foreclosure mitigation efforts. In the March
report, the Panel will examine existing foreclosure mitigation
efforts. The report will consider key areas including: the need
for more detailed and comprehensive information about mortgage
loan performance and loss mitigation efforts; the primary
drivers in loan default, including affordability, negative
equity and mortgage fraud; impediments to successful
foreclosure mitigation efforts; and existing foreclosure
programs and alternative approaches.
That report will also update the public on the status of
its TARP oversight activities. The Panel will continue to
release oversight reports every 30 days.
The Panel notes with great interest the release by the
Government Accountability Office (GAO), on January 30, 2009, of
a report titled Troubled Asset Relief Program: Status of Effort
to Address Transparency and Accountability Issues.
Independently agreeing with the Panel's unresolved concerns,
GAO highlighted Treasury's continued need for action both to
improve transparency and accountability in the TARP and to
articulate and communicate a coherent overall strategy. The
Panel intends to pursue these issues closely and to address
them in future reports.
The Panel also notes with approval the efforts of TARP
Special Inspector General (SIG) Neil Barofsky to prompt TARP
recipients to account for their use of taxpayer funds and
satisfy the conditions and reporting requirements already in
place. The Panel strongly calls on Treasury and the Office of
Management and Budget to aid, rather than hinder, SIG
Barofsky's investigation.
PUBLIC PARTICIPATION AND COMMENT PROCESS
The Panel encourages members of the public to visit its
website at cop.senate.gov. The website provides information
about the Panel and the text of the Panel's reports. In
addition, concerned citizens can share their stories, concerns,
and suggestions with the Panel through the website's comment
feature. To date, the Panel has received more than 3,500
comments, and the Panel looks forward to hearing more from the
American people. By engaging in this dialogue, the Panel aims
to enhance the quality of its ideas and advocacy.
ABOUT THE CONGRESSIONAL OVERSIGHT PANEL
In response to the escalating crisis, on October 3, 2008,
Congress provided the U.S. Department of the Treasury with the
authority to spend $700 billion to stabilize the U.S. economy,
preserve home ownership, and promote economic growth. Congress
created the Office of Financial Stabilization (OFS) within
Treasury to implement a Troubled Asset Relief Program. At the
same time, Congress created the Congressional Oversight Panel
to ``review the current state of financial markets and the
regulatory system.'' The Panel is empowered to hold hearings,
review official data, and write reports on actions taken by
Treasury and financial institutions and their effect on the
economy. Through regular reports, the Panel must oversee
Treasury's actions, assess the impact of spending to stabilize
the economy, evaluate market transparency, ensure effective
foreclosure mitigation efforts, and guarantee that Treasury's
actions are in the best interests of the American people. In
addition, Congress has instructed the Panel to produce a
special report on regulatory reform that will analyze ``the
current state of the regulatory system and its effectiveness at
overseeing the participants in the financial system and
protecting consumers.''
On November 14, 2008, Senate Majority Leader Harry Reid and
the Speaker of the House Nancy Pelosi appointed Richard H.
Neiman, Superintendent of Banks for the State of New York,
Damon Silvers, Associate General Counsel of the American
Federation of Labor and Congress of Industrial Organizations
(AFL-CIO), and Elizabeth Warren, Leo Gottlieb Professor of Law
at Harvard Law School to the Panel. With the appointment on
November 19 of Congressman Jeb Hensarling to the Panel by House
Minority Leader John Boehner, the Panel had a quorum and met
for the first time on November 26, 2008, electing Professor
Warren as its chair. On December 16, 2008, Senate Minority
Leader Mitch McConnell named Senator John E. Sununu to the
Panel, completing the Panel's membership.
In the production of this report, the Panel owes special
thanks to our Advisory Committee of Adam M. Blumenthal,
Professor William N. Goetzmann, and Professor Deborah J. Lucas,
to Tim Massad and Catherina Celosse for their legal analysis,
as well as to the hardworking staff at Duff & Phelps. The Panel
also thanks Ting Yeh for his careful research support on this
report.
APPENDIX I: LETTER FROM MR. LAWRENCE SUMMERS TO CONGRESSIONAL
LEADERSHIP, DATED JANUARY 15, 2009
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APPENDIX II: LETTER FROM CONGRESSIONAL OVERSIGHT PANEL CHAIR ELIZABETH
WARREN TO TREASURY SECRETARY MR. TIMOTHY GEITHNER, DATED JANUARY 28,
2009
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APPENDIX III: REPORT OF THE ADVISORY COMMITTEE ON FINANCE AND VALUATION
TO THE CONGRESSIONAL OVERSIGHT PANEL
Report to Congressional Oversight Panel on the Emergency Economic
Stablization Act of 2008
Adam M. Blumenthal, Managing General Partner, Blue Wolf
Capital Management.
William N. Goetzmann, Edwin J. Beinecke, Professor of
Finance and Management Studies and Director of the
International Center for Finance at the Yale School of
Management, and Research Associate of the National Bureau of
Economic Research.
Deborah J. Lucas, Donald C. Clarke, HSBC Professor of
Consumer Finance at the Kellogg School of Management at
Northwestern University, and Research Associate of the National
Bureau of Economic Research.
SUMMARY
A key question posed by the Congressional Oversight Panel
for the Emergency Economic Stabilization Act of 2008 (``EESA'')
is whether or not the investments in financial institutions
made by the U.S. Department of the Treasury (``Treasury'')
under the Troubled Asset Relief Program (``TARP'') represent a
fair deal to taxpayers. To provide insight into that question,
we compared the price paid by Treasury for these securities
with the values implied by the open market for some of the
largest investments made under the TARP.\1\
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\1\ The investments chosen represent the largest investments made
in non-automotive financial institutions other than the second and
third investments in Bank of America (of $10 billion and $20 billion)
which occurred in January 2009, too recently to be included.
SUMMARY OF ESTIMATED VALUE CONCLUSIONS
[Dollars in billions]
----------------------------------------------------------------------------------------------------------------
Total estimated value
--------------------------------------------
Purchase program participant Valuation Face Subsidy
date value Value ---------------------------------
Percent $
----------------------------------------------------------------------------------------------------------------
Capital Purchase Program:
Bank of America Corporation............ 10/14/08 $15.0 $12.5 17 $2.6
Citigroup, Inc......................... 10/14/08 25.0 15.5 38 9.5
JPMorgan Chase & Co.................... 10/14/08 25.0 20.6 18 4.4
Morgan Stanley......................... 10/14/08 10.0 5.8 42 4.2
The Goldman Sachs Group, Inc........... 10/14/08 10.0 7.5 25 2.5
The PNC Financial Services Group....... 10/24/08 7.6 5.5 27 2.1
U.S. Bancorp........................... 11/03/08 6.6 6.3 5 0.3
Wells Fargo & Company.................. 10/14/08 25.0 23.2 7 1.8
-------------------------------------------------------
Subtotal........................... 124.2 96.9 22 27.3
-------------------------------------------------------
311 Other Transactions*............ 70.0 54.6 22 15.4
SSFI & TIP:
American International Group, Inc...... 11/10/08 40.0 14.8 63 25.2
Citigroup, Inc......................... 11/24/08 20.0 10.0 50 10.0
-------------------------------------------------------
Subtotal........................... 60.0 24.8 59 35.2
-------------------------------------------------------
Total.......................... 254.2 176.2 31 78.0
----------------------------------------------------------------------------------------------------------------
* Extrapolates 22 subsidy rate from 8 studied CPP investments. See discussion below.
Of the $184 billion of TARP funds analyzed, we
estimate the securities received would have a fair market value
of approximately $122 billion when Treasury announced its
agreement to buy them.
The eight purchases made under the TARP Capital
Purchase Program, aimed at healthier banks, had a subsidy rate
to those banks of 22%. The securities subsequently purchased
from AIG and Citigroup under the Systemically Significant
Failing Institutions Program and the Targeted Investment
Program had a significantly higher subsidy rate of 59%.
If one takes this discount for the investments
made under the CPP and applies it to the entire $194 billion
committed to capital purchases in financial institutions
participating in that program, the total subsidy under the CPP
would be approximately $43 billion.\2\ When added to the $35
billion discount on $60 billion invested in AIG and in
Citigroup outside of the CPP, we estimate that of the $254
billion invested to date in securities of non-automotive
financial institutions, and exclusive of the most recent Bank
of America investment, the amount that represents a subsidy to
those institutions is $78 billion.
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\2\ Treasury's subsequent investments under the CPP were to
institutions that differed from those analyzed by Duff & Phelps in
several important respects such as size and scope of activities, and
the transactions took place under different market conditions. In
extrapolating the costs, we did not attempt to evaluate the effect of
these differences.
A value was estimated for each security as of the time
immediately following the announcement by Treasury of its
purchase. This valuation approach takes into account investors'
perceptions about how the TARP investment itself, and other
government programs announced concurrently, affected value.
Whether the subsidy provided by Treasury to financial
institutions represents a fair deal for the taxpayers is a
question for policy debate and judgment, not one that can be
answered in a purely quantitative way. The Treasury Department
has pointed out that the loss of wealth and diminution in asset
values that would accompany failure of one or more major
financial institutions could represent a far larger sum.
A substantial portion of the subsidy under the CPP program
can be attributed to the decision by Treasury to provide
capital on the same terms to all participants. Treasury chose
to offer ``one size fits all'' pricing in order to encourage
all institutions to participate, and in so doing disregarded
apparent differences in their financial condition. A
consequence is that Treasury effectively offered weaker
participants greater subsidies than it offered to stronger
participants. For example, the analysis in the report suggests
that Treasury received securities from Wells Fargo worth an
estimated $23.2 billion as of the valuation date for its
investment of $25.0 billion, or 93% of face value, while from
Morgan Stanley, it received securities worth an estimated $5.8
billion as of the valuation date for its investment of $10.0
billion, or 58% of face value.
The TIP and SSFI programs were intended to assist
institutions under more stress than those participating in the
CPP. Under these programs AIG and Citigroup received funds on
terms that were only slightly more stringent than those offered
to CPP participants, and the resulting subsidy rates were much
higher in these two transactions. It is worth noting that at
the time of these two investments, there were numerous
government commitments to these institutions; we focused only
on the value of the TARP investments.
By applying the same methodology to three major investments
by private investors in financial institutions which occurred
in the same time frame as the Treasury investments (the $5
billion investment by Berkshire Hathaway in The Goldman Sachs
Group, the $9 billion investment by Mitsubishi in Morgan
Stanley and the K7 billion investment by Abu Dhabi and Qatar
Holding in Barclays plc), it was estimated that the private
investors received securities with a fair market value as of
the valuation dates of at least as much as they invested, and
in some cases worth substantially more. (Berkshire Hathaway
received Goldman Sachs securities with a fair market value of
110% of the amount paid, Abu Dhabi and Qatar Holding received
securities with a fair market value of 123% of the amount paid,
and Mitsubishi received securities with a fair market value of
91% of the amount paid.)
Such comparisons are offered only as a benchmark. The
question of whether Treasury could have negotiated investments
that had comparable pricing and satisfied its public policy
objectives at the same time is not one that the report can
answer.
A. Introduction
The U.S. Department of the Treasury (``Treasury'') used
almost all of the $350 billion of taxpayer dollars provided to
it to in the first installment of the the Troubled Asset Relief
Program (``TARP'') created by the Emergency Economic
Stabilization Act of 2008 (``EESA''). Of this amount, Treasury
has spent, or committed to spend, approximately $310 billion to
purchase preferred stock and warrants of financial
institutions.
Most of these purchases were made pursuant to a program
developed by Treasury called the Capital Purchase Program
(``CPP''). In addition, outside of the CPP, Treasury had
invested an additional $60 billion in two financial
institutions, Citigroup and AIG, through other programs as of
the date of our study (an additional investment in Bank of
America has since been announced, but we did not review it).
The CPP, announced on October 14, 2008, was implemented through
a series of Treasury cash investments in exchange for preferred
shares and warrants from a broad range of financial companies.
All participating institutions obtained essentially the same
terms on the preferred shares (a 5% dividend, increasing to 9%
after five years) and warrants to purchase common stock equal
to 15% of the face value of the preferred investment, with the
companies having the right to cancel half of these warrants
under certain circumstances. Terms differed somewhat for non-
publicly traded institutions and for the investments outside of
the CPP.
Treasury allocated $250 billion of the funds under EESA to
CPP. To date, it has spent or committed to spend $194 billion
of that amount to purchase preferred stock and warrants of 319
financial institutions under this program.
In this report, we focus on the value of Treasury's
investments in a set of the largest participants in the CPP
program, and the value of Treasury's investments in Citigroup
and AIG made under related programs. In order to provide
information helpful in assessing whether the public is
receiving a fair deal under the TARP program, we asked two
questions in particular: (i) what was the fair market value of
the preferred stock and warrants Treasury received in exchange
for these cash infusions to financial institutions and (ii) how
do these values compare to what was received in several
privately negotiated transactions, including the earlier
investment made by Warren Buffett's Berkshire Hathaway Inc.
(``Berkshire Hathaway'') in The Goldman Sachs Group
(``Goldman'') and the investment made by Mitsubishi UFJ
Financial Group (``Mitsubishi'') in Morgan Stanley, two of the
institutions that received TARP funds, and by Qatar Holdings
and other middle eastern entities in Barclays plc
(``Barclays'') at the end of October 2008.
To answer these questions, on the Panel's behalf, we
designed the scope and methodology for a valuation project and
selected Duff & Phelps (``D&P''), one of the largest valuation
firms in the world, to conduct a rigorous valuation study
implementing that plan. D&P frequently conducts arm's-length,
independent valuations of securities like the TARP investments
for which no active trading market exists. We directed D&P to
provide an analysis of the likely fair market value of the
securities received by Treasury in the ten largest investments
made under the TARP. Given the particular details of Treasury's
investments and the desire to comprehensively review how they
relate to publicly traded securities as well as to comparable
private investments, we judged that the professional experience
and judgment of a major firm such as D&P would most effectively
interpret market information and yield reliable, quantitative
answers. In the sections that follow, we describe the scope,
methodology and conditions of the D&P analysis, and summarize
their basic findings. We then apply the estimates made by D&P
to the question posed by the Panel.
B. Process
Immediately after the Congressional Oversight Panel was
formed, the Panel created an Advisory Committee on Finance and
Valuation to create a valuation study. The members of the
Advisory Committee are: Adam M. Blumenthal, Managing General
Partner of Blue Wolf Capital Management and Former First Deputy
Comptroller of the City of New York; Professor William N.
Goetzmann, Edwin J. Beinecke Professor of Finance and
Management Studies and Director of the International Center for
Finance at the Yale School of Management, and Research
Associate of the National Bureau of Economic Research; and
Professor Deborah J. Lucas, Donald C. Clarke HSBC Professor of
Consumer Finance at the Kellogg School of Management at
Northwestern University, and Research Associate of the National
Bureau of Economic Research, and the former Chief Economist of
the Congressional Budget Office.
Members of the Advisory Committee created a detailed scope
for the valuation project, and identified and interviewed or
had discussions with five firms who were considered as
candidates to perform the valuation work. The Advisory
Committee recommended the selection of Duff & Phelps, LLC
(D&P), one of the largest valuation firms in the world, based
on a number of factors. D&P and the Advisory Committee then
designed a methodology to be used to implement the project
design. The Advisory Committee periodically reviewed with D&P
their application of the valuation methodologies and the
assumptions underlying them.
C. Scope
The valuation project was designed to provide an estimate
of the fair market value of the securities purchased by
Treasury in its eight largest purchases under the CPP, and its
investments in AIG and Citigroup outside the CPP. The Panel
focused on these investments because they were among the
largest commitments made under the TARP.\3\ Collectively, they
represent a total expenditure of $184 billion, or 53% of the
first $350 billion authorized by Congress for the TARP.
---------------------------------------------------------------------------
\3\ The additional $20 billion investment in Bank of America on
January 16, 2009 occurred too late to be included in the valuation
report.
---------------------------------------------------------------------------
The scope called for D&P to take into account in its
analysis only information that was publicly available. They
were asked what an arm's-length investor would pay for the
securities. This presupposed that an investor would not have
access to material nonpublic information, but would have
comprehensive access to public filings, analyst reports, and
trading information on all of the publicly traded securities
issued by the companies. Importantly, by basing estimates on
the market price immediately following the announcement by
Treasury of a purchase, the valuation takes into account
investors' perceptions about how the intervention itself
affects value going forward.
The scope also called for the firm to take into account
major privately negotiated investments that occurred around the
same time as the TARP investments under consideration, in
particular, investments by Warren Buffet's Berkshire Hathaway
in Goldman Sachs, by Mitsubishi in Morgan Stanley, and by Qatar
Holding and Abu Dhabi in Barclays, all of which occurred in
September and October of 2008.
The scope specifically excludes any effort to place a value
on the policy objectives of Treasury in making these
investments, apart from those reflected directly in security
prices. It also excludes consideration of any indirect effects
of the purchases on other governmental or private interests.
For instance, interdependencies between institutions may mean
that helping one enhances the value of others, as was thought
to be important with AIG. Those objectives, as well as the
broader implications for the financial system and the economy,
obviously must be considered in the policy debate on whether
the TARP investments were a good use of public funds, but they
are outside the scope of the valuation analysis, which
addresses only the subsidies to the institutions as measured by
the difference between the prices paid for the securities and
estimated fair market values.
We do not attempt to value other broad financial
interventions which Treasury, the Federal Reserve Bank, the
FDIC, or other government affiliated entities made in the
financial markets, in some cases simultaneously or in close
proximity to the TARP investments. We also do not value other
government investments in the same companies. For example, at
the time of the TARP investment, Treasury already owned 79.9%
of AIG, as the result of a prior loan to AIG by the Federal
Reserve Bank of New York, and the proceeds of the AIG loan were
used to repay part of the Fed's loan to AIG. In this case, we
valued the TARP securities, not the Fed's loan, or the
government's pre-existing equity interest in AIG.
The scope includes only the value of the securities at the
time of the announcement of the investment. As such, it does
not consider their current market value, which may be
considerably different than the values reported.
Finally, the scope provides for an estimate of the subsidy
received by each institution as a whole, but it does not cover
how the subsidy will be divided among different classes of
stakeholders (e.g., stock holders, bond holders, employees,
suppliers and customers).
D. Methodology
The methodology used in the valuation report is discussed
below and is described at much greater length in D&P's report.
The Advisory Committee and D&P developed a general approach,
which was to evaluate the preferred shares and the warrants
obtained by Treasury separately, company by company.
Recognizing that any single valuation approach might provide a
limited perspective on the factors influencing the value of the
securities, the Advisory Committee asked D&P to consider
multiple methods that offered a means to cross-validate their
estimates. All of these approaches rely on some basic
assumptions, the most important of which is that the prices for
securities similar to those issued under the TARP were trading
in the capital markets at fair values, which as defined by D&P
is ``the price at which they would change hands between a
willing buyer and a willing seller when neither is acting under
compulsion and when both have a reasonable knowledge of the
relevant facts.'' Despite the turmoil in the capital markets,
the Advisory Committee believes, and D&P confirmed through
analysis, that there was sufficient liquidity and market volume
in the trading of securities at that time to rely on market
pricing for analysis. D&P was not asked to consider whether
these market prices were consistent with other notions of
fundamental economic value. D&P's results are provided as a
range of values. The midpoints of those ranges were selected as
representative values for this report.
E. Preferred stock valuation
Preferred shares are legally a type of equity, but they
have several characteristics that are similar to bonds. They
are senior in priority to the common shares of a company, but
junior to the debt of the firm. The preferred shares issued
under CPP are non-voting securities which provide for a 5%
dividend for a five-year period and a 9% dividend in perpetuity
thereafter. A company can choose not to pay a preferred
dividend without declaring bankruptcy, but the dividends on the
preferred shares issued by bank holding companies under CPP are
cumulative, meaning that any missed dividends must be paid in
full before common stockholders can receive dividends. The
preferred shares are callable under certain conditions
described in full in D&P's report.
As a check on the robustness of the estimates, D&P used
several methodologies to value the preferred stock issued in
the investments: two based on the market values of different
types of comparable publicly traded securities and one using a
contingent claims analysis approach.
(i) Discounted Cash Flow Analysis Using Market Yields
(``Yield-Based Discounted Cash Flow Approach'')
This approach involves estimating the future expected cash
flows (dividend payments and return of principal) on the
preferred securities, and discounting those projected cash
flows at a market yield derived from the prices of comparable
securities. Finding the appropriate discount rate involved
analyzing the yields of the publicly traded preferred stock and
debt securities of each institution based on transaction prices
in the days following Treasury's announcement of the
investments. In those instances where sufficiently liquid
preferred securities were available for comparison, D&P used
them as the primary basis for determining a discount rate. In
either case, D&P then systematically adjusted yields to take
into account the differences between the terms of the CPP
preferred shares and the terms of the publicly traded
securities. Adjustments were made for the call options, the
cumulative dividend, and other factors.
(ii) Discounted Cash Flow Analysis Using Risk Adjusted
Survival Probabilities Derived from CDS Spreads
(``CDS-Based Discounted Cash Flow Approach'')
Like the yield-based method, this approach is based on
future contractual cash flows adjusted for expected losses, a
risk premium, and the time value of money. In this case, the
adjustments are based on information about default and the
price of credit risk implied by the premiums charged on credit
default swaps (``CDS''). Values estimated in this manner were
compared to those derived from the Yield-Based Discounted Cash
Flow Approach. An advantage of the CDS prices is that they are
generally determined in a more liquid market, and thus they may
better capture the market assessment of risk. However, CDS
prices reflect the market's required return on debt securities,
not on preferred shares, and thus valuation requires an
adjustment for the differences between the two types of
securities. Because of the difficulty of determining the
appropriate adjustment, this method was used primarily as a
check on whether the other two approaches were generating
reasonable estimates of value.
(iii) Contingent Claims Analysis
This methodology is distinctly different from the yield-
based approaches. It relies on a probabilistic model of how the
firm's asset value, and therefore, its ability to pay
claimants, evolves over time. The model is calibrated using
data on stock prices and their volatility, and on the book
value of debt. Preferred shares are assumed to receive dividend
payments as long as the solvency condition is satisfied, but to
recover little or nothing in bankruptcy. Default occurs when
assets drop below a trigger point based on debt outstanding.
The value of the preferred shares is based on the discounted
present value of dividends and any return of principal,
averaged over simulations of a large number of possible time
paths of a firm's asset value.
This mathematical framework is used in the private sector
for credit risk modeling and has also been used in a government
context for the valuation of government guarantees. This
approach allows for sensitivity analysis of the quantitative
importance of various assumptions. The results of the
contingent claims analysis are consistent with the yield-based
approaches, and in addition, make apparent the sensitivity of
estimated value to assumptions about the volatility of the
firm's underlying assets and the events that trigger
bankruptcy.
F. Warrant valuation
A warrant confers the right to acquire a share of stock
from a company within a specified time period for a
predetermined price, called the exercise price. Warrants allow
an investor to participate in potential stock price increases
since they generate a gain whenever share prices rise above the
exercise price of the warrant.
Treasury required each publicly held institution receiving
an investment to issue warrants at an exercise price equal to
the average trading price for the 20 days prior to the day of
Treasury's approval of the institution's participation in the
CPP. The number of common shares to be acquired was set at a
number which, when multiplied by the exercise price, was equal
to 15% of the total amount of Treasury's investment in the
preferred shares. Thus, if Treasury invested $10 billion in the
institution, Treasury would receive warrants for $1.5 billion
of common stock. If the exercise price of the warrants was $15
per share, then Treasury would receive warrants for 100 million
shares. The warrants are subject to a reduction feature whereby
half of the warrants may be cancelled by the issuing
institution if it meets certain conditions involving sale of
common stock to investors in private sector transactions prior
to year-end 2009, a feature which should reduce the upside to
Treasury. These warrants have a value independent of the
preferred shares themselves. D&P valued the warrants using a
widely used option pricing methodology, a Monte Carlo model,
which allowed them to take into account the conditions of the
warrant contract.
Warrant values depend on a number of inputs, including the
current stock price, the exercise price, the risk free rate of
return, the expected future volatility of the stock price, the
dividend yield on common stock, and the number of warrants
issued in relation to the outstanding shares of stock and other
features specific to the TARP offerings. The D&P valuation used
the stock price of the company on the chosen date of valuation,
a forward-looking set of short-term discount rates based upon
the current Treasury yield curve, an estimation of volatility
drawn from historical stock price fluctuations, as well as a
comparison to volatilities implied by prevailing market prices
of long-dated equity options and the appropriate ratio of
exercised warrants to outstanding shares.
In most instances, the value of the warrants was small
relative to the value of the preferred stock itself.
G. Reduced marketability discount
Under all of the methodologies, and for both preferred
stocks and warrants, D&P applied a ``reduced marketability
discount factor'' to reflect the fact that the large size of
Treasury positions made them potentially costly to liquidate
and hence less valuable. Based on academic and industry
studies, they estimated this factor to be between 5% and 10%
for the preferred stocks and between 5% and 20% for the
warrants.
H. Comparable transactions
Utilizing similar methodologies, D&P also analyzed three
transactions which were concluded around the time of the TARP
investments: the $5 billion Berkshire Hathaway investment in
Goldman Sachs announced on September 23, 2008 and closed on
October 1, 2008; the $9 billion Mitsubishi investment in Morgan
Stanley, which was announced on September 22, 2008, amended,
and then closed on October 13, 2008; and the K7 billion
investment by Abu Dhabi and Qatar Holding in Barclays plc which
was announced on October 31, 2008 and completed on November 27,
2008. D&P estimated that Berkshire Hathaway received securities
with a fair market value between 108% and 112% of the actual
amount paid, based on prevailing market prices for similar
securities; that Mitsubishi received securities with a fair
market value between 88% to 94% of the amount paid; and that
Qatar Holdings and Abu Dhabi received securities with a fair
market value of between 122% to 125% of the amount paid.
Stated differently, Berkshire Hathaway, Qatar Holding and
Abu Dhabi paid less for their securities than what one would
expect other investors to pay; all of the private investors
received relatively more valuable securities for their
investments than did Treasury.
D&P concluded that this broad range of outcomes reflects
unique circumstances at individual financial institutions, and
in some cases contractual terms that severely limited
marketability. In addition, there may also be some value
accruing from Warren Buffett's reputation as a canny investor
which enabled him sufficient leverage to purchase securities in
Goldman Sachs at a significant discount to the prevailing
market value of similar securities. Because of such special
circumstances, they concluded that the individual transactions
should not be taken as a benchmark for valuation of the TARP
securities but rather as an indicator of the potential for
investors to extract price concessions below prevailing market
values in certain circumstances.
The issue of whether the government could have obtained
similar discounts from prevailing market values on similar
securities remains a question for Treasury. The question also
remains of whether, even if it could have negotiated a
transaction benchmarked to these transactions, such a deal
would have met policy objectives, but this question is outside
of the scope of the valuation report. As a result, the D&P
analysis uses public market trading data that assumes no
positive strategic advantage that might accrue to a large
shareholder. The analysis of comparable transactions does,
however, provide information about the relative discounts that
accrued to some other major private actors so that the Panel
may understand their magnitude.
I. Conclusions of the valuation analysis
The table below lists the TARP investments reviewed in the
valuation showing institution, amount, date announced and the
Treasury program under which the investment was made.
[Dollars in billions]
------------------------------------------------------------------------
Purchase program participant Date Amount
------------------------------------------------------------------------
Capital Purchase Program:
Bank of America Corporation................. 10/14/08 $15.0
Citigroup, Inc.............................. 10/14/08 25.0
JPMorgan Chase & Co......................... 10/14/08 25.0
Morgan Stanley.............................. 10/14/08 10.0
The Goldman Sachs Group, Inc................ 10/14/08 10.0
The PNC Financial Services Group............ 10/24/08 7.6
U.S. Bancorp................................ 11/03/08 6.6
Wells Fargo & Company....................... 10/14/08 25.0
----------
Subtotal................................ ........... 124.2
SSFI & TIP:
American International Group, Inc........... 11/10/08 40.0
Citigroup, Inc.............................. 11/24/08 20.0
----------
Subtotal................................ ........... 60.0
----------
Total............................... ........... 184.2
------------------------------------------------------------------------
The next table shows D&P's estimates of the fair market
value of each of the investments, in each case as of the
respective dates the investments were announced. Taken as a
whole, D&P concluded that the fair market value of the
investments as of such dates, in the aggregate, was between
$112 and $132 billion, or between 61% and 71% of the amount
Treasury paid for them. Thus, of the total $184 billion
invested in these transactions, between $53 and $73 billion
represented overpayment relative to the estimated fair market
value of the securities.
(a) In the case of two of the eight largest investments
under the CPP, U.S. Bancorp and Wells Fargo & Company, which
the market deemed least risky, and for which Treasury paid
$31.6 billion in the aggregate, D&P concluded that the fair
market value of the investments was at or somewhat below the
amount paid for them by Treasury, with a range of 87% to 99% of
Treasury's cost. That is, D&P believes that a third party buyer
would have paid between $27.6 billion and $31.3 billion for
securities for which Treasury paid $31.6 billion.
(b) In the case of the other six CPP investments, in Bank
of America, JP Morgan Chase & Co., Goldman Sachs, the PNC
Financial Services Group, Citigroup, and Morgan Stanley, which
the market deemed riskier, D&P concluded that the fair market
value of the investments was significantly below the price paid
by Treasury, with a value range of 47% to 68% of face for
Morgan Stanley, which bore the greatest discount, to 77% to 89%
of face at Bank of America. In the aggregate for these six
investments, for which Treasury paid $92.6 billion, D&P
estimated a value range of $61.6 to $73.2 billion.
(c) In the case of the $60 billion in investments outside
the CPP program, consisting of the November investments in AIG
under the SSFI program and in Citigroup under the TIP, D&P
concluded that the government received value equal to between
$22.5 and $27.1 billion, or 37% to 45% of the amount invested.
SUMMARY OF ESTIMATED VALUE CONCLUSIONS
[Dollars in billions. All values are after applicable discounts due to reduced marketability]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total estimated Duff & Phelps value range
value* -----------------------------------
Valuation Face ------------------ Values Percent of face
Purchase program participant date value Midpoint Discount to face -----------------------------------
------------------
Percent $ Low High Low High
--------------------------------------------------------------------------------------------------------------------------------------------------------
Capital Purchase Program:
Bank of America Corporation................................ 10/14/08 $15.0 12.5 17 $2.6 $11.6 $13.3 77 89
Citigroup, Inc............................................. 10/14/08 25.0 15.5 38 9.5 14.2 16.8 57 67
JPMorgan Chase & Co........................................ 10/14/08 25.0 20.6 18 4.4 19.0 22.2 76 89
Morgan Stanley............................................. 10/14/08 10.0 5.8 42 4.2 4.7 6.8 47 68
The Goldman Sachs Group, Inc............................... 10/14/08 10.0 7.5 25 2.5 6.8 8.2 68 82
The PNC Financial Services Group........................... 10/24/08 7.6 5.5 27 2.1 5.2 5.8 69 77
U.S. Bancorp............................................... 11/03/08 6.6 6.3 5 0.3 5.9 6.7 89 102
Wells Fargo & Company...................................... 10/14/08 25.0 23.2 7 1.8 21.7 24.6 87 99
---------------------------------------------------------------------------
Subtotal ........... 124.2 96.9 22 27.3 89.2 104.5 72 84
SSFI & TIP:
American International Group, Inc.......................... 11/10/08 40.0 14.8 63 25.2 14.2 15.4 36 38
Citigroup, Inc............................................. 11/24/08 20.0 10.0 50 10.0 8.3 11.7 41 59
---------------------------------------------------------------------------
Subtotal................................................... ........... 60.0 24.8 59 35.2 22.5 27.1 37 45
Total...................................................... ........... 184.2 121.6 34 62.6 111.7 131.6 61 71
--------------------------------------------------------------------------------------------------------------------------------------------------------
* As of the respective valuation dates. Midpoint is midpoint of Duff & Phelps range.
J. Discussion
There were significant differences in the risk of the
institutions that received funds under the TARP, as evidenced
by the very different yields on their securities that investors
demanded in the capital markets and documented by D&P. In
financial institutions which the markets judged to be
relatively less risky, Treasury received securities with values
slightly below what was paid for them. In institutions which
the market viewed to have greater risk, the value of securities
received by Treasury was further below fair market value.
The Advisory Committee believes that this result is a
consequence of the policy decision by Treasury to offer uniform
terms under the CPP to all financial institutions irrespective
of their relative financial condition. For firms with a
relatively high probability of default, the 5% dividend rate on
the preferred shares was substantially below their market cost
of capital, whereas for the healthier firms, it offered a
smaller advantage over market rates. Further, the option for an
institution to extend the financing beyond the fifth year at a
9% rate only had substantial value to the weaker institutions.
A further benchmark for understanding the results of the
valuation exercise is that the CPP facility was structured to
be voluntary. To induce the relatively healthy financial
institutions to participate, the terms for them had to be set
so that they did not surrender more value than they received.
The decision by Treasury to treat everyone equally led to the
best institutions more or less breaking even and weaker
entities benefiting from receiving financing on the same terms
as their stronger peers.
A potential reason to refrain from discriminating among
TARP borrowers is the potential adverse effect on public
expectations about particular institutions. Put simply, if the
public thinks that Treasury knows something about a bank that
the public does not know, the markets may interpret any signal
from Treasury as a positive or negative indication about the
health of the firm. Avoiding this type of signaling may have
been a concern in crafting the program. On the other hand, as
the report illustrates, the market was aware of the
differential risk profile of these banks at the time the
investments were made. To the extent that adverse signaling was
a concern, risk-based pricing based only on public information
may have been possible. However, proposing alternative
mechanisms ex post is outside of the scope of this report.
K. Conclusion
Our report concludes, based on analysis set forth in great
detail in D&P's report, that the fair market value of the
securities received was, in most cases, significantly less than
what Treasury paid; and we identify the structural reasons in
the program that led this to be true. We are not attempting in
this report to answer the question of whether the investments
were good or bad from a policy perspective, or whether Treasury
will eventually recover its investment or even come out ahead.
Whether they were of positive benefit to the nation requires an
assessment of their effects on the functioning of the U.S.
economy. Consequently, this involves a policy debate and
requires an assessment as to whether these investments are part
of a coherent strategy to achieve the objectives of EESA. The
fundamental question is whether the actions taken by Treasury
are working to stabilize financial markets and institutions and
helping American families. This report provides information on
the value conveyed to these institutions at the time of the
intervention, which should be a useful input into a broader
cost-benefit analysis of the TARP. We hope that by quantifying
the cost of the initial largest investments made to date, we
have made a contribution to that debate.
APPENDIX IV: SUMMARY OF THE LEGAL REPORT TO THE CONGRESSIONAL OVERSIGHT
PANEL FOR ECONOMIC STABILIZATION CONCERNING THE TARP INVESTMENTS IN
FINANCIAL INSTITUTIONS
TIMOTHY G. MASSAD
A. Scope and methodology of legal report
The Panel asked Timothy G. Massad, a corporate lawyer with
a New York-based law firm for almost 25 years, including 17 as
a partner, to prepare a legal analysis of the TARP investments.
He specializes in corporate finance. Mr. Massad took a leave of
absence from his firm in late December in order to serve as
special legal advisor to the Panel on a pro bono basis and to
prepare the report. Catherina Celosse acted as counsel for the
Panel in the development of the legal report.
The legal analysis focuses on the Capital Purchase Program
(``CPP'') created by Treasury as a whole and the largest
investments thereunder, as well as the AIG, second Citigroup
and most recent Bank of America investment made outside of the
CPP. The CPP was for healthy banks. The AIG investment in
November 2008 was made under the Systemically Significant
Failing Institutions (``SSFI'') program and the Citigroup and
Bank of America investments were made under the Targeted
Investment Program (``TIP''), which were programs for
institutions in greater difficulty or at risk of failure.
The legal analysis provides an explanation of the structure
and terms of these investments. It also considers whether the
terms received by Treasury were customary and consistent with
market practice from a legal (but not a valuation) standpoint.
There is a wide range of market practice, and terms vary
depending on many factors including in particular the credit-
worthiness of the issuer, the relative strength of the parties
and the preferences of investors. Opinions also vary as to what
is customary, and the analysis cannot be reduced to a
quantitative assessment as with the valuation analysis. While
the legal analysis reviews the material terms of the agreements
individually, an investment decision by a private investor to
purchase securities of this type is usually made on the basis
of the terms as a whole, and an investor's willingness to agree
to a particular set of non-economic terms usually is greatly
influenced by the attractiveness of the economic terms.
In examining whether the terms were consistent with market
practice, the analysis considers in particular the terms of a
set of recent transactions agreed upon with the Panel. These
include the investments by Berkshire Hathaway Inc. in The
Goldman Sachs Group, Inc. (``Goldman Sachs'') and by Mitsubishi
UFJ Financial Group (``Mitsubishi'') in Morgan Stanley in the
fall of 2008, as well as four other investments in Citigroup,
Merrill Lynch and Morgan Stanley that were made between late
2007 and the fall of 2008 (the ``U.S. comparative
transactions''). In addition, these transactions include the
investments by the government of the United Kingdom in Royal
Bank of Scotland and Lloyds TSB--HBOS in October 2008 (the
``U.K. government investments'') and the investment in Barclays
Bank PLC by Qatar Holdings and Sheikh Mansour of Abu Dhabi.
The scope and methodology of the report was agreed upon
with the Panel, including that the report would be based solely
on review of publicly available information concerning the
investments.
As with the valuation analysis, the legal analysis does not
address whether the investments were good or bad investments.
Because they were investments by the government seeking to
fulfill certain public policy purposes, that conclusion
requires not only a consideration of the terms of the
investments but also an evaluation of the public policy
objectives and whether the investments contributed to achieving
those objectives, matters which are beyond the scope of the
legal report. The assessment of whether the terms were
consistent with market practice is only intended to provide a
benchmark. It is not intended to judge whether Treasury made
the right public policy choices or suggest that public policy
objectives should not influence those terms.
The legal report does not consider the other actions that
were taken by the U.S. government in response to the financial
crisis concurrently with the making of these investments,
including specific arrangements made with particular
institutions that received TARP funds. Although these actions
are relevant to evaluating the effectiveness of the investments
from a policy standpoint, they are beyond the scope of the
report.
B. Findings
The summary below highlights some of the findings of the
legal report.
(i) Documentation of TARP Investments--Use of Standard
Forms. Treasury created standard documentation for the CPP
investments. In the transactions reviewed, there were no
variations in terms from the standard forms other than those
contemplated by the forms themselves, such as those related to
size of the investment, number of shares issued and strike
price of the warrants.
Treasury created two sets of forms, one for publicly held
qualified financial institutions or ``QFIs'' (the Public QFI
forms) and one for non-publicly held qualified financial
institutions excluding S corporations and mutual organizations
(the Non-Public QFI forms). Of the total $194.2 billion
invested as of January 23, 2009, approximately $1.7 billion has
been invested in 90 institutions that are privately held or are
community development institutions.
Similarity to Berkshire Hathaway Papers. The CPP standard
forms are quite similar to, and appear to have been based on,
the papers used by Berkshire Hathaway for its investment in
Goldman Sachs. The pricing-related terms (such as dividend
rate, number and exercise price of warrants (including the
warrant reduction feature discussed below) and optional
redemption premium) of the Treasury agreements are not nearly
as favorable to Treasury as the terms that Berkshire Hathaway
received, as discussed in the valuation report. In most other
areas the terms obtained by Treasury are as good as, and in
some cases better than, those in the Berkshire Hathaway
agreements (such as voting rights of the preferred stock,
restrictions on dividends and stock repurchases, warrant anti-
dilution protection and exercise period, transfer restrictions,
representations and warranties and amendments), although such
other provisions generally are not as important to the average
investor. One other area where the terms obtained by Treasury
are not as good, though it could be thought of as a pricing-
related term, is the issuer's right to repurchase the warrants
and underlying common shares at fair market value following
redemption or transfer by Treasury of the preferred.
Incentives to Replace Treasury Investment. In order to meet
regulatory requirements, Treasury could not require the issuer
to redeem the securities (that is, repay Treasury) at a fixed
date. However, Treasury included a number of provisions, as
discussed below, that appear to be designed to encourage the
QFI to replace the Treasury investment with private capital,
which was presumably one of Treasury's objectives. These
include the dividend step-up provision, the lack of a premium
on optional redemption and (in the Public QFI form) the QFI's
right to reduce the number of warrants in certain circumstances
and to repurchase the warrants and underlying common shares at
fair market value once the preferred stock is redeemed or
transferred. (The common stock dividend restrictions may also
encourage replacement of the Treasury investment.) Some of
these provisions have a negative impact on valuation as
indicated by the valuation report; that is, they make the
security less attractive to an average investor.
Passive Investor Philosophy. The contracts generally
provide for Treasury to be a passive investor. This is
evidenced by providing for only limited voting rights, not
having any board seats or board observers, agreeing not to
exercise voting rights on common shares acquired under the
warrants and (in the CPP investments) not imposing any
covenants other than those that are customary for passive
preferred stock investments. There are, for example, few
covenants that restrict operations or that are directed at the
public policy objectives of EESA. This approach can be
contrasted with the more activist approach of the U.K.
government as well as the approach taken by Treasury in the
TARP loans made to the automotive companies, as discussed in
the report.
Consequences of Using Standard Forms. The legal analysis
also considered the implications of Treasury's decision to
structure the program by creating standard forms that were used
for all transactions, which implications are relevant to the
debate as to whether the investments were good policy choices.
First, the design of the program enabled Treasury to avoid
having to negotiate any of the terms with any institution,
which would have required substantially more Treasury resources
and many policy or credit choices. That would have made it
difficult to complete as many transactions as quickly as
Treasury did. The program design also may have contributed to a
perception that the program was fair at least as among
financial institutions that were deemed eligible. That may have
encouraged participation. Speed of execution and wide
participation were important Treasury objectives in October
2008 when the program was launched. The absence of individually
negotiated terms meant also that completed transactions did not
suggest to the marketplace that, because of the inclusion of
more restrictive terms in one case versus another, Treasury had
determined that one institution was weaker than another; such
signals could have in turn affected confidence in, or market
prices of the securities of, particular institutions. Treasury
also avoided subjecting itself to criticism for why it required
or did not require particular terms for an institution. On the
other hand, the program design meant that Treasury could not
address differences in credit quality or risk among
institutions, or in their need for capital, by varying the
terms of each investment.\1\ Insofar as the standard terms were
set for strong institutions, they may have been too lenient for
weaker institutions. The program design also meant that
Treasury could not impose specific requirements on a recipient
to take certain actions that it deemed necessary for the
stability or soundness of an institution (The Treasury view may
have been that the government could use its power as a
regulator to do so). It meant Treasury's only choice was to
decide whether an institution was eligible and what the size of
the investment would be within the range of 1-3% of risk-
weighted assets. A determination that an institution was not
eligible had potentially harsh consequences for the
institution.
---------------------------------------------------------------------------
\1\ In customary market practice, there are often differences in
pricing-related terms as well as non-economic terms depending on the
credit-worthiness of the issuer. In theory, Treasury could have
incorporated a customized, risk-based approach to setting the dividend
rate at least for large public companies, for example by reference to
the yields on other publicly traded securities or credit default swap
rates (or perhaps they could have varied the number of warrants taken),
and still have maintained the general standardized terms of the
documents. But this would have left the question of how to price the
securities for less widely-traded institutions, and its effects on
speed of execution and participation rates are impossible to know.
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A major question for the policy debate is therefore whether
the basic design of the program--provide capital to a large
number of institutions by using standard terms designed for
``healthy'' banks--made sense, because so many issues follow
from the answer to that question.
TIP/SSFI Investments. Treasury used the CPP forms with
modifications for the TIP/SSFI investments. The CPP was a
voluntary program for healthy banks; TIP and SSFI are for
institutions experiencing more difficulty or at risk of
failure. The two institutions funded under the TIP also
received funds under CPP, and the TIP program was not created
until months after the first investment now grouped under that
program was announced. The Panel may wish to consider whether
these various programs fit together into a coherent overall
strategy.
(ii) Basic Structure of the Investments. Treasury acquired
preferred stock and warrants. In the CPP investments, Treasury
purchased senior preferred stock in an amount equal to 1-3% of
risk weighted assets of the institution but not more than $25
billion. Risk-weighted assets are the total assets weighted for
credit risk and are a measure used to determine adequacy of
capital. The preferred stock qualified as Tier 1 capital, which
is a core measure of capital for a financial institution, as a
result of a contemporaneous regulatory change by the Federal
Reserve Board. The structure of the investment was consistent
with Treasury's goal of bolstering the capital of institutions,
which had been depleted by, among other things, losses on
mortgage-related assets.
Priority of Preferred Stock. Preferred stock provides
Treasury with priority over common stock as to payment of
dividends and in liquidation. The TARP preferred stock pays
dividends at a fixed rate, and the dividends are cumulative
(except for banks that are not subsidiaries of bank holding
companies), which means the dividends, even if not declared by
the board of directors in a particular period, continue to
accrue, thus enhancing the investor's return. Unpaid cumulative
dividends also compound at the dividend rate then in effect,
which is favorable to the investor. The preferred stock is
senior, which insures that no other preferred stock can have a
higher priority as to payment of dividends or in liquidation.
Blank Check Preferred. Another reason preferred stock may
have been attractive to Treasury and to the financial
institutions seeking CPP funds is that many public corporations
have what is known as ``blank-check preferred'' which allows
the board of directors to issue preferred stock having the
desired terms without having to obtain approval (in most cases)
from common stockholders, thus facilitating a quick
transaction.
Stockholder approval can nevertheless be necessary pursuant
to the rules of the national securities exchanges if the common
shares underlying the warrants equal 20% or more of the total
outstanding common shares. Treasury provided that in this case,
the institution was not only required to get approval, but the
exercise price of the warrants would decline if approval was
not obtained quickly.
Warrants--Basic Terms. In the CPP investments, Treasury
received warrants to acquire common shares equal to 15% of the
value of the preferred investment, which give it an opportunity
to realize upside, without giving up its fixed return, if the
common stock price of the institution increases. The exercise
or strike price of the warrants was set at the current market
price of the common stock. Sometimes, warrant exercise prices
are set at a premium to current market price of the common
stock, which would be less favorable to Treasury as it would
require greater price appreciation in order to realize a gain.
The warrants were immediately exercisable (subject to a
reduction feature) and had a term of ten years, which
potentially gives Treasury a long time to realize any gain.
The Non-Public QFI form for the CPP program differs in that
Treasury acquires a warrant for a preferred stock that pays a
9% dividend, which it exercises immediately. There is no
provision for reduction of warrants.
Warrant Reduction. One unusual feature of the Public QFI
forms is that the issuer is entitled to reduce the number of
common shares which may be acquired on exercise of the warrants
by 50% if it sells equity that qualifies as Tier 1 capital in
an amount equal to Treasury's investment before December 31,
2009. This feature could eliminate much of Treasury's upside
with respect to the warrants. However, it may serve a public
policy goal of creating an incentive for the issuer to raise
capital which could be used to replace the Treasury investment
(although actual redemption of the preferred is not required in
order to reduce the warrants).
Structure of TIP/SSFI Investments. The basic structures of
the TIP/SSFI investments were similar to the CPP forms--
Treasury acquired nonconvertible senior preferred stock paying
cumulative dividends as well as warrants. There were
differences in pricing-related terms (such as dividend rates,
numbers and exercise prices of warrants and absence of the
warrant reduction feature found in the CPP investments) as well
as in non-pricing terms as described below. Treasury has the
unilateral power to change the dividend rate in the AIG
transaction, which is highly unusual.
Structures of Comparative Transactions. The basic structure
of the CPP investments was quite similar to the Berkshire
Hathaway investment in Goldman Sachs. Berkshire Hathaway
purchased cumulative perpetual preferred stock paying a fixed
dividend, plus warrants to acquire common stock that were
exercisable for five years. The structures used in the other
U.S. comparative transactions were somewhat different.
Mitsubishi purchased noncumulative convertible preferred stock.
Noncumulative dividends do not accrue if not paid. However,
noncumulative perpetual preferred stock can be treated as Tier
1 capital without limit. Convertible preferred stock gives the
holder the right to convert into common stock at a price (and
thus realize an upside that is tied to common stock price
appreciation as with the warrant), although it must give up the
fixed return of the preferred stock to do so. Two of the other
U.S. comparative transactions also involved purchases of
noncumulative convertible preferred stock. The other two U.S.
comparative transactions involved sales of units in which the
investor acquired common stock and trust preferred securities.
These latter two investments are more complex transactions that
have certain tax advantages for the issuers, although they also
involve acquiring a combination of a fixed return and a
potential to realize upside in the common stock price.
The U.K. government transactions are quite different in
structure. The U.K. banks made open offers to their existing
shareholders to purchase ordinary shares (the equivalent of
common shares), and the U.K. government agreed to purchase the
ordinary shares to the extent existing shareholders did not
take them up, and to buy preference shares that pay
noncumulative dividends. Because few shareholders took up the
offers, the U.K. government purchased almost all the ordinary
shares offered. As a result, it owns 57.9% of one of the banks
and 43.4% of the other. The Barclays transaction involved the
sale of three securities: perpetual reserve capital instruments
which pay a fixed return in cash or common shares, warrants for
common stock and mandatorily convertible notes.
(iii) Dividends. The dividend rate on the CPP investments
increases from 5% to 9% per annum after five years. This
creates the potential for higher returns, and it may also
create an incentive for the issuer to redeem the preferred
stock. The dividend rates in the TIP/SSFI investments are
higher to begin with and do not increase.
(iv) Redemption and Repurchase. In order for the preferred
stock to be treated as Tier 1 capital for regulatory purposes,
it must be perpetual; the issuer cannot be required to redeem
it (that is, repay Treasury) at a fixed date or upon the
occurrence of certain events. However, the CPP forms provide
for redemption at the option of the issuer in the first three
years if the issuer receives proceeds from a qualified equity
offering (essentially a sale of equity securities constituting
Tier 1 capital for cash) equaling at least 25% of the
investment price. After three years, the issuer can redeem at
any time. Redemption is at par (without a premium). The absence
of a premium, and the fact that the issuer can redeem so early,
is not advantageous to an investor who wishes to lock in a rate
of return (and negatively impacts the valuation of the
securities), but it may serve a public policy objective of
encouraging institutions to replace Treasury investment with
private capital.
The CPP forms also give the issuer the right to repurchase
the warrants and any common shares acquired upon exercise of
the warrants at fair market value once the preferred shares are
redeemed or transferred by Treasury. (Fair market value is
determined initially by the issuer's board of directors but is
subject to an appraisal process if Treasury disagrees.) This
provision is very unusual and again negatively affects
valuation, but it may serve the public policy objective of
encouraging replacement of the Treasury investment. It may also
reflect past experience in U.S. government bailouts, such as in
the Chrysler bailout when, after Chrysler recovered and paid
off the government loans, there was debate over whether the
government should realize a profit on the warrants it received
or give them back to Chrysler. The repurchase right sets up a
procedure that may avoid a similar controversy.
The TIP/SSFI investments contain redemption provisions at
par and a repurchase right that are similar to the CPP forms.
(v) Covenants. The Panel requested that the legal analysis
review the covenants included in the TARP investments from the
standpoint of not only what was found in the comparative
transactions, but also from the standpoint of whether there
were provisions that addressed the public policy purposes of
the investments. The analysis noted that that there is a wide
range of market practice in commercial transactions when it
comes to covenants. Wellknown, seasoned investment grade
issuers generally face lighter covenants when raising funds in
normal circumstances than do less credit-worthy companies.
Covenants may also vary depending on, among other things, the
form of the investment, the context of the transaction and the
leverage of the investor. There are generally fewer covenants
in purchase agreements for equity securities as compared to
loans and other debt financing arrangements, in part because
there is a more practical remedy for a covenant violation in a
debt financing (the investor can call a default and accelerate
the debt) than in an equity investment.
The analysis summarized the covenants in the TARP
investments as follows. Whether the covenants in any particular
area, including those pertaining to dividends, executive
compensation, lending and use of proceeds, are appropriate or
adequate is a matter for the policy debate. That debate should
consider in particular whether covenants should be more
restrictive if the economics of the investments provide less
than fair value to Treasury, and whether the use of standard
forms created an inherent risk of covenants that were too
lenient for some, as discussed earlier.
(a) Dividend Restrictions and Stock Repurchases. The TARP
investments include restrictions which insure the priority of
dividends on the preferred stock that are similar to those in
the comparative transactions. This is a standard covenant in a
preferred stock transaction. They also include a covenant that
prohibits increases in the dividends on common stock, which is
not as common (none of the U.S. comparative transactions or the
Barclays transaction has such a restriction). By contrast, the
U.K. government transactions and the TARP investments in the
automotive companies prohibit all dividends on common shares.
The TARP investments also restrict repurchases of common stock,
which can be thought of as economically equivalent to a
dividend payment in terms of the interests of the preferred
stock investor. These covenants are subject to exceptions. The
covenants regarding dividends and stock repurchases are more
restrictive in the TIP/SSFI investments than in the CPP forms,
in that dividends are prohibited in AIG's case for five years
and limited to $0.01 per share per quarter for up to three
years in the case of Bank of America and Citigroup.
(b) Executive Compensation. The CPP forms contain a
covenant implementing the executive compensation provisions of
EESA but do not contain more detailed restrictions or any
reporting requirements, though Treasury has recently published
rules to require certain reports and certifications. The TIP/
SSFI investments contain slightly more restrictive executive
compensation covenants (which apply to a larger group of
executives and cover more payments) and related reporting
requirements.
(c) Lending/Foreclosure Mitigation/Use of Proceeds. Because
the TARP investments were made with public funds to achieve
certain policy objectives, one must consider whether there were
covenants directed at those policy objectives. The CPP forms
contain recitals--introductory language--that state that the
QFI ``agrees to expand the flow of credit to U.S. consumers and
businesses'' and agrees to work to ``modify the terms of
residential mortgages to strengthen the health of the U.S.
housing market.'' However, no specific covenants concerning
these issues were included in the CPP investments. There are
also no covenants in the CPP investments restricting use of the
proceeds nor any requirements to report how the funds are used.
There are no covenants requiring the issuer to take actions
with respect to the problems that may have led to the need for
the Treasury investment, such as covenants to develop a
restructuring plan (as in the U.K. transactions and the
automotive investments), to sell certain assets, to not engage
in or limit particular types of business, etc.
Except for the other matters noted below, there were
generally no other covenants or provisions in the CPP
investments that imposed restrictions on, or required changes
to, operations or business practices or that were directed at
the specific public policy objectives cited by Treasury for
making the investments. The legal report notes that the use of
standard forms meant Treasury could not include customized
covenants that required particular institutions to take
particular actions that Treasury felt were desirable to improve
strength and stability. The legal report also speculates as to
why Treasury chose not to include general covenants directed at
policy objectives, which may have been because Treasury
believed that it was more important to get large numbers of
institutions to participate in the program and such covenants
would have discouraged participation. It could also be because
Treasury wished to be a passive investor and exercise its
authority as a regulator rather than an investor (which passive
approach, as noted earlier, was also evidenced by having only
limited voting rights, not voting the warrant shares, and not
having board seats or board observers). It could also be that
Treasury believed contractual covenants cannot address the
policy objectives effectively.
The TIP/SSFI investments contain a few more restrictions.
In the case of the AIG investment, the proceeds were applied
directly to pay down loans provided by the Federal Reserve
Board of New York. In the case of the second Citigroup and
third Bank of America investments, there are no restrictions on
use of the proceeds but there are reporting requirements
concerning use of the proceeds. Citigroup also agreed to
implement the FDIC's mortgage modification program with respect
to certain assets. All three TIP/SSFI investments contain
covenants that pertain to policies on lobbying, governmental
ethics, political activity and corporate expenses. There are no
covenants on lending. Although there are no other significant
restrictions, the analysis noted that the credit agreement
between the Federal Reserve Bank of New York and AIG imposes
more restrictive covenants on AIG with respect to operation of
its business. In addition, a trust for the benefit of Treasury
holds almost 80% of the voting equity of AIG, which gives the
trust the ability to direct management.
The approach taken by Treasury can be contrasted with that
taken by the U.K. government. The U.K. banks are required to
maintain lending to the mortgage market and to small and medium
enterprises at their respective 2007 levels, although this is
subject to a caveat that appears to relieve them of any
obligation to engage in uncommercial practices. The U.K. banks
are also required to submit restructuring plans.
Treasury's approach can also be contrasted with what
Treasury did in the case of the loans to the automotive
companies, where extensive covenants restricting the companies
were included. These included prohibitions on all dividends,
restrictions on executive compensation, restrictions on
material transactions outside the ordinary course of business,
a requirement to divest corporate aircraft, reporting
requirements, and a requirement to develop a restructuring plan
meeting certain public policy objectives.
While it is more common to see restrictions of this sort in
debt financings than in preferred stock investments, one could
take the view that the use of preferred stock for the banking
institution investments was driven by the need to satisfy
capital requirements, not to realize higher equity returns, and
should not dictate the covenant package. The differences
between the covenants in the automotive loans (and AIG credit
facility) on the one hand versus the banking institution
investments on the other may have been driven more by the
overall design of the program--that is, it was a voluntary
program intended for large numbers of ``healthy'' banks, not a
rescue of a single institution, and it was for institutions
which the government already regulates.
(d) Other. The CPP forms contain a limited right of access
to information that relies on the information received by the
U.S. government in its capacity as regulator. The Non-Public
QFI forms contain restrictions on affiliate transactions.
(vi) Voting and Control Rights. All the investments provide
that the holders of the preferred stock have the right to vote
on amendments to the charter and certain material transactions
if their interests could be adversely affected. These are
customary voting rights for preferred stock, and are contained
in the four U.S. comparative transactions in which preferred
stock was issued as well as in the U.K. government investments.
In addition, the investments provide that if dividends are not
paid for six quarterly periods (in the case of the CPP) or four
quarterly periods (in the case of the TIP/SSFI investments),
the holders of preferred stock have the right to elect two
directors. This is a provision that is very frequently, but not
always, included in preferred stock investments. For example,
Mitsubishi obtained such right but Berkshire Hathaway did not,
and it was included in one of the other two U.S. comparative
transactions in which preferred stock was issued. In the U.K.
government transactions, the preference shares also obtained
additional voting rights upon a failure to pay dividends.
Treasury agreed not to exercise voting rights with respect
to any common shares acquired on exercise of the warrants. This
is a very unusual term. However, it does not apply to any
person to whom Treasury transfers the warrants (or underlying
shares) and thus does not affect resale value of the warrants
or underlying shares.
In the U.K. government transactions, the government
obtained the contractual right to designate two or three
directors. Because the U.K. government ended up acquiring 58%
and 43% of the common equity of the two banks in the open
offers, it has the practical ability to designate the entire
board of directors without the benefit of these contractual
provisions. In one of the U.S. comparative transactions the
investor acquired the right to designate a director.
The legal analysis notes that although the voting rights
obtained by Treasury in the TARP investments are customary for
preferred stock investments, the issue of what type of voting
rights, or influence over management, Treasury should have in
an investment made with taxpayer funds raises public policy
concerns that the Panel may wish to consider. Treasury may not
have sought greater contractual rights of influence because of
a view that the government should exercise influence as a
regulator but not as a shareholder.
(vii) Transfer Restrictions. Treasury did not agree to any
contractual restrictions on its ability to transfer the
preferred stock or the warrants, other than agreeing not to
transfer more than 50% of the warrants during the warrant
reduction period. There were transfer restrictions in all the
U.S. comparative transactions, including a five year
restriction in the case of the Berkshire Hathaway investment in
Goldman Sachs. Treasury also received registration rights for
public QFIs, which facilitates its ability to resell the
securities because such rights enable it to do so in a public
offering, and it can require the issuer to list the preferred
stock on a national securities exchange. Registration rights
were granted in only three of the U.S. comparative
transactions.
(viii) Representations and Warranties and Conditions to
Closing. Treasury required the issuers to make far more
extensive representations and warranties in the purchase
agreements than was the case in the Berkshire Hathaway deal or
the other U.S. comparative transactions. (Representations and
warranties assist the parties to a transaction in performing
due diligence and in allocating risk. If an inaccuracy is
discovered prior to closing, Treasury would have a right not to
purchase the securities; once the securities are purchased,
Treasury may have a claim for damages but the value of this is
limited since it would reduce the value of the issuer.) The
Treasury forms also impose conditions to closing including
receipt of legal opinions and officers certificates. Although
these are not unusual and should not be difficult to meet, they
are not always obtained by an investor and were not included in
the Goldman-Berkshire Hathaway transaction, for example.
(ix) Other. The CPP forms provide that Treasury has the
unilateral right to amend any provision of the purchase
agreement to the extent required to comply with any changes
after the signing date in federal statutes. This is a highly
unusual provision that is favorable to Treasury and could be
used, for example, to remedy deficiencies in reporting
requirements. It is also included in the TIP/SSFI investments.
APPENDIX V: LINK TO VALUATION REPORT OF DUFF & PHELPS TO THE
CONGRESSIONAL OVERSIGHT PANEL
Visit: http://COP.Senate.gov