Congratulations! You’re an Investment Banker!

Now what? 

Well, I suggest you start looking at the terms and conditions of our new portfolio and clients.  Right now, it’s $250 billion that you and I share with all the other U.S. Tax Payers.  So far, about $125 billion dollars has been divvied up among the major banks. In return for that investment, we get preferred stocks and warrants for common stock.   There are some sweeteners for us and a few for them.  This is the first of the plans that are supposed to ‘inject’ money into banks and ‘unfreeze’ the credit markets.  The release of similar plans by the Europeans on Monday gave us that huge bounce on Monday.  (Remember the one I thought could be a dead cat bounce and possibly is?)

The European plan also provided the structure for the terms of this deal as well as the impetus to move on it.

So, what goodies do our financial intermediaries get from the deal?

1)  The US will guarantee new debt issued by banks for three years. This means any bank that lends to another doesn’t have worry about getting it back.  That also means that they don’t have to hold a large amount in reserve for potential loan losses so it should expand consumer lending.

2)  The Fed will become the buyer of last resort for commercial paper.  This means if a bank is lending to a business in the short run to help it with its working capital needs for things like buying inventory or bridge loans to cover day-to-day business expenses, and the business defaults, the Fed will buy the commercial paper from the bank.  The bank will not suffer the loss.  This is again decreases default risk and means the banks don’t have to worry about upping their reserves for potential loan loses or holding back loans to businesses that may have less than stellar ratings.  A good example of businesses with less than stellar ratings are Ford, GM, and a lot of the airline companies.

3) The FDIC will offer an unlimited guarantee on bank deposits that are not interest bearing.  Since several European banks did this, this is a response to stop the possible flow of business checking accounts and payroll accounts to foreign banks.  There may be some consumer accounts, campaign, or non-profit checking accounts that get protection here also but it is primarily geared to businesses.

What do we get?

1) Bank Equity:  The government will get preferred shares and warrants for common stock with an expectation of a ‘reasonable’ return.   This means that the government gets first shot at any profits and dividends earned by the bank holding company.  No dividends can be given to common stock holders without first paying preferred stock holders.  Preferred stock also has priority in terms of ownership of any assets liquidated in a bankruptcy.  Most preferred stock does not come with voting rights.  A warrant is a security that allows the holder to purchase a share of common stock in that bank holding company at a specified price.  This price is usually higher than the current market price of the common stock. Some warrants stay attached to the preferred stock and basically serve to increase the yield on that stock.  Others can be detached and sold on the side.

The preferred stock that will be issued in this plan will pay special dividends.  At first, it will be at a 5% interest rate that will increase to 9% after five years.  The warrants will be worth 15% of the face value of the preferred stock. (The basic reason for the warrants is that if the stock goes up, the government can exercise the warrant, get the stock from the bank holding company, sell it on the market, and realize a profit.  These profits then go to the Treasury to pay down the Federal Deficit and offset the cost of the program.)

2)  Restrictions on Executive compensation for those institutions that sell shares to the government.  These restrictions include a clawback provision and a ban on golden parachutes as long as the Treasury holds equity issued under this program.

Clawback provisions are written in a way that the government can recover performance-based compensations to CEOs and other executives in the bank to the extent they later determine that performance goals were not actually achieved.  You have to write the specifics into the contract but usually it can be due to a restatement of financial results as well as some other reasons.  The restatement of the financial results usually has to be significant.  It can also kick in if there are determined to be some kind of misconduct. 

Gold parachutes are guaranteed severance compensation packages that  will executives receive if control of a company changes hands that results in a management shift.

Who do we own to date:

$25 billion:  Citigroup, JPMorgan Chase, Bank of America (parent now of Merrill Lynch), Wells Fargo (parent now of Wachovia)

$10 billion: Goldman Sachs, Morgan Stanley

Others with less than that:  Bank of New York, State Street and thousands of yet unannounced little guys.

Other issues:  At this time, the banks will not be asked to eliminate dividends.  CEOs are not required to resign.  All of the banks signed the agreement and entered into the deal so there would not be any stigma based on who needed the program and who did not.  We’ve basically just semi-nationalized the banking system in the U.S. 

Okay, so now we’re all investment bankers.  What I want to know is when do we get our bonus checks?