Though 13 banks have bought back preferred shares issued through the Treasury Department's capital initiative, all but one continue to haggle with the government over the price of the program's warrants.

Only two banks have completed the process of exiting the Capital Purchase Program, and the first was the privately held Centra Financial Holdings Inc. of Morgantown, W.Va.

To buy its way out of the government's $15 million investment, the $1.2 billion-asset company proposed paying a dollar for each of its 750 warrants. The Treasury insisted on the $1,000 face value, or a $750,000 payment.

"It was incredibly unfair," said Douglas Leech, Centra's chairman, president, and chief executive officer. The company's board opted to proceed with the sale rather than continue to operate under restrictions enacted by Congress in recent months, or risk dilution for other investors. "We felt that the financial penalty for staying in the program would have been exponentially greater," Leech said.

The other bank to escape the Troubled Asset Relief Program was First UBL Corp in Oakland, Ca., which repaid a $4.9 million investment and $245,000 for the warrants on April 22.

The $1.08 billion-asset Shore Bancshares Inc. of Easton, Md., is among the 11 banks that have returned Tarp capital but continues to negotiate a repurchase of the 107,000 warrants it issued to receive $25 million from the Treasury.

"What it boils down to is an onerous prepayment penalty," W. Moorhead Vermilye, Shore's president and CEO, said in an interview last week.

The big push to return Tarp capital began after Congress enacted limits on executive compensation. Many executives saw a slippery slope forming that could lead to other government interference in the way they do business.

In fact, Congress reinserted itself in this debate again this week. The Senate moved to soften language in the Emergency Economic Stabilization Act that requires the Treasury to liquidate warrants once Tarp funds are repaid. The amendment adopted Wednesday would give the Treasury more flexibility.

The Treasury may have little political choice but try to get the highest return on what has become a massive investment in the banking industry.

"It becomes a question of how much the Treasury Department is going to fight," said Chip MacDonald, a lawyer at Jones Day in Atlanta. "There is probably some middle ground, but it certainly sounds like the government is going to fight pretty hard to maximize its return."

Finding the middle ground could prove difficult given the volatility in stock prices and how they relate to the warrants' strike price.

Since buying back its preferred stock in mid-April, Shore Bancshares' common stock has seesawed from 7.7% to 21.5% below the warrants' strike price of $21.65 a share. "There is no way you can estimate a price," Vermilye said.

The Treasury also has the right to sell the warrants to outside investors through brokers, which runs the risk of diluting common shareholders.

Kelly King, BB&T Corp.'s CEO, told analysts during the Winston-Salem, N.C., company's first-quarter earnings conference call that the warrants raise the "implicit cost" of participating in Tarp above the 5% dividend paid on the preferred shares.

BB&T, which has $143.4 billion of assets, paid the Treasury about $41 million in preferred-stock dividends in the first quarter.

"You don't get out from under the potential dilution" of leaving the warrants outstanding, King warned. "You just run the math in terms of the future cost of capital of the increasing stock value versus the penalty to retire the warrants up front."

Under Tarp rules, a bank can reduce its outstanding warrants by as much as half if it raises private capital on its own by yearend. So, for instance, say a bank received $100 million in Tarp capital. It could raise that amount from private investors, repay the Treasury and see the number of warrants held by the government be cut in half. "I think there is a burning desire to do that," MacDonald said, "since people began calling Tarp a scarlet letter and as the rules continue to change."

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