Two years on, it is clear the Troubled Asset Relief Program put the nation's largest financial firms on sounder footing. But for community banks the program's legacy is far more mixed.

By number, community banks were, and remain, Tarp's biggest customers; of the 622 banks that still hold Tarp funds, 73% have assets of less than $1 billion; 52% have less than $500 million.

Barbara A. RehmAn analysis by SNL Financial shows that these community banks are making less money, returning less to shareholders and have more nonperforming assets than similarly sized institutions that did not take Tarp funds.

"Tarp left the big banks in a stronger position and left the smaller banks in a weaker position, and that is an equation that is embarrassing for anyone involved," said Louis Hernandez Jr., chairman and CEO of Open Solutions and author of the book "Too Small to Fail."

"Tarp was not designed for community-based institutions," he said. "In the end it hurt them."

Of course, Tarp helped some community banks. Yet according to SNL, the average Tarp taker with assets of $100 million to $300 million lost $1.5 million in the 12 months that ended June 30, and posted a return on average equity of negative-8.19%. The average commercial bank in that asset range made a $381,000 profit and had a 3.35% return.

SNL took a detailed look as the 327 banks with assets of less than $500 million that still owe Tarp funds. More than 50%, or 170 banks, lost money in the 12 months ending June 30. And for the most part, the smaller the bank, the worse it's doing.

Banks in every state but two — Montana and Vermont — took Tarp funds. And not surprisingly, banks that are struggling are not interested in talking about the program. Phone calls to many community banks went unreturned; only three in the Washington area talked to me, or at least answered the phone.

Maryland Financial Bank in Towson has missed three dividend payments on the $1.7 million it got from Tarp. Nearly 6.5% of the $83 million-asset bank's loans are nonperforming, according to SNL. Robert R. Chafey, the bank's president and chief executive, picked up his own phone when I called. He politely declined to discuss anything having to do with Tarp.

Steve Ashman, chairman of the $260 million-asset Capital Bank in Rockville, Md., was happy to talk about Tarp. His bank, which took $4.7 million in Tarp funds in December 2008, was and remains healthy.

"The rationale for taking it was first and foremost insurance against a deeper and more prolonged downturn. We just didn't know how deep the hole was," Ashman said. "It allowed me to sleep at night during those dark days; on balance I don't regret doing it."

He noted the program's "incredible bureaucratic reporting requirements," and said Capital Bank plans to repay its Tarp funds by yearend.

Eagle Bank is a $2 billion-asset outfit in nearby Bethesda, Md., and its chairman, Ronald Paul, said its $23 million in Tarp funds have helped both sides of the ledger. Being so well capitalized has attracted large depositors and fueled phenomenal loan growth.

"We were able to capitalize on the loan opportunities that came our way," Paul said. "We were able to put the money out in loans because the big banks just turned off the spigot."

To qualify for Tarp funding, a bank had to be approved by its primary regulator, and by all accounts that screening was vigorous. Only financially healthy banks with good prospects were allowed in.

The idea was a bank would invest the Tarp capital and generate the returns needed to repay it.

Yet it hasn't worked out that way, largely because the economy hasn't recovered as expected, capital markets remain largely closed to community banks and commercial real estate hasn't yet found a bottom.

"I would say those who got it are disappointed that the economy hasn't turned around," said Alex Sanchez, president of the Florida Bankers Association. "They were hoping that the Tarp money would have jump-started them."

Banks that accepted Tarp funds also are under a closer regulatory eye.

"Anything that requires regulatory approval is jeopardized if you still have Tarp money," said Mark Olson, co-chairman of Treliant Risk Advisors. "It's a bit of a scarlet letter to have Tarp, and until you get out from under Tarp you can't do things that generate market value, like paying dividends."

A law just signed by President Obama creating a $30 billion small-business lending fund is designed to provide a way out of Tarp for community banks.

The Treasury Department still needs to write the rules, though the idea is banks could exchange their Tarp funds for money in this fund. They would be free of warrants and restrictions on things like executive pay and the more a bank lends, the more it could reduce the 5% dividend it owes the government on the capital.

Rusty Cloutier, the chief executive of MidSouth Bank in Lafayette, La., is ready to convert his $20 million of Tarp funds.

"I called my regulator and said I am willing to be the guinea pig," he said. "If I increase my small-business loans by 10% over two years, that's $800,000 to the bottom line, which allows me to be much more competitive with the big banks."

But while the small-business fund may help banks like MidSouth and Eagle, which also is leaning toward converting, it will not help the hundreds of community banks that are unprofitable.

"We think it is going to be really challenging to get approved," said Diane Casey-Landry, the chief operating officer of the American Bankers Association. "We don't anticipate a great rush, nor do we think the regulators will be pushing it."

The verdict on Tarp for community banks won't be clear until 2013, when the dividend on the capital will nearly double, to 9%. If the economy has recovered by then and community banks are generating the kind of business and returns needed to repay the government, then it'll likely be judged a success.

But at this point, more than 100 banks are behind on their dividend payments to the Treasury, and it seems clear that a program designed to stabilize the largest banks morphed into one that's become a costly burden on hundreds of community banks.

Barb Rehm is American Banker's editor at large. She welcomes feedback to her weekly column at Barbara.Rehm@SourceMedia.com.

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