Failure of Tarp Banks Remains Industry Concern

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As the Treasury Department winds down the Troubled Asset Relief Program, some banks will exit on their own, some by auction and others by burning out.

Regulators shuttered two banks with Tarp money last week. The holding company for the $201 million-asset Excel Bank had $4 million in subordinated debt from Tarp, and the $159 million-asset GulfSouth Private Bank had $7.5 million in preferred stock.

Of the more than 700 banks that received Tarp, about 20 have failed since the onset of the financial crisis. Six of those banks have failed this year, with the Tarp investments ranging from $900,000 to the parent of Glasgow Savings Bank to $30 million at the holding company of Tennessee Commerce Bank.

The failures serve as a good reminder that, while Tarp was a buffer for many, it certainly wasn't a panacea, banking lawyers say.

"There are plenty of banks that could have survived had they received Tarp, but then there are some who got it, but tanked despite how viable they looked at the time," says Lawrence Kaplan, a partner at Paul Hastings.

"Tarp has not been a vaccination against failure," Kaplan says. "Some Tarp banks got sick and [the Treasury investment] didn't give the regulators any pause."

The number of Tarp failures is relatively low because community banks had to pass a viability test before receiving the infusion. After the initial rounds of investments in late 2008, smaller banks had to prove to the Treasury that they could survive without Tarp capital in order to qualify for the funding.

Conditions change. As the economy continued to sputter, the capital cushion has thinned for many Tarp recipients. As a result, more banks with Treasury funds are likely to fail. Thirty of the 185 banks that are considered to be at high risk for failure have Tarp funds, according to second-quarter data from Trepp.

The iBank Monitor, another firm that tracks banking data, has 15 banks with Tarp investments of $306.7 million on its "critical list." Another 102 are on its watch list.

It's unclear if the troubled banks are among those that the government plans to auction in pools. In June, the Treasury sent a letter to 200 of the roughly 300 banks left in Tarp telling them it was considering pooled auctions as part of a broader strategy to exit the program. The Treasury has also sold stakes in individual banks through auctions this year, including stakes in 11 banks in an auction that took place on Wednesday and brought in $70.7 million in proceeds.

Kaplan says it is unlikely that the Treasury would add stakes in the most-troubled banks to its pooled auctions. Even if they do, investors can look for the banks that have deferred dividend payments to sort out any struggling banks.

Investors may not be fazed if struggling banks are included in upcoming auctions, but it could influence pricing, says Frank Bonaventure Jr., a partner at Ober, Kaler, Grimes & Shriver.

"Bidders can take into account the financial condition of the banks in the pool and, if there are those who are likely to fail in there, it is going to be reflected in their bid," Bonaventure says. "To me, it is going to be a mechanism of price more than anything."

The Treasury doesn't comment on individual banks, but it appears that the agency is not worried that a couple of failures, or the demise of other Tarp recipients, will deter potential bidders.

"We've seen strong results in our auctions — including the one Treasury conducted this week," Timothy G. Massad, the Treasury's assistant secretary for financial stability, wrote in an email. "They're one part of our overall strategy to help community banks replace temporary government support with private capital as we wind down Tarp."

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