Several banks rushed to repay investments under the Troubled Asset Relief Program in December, but hundreds head into the new year desperate for an exit strategy, even if it means selling.

Most of the latter are smaller in size and, in a bit of a twist, owe less than those that have already repaid Tarp funds. But the credit quality of their assets continues to deteriorate, and many cannot pay the dividends owed on the funds, making it nearly impossible to raise the capital to buy back the preferred shares. For those banks, options are few.

"A lot of these little banks that took Tarp are stuck," said Matthew Kelley, an analyst at Sterne, Agee & Leach Inc. "There just is not an ability for them to go out and raise the types of equity to repay and to achieve the capital ratios that have been outlined by regulators."

As a group, banks that left Tarp in 2009 had more assets, higher capital ratios, a lower percentage of nonperforming assets and higher-paid executives, said Linus Wilson, a finance professor at the University of Louisiana at Lafayette who has researched the program.

While banks that have left Tarp received an average investment of about $1.25 billion, those that remain have an average investment of $61.6 million, Wilson said. Most remaining participants received investments of less than $10 million. They are also more likely to fall behind on their dividend payments to the Treasury Department.

Lingering problems are likely to force many banks to sell in 2011. "I think you're going to see more sales of some of the distressed institutions that do have Tarp," Kelley said.

Even the larger participants must balance the need to repay Tarp with the potential shareholder dilution that would result from raising capital, industry observers said.

Several, including Marshall & Ilsley Corp. in Milwaukee, Whitney Holding Corp. in New Orleans and Wilmington Trust Corp. in Delaware, elected to sell themselves last year, leaving acquirers to pay back the Treasury.

Others have preserved shareholder value by paying off their investments little by little with retained earnings.

Webster Financial Corp. in Waterbury, Conn., used accumulated earnings to repay half of its outstanding Tarp in two payments before raising capital in December to pay off the balance.

Stephen Moss, an analyst at Janney Montgomery Scott, said some small banks may pursue private placements or common equity offerings with retail support from regional investment banks.

"It's really on a case-by-case basis," Moss said. "I'm sure everyone wants to get out of Tarp here, so it's a mix of running the numbers, how much earnings can you retain to get out of Tarp, and how long will it take, obviously."

Wilson said he expects hundreds of banks to exit by refinancing into the Small Business Lending Fund, a $30 billion fund signed into law in September as part of the Small Business Jobs Act. Under the program, banks with assets of less than $10 billion can apply for capital with an initial 5% dividend payment, which could drop to as low as 1% for a few years as banks increase lending. Under Tarp, banks pay a 5% dividend, which will increase to 9% in 2013.

Although the shift from Tarp may arrest the surge in missed dividends or interest payments, Wilson said the government is making large concessions to small banks. He estimated that up to 580 Tarp recipients could migrate to the Small Business Lending Fund, which could cost the government $2.5 billion.

"This improves the Tarp statistics, but it means taxpayers get less money from their investments," Wilson said.

For companies with few options, waiting it out may be the best choice, said Mark Fitzgibbon, an analyst at Sandler O'Neill & Partners LP. "I think the people that can raise capital probably will, and the people that can't will look for other ways to deal with it or just let the Tarp rot as long as they can," he said.

Especially for companies that are performing well but whose stock prices are depressed, Fitzgibbon said it may make sense to keep the Tarp funds on the books, keep paying the dividend and wait until the price better reflects the company's earnings power.

It's not only small banks that are growing weary of Tarp.

Moss said the remaining regional banks and big community banks that haven't left the program will start to feel pressure, especially since several large participants recently repaid their investments.

Huntington Bancshares Inc. in Columbus, Ohio; First Horizon National Corp. in Memphis, Tenn.; Susquehanna Bancshares Inc. in Lititz, Pa.; and Wintrust Financial Corp. in Lake Forest, Ill. — which collectively held more than $2 billion in outstanding Tarp funds — all redeemed their shares from the Treasury in the closing weeks of 2010.

"Any large name at this point, I think they have to start feeling some pressure, because now they're the last remaining ones," Moss said. "There's definitely an overhang on your stock, it definitely is a factor in valuation, and I think that's something that management is going to have to deal with, even if they don't want to dilute shareholders."

For small banks, even the healthy ones, keeping up with dividends is often a problem. In total, 135 companies have missed at least one dividend payment, and 123 missed the latest quarterly payment, Nov. 15, according to data from SNL Financial in Charlottesville, Va.

Jeffrey Hare, a lawyer at DLA Piper in Washington, said he works with many clients with outstanding Tarp funds who feel they are in a position to pay the dividends but are unable to get regulatory approval.

"The regulators in some instances are taking a pretty strict view on not permitting dividend payments, even though it has some negative outcomes for the institution," Hare said.

The stigma of having unpaid dividends can make it that much more difficult to persuade an investor to participate in a capital raise, Hare said.

Chip MacDonald, a lawyer at Jones Day in Atlanta, said he expects the Treasury to be more flexible about recapitalizations of Tarp-holders. The agency worked with several companies in 2010, including Sterling Financial in Spokane, Wash., and Hampton Roads Bankshares in Norfolk, Va., on deals to swap preferred shares for common stock at a discount to attract investors.

MacDonald said it will be more urgent for companies to set Tarp-redemption strategies, especially as the threat of a higher dividend payment looms.

"The closer we get to 2013, the more people are going to be thinking about what they've got to do to replace Tarp, because it's going to get much more expensive," MacDonald said.

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