WASHINGTON — The Treasury Department's recent auction of preferred shares in six banks may signal that the agency has finally found a path to end its bank investments under the Troubled Asset Relief Program.

Although the largest institutions have long repaid Treasury's investments during the financial crisis, 348 — mostly small — institutions still owe Treasury $12 billion, and it's been unclear how the agency plans to recoup its money.

Observers were heartened by Treasury's decision last month to auction off its stake in six banks, saying that even though Treasury took a loss, it was far outweighed by the benefits.

"It's a win-win situation," said Kip Weissman, a partner with the law firm Luse, Gorman, Pomerenk & Schick. "Obviously for the banks, but it's a win for Treasury and it's a win for the administration, because they're getting out of Tarp, which the public doesn't like, and they're also adding ammunition to say that Tarp was successful, because it's all incremental profit now."

"Every nickel they get at this point out of this profitable program is just more good press for them," Weissman said.

Treasury auctioned its preferred shares in the $4 billion-asset Banner Corp. (BANR) of Walla Walla, Wash.; the $3.1 billion-asset First Financial Holdings Inc. (FFCH) of Charleston, S.C.; the $2.7 billion-asset MainSource Financial Group Inc. (MSFG) of Greensburg, Ind.; the $2.1 billion-asset Seacoast Banking Corporation of Florida (SBCF) in Stuart, Fla.; the $2.7 billion-asset Wilshire Bancorp Inc. (WIBC) in Los Angeles; and the $4.3 billion-asset WSFS Financial Corp. (WSFS) in Wilmington, Del.

"Today's auction is part of our ongoing efforts to wind down TARP," Tim Massad, Treasury's assistant secretary for financial stability, said in a March 29 press release. "TARP's bank programs succeeded in stabilizing our financial sector and have already earned a significant profit for the taxpayer."

Treasury lost about $50 million in its first auction of preferred shares, recouping just $362 million of the $411 million it originally invested in the six banks. But Treasury noted that the total income on the investments, including dividends and interest, was $426.4 million, represented a net profit of about $15.6 million. And overall, it has recovered approximately $260 billion from its bank programs under Tarp — due to repayments, interest and dividends — compared to the $245 billion initially invested.

"I think one of the things you've got to remember — and if you look at our cost estimates it's apparent — the taxpayers have made money on this program overall," said a Treasury official, who spoke on condition of anonymity. "But with respect to the small banks that remain in the portfolio, we have expected to see some costs."

If anyone wants to see Tarp unwound as much as the banks, it's the Treasury Department, observers agreed.

Although most expect the loss rates would increase if the auctions were expanded to other weaker banks, it may be worth it to the administration to wrap up most, if not all, of their investments before the November election, said Jaret Seiberg, a political analyst with Guggenheim Research LLC.

"They can take a lot of loss on the remaining stuff and still have a profitable program just because of the numbers," he said.

Seiberg said it's also a good deal for taxpayers by getting them out of an underwater investment.

"The point of Tarp was never to make money, it was to stabilize the financial system, and Tarp clearly worked," Seiberg said. "And if you look at the dividends paid plus the recovery on the auction of the stock, I suspect that they were pretty much break-even, and I think that's a huge win for the program."

It's still unclear the extent to which Treasury will use the auctions to sell off its investments in the future. The experiment was one of several options proposed by investment advisory firm Houlihan Lokey Capital Inc., which Treasury hired last November to consider alternatives for recovering its remaining Tarp investments.

"We haven't drawn any conclusions yet about that," the Treasury official said. "We're continuing to review the range of options we have to continue to wind down the program."

Treasury's mandate now is to exit the program in a way that maximizes recoveries to taxpayers while continuing to promote financial responsibility, the official said.

"The auction was really a test in that regard because we said, 'How can we help the small bank sector while still exiting and meeting our objectives,'" he said.

But that may not be enough to satisfy the program's critics, including Christy Romero, the special inspector general for Tarp. Romero's office has been calling on Treasury to come up with an exit plan, in conjunction with regulators, for the small banks that remain in Tarp.

"I can't tell if this auction is part of a plan," Romero said. "Treasury needs to come out with a plan, and the plan can have multiple paths depending on the state of the bank, but I'm still seeing no concrete exit plan for these community banks."

In the meantime, industry lawyers and analysts said they expect to see more auctions and more interest from investors.

"There is a market for these," said Matthew Schultheis, a senior analyst with Boenning & Scattergood Inc., "and the more successful the banks are, the greater likelihood Treasury will be able to auction them successfully."

Weissman agreed, saying private equity investors will be looking for investments in decent companies that will be able to redeem the preferred shares quickly, which could provide a higher return.

"You're going to see more of this," Weissman said. "When you buy the paper that's going to be refinanced soon well below par, you can make a ton quickly. So investors, hedge funds, will start to get excited about this."

Investors who purchase the preferred shares won't inherit any controlling interest in the company, but they will be entitled to the same 5% dividend payments previously paid to the Treasury Department.

Schultheis said some investors would prefer to receive the dividends, or even to see the rate increase to 9% on the program's fifth anniversary next year. That makes the 163 banks who've missed dividend payments that much less attractive to investors.

"When they start to get into the guys who have deferred (dividend payments), I think it's going to be much more difficult to accommodate this without a very steep discount, to the point where Treasury may just want to hold onto them anyway," Schulteis said.

Indeed, the auctions are just one option the agency could pursue, including waiting for a bank to buy back its own shares.

Over the past couple years, Treasury has also taken haircuts on investments in a number of struggling banks seeking to recapitalize or sell themselves, a strategy that is likely to continue.

There are still situations where Treasury will expect certain banks to repay, according to the Treasury official, and certain situations where a bank cannot. When there is a restructuring proposal, Treasury will entertain it, as long as it provides adequate value to taxpayers, the official said.

Chip MacDonald, a partner with the Jones Day law firm in Atlanta, said Treasury may also consider auctions of larger pools of Tarp securities, perhaps with a mix of healthy and weak banks, as well as banks located in different regions with different credit risks.

"I think there are going to be one or two more auctions, but at some point you get down to smaller, less liquid names, with smaller amounts of Tarp," MacDonald said. "There's greater risk to an investor in buying a single name in an auction than there is in buying a pool."

But he said Treasury's actions make it more important for banks to be proactive and find their own way out of Tarp, rather than leaving their fate in the hands of Treasury and private investors, MacDonald said.

"I think banks need to be planning for self-help and finding alternatives to being put in a Treasury pool or a Treasury auction," MacDonald said. "They need to be proactive in finding alternatives that suit their own needs better than might be available based on the transaction timing and structure and the interest of vulture investors."

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