WASHINGTON — The Small Business Lending Fund provided an exit path for the healthiest institutions in the Troubled Asset Relief Program, but left the latter program full of weak banks with dim repayment prospects, according to a watchdog report due out Wednesday.

The report by the special inspector general for Tarp provides the first analysis of the 137 banks that used SBLF to refinance out of Tarp's Capital Purchase Program. It found that the small business lending program culled a large number of the healthier banks from Tarp, while the remaining banks have less capital, missed dividend payments and in many cases were subject to enforcement actions from their regulators.

"Those are all banks that presumably are going to have a harder time raising capital that they need to repay their Tarp investment," Christy Romero, the special inspector general for Tarp, said in an interview Tuesday.

Romero reiterated her call for the Treasury Department and the banking regulators to implement an exit plan for the mostly small community banks left in the government program.

Of the 351 banks remaining in Tarp as of March 31, 46% were not current on their dividend payments, and about one-third had missed five or more dividends payments to Treasury, according to the report. One-third faced formal enforcement action by their federal regulator, the report said.

"It just goes to show you that the banks that are in Tarp are really relying on the funds as a capital buffer," Romero said. "Therefore, it's that much more important that Treasury and the banking regulators figure out a way to help them exit. And replacing that capital with private capital is the best way to do that."

Treasury has taken haircuts on some of its investments and recently auctioned off its preferred shares in six banks in order to facilitate repayment. But to date, the Small Business Lending Fund has been the only coordinated strategy to help banks exit Tarp, the report said.

The program was implemented in 2010 as part of the Small Business Jobs Act, and provided $30 billion to institutions with less than $10 billion of assets, including banks that wanted to use the funds to repay Tarp. In exchange, the institutions are required to increase their small business lending or ultimately pay higher dividends.

Treasury distributed approximately $4 billion in SBLF funding to 337 institutions, 137 of which were in Tarp.

"The sheer number of CPP banks that applied indicates that SBLF was a key potential exit strategy for more than half of the community banks in CPP," the report said.

Treasury denied applications from 178 Tarp applicants — 79 were ineligible because of missed dividend payments, four were rejected by their regulator, 51 were rejected by the initial review committee, 17 were rejected after review by the investment committee, and two after review by the Treasury official overseeing the program, the report said.

Romero's office has launched an audit into the refinancing of Tarp banks into SBLF, and is looking at whether Treasury and the bank regulators consistently evaluated SBLF applicants from Tarp institutions.

Only 3.7% of the Tarp banks that received SBLF funding had a Tier 1 common capital ratio under 7%, compared with 20.2% of the banks left in Tarp after SBLF.

Banks in the Midwest and Southeast also had a tougher time securing funding, the report found.

More than 50% of Tarp banks that applied for SBLF funding in the Western region, Southwest, Plains, Mid-Atlantic and Northeast received Tarp funds.

But Treasury accepted only 16 of the 71 Tarp banks in the Southeast, or 23%, that applied to SBLF, and only 33 of the 88 banks located in the Midwest, or 38%. As a result, those banks are home to the largest population of remaining banks in Tarp, according to the report.

Romero said it first appeared the discrepancy existed because these markets were hardest hit by the housing crisis, and are home to many struggling banks. But she said she is now focusing her audit — which includes interviews and in-depth reviews of decisions made by Treasury and the banking regulators — on whether and to what extent location factored into the decision making.

"I don't want to rush to judgment as to whether that's the case," she said. "I'd rather look at some real evidence before we make a decision on that."

The report also found that Tarp banks fared better under SBLF than their non-Tarp counterparts.

SIGTARP has previously reported that Tarp banks received two-thirds of the total SBLF funding distributed, or $2.7 billion.

The report found that those banks also received larger investments than non-Tarp banks — 61% of them received investments of more than $10 million, compared with 22% of non-Tarp banks — and tended to be larger in size. The average Tarp bank received an SBLF investment of $19.6 million, compared to an average investment of $6.9 million for non-Tarp banks.

Nevertheless, Treasury has hailed the program as a success, despite complaints from lawmakers and industry observers that it took too long to launch the program and only distributed a fraction of the funds.

A Treasury report released earlier this month found that SBLF banks have increased small business lending by $1.3 billion, or 37%, from the fourth quarter, and have boosted lending more than 25% over baseline levels.

"The loans the participating institutions make mark important progress toward helping to support small businesses and local economies across the nation," Don Graves, Treasury's deputy assistant secretary for small business, community development and housing policy, said in a blog post on the Treasury website April 8.

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