Fifth in a series

A year after the Troubled Asset Relief Program came along, a growing number of community banks the government spurned are on the brink of failure.

Consider Irwin Financial Corp., which has been lobbying unsuccessfully since spring for the Treasury Department to create a Tarp-for-strugglers option.

The $3.3 billion-asset company reported Wednesday that it has a regulatory order requiring its bank unit to boost capital dramatically and shed a third of its brokered deposits by the end of the month.

Irwin conceded that it has "no realistic prospect" of satisfying the order.

Though Jamie Dimon, JPMorgan Chase & Co.'s chief executive, famously compared having Tarp funds to wearing a scarlet letter, observers said companies unable to get government capital are the ones truly being scorned.

They cannot get capital elsewhere and, like Irwin, more are running out of options to save themselves.

"Intended or not, the Treasury identified who it sees as the long-term winners with Tarp. If you applied and didn't get it, you are not viewed as a long-term survivor," said Timothy Koch, professor of finance at the University of South Carolina and president of the Graduate School of Banking at the University of Colorado. "The regulators are really putting them behind the eight ball. They have to struggle to survive. At best, they might muddle their way through this."

Some question the strategy of allowing banks to fail, if Tarp would make them viable.

"They have deemed giving Tarp to struggling community banks as open-bank assistance, something they won't do," said Rob Klingler, an associate in the Atlanta office of the law firm Bryan Cave LLP. "But we learn something in each crisis, and this might be the take-away from this one. We need to look at alternatives other than closing the bank. The regulators have made a mistake in some situations in closing the banks rather than making an investment in them."

Bob Olson, the president of St. Stephen State Bank in Minnesota, is particularly miffed.

Late last year, the $25 million-asset St. Stephen applied for $860,000 in Tarp funds. Regulators have been encouraging Olson to withdraw the application for months, but he refuses.

He complained that the process is unfair to community banks, which are being held to a higher standard than the largest banks in the country. Small banks must submit to being judged for their worthiness, while the large banks, strong and weak alike, were forced to take Tarp.

Olson also argued that in not granting Tarp to strugglers, the Treasury has missed an opportunity to bolster the economy.

"Had we received Tarp, we would not have had to shrink the bank, and we would be in a position where we could make new loans," Olson said. "All the money went to the top. But we all know that community banks fuel the economy. I think the net effect of this is that our business communities are suffering."

The privately held St. Stephen has a cease-and-desist order requiring a leverage ratio of 8% and a total risk-based capital ratio of 11%. At the end of the second quarter, those ratios were 4.07% and 6.35%, respectively, leaving the bank undercapitalized.

In addition to shrinking, Olson said he is "passing the hat" around to investors to raise capital. He declined to comment on the bank's chances for survival, but said "the lack of Tarp significantly affects the survivabilty of many, many community banks."

Despite his bank's troubled condition — 7% of its loans are noncurrent — Olson is not backing down. His hope is that there might be a policy change.

"I have asked, 'If we do withdraw our application and then there is a policy change, would we be able to reapply?' and I can't get a clear answer on that," Olson said. "For that reason alone, it seems silly to withdraw."

Irwin's approach has been decidedly more creative. In May the Columbus, Ind., company asked the Treasury to create a program that would allow those with capital commitments from private investors to qualify for Tarp funding, if they would be viable after the infusion. To qualify for Tarp now, a company must be viable without any government capital.

But any Tarp-for-strugglers program seems increasingly unlikely, said Mike Stevens, the senior vice president for regulatory policy for the Conference of State Bank Supervisors. "You hear things every now and then about it, but I haven't seen any real traction. The momentum is not there," Stevens said. "I question if the interest is there either — at least on the side of the federal government."

Neither Irwin nor the Treasury returned calls for comment.

Ross Demmerle, an analyst at J.J.B. Hilliard, W.L. Lyons Inc., said he does not see how Irwin can clear the hurdles that regulators have put in its way. Among other things, Irwin's bank unit must revise its second-quarter results, which is likely to leave it undercapitalized and ineligible to hold public money. That would force it to give up municipal deposits, a key source of its liquidity.

"The orders are basically creating a liquidity crisis for the bank," Demmerle said. "The government is making a run on the bank." He called the order "an ultimatum" that Irwin cannot satisfy. "I don't expect them to be around much longer based on this."

Stephen Geyen, an analyst at Stifel, Nicolaus & Co. Inc., wrote in a research note that Irwin also is unlikely to boost its capital ratios as required. "Barring the arrival of a white knight, we view the prospect for a capital raise in the required time as quite remote."

In recent months many undercapitalized companies that had applied for Tarp gave up, including the $2.4 billion-asset Cascade Bancorp Inc. in Bend, Ore. Others have not publicly reported the status of their Tarp applications, among them the $18 billion-asset, privately held FBOP Corp. in Oak Park, Ill.

Eliot Stark, a managing director at the investment bank Capital Insight Partners Inc., said he expects that nearly all struggling banks have tried to get Tarp. "If you look at the banks with low capital ratios and some type of regulatory problem, you can pretty much assume they applied for Tarp and didn't get it," he said. "A small number may have not applied for a philosophical reason, but if you are really desperate and have no access to any other capital, why wouldn't you go after it?"

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