The Treasury Department appears increasingly willing to accept bigger haircuts in future bank stock auctions.
During its latest auction of preferred stock and subordinated debt tied to the Troubled Asset Relief Program, the agency accepted a 60% discount on the shares of five banks, taking its biggest hit to date. Big discounts will likely be the norm in future auctions, industry observers say.
Treasury "is clearly getting down to more of the problem banks," says Robert Fleetwood, a partner at Barack Ferrazzano Kirschbaum & Nagelberg. "I don't see discounts as terribly negative. They'll continue to try to exit the program as quickly as they can."
The government and most remaining Tarp banks are eager to end the program. The Treasury has held 19 auctions since March 2012, and several banks have voluntarily exited Tarp to avoid a fast-approaching dividend hike.
In a July 25 auction, Treasury recouped 39% of the $325 million it invested in First Banks in Clayton, Mo.; First Intercontinental Bank (FIEB) in Doraville, Ga.; Community Pride Bank in Isanti, Minn.; Universal Bancorp in Bloomfield, Ind.; and Virginia Company Bank (VGNA) in Newport News. The previous 18 auctions had an average discount of 14%, according to SNL Financial.
The Treasury failed to sell about 11,800 preferred shares in the $6.4 billion-asset First Banks.
The Treasury has yet to report a steady drop in pricing, though industry experts say several factors could force deep discounts. Generally, remaining Tarp banks are less attractive, or have greater performance challenges, compared to banks included in earlier auctions.
Some Tarp banks have "limped along for a number of years," says Kevin Petrasic, a partner in the corporate department at Paul Hastings. "So investors might not have the patience to see their true return," especially when other investment opportunities exist.
Treasury officials declined to discuss the pricing of future auctions. A source familiar with Tarp who asked to be unnamed told American Banker that discounts should be expected because future auctions will likely feature banks that are behind on paying Tarp dividends.
Tarp has so far resulted in a net gain for taxpayers, with pricing holding up better than expected, says Timothy Massad, Treasury's assistant secretary for financial stability.
Pricing and profitability remove some pressure to push for higher prices and could influence decision-making as Treasury weighs bigger returns against a desire to exit Tarp, industry experts say. Since many remaining stakes are small, "whether you get 90% vs. 60% doesn't move the needle too much," Fleetwood says.
Previously, Tarp banks could avoid having shares sold in pooled auctions by bringing Treasury a designated bidder. Those bidders helped establish baseline prices, says Jason Zgliniec, a partner at Schiff Hardin. Treasury has eliminated that practice, which could lead to lower prices, he says.
Several factors could keep discounts in check, industry experts say. The economy has improved, banks have worked through many of their past credit issues, and bank failures are declining. Those factors could explain why Treasury continues to auction shares in individual banks, as opposed to holding more pooled auctions.
"Because we have done a number of auctions, we have now built up a process with strong participation," Massad says. "Originally, we had concerns about conducting single bank auctions for the smaller positions, but we have been able to successfully auction those positions."
Credit quality at the current Tarp banks can vary widely, Massad says.
Diverse credit profiles could explain the varied pricing of previous auctions, including slight premiums during the June 6 and July 3 sessions. In addition, several smaller, healthier, banks remain in Tarp simply because they have more limited access to the capital markets, industry experts say.
"Community banks were persuaded and sometimes pressured by regulators to take Tarp and are really now caught in a vise grip," says John Berlau, senior fellow for finance and access to capital at the Competitive Enterprise Institute. "They may [lack] the means to pay back Tarp and, in the meantime, the restrictions that come with Tarp are putting a crimp on their ability to grow."
Regardless of pricing concerns, some bankers are eager to avoid auctions. The auctions include some reputational risk, and the process can introduce unknown investors to the auctioned banks. Treasury's inability to sell shares, or a willingness to accept steep discounts, "is not a ringing endorsement," Petrasic says.
Some Tarp investors are unwilling to work with banks unless they are paid in full, including late dividends, says Kenneth Lehman, a Virginia investor who recently agreed to cancel his Tarp shares in Delmar Bancorp in Maryland. Lehman also waived $600,000 in unpaid dividends and agreed to invest $6 million for 40% of Delmar's common stock.
Enterprise Financial Services (EFSC) in St. Louis, Mo., wanted to avoid the uncertainty of an auction, says Stephen Marsh, chairman of the $3.1 billion-asset company's bank. Enterprise, which received $35 million in December 2008, also felt a responsibility to fully repay taxpayers since Tarp helped it during the financial crisis, he says. Enterprise repurchased its Tarp shares in November; it bought back its warrants earlier this year.
"It was an efficient source of capital at a time when the credit markets were risky," Marsh says. "It worked effectively for us and our shareholders and we wanted a good return for the government."
Paul Davis contributed to this article.