Treasury Needs Tarp Exit Strategy for Small Banks, Report Says

WASHINGTON — The Treasury Department needs to develop a clear exit strategy for hundreds of community banks still stuck in the Troubled Asset Relief Program, according to a government watchdog report due out Thursday.

In contrast to the largest U.S. banks, which have repaid funds received from Tarp, 390 small and mid-sized banks remain stuck in the program. Nearly half of those banks are not paying the dividend or interest that they owe to the federal government, according to the report from the Special Inspector General for Tarp.

"Compared to larger banks, community banks may face an uphill battle to exit Tarp," the report states. "Community banks do not have the same access to capital as the larger banks. They are more exposed to distressed commercial real estate related assets and non-performing loans."

If banks remain in Tarp until late 2013 or beyond, the dividend rate that they owe the government is scheduled to rise from 5% to 9%, which could put greater pressure on their balance sheets.

In certain cases, the Treasury Department has allowed participating banks to restructure the government's investment. Such deals often result in taxpayers taking a partial loss on their investments in order to avoid absorbing a larger hit.

The Treasury Department currently evaluates these banks on a case-by-case basis, looking at factors such as the bank's capital position, the economic impact of the proposal transaction on the federal government, and guidance from the bank's primary supervisor.

But the watchdog report recommends that the Treasury Department develop criteria for determining whether and how much of a discount it will be willing to accept.

"Otherwise, you risk the exit plan for these small banks being ad hoc and inconsistent," Christy Romero, the acting special inspector general for Tarp, said in an interview.

In a letter attached to the report, Assistant Treasury Secretary Timothy Massad defended the government's case-by-case approach.

"We believe our overall approach recognizes that each bank's situation is unique, and that such approach is better suited to fulfilling our statutory responsibilities than attempting to devise standard discounts or terms for all situations," Massad wrote.

Although banks have now repaid about $185 billion out of the $205 billion spent under the main Tarp program for the banking industry, a majority of the banks that entered the program have never left, mostly because the largest banks received vastly more Tarp funds than small banks did in 2008 and 2009.

Romero contrasted the concerted push that Treasury made to allow large banks to exit Tarp with its lack of a clear plan for small banks.

"And there needs to be a big push to get these community banks out of Tarp," she said. "There is still some time for Treasury, in consultation with the federal banking regulators, to take some action."

In 2010, the Obama administration and Congress did devise a way for some of the small banks in Tarp to leave the program. The new government program, known as the Small Business Lending Fund, allowed 137 banks to leave Tarp.

In effect, these banks swapped one source of government funding for another source, which comes with different terms and conditions, and provides participating banks an incentive to increase their lending to small businesses.

But many Tarp banks were deemed ineligible for the Small Business Lending Fund, and the new program is no longer admitting participants.

That leaves 390 banks in Tarp. As of September 30, 193 Tarp banks had missed dividend or interest payments owed to the Treasury Department, according to the report released Thursday. In some cases, the banks may be missing payments because their regulators have ordered them not to pay dividends.

The report pegs the value of the payments missed by the 193 Tarp banks at $356.9 million.