Treasury Steps Up Efforts to Push Banks Out of Tarp

WASHINGTON — The Treasury Department is stepping up efforts to unwind its remaining commitments from the 2008 bailout.

While the government is all but rid of investments in large financial institutions that received Troubled Asset Relief Program funds, 380 small and medium-sized institutions still hold roughly $17 billion in Tarp capital.

Treasury sent a letter to those institutions this week, saying it had hired an investment advisory firm, Houlihan Lokey Capital Inc., "to explore options for the management and ultimate recovery of our remaining… investments." Even though banks have another two years before the dividend rate on Tarp funds skyrockets, the letter sent an unmistakable, albeit subtle, message: it's time to start thinking about how to repay the money.

"They're saying to the 380 remaining banks, 'We want to light a fire under you to figure out how you're going to get rid of Tarp,' because they want to wrap the program up," said V. Gerard Comizio, a partner at Paul, Hastings, Janofsky & Walker, LLP.

The move follows criticism from a special Tarp watchdog, which issued a report in October saying Treasury lacked a broad plan for weaning community banks off the program. The report noted that Treasury is contractually blocked from forcing banks to repay their funds, but encouraged it to begin engaging remaining participants about how they will stand on their own two feet.

Despite Treasury's nudges, however, it remains unclear exactly how banks are supposed to exit. Unlike large institutions, which have greater capital access, the smaller ones still in the program face a variety of different circumstances. The healthiest may have no problem buying back shares, while other still-fragile institutions may favor a more gradual unwinding of government capital — such as converting preferred shares to common stock — or no change at all. Regulators, too, are reluctant to see small banks repay government capital if it might weaken its capital position.

"The regulators are still very focused on capital, and they would be loath to have a bank prepay if they had any concerns about the capital level," said Kip Weissman, a partner with Luse, Gorman, Pomerenck & Schick. "That doesn't mean that they're not telling banks to start planning now."

While noting Treasury's contractual restrictions, the letter made clear its preference for winding down the Capital Purchase Program, the main Tarp vehicle through which Treasury invested in commercial banks.

"As you know, under the terms of the" investment agreement, "Treasury cannot require banks to repay the CPP investments, and there has been no change to these terms. In addition, any CPP repayment requires regulatory approval," Sloan Deerin, the director of the CPP, wrote in the Nov. 30 letter. "As has been our policy, however, we encourage CPP institutions that have regulatory approval to repay their Tarp investment. Replacing government capital with private capital is an important component of fully restoring financial stability."

Deerin signaled the letter was the start of an engagement process for Treasury and the remaining recipients to discuss the transition from public to private support.

"In order to continue our efforts to facilitate the government's exit from supporting the banking system, Houlihan Lokey will work with Treasury's existing asset managers, who monitor each investment in the program, to explore options," he wrote. "In the coming weeks Treasury will be contacting you and other banks in the Capital Purchase Program to discuss the options we are considering and any thoughts you may have."

In a statement Friday, Tim Massad, assistant Treasury secretary for financial stability, said, "We have already recovered an amount from banks that is greater than the TARP assistance provided, and as we continue to wind down the program, we're exploring a range of options for managing and ultimately recovering our remaining bank investments."

Attempts to get more institutions to trade in their reliance on Tarp funds come as Treasury continues to tout the program's returns. The letter cited recoveries so far of $258 billion, out of $245 billion it originally awarded through both the CPP and special bailout packages to top money-center banks. Meanwhile, banks that hold on to their investments more than five years after the initial Tarp issuances will see their dividend rate increase four percentage points to 9%.

"They'd like to declare victory, but they need to wrap up as many of these banks as possible to be able to have some meaningful final data on how much money was paid out, … and how much it actually ended up costing taxpayers at the end of the day," Comizio said.

While the letter signals some eagerness on the government's part to put the bailout to bed, the letter also signals willingness to work with institutions that are considering their options. Tarp's special inspector general, which issued the October report urging Treasury to move forward, said the letter may be a good first step.

"Treasury does need to develop a concrete, clear exit path for these smaller and medium-sized banks to exit working with the federal banking regulators. They did it for the larger banks, and the larger banks were still under the same conditions that Treasury has no right to require them to pay it back," Christy Romero, the acting head of SIGTARP, said in an interview.

"I'm not aware of the letter, but SIGTARP welcomes actions that Treasury will take to implement our recommendations. There are risks if Treasury sits back and waits for banks to come to it with a proposal to sell the taxpayers' investment at a discount, or exchange it for a lower-priority stock. …There needs to be a plan here."

Yet observers said it may be harder for Treasury to deal with their investments in community banks, compared with larger ones, because of the remaining high quantity of smaller participants.

"The program probably at this point is somewhat inefficient in terms of Treasury's ability to manage it. The biggest banks have all paid it back. But they're working with a somewhat large number of smaller banks," said Sanford Brown, a managing partner at Bracewell & Giuliani LLP in Dallas. "It's true for private equity shops that they would rather have just a few large investments than a lot of small investments. Generally speaking, each investment takes about the same amount of time to manage."

Some bankers still in the program said they expected Treasury's letter.

"They did a good job of explaining" the process, said Bob Eastman, chief executive officer of the $138 million-asset Sunset Bank in Waukesha, Wis. The holding company, Waukesha Bankshares Inc., received about $5.6 million from Tarp in June 2009, and has since paid Treasury over $600,000 in dividends. "We do have a contract with them, and they're not trying to force us to repay."

Eastman said he conveyed in a response letter to Treasury some of his own ideas for winding down the investments, including blanket regulatory approval for institutions to gradually repay their capital.

"The best way for them to get paid is to let the banks pay it back on an installment basis," Eastman said.

Romero expressed doubts about whether Treasury would try to apply pressure on institutions to repay. She noted the coming dividend increase could be enough motivation.

"The banks are already under pressure by the looming dividend rate increase, so Treasury needs to act well in advance of that to try and help them work on an exit path," she said. "Treasury may need to consider whether it renegotiates that dividend rate."

A broad plan for weaning off the smaller institutions, she added, does not necessarily mean every bank will take the same path out of the program. "Developing a clear plan for exiting Tarp doesn't mean a one-size-fits-all approach," she said. "There can be different paths that take into account, for example, if a bank is having problems. Our issue is that it not be on a case-by-case basis."

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