There is a reason Timothy Geithner, on just his second day as Treasury secretary, vowed to improve the approval process for banking companies seeking capital from the government.
The Capital Purchase Program has been under fire for months, mainly because it is impossible to tell why some firms are being rejected for investments while others get billions. Plenty of bankers have complained, but one community bank went to court.
National Bank of Commerce in Berkeley, Ill., sued the Treasury Department, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corp. after its application for the program was denied in November.
The $431 million-asset bank lost the case, and the court sealed the documents. Soon after, on Jan. 16, the bank failed.
The rejection highlights criticism that the Treasury is picking winners and losers. It may be that every investment decision to date was perfectly reasonable, but the results can seem random, because the government has not detailed its decision-making criteria. (See related
"There seems to be some kind of arbitrary decision-making that is not consistent," said Rep. Danny Davis, D-Ill., who lobbied the Treasury on behalf of the bank, which was located in his Chicago-area district. "Obviously, I don't think it is the decision that I would like to have seen, and I think there was some unfairness."
The bank argued that it had been well capitalized before the government took over Fannie Mae and Freddie Mac in September, and that its capitalization was damaged by the losses suffered after preferred shares in the two government-sponsored enterprises lost value.
The suit hinged on a provision in the Emergency Economic Stabilization Act that directed the Treasury to consider the hit community banks took on GSE preferred shares.
The same provision was used to justify the recapitalization of OneUnited, a Boston bank that House Financial Services Committee Chairman Barney Frank lobbied regulators to save.
The provision "was meant to cover banks that were heavily invested in Fannie and Freddie preferred and common stock, and as a result of government action that wiped out their preferred stock, their capital base was affected," a spokesman for the Massachusetts Democrat said. "The Fannie and Freddie issue affected small community and minority-owned institutions far more than larger institutions who had a wider capital base."
The provision requires the Treasury to consider recapitalizing banks with under $1 billion of assets that were well or adequately capitalized as of June 30 and fell below that level as a result of losses on GSE preferred shares.
The law specifies that consideration should go to banks "serving low- and moderate-income populations and other underserved communities."
Kenneth Thomas, a Community Reinvestment Act consultant, said National Bank of Commerce met those requirements.
"They had a stronger CRA rating than OneUnited did," Mr. Thomas said.
"If they would have looked at everything and put aside the minority bank aspect of OneUnited, National Bank of Commerce should have gotten the money."
Ron Glancz, a partner at Venable LLP, said it is hard to judge the merits of National Bank of Commerce's case, though suing regulators is difficult in general.
"The thing that seems unfair is where you have smaller institutions, which have this GSE stock, and they're certainly greatly impacted," he said. "That's why I think Congress passed that law, but there is discretion out of Treasury and the agencies."
He noted recent steps by the Treasury to improve the process.
"The new administration recognizes the lack of transparency at Treasury under the Bush administration, and I think they're taking some really good steps to prevent undue influence, whether it's by lobbyists or by lawmakers," he said.
"The key is to make sure it not only has the appearance of being fair, but is in fact fair and transparent."
Commerce Bancorp Inc., the Berkeley parent company of National Bank of Commerce, had tried to raise $10 million of capital through a stock offering. A private placement memorandum dated Dec. 31 said it would sell up to 1.6 million shares at $6.25 each.
But the company did warn potential investors.
"The bank is currently operating under significant restrictions on its business activities due to its critically undercapitalized status and regulatory insolvency," it said in the memorandum.
As of December 2007, National Bank of Commerce's investment in Fannie and Freddie shares was valued at roughly $98 million, or 23% of its assets. By September the value had fallen to $72 million, and after the government takeover of the GSEs, it fell to $4.5 million.
The memorandum said Commerce Bancorp would apply to the FDIC for "open bank assistance" to augment the private placement. The funds raised in the offering would be put in escrow, to be returned to investors if the FDIC rejected the idea.
The company argued that this option would be less costly to the FDIC than a sale or liquidation. The four scenarios suggested in its proposal for assistance ranged from $26.8 million to $75.2 million. All of them envisioned the FDIC buying the GSE preferred stock, in exchange for a stake in the bank.
The agency did not provide assistance, and it estimated that National Bank of Commerce's failure would cost $97.1 million.
Government officials defended their actions, saying National Bank of Commerce was eligible under the program for just $12 million, less than half of what it needed to be considered well capitalized.
"While the OCC considers recommendations on … funding proposals to be supervisory communications and therefore confidential, it should be noted that the amount of money needed to recapitalize the bank was far in excess of what was allowable" through the Capital Purchase Program, an OCC spokesman said.
The FDIC did not respond to requests for comment. The Treasury Department declined to comment.
A former official at National Bank of Commerce confirmed that it had sued the government over the rejection of its application, but would not provide any further details.
