The Treasury Department might as well be ordering unhealthy banks to pay back their bailout aid or find a buyer.

That is the unstated message in a letter regulators sent last week to banks that have yet to repay more than $17 billion outstanding under the Troubled Asset Relief Program's Capital Purchase Program,

Many of the 380 lenders that have yet repay the government — mostly small banks with business property troubles — have been counting on at least two more years to fix their problems and come up with the money.

That is because holding onto federal assistance will get dramatically more expensive in late 2013, when dividends soar on Tarp funds. The Treasury's notice to Tarp-holders that it has hired the investment bank Houlihan Lokey Capital Inc. to explore its debt-collecting options is a not-so-subtle message to banks fighting to remain independent that they may have less time than they were counting on to turn things around.

If small banks cannot retire their debt by growing profits, raising the cash from investors, or getting a federal small business loan, that pretty much leaves one option on the table: selling the franchise, a process that can take six months to a year.

Treasury intends to begin reaching out to Tarp-holders in the coming weeks to discuss their repayment options.

"It's not surprising that they want their money back," says Christopher McGratty, an analyst with Keefe, Bruyette & Woods Inc. "It's a lingering issue — there has been quite a few that have returned it. But there are still quite a few out there that have not."

A few are big, relatively healthy companies such as M&T Bank Corp. or Sterling Financial Corp. in Spokane, Wash., that can probably afford to return their Tarp, but are holding onto it as a capital cushion while they buy other banks. Most Tarp-holders are small operations struggling to attract customers and investors amid rising costs. The Treasury has the most incentives in nudging the smallest lenders to the altar because it is losing money on them. As of the end of September, the Treasury estimates taxpayers will lose $3.2 billion on aid to banks with less than $10 billion of assets, while earning $16 billion on Tarp to banks bigger than that.

That is because small banks have been the ones struggling to return their aid and cover their dividend payments. More than half the money the Treasury gave to smaller banks remains outstanding, or $8.4 billion, while it has recovered more than 95% of the money doled out to larger institutions, according to the Treasury's latest Tarp report to Congress in November.

A takeover is the option of last resort for paying back the government because the selling shareholders would have to settle for less money from shareholders.

Just two of the five banks that repaid $20 million in Tarp in October did so via mergers. Frustrations with heavy-handed regulators led Main Street Bank in Kingwood, Texas, to retire its Tarp aid and sell its operations to Houston's Green Bancorp. Main Street plans to be a niche lender that does not answer to the Federal Deposit Insurance Corp. Beach Business Bank of Manhattan Beach, Calif., meanwhile, retired a portion of its Tarp ahead of its pending sale to First PacTrust Bancorp Inc.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.