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| Why Some Good Banks Won't Take TARP Money |  
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February 3, 2009 - TARP stands for Troubled Asset Relief Program. You may have heard about it, how $194.2 billion has already been given out by the agency to 317 institutions in 43 states and Puerto Rico. The Treasury is in charge and estimates that 25% of about 8000 banks may apply for funds. But not all of them will take it. What should investors think about a bank they own that qualifies but doesn't take the money?The first thought should be that the bank is probably healthy. The Treasury isn't interested in saving banks that are too far gone, underwater in bad loans with capital bleeding daily. That's not the purpose of the program. It's funds are to be invested, get a 5% return for 5 years, then 8% thereafter. No investor wants to own a failing business, bank or otherwise. Especially not the Treasury department which is already under fire for investing the first round of capital without restrictions or accountability.
It's that area of accountability, restrictions and terms of the contract that are making new banks hesitant to sign on the dotted line, in particular healthy banks that have a thriving business (yes, there are many of those). The accountability is really no problem. Any good bank will want to take the funds and deploy them in a profitable way. But here's the catch: one of the terms of the contract says that the funds shall be deployed into investments that are deemed safe for the bank. Safe will be defined by the Treasury, and it will hold management personally accountable for those investments. Sounds fair, right?
Well further reading of the TARP contract says that the Treasury has the right to change any terms of the contracts at any time. It may decide to up the interest rate on the preferred stock or require more warrants or options on the stock. Unilaterally, it may decide that what was once considered a safe investment is no longer one. While it seems logical that making mortgages is a sound investment given the right lending parameters, in the future, it may not be considered a safe investment because a new administration is in place or some new bureaucracy takes over. Then the bank and its management are in for considerable stress.
Another provision: no dividends can be initiated while the bank has TARP money. So for a bank that has successfully grown and paid a higher dividend every year, one that investors have come to expect, that practice is over. Most likely those investors will sell the stock and go elsewhere for dividend growth. That will hurt the stock price, something no management wants. If a healthy bank has never paid a dividend and wants to, it can't once it has TARP funds.
Another restriction: compensation for the CEO and other senior management, both in salary and bonuses. Very few CEO's are comfortable with the idea that they will not be rewarded for outstanding performance in the most difficult economic environment since the depression. If a current compensation program is considered too generous, it has to be renegotiated to a level acceptable to TARP. The decision to take TARP funds lies with the board of directors, not the management of the bank.
One more: no acquisitions. Healthy banks always look to add to their deposit base or their geographic reach. If TARP money is taken, then these banks, and any others looking to buy weaker banks or well-positioned banks, won't be able to. If acquisitions are part of a well-designed growth plan, the TARP funds would stop it cold.
With all these restrictions, does it mean that a bank that decides to use TARP funds is weak? Not at all. There are great opportunities in this market for smart investors. By having additional capital to grow and make extraordinary profits in these troubled times is the main reason a bank will take the money. But if those investments which are now considered appropriate go on the inappropriate list, management will be very troubled. Remember, the contract is one sided. At any time any part of the contract can be changed. By a government bureaucrat. Wouldn't that scare anybody?
There is a new development occurring with TARP money, one not originally thought of when the program was devised. Banks are refusing the money to show that they are strong enough without it. A PR move, if you will. They apply for it, get approval, then announce they won't take it. Not all banks will make an announcement out of it, but some will. Again, it shows that they could have it if they want it, but they don't need it. That should give investors some comfort.
Banks that qualify for TARP have a tough decision to make. If they take it, things could work out extremely well, profits could jump, if management is adept and invests wisely. On the other hand, they could take the money, adversely change their dividend policy or not initiate any because of restrictions, pay the 5% interest rate, and make bad investments, lose the money, then have the government come in and change the contract, putting them out of business.
If you don't think that can happen, here's a recent example of how the banks got hurt by regulators. Banks were encouraged by the regulators to buy FNMA and Freddie Mac preferred stocks. It was considered a safe investment because the two companies were GSE's (government sponsored enterprises). Regulators liked to see these investments on the books. Then the government decided to let the two companies go out of business. The banks were the main holders of these preferred issues and took large hits to capital. It's this kind of government "help" that makes bankers skittish about the TARP money. - Ted Allrich |
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