Daniel Gross

Banks Pay Back TARP Funds by. . .Borrowing From Treasury

Most of the big banks have repaid the government funds they received under the Capital Purchase Program (CPP), the pillar of TARP under which Treasury bought preferred shares in the nation's banks. Enough so that, combined with dividends and sales of warrants, Treasury has declared that taxpayers have earned a profit on the CPP. Thus far, $245 billion has gone out, and $255 billion in repayments, interest and warrants has come back, yielding a profit to taxpayers of $10 billion. And there's several billion more where that came from.

Many of the small banks that took relatively small chunks of capital have been slower to exit. Last week, however, there was a mini stampede. The transactions are reported here. Eight banks paid back their funds on July 14. They were:

  • Eagle Bancorp of Bethesda, MD: $23.235 million
  • First California Financial, Westlake Village, CA: $25 million
  • Cache Valley Bank, Logan, UT: $4.77 million, plus $263,000 to buy back preferred shares granted to Treasury in lieu of warrants
  • Security Business Bancorp, San Diego, CA: $5.8 million, plus $290,000 to buy back preferred shares granted to Treasury in lieu of warrants
  • BOH Holdings of Houston, Houston, TX: $10 million, plus $500,000 to buy back preferred shares granted to Treasury in lieu of warrants
  • BancIndependent, Sheffield, AL: $21.1 million, plus $1.055 million to buy back preferred shares granted to Treasury in lieu of warrants
  • York Traditions Bank, York, PA: $4.871 million, plus $244,000 to buy back preferred shares granted to Treasury in lieu of warrants
  • Centric Financial, Harrisburg, PA: $6.056 million, plus $182,000 to buy back preferred shares granted to Treasury in lieu of warrants

That adds up to a total of $103.3 million.

But sometimes there's less than meets the eye. Generally, banks that repaid CPP funds did so with cash raised from earnings, or by raising new outside capital. In finance and banking you always have to read the fine print. And if you go back to the report, you'll notice that the fine print accompanying the entries for each of the above exits makes reference either to Footnote 49 or Footnote 50. Footnote 49 reads: "Repayment pursuant to Title VII, Section 7001(g) of the American Recovery and Reinvestment Act of 2009 using proceeds received in connection with the institution's participation in the Small Business Lending Fund." Footnote 50 reads: "Repayment pursuant to Title VII, Section 7001(g) of the American Recovery and Reinvestment Act of 2009 — part of the repayment amount obtained from proceeds received in connection with the institution's participation in the Small Business Lending Fund."

All of which is to say that these banks repaid cash owed to a program run by the Treasury Department by. . . borrowing from another program run by the Treasury Department.

The Small Business Lending Fund was created last fall as part of the Small Business Jobs Act, a bipartisan piece of legislation passed last fall. The idea was to make cash available to smallish community banks (those with assets of $10 billion or less), and then give them incentives or rewards for making small-business loans, defined in this fact sheet as "certain loans of up to $10 million to businesses with up to $50 million in annual revenues."

Here's how it works. As with the CPP, Treasury will lend to the banks by buying preferred shares. As with CPP, the shares bear a five percent annual dividend rate. (However, Treasury won't receive warrants in exchange for making the loans, as it did under CPP). So far, so similar. But here's the difference. Banks that have boosted, or will boost, their lending to small businesses will pay a lower interest rate. "If a bank's small business lending increases by 10% or more, then the rate will fall to as low as 1%. Banks that increase their lending by amounts less than 10% can benefit from rates set between 2% and 4%." Meanwhile, those that take the cash and don't lend will be punished. "If lending does not increase in the first two years, however, the rate will increase to 7%. After 4.5 years, the rate will increase to 9% if the bank has not already repaid the SBLF funding."

Sounds good. But it seems like the first recipients (the deadline for application was May 16, 2011) are using the capital largely to replace more expensive CPP capital. So, for example, Eagle announced that it was using $23.25 million of the $56.6 million in SBLF funds it received to exit the CPP, effectively replacing five percent money with one percent money. As Chairman and CEO Ronald D. Paul noted: "We are also proud to note that our growth of $98 million in SBLF qualified loans over the initial reporting period has made us eligible for a dividend rate of 1.0%, the most favorable dividend rate available in the program." First California Financial used the entire amount of its SBLF funding ($25 million) to repay CPP funds. Security Business Bancorp used nearly 70 percent of the $8.9 million in SBLF funds it received, at the low one percent rate, to pay back its CPP funds.

There are likely many more such examples to come. This first round represents a small portion of the funds available under the SBLF. And the SBLF represents a potentially excellent deal for banks. (Borrowing $10 million at 1 percent instead of 5 percent adds up to a $400,000 annual savings in interest costs.) As important, the initiative offers banks that have yet to earn their way out of TARP a quick and easy exit. SBLF and TARP may each have four letters, but only the latter is regarded as a four-letter word.

Replacing one form of government capital for another doesn't do anything to lessen the public sector's involvement in the system. As with the CPP, taxpayers will eat the costs if banks taking SBLF funds can't return the capital. And I'd much prefer to see banks exiting TARP on their own power. But this new wrinkle at least remedies a design flaw of the original CPP by rewarding banks for lending more and punishing them for hoarding cash.

Still, when combing through the reports of TARP exits, it's important to realize that many banks are simply swapping a government crutch for a cheaper government walking stick.

Daniel Gross is economics editor at Yahoo! Finance.

Email him at grossdaniel11@yahoo.com; follow him on Twitter @grossdm.

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