A New Capital Injection Program?

February 6, 2009

Authored by: Robert Klingler

On February 6, 2009, the Wall Street Journal ran a story indicating that the Treasury Department is shifting away from a “bad bank” concept and towards a second round of capital injections.  This second round of capital injections, according to the Wall Street Journal, would carry stricter terms than the current TARP Capital Purchase program and would be targeted towards weaker banks.

Instead of buying preferred shares, as it did before, the government is discussing taking convertible preferred stakes that automatically convert into common shares in seven years.

To get money, banks would likely have to pay a higher dividend to the government than the 5% rate the government charged in the first round of infusions and agree to a host of new restrictions, such as lending above a baseline level, reporting frequently on their use of the money and curbing executive salaries. While Treasury wouldn’t preclude healthy banks from participating, the stricter terms would likely attract primarily weaker banks in need of capital.

Treasury Secretary Geithner is expected to announce the details of a new plan on Monday.

While predicting the future is always difficult, and particularly so in the rapidly changing world of the Troubled Asset Relief Program, we are skeptical  that the program will provide quick relief to troubled community banks with total assets of less than $1 billion. We also expect that any new program will not be intended to help the most troubled of community banks; but rather aimed at institutions that don’t meet the real estate concentration tests that we believe are now being used to assess viability under the TARP Capital Purchase program.

Like the TARP Capital Purchase Program, any new program is likely to be initially targeted to the largest public institutions, with terms being announced for private and subchapter S institutions over time.  Unfortunately, this may also further delay the willingness of private equity to investment in community banks, as everyone continues to wait to see if the government is willing to invest.