On January 26, 2012, the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) released its latest Quarterly Report to Congress.  At 302 pages, I can’t say that it’s recommended reading for anyone, but there are portions of it that may be of significant interest to those in the industry.

One of the central themes of the SIGTARP report is that TARP will continue to exist for years.  In addition to programs designed to support the housing market and certain securities markets that are scheduled to last until as late as 2017, 371 banks remain in the TARP Capital Purchase Program.  While I disagree with some of SIGTARP’s conclusions and framework for the issues, I agree that a clear and workable exit plan for community banks is crucial to financial stability.”  SIGTARP has recommended that Treasury develop a clear TARP exit path for community banks, especially in light of a steep rise in the TARP dividend rate from 5% to 9% starting as soon as late 2013.  “Treasury must develop a workable plan in consultation with the regulators and begin executing that plan to remove uncertainty related to these banks.”

Despite its negative public perception, the overall Capital Purchase Program is universally thought to have earned a positive return for the government.  While estimates for the total TARP program continue to show a significant cost, these costs are primarily tied to the housing support programs (which were never intended to be profitable) and relief provided to AIG and the automotive industry.  Estimates on the CPP program, on the other hand, range from a gain of between $7 billion and $17 billion.  Specifically, the Office of Management and Budget estimated on November 18, 2011 (using data as June 30, 2011) that the CPP would result in a $7 billion gain; the Congressional Budget Office estimated on December 16, 2011 (using data as of November 15, 2011) that the CPP would result in a $17 billion gain; and the Treasury estimated on November 10, 2011 (using data as of September 30, 2011) that the CPP would result in a $13 billion gain.  While Treasury may incur losses on some of the remaining investments, the program as a whole (even without considering how bad the economy may have performed in the event the Treasury had not invested in banks under the CPP), will be profitable.  Investing is a risk/reward analysis, and any investment strategy, especially when considering investments in over 700 financial institutions, should be viewed at the portfolio level.  To that extent, TARP generally, and the CPP specifically, should be viewed as a success.

Under the CPP, Treasury invested a total of $204.9 billion of TARP funds in 707 financial institutions.  Through December 31, 2011, 279 banks – including the 10 largest recipients of funds and 137 that exited TARP by refinancing the investment under the Small Business Lending Fund (SBLF) program – had fully repaid CPP or the Treasury had sold the institution’s stock.  In addition, 28 banks converted their CPP investments into CDCI investments and 13 banks have partially repaid.  On the other hand, 12 CPP investments have been sold for less than their par value and 14 are in various stages of bankruptcy or receivership.

As of December 31, 2011, $185.5 billion of the principal (or 90.5%) had been repaid, leaving approximately $19.5 billion outstanding.  Of the repaid amount, $355.6 million was converted into CDCI investments (which is part of TARP), and $2.2 billion was converted into SBLF investments (which is not part of TARP).  In addition, Treasury has received approximately $11.4 billion in interest and dividends and $7.7 billion from the sale of common stock warrants that were obtained in connection with the CPP financings.

The SIGTARP report notes that smaller and medium-sized banks are not existing TARP with the same speed as the larger banks.  Many are not able to pay their dividends and some are operating under an order from their regulator.  Compared with larger banks, the SIGTARP report notes that “community banks may face an uphill battle to exit TARP.”  Community banks do not have the same access to capital as the larger banks and can be more exposed to distressed commercial real estate-related assets and non-performing loans.

SIGTARP reports that “despite the dramatic efforts to expedite the exit of the largest banks from TARP, there appears to be no corresponding concrete plan for community banks’ exit from TARP…” Treasury has acted on a case by base basis to sell its TARP investments (sometimes at a discount) or exchanged for stock with lower priority in connection with a merger, acquisition or sale to a third party that invested new capital, but these actions have remained the exception rather than the rule.  Accordingly, SIGTARP reiterated its prior recommendations:

  1. Treasury, in consultation with Federal banking regulators, should develop a clear TARP exit path to ensure that as many community banks as possible repay the TARP investment and prepare to deal with the banks that cannot. Treasury should develop criteria pertaining to restructurings, exchanges, and sales of its TARP investments (including any discount of the TARP investment,
    the treatment of unpaid TARP dividend and interest payments, and warrants).
  2. Treasury should assess whether it should renegotiate the terms of its Capital Purchase Program contracts for those community banks that will not be able to exit TARP prior to the dividend rate increase in order to help preserve the value of taxpayers’ investments.

The SIGTARP report acknowledged that Treasury has engaged Houlihan Lokey to provide capital markets disposition services for its remaining CPP investments.  Houlihan is earning a flat fee of $375 thousand a month to provide a variety of services to Treasury, including:

  • Analyzing, reviewing and documenting financial, business, regulatory, and market information related to potential transactions of CPP investments;
  • Advising and monitoring restructuring strategies prior to the disposition of CPP investments;
  • Reporting on the potential performance of certain CPP investments and their disposition given a range of market scenarios and transaction structures;
  • Analyzing and proposing disposition alternatives and structures, including the use of additional underwriters, brokers, or other capital markets advisors for the best means and structure to dispose of such assets; and
  • Maintaining a compliance program designed to detect and prevent violations of Federal securities laws, and identifying documenting and enforcing controls to mitigate conflicts of interest.

The SIGTARP report notes that Treasury’s next steps in developing clear TARP exit paths for the smaller banks are critical, and encourages Treasury to proactively reach out to participant banks rather than waiting for banks to propose exchanges.  While Treasury does not want to devise standard discounts or terms for small banks to exit CPP, saying “each bank’s situation is unique,” SIGTARP reiterates its recommendations that the issues should be addressed solely on a case-by-case basis.

Given the economics at stake, designing multiple exit strategies that facilitate the conclusion of the CPP may be in everyone’s interest.  In its most simple terms, Treasury invested a total of $204.9 billion in cash, received cash proceeds of $204.6 billion, and still has $19.5 billion in principal amount of securities outstanding. Using the estimated gains of between $7 billion and $17 billion for the program, Treasury expects to receive between 36% and 88% of the remaining outstanding CPP funds (without giving any consideration to remaining warrants or dividends and interest).