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Trapped by TARP – An Update on the Capital Purchase Program

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.

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SIGTARP Summarizes Results and Posts Individual Responses

On August 19, 2009, the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) published its latest Audit Report, titled “Despite Evolving Rules on Executive Compensation, SIGTARP Survey Provides Insights on Compliance.” The Report summarizes the results of SIGTARP’s survey of the first 364 TARP CPP recipients, focusing on their executive compensation responses. (SIGTARP previously published its Audit Report on the responses related to the use of TARP funds.)

In the aggregate, the responses are not particularly insightful.  As noted in the Report’s conclusion:

Since EESA was enacted on October 3, 2008, the legislation and implementing guidance on executive compensation for TARP recipients have been in flux.  Nevertheless, most CPP recipients report that they have made a concerted effort to comply with executive compensation limitations.  Moreover, many institutions reported that they intend to comply with the additional restrictions on executive compensation enacted under ARRA.  Nonetheless, some recipients voiced concerns about the new restrictions; in particular, they noted a need for further Treasury guidance or regulations to implement ARRA executive compensation limits.”

However, in addition to the Audit Report itself, SIGTARP has published redacted copies of all of the SIGTARP survey responses.  Responses are listed both alphabetically, and by state.

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Additional Clarity on TARP Approval Process & Standards

On August 6, 2009, the Office of the Special Inspector General for TARP (SIGTARP) published its report on whether external parties (i.e. politicians) unduly influenced TARP Capital Purchase Program decisions.  We will write more about that subject shortly, but the Report also provided the most detailed summary that we’ve seen of the factors considered by Treasury and the federal banking regulators in determining whether to approve a TARP application.

First, composite CAMELS ratings clearly played a significant role in determining the likelihood of success for any given institution.

  • 1-rated institutions were generally sent directly to Treasury for approval, and seemingly regularly approved for Capital Purchase Program funds.
  • 2-rated institutions with “acceptable performance ratios” were also sent directly to Treasury for approval, and again appear to have been regularly approved for funds.  2-rated institutions with “unacceptable performance ratios” were subject to further review by the interagency council, where at least three of the four federal banking regulators had to approve the application.  The Report states that the interagency council then analyzed “the viability of the institution based on the quantitative and qualitative  factors of the case” in determining whether to recommend approval to Treasury.
  • 3-rated institutions were originally treated like 2-rated institutions, but “relatively early in the CPP application review process,” Treasury decided that all 3-rated institutions needed to be reviewed by the interagency council.
  • 4- or 5-rated institutions were generally asked to withdraw, without the application being forwarded to the interagency council.

The Treasury would then make an independent evaluation of each application before making recommendations to the three-member Treasury Investment Committee.  The Treasury Investment Committee would then make a recommendation for final approval to the Assistant Secretary.  While only the Assistant Secretary can actually approve a TARP CPP application (all other actions are merely recommendations to approve), according to the Report, the Assistant Secretary had not rejected any recommendation forwarded by the Investment Committee for approval.

Performance Ratios

The Report also includes, as an Appendix, a copy of a “Case Decision Memo Template” that appears to have been the form used by the region/district level office of each federal banking regulator that reviewed TARP CPP applications.  The Memo provides further guidance on the specific performance ratios considered by the agencies.  In addition to CAMELS and CRA ratings, the  Memo called for an evaluation of the following performance ratios, both before and after a TARP infusion and both for the holding company and the largest bank subsidiary:

  • Tier 1 Risk-Based Capital
  • Total Risk-Based Capital
  • Tier 1 Leverage Ratio
  • Classified Assets/(Net Tier 1 Capital + ALLL)
  • (NPLs + OREO)/(Net Tier 1 Capital + ALLL)
  • Construction & Development Loans/Total Risk-Based Capital

While the first three performance ratios are consistent with the three historical measures of bank capitalization, the last three performance factors highlight the focus of the banking regulators on these ratios.

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SIGTARP Outlines Fraud Investigations

At a conference on July 28, 2009, Neil Barofsky, the Special Inspector General for TARP, outlined the types of fraud that his office was investigating.  He indicated that review of the Capital Purchase Program is his primary objective at this time, and that the office is investigating allegations of securities fraud, accounting fraud, falsified financial statements, criminal misrepresentations, and fraudulent practices involving mortgage modifications.  Barofsky noted that his office is currently conducting “10 or 11” audits involving government spending that could lead to criminal fraud charges.

The focus appears to be on “application-stage” fraud, involving actions taken by entities when they were applying for Capital Purchase Program funds.  Barofsky noted that “these are banks that are cooking their books, whether it’s false valuation of assets, whether it’s round-trip transactions — really whatever we’ve seen recently in large accounting fraud, we’re investigating, looking at institutions that did that in order to get TARP funds.”

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SIGTARP Survey Results

SIGTARP Survey Results

July 23, 2009

Authored by: Robert Klingler

On July 20, 2009, the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) published the results of the SIGTARP Survey of Initial TARP Capital Purchase Program Recipients.  Despite the report’s flaws, some of which are discussed below, the results should be read by all TARP recipients.  The report does a good job summarizing how banks use capital (see in particular Appendix B) and exploring the myriad of ways in which TARP funds have been used.

Report Conclusions

Titled “SIGTARP Survey Demonstrates that Banks Can Provide Meaningful Information on Their Use of TARP Funds,” the report recommends that Treasury require TARP Capital recipients to submit periodic reports to Treasury on the uses of TARP funds, including what actions they were able to take that they would not have taken otherwise.

The actual results of the survey, however, would seem equally to support a conclusion that, because TARP funds are capital, the specific uses of TARP funds cannot be specifically identified.  Instead, the TARP Capital Purchase Program has provided additional capital to banks to allow them to continue to engage in all of the activities in which they engage in, including lending.

Disclosure of Individual Responses

The SIGTARP report aggregates the responses of the 360 bank recipients of TARP funds through January 31, 2009.  (SIGTARP has not given any indication that it intends to survey subsequent recipients of TARP funds.)  Although individual responses are not included in this report, SIGTARP indicates that it intends to post all responses, redacted as necessary, on its website within 30 days.

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Enhanced Deposit Insurance Extended Through 2013

On May 20, 2009, President Obama signed the Helping Families Save Their Homes Act of 2009 (Senate Bill 896).  Among other things, the Act:

  • extended the $250,000 deposit insurance limit through December 31, 2013;
  • extended the length of time the FDIC has to restore the Deposit Insurance Fund from five to eight years;
  • increased the FDIC’s borrowing authority with the Treasury Department from $30 billion to $100 billion;
  • increased the SIGTARP’s authority vis-a-vis public-private investment funds under PPIP (including the implementation of conflict of interest requirements, quarterly reporting obligations, coordination with the TALF program); and
  • removed the requirement, implemented by the American Recovery and Reinvestment Act of 2009, for the Treasury to liquidate warrants of companies that redeemed TARP Capital Purchase Program preferred investments.  The Treasury is now permitted to liquidate such warrants at current market values, but is not required to do so.

This extension does not affect the Transaction Account Guarantee provided by the FDIC’s Temporary Liquidity Guarantee.  The Transaction  Account Guarantee, which provides an unlimited guarantee of funds held in noninterest bearing transaction accounts, is still scheduled to expire on December 31, 2009.

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SIGTARP Reports to Congress

SIGTARP Reports to Congress

April 22, 2009

Authored by: Robert Klingler

On April 21, 2009, Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program, released his quarterly report to Congress.

Survey Results

As we’ve previously discussed, Barofsky has issued letters to many TARP Capital Purchase Program recipients requesting information on how the institutions have used the TARP funds and how the institution was addressing the executive compensation limits.   As clarified in the report to Congress, SIGTARP sent letters to all recipients of TARP funds through January 30, 2009, a total of 364 recipients.  There is no indication that SIGTARP will be sending any letters to subsequent recipients.  SIGTARP received responses from all 364 recipients, a 100% response rate.  (It’s amazing how much more likely one is to respond to a survey when threatened with government action if one doesn’t respond.)

In testimony before the Senate Finance Committee on March 31, 2009, Barofsky had indicated that while his analysis was ongoing, he had concluded that one thing “was apparent from the responses – complaints that it was impracticable or impossible for banks to detail how they used TARP funds were unfounded.”  Barofsky does not repeat this conclusion in the report to Congress, but rather notes that the responses “provided a broad range of answers to the two sets of questions.”  While some banks identified detailed and specific uses of the funds, others provided more general responses.

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SIGTARP Seeks Use of TARP Funds

On February 5, 2009, the Office of the Special Inspector General Troubled Asset Relief Program (SIGTARP) began issuing letters to TARP Capital recipients requesting information on how the institutions have used the TARP funds and how the institution was addressing the executive compensation limits.  The requested information is due 30 days following the request; as a result, the first responses are due the week of March 2, 2009.  On February 25, 2009, SIGTARP provided a Frequently Asked Questions supplement to their initial request.

As noted in the FAQ, SIGTARP is not tasked with monitoring whether any individual bank is in compliance with TARP requirements.  However, the responses provided to SIGTARP may ultimately result in political and regulatory pressure against institutions that expressly rebut the presumption that TARP funds should be used to spur lending (despite the recession).  Institutions should absolutely provide a good faith effort to tell their story regarding the anticipated and actual uses of funds; especially as a senior executive officer is asked to certify to the accuracy of the responses under Title 18, United States Code, Section 101.  This code section makes it a felony to provide false statements to federal officials, and was the statute ultimately used to send Martha Stewart to jail.  However, institutions should also be aware of the political environment in which these responses will be read (and potentially more widely circulated).

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SIGTARP's Initial Report to Congress

Adding to the acronyms involved, on February 5, 2009, the Office of the Special Inspector General for the Troubled Asset Releief Program (SIGTARP) released its initial report to Congress.  The report clocks in at 108 pages plus 77 pages of appendices, but appears to do an excellent job summarizing the Emergency Economic Stabilization Act, the overall TARP program, as well as the specific investments made under TARP.

Highlights include tables on page 47 and 48 that outline the basic terms of all of the TARP equity and debt investments and a complete list, as of January 23, 2009, of the warrants held by the Treasury under TARP, including the strike and market price, in Appendix D.  (Most of the warrants held are very “out of the money.”)

TARP Capital Evaluation Process

The report includes a relatively useful summary of the evaluation process being used under the TARP Capital Purchase program.  According to the report, all applicants are classified by their federal banking examiner into one of three categories:

  • Category One
    • CAMELS Composite 1
    • CAMELS Composite 2 and for which the most recent examination rating is not more than 6 months old
    • CAMELS Composite 2 or 3 and “acceptable performance ratios”
  • Category Two
    • CAMELS Composite 2 and for which the most recent rating is more than 6 months old
    • CAMELS Composite 2 or 3 and “overall unacceptable performance ratios”
  • Category Three
    • CAMELS Composite 4 or 5
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Treasury to Ask Recipients About Use of TARP Funds

Neil Barofsky, the Treasury Department’s Special Inspector General for the Troubled Assets Relief Program, plans to ask all TARP fund recipients to “account for their use of TARP funds and to describe their efforts to comply with applicable executive compensation restrictions.”  Mr. Barofsky describes the initiatives of the Office of the Special Inspector General for the Troubled Assets Relief Program in a letter, dated January 22, 2009, to the raking member of the Senate Finance Committee.

Specifically, the Treasury intends to request from each entity that has received TARP funds to provide, within 30 days of the request:

  • a narrative response outlining their use or expected use of TARP funds;
  • copies of pertinent supporting documentation (financial or otherwise) to support such response;
  • a description of their plans for complying with applicable executive compensation restrictions; and
  • a certification by a duly authorized senior executive officer of each company as to the accuracy of all statements, representations, and supporting information provided.
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