Jeff Davis is senior vice president and director of research for the Nashville office of Chicago-based Howe Barnes Hoefer & Arnett Inc. He has closely followed the federal government’s Troubled Assets Relief Program and its Capital Purchase Program. TARP was born from the Emergency Financial Stabilization Act of October 2008.
Recently, City Paper correspondent William Williams asked Davis to offer his views on TARP and CPP.
To date, various Tennessee-based financial institutions are known to have received TARP Capital Purchase Program monies. What is your take on the program?
Many, but not all, banks that took TARP capital would like to return it because it has become to be viewed as bailout money by the public — and most in Congress — with increasing strings attached to it and therefore an increasing cost separate the 5 percent coupon.
Bankers are concerned that Washington will end up running their already heavily regulated businesses, telling the banks where to lend, how much to lend, what to pay their employees, etc. When the program began last fall, it was intended to create an extra capital cushion to absorb losses for the "good" banks and thereby put to rest concerns about counter-party risks (as were the liquidity guarantee programs).
Keep in mind that banks leverage capital with deposits and borrowings (typically 9:1 to 15:1) to fund loans and buy bonds. That means capital is for absorbing losses in excess of the loan loss reserve; it is not lent directly but indirectly through the leveraging process.
To the "good" banks’ chagrin, regulators gave many weak banks TARP capital when their survivability prospects were questionable. In doing so, the public and Congress tended to paint all banks with a troubled-bank label. So, those that can stand a reduction in capital and capital ratios have moved to return the money.
One other unintended consequence of TARP is that it virtually shut down capital raises by banks in the public and private capital markets. Many banks took TARP capital at the urging of the regulators, thinking it was cheap based upon the 5 percent coupon. Some view their decisions as a mistake given what has happened with the politicization of TARP capital.
Also, TARP has hurt the capital markets and their key function — the allocation of capital to businesses that can generate appropriate risk-adjusted returns versus the denial of capital to those that cannot do so. Stated differently, TARP capital became a form of socialistic capital. All but the lowest-rated banks got it on the same terms regardless of performance and prospects.
What does the future hold?
Many banks that intend to return TARP preferred early may wait to see how the economy plays out this year even though their capital position may look fine. Pinnacle probably is in this group even though the company continues to be profitable, while First Horizon will need to hold onto the capital until (a) the economy and real estate values stabilize then improve, thereby allowing FHN to become profitable again; and/or (b) FHN can tap the capital markets for replacement common equity capital.
The unknown for bankers is how deep and how long the recession lasts. The more capital, the better for a given bank in a recession. This is also true when the economy turns because lending opportunities increase — as do opportunities to acquire weakened and failed competitors.
When you talk to Tennessee bankers — and industry officials and analysts in general — what sense do you get regarding their views of the TARP program?
Some hate it. Some are thankful, knowing that if they had not obtained it that the regulators would have deemed them to be critically under-capitalized and, therefore, a candidate to be seized. Kept alive, some are de facto zombie banks.
It seems some banks are participating due to loan growth, which means they need more capital. I’m sure this is an oversimplification, but what can you say regarding this?
We covered how capital funds loan growth — i.e., it is not lent per se but provides for leveraging when paired with deposits and borrowings that then form the pool of cash to be lent. When TARP was started, some banks such as Pinnacle were growing their loan portfolios rapidly, largely as a result of taking business from weakened competitors. TARP capital became a means to make sure capital ratios were maintained as the balance sheet grew.
With a deepening recession, deteriorating asset quality and declining loan demand from borrowers that can pay banks back, the need for capital to support balance sheet expansion is declining.
What is your take on the trend of banks to “reverse field” and return CPP monies?
The original TARP bill required the banks to go to market to raise replacement capital because the regulators wanted to make sure the banks remained exceedingly well capitalized. Banks that wanted to return the capital as of year-end could not do so because the capital markets were closed to new bank issuances.
Once the issue became so politicized as a "bailout," updated legislation this year provided for the repayment of capital without tapping the markets provided the banks' regulators were OK with the decision. Many banks that would like to repay TARP given the baggage now associated with it would not necessarily get approval from their regulator because the economy and asset quality continue to deteriorate.
What is the repayment time frame for banks considering taking or returning TARP monies?
It depends on a given bank's view of (a) its asset quality; (b) its capital cushion without TARP preferred; (c) how long the recession is expected to last; and (d) the ability to tap the capital markets or local investors for additional capital if need be.
As of early May, we have seen several banks tap the capital markets to raise common equity to repay TARP. These banks do not have material asset quality issues, and they have seized the improvement in the capital markets to raise funds even though the price is somewhat lower than the boards probably would have liked.
The problem with waiting is one does not know if the capital markets will turn south again, shutting the door on solid banks to raise common stock, or if markets continue to strengthen and let more solid and maybe even some marginal banks tap the markets.