Tickers in this Article: C, BAC, JPM, WFC, UMPQ, BPFH, FMER
A recent report from the government panel overseeing the bailout concludes that the efforts to stabilize the financial system through large capital injections have not helped smaller banks. These smaller institutions continue to struggle with paying dividends and finding capital to replace the funds invested by the government. Although these smaller institutions don't control large amounts of assets, they do lend locally, and this lending activity is important to a sustained resumption of economic growth.

IN PICTURES: Obtaining Credit In A Bad Economy

Background

The Troubled Asset Relief Program (TARP) was authorized by the Emergency Economic Stabilization Act, passed in 2008 during the waning days of the Bush presidency. One of the most important TARP components was the Capital Purchase Program (CPP), which consisted of the U.S. Treasury capitalizing the financial system through the purchase of dividend-paying preferred stock from hundreds of banks.

The program provided $205 billion in capital to more than 700 institutions. Larger banks led by Citigroup (NYSE: C), JPMorgan Chase (NYSE: JPM), Bank of America (NYSE: BAC) and Wells Fargo (NYSE: WFC) received the bulk of the capital.

The Panel

The Congressional oversight panel was set up to monitor the bailout and has five members split between Republican and Democratic appointees. Elizabeth Warren is the current head of the panel.

Conclusions

The oversight panel said that some smaller banking institutions, which the report defines as banks with less than $1 billion in assets, are finding it difficult to raise capital to replace the CPP. This may be costly to these institutions, as the program was designed as an incentive to banks to redeem the preferred shares as quickly as feasible. The dividend rate on the preferred is set to increase from 5% to 9% in 2013.

Approximately 14% of all small banks in the CPP have already defaulted on dividend payments, and only 10% of small banks have repaid the capital. There is still $24.9 billion outstanding.

Still Profitable

Although the CPP continues to attract criticism from many quarters, the program has been profitable to the government to date, with an internal rate of return (IRR) of 9.9%. However, this only includes data from institutions that have fully repaid the government. Individual returns vary for these banks that have fully redeemed, with the government earning a 20.3% IRR on its investment in Firstmerit Corp. (Nasdaq: FMER), but only a 6.6% IRR on Umpqua Holdings (Nasdaq: UMPQ).

The latest bank to redeem the preferred stock held by the government was Boston Private Financial Holdings (Nasdaq: BPFH), which redeemed $104 million in capital in mid-June 2010.

Think Small

During the financial crisis, our leaders focused mostly on the stability of the largest banks, as these institutions carried the most systemic risk to the system if a failure occurred. While this is correct, smaller institutions are also important and may be needed for future economic growth in the United States. (For a review of the TARP program, see Liquidity And Toxicity: Will TARP Fix The Financial System?)

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