Banks Eager to Repay Bailout Money to Escape Government Control

Many of the financial institutions that received Troubled Asset Relief Program (TARP) money are now looking to repay it to prevent government intervention into their operational decisions.

The money has been used primarily to shore up balance sheets, according to Dana Wiklund, research director for Financial Insights. “For example, 64 percent of Citi’s assets are in investments. As the value of those investment erodes, more equity is needed.”

The TARP provided that equity.

“The whole idea was to help support the balance sheets of these banks that had stopped lending,” agreed Dan North, chief economist at Euler Hermes ACI, a trade credit insurance firm.

But some banks are saying they are lending out the TARP money, not using it primarily to shore up capital.

Citi (NYSE: C) announced last week that it would lend up to $5 billion to state and local governments, municipal agencies, universities and non-profit hospitals to fund projects that will help create jobs and spur economic growth. The municipal program and three other new primary lending initiatives approved by Citi in the first quarter of 2009 are supported by capital the U.S. Treasury invested in the company as part of TARP.

All of the initiatives are presented in Citi’s second quarterly TARP Progress Report published this week: "What Citi is Doing to Expand the Flow of Credit, Support Homeowners and Help the U.S. Economy." The report can be found at on Citi’s Web site.

Wiklund called the posturing by banks to show that they are lending TARP funds a public relations move; if the balance sheets weren’t shored up first, the lending wouldn’t have occurred.

Paying It Back
Now that the financial markets are stabilizing, “banks want to get back to business as usual, without having the spectre of the government hanging over them,” North says. “On the other side, Treasury doesn’t want to take this money back right a way. A number of banks that passed the stress tests are eligible to give back the money, but the government wants to make sure that not only these banks, but the whole financial system is in good shape.”

Another analyst noted that there is a bit of a paradox in the government’s position. “If the government gets the money back, TARP will have worked and the taxpayer will be made whole,” said John Jay, senior analyst at Aite Group. “So [the hesitation to take the money back] is a little curious, I just wonder if they want to keep their hands in these banks for a while to make sure things are OK.”

He added that banks are trying to get out from under TARP because they think government intervention is too heavy handed.

“Any time you want to do anything minor, you have to get approval,” Jay said. “Bankers feel that the government provided TARP to save them, but isn’t let them do what they can in order to be profitable.”

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Another part of the government’s plan to aid creditors, the Term Asset-Backed Securities Loan Facility (TALF), is expanding, which North says is a good thing for investors and for the economy.

The TALF is designed to increase credit availability and support economic activity, in part, by facilitating renewed issuance of consumer and business asset-backed securities (ABS) and commercial mortgage-backed securities (CMBS).  The Fed authorized the TALF on Nov. 24, 2008, under section 13(3) of the Federal Reserve Act. Under the TALF, the Federal Reserve Bank of New York has extended loans secured by triple-A-rated newly issued ABS backed by certain consumer and business loans and leases.

^pullquoteThe TALF program presents potential positive market impact for the ARM industry, especially debt purchasers (“ASK THE EXPERTS: Will the TALF Program Benefit Debt Buyers?” May 19).pullquote^

“TALF is the greatest deal ever known to investors,” North said. “You only have to put up 6 percent, government puts out the rest on a non-recourse loan. Taxpayers are taking all the risk. It’s a fantastic deal for investors. The idea is to support the credit markets. If it works, it will be a good thing, too. It will have opened up the credit markets more. If it does support credit market, it will good thing, but it does give the taxpayer the whole [potential] downside.”

TALF Expansion
The Federal Reserve Board on Tuesday announced that, starting in July, certain high-quality commercial mortgage-backed securities issued before January 1, 2009 (legacy CMBS) will become eligible collateral under TALF.

“That’s a really wise move,” North said. “The CMBS market could be at risk for a higher than expected amount of defaults.”

By putting CMBS under TALF, some of that risk of default is removed, North said.

On May 1, the Fed announced it would expand the range of acceptable TALF collateral to include newly issued CMBS starting with the June subscription.

On March 23, the Federal Reserve announced that it would evaluate extending the list of eligible collateral for TALF loans to include certain legacy securities. The objective of the expansion is to restart the market for legacy securities and, by doing so, stimulate the extension of new credit by helping to ease balance sheet pressures on banks and other financial institutions. Tuesday’s announcement marks the first addition of a legacy asset class to the list of eligible TALF collateral.

The CMBS market, which has financed approximately 20 percent of outstanding commercial mortgages, including mortgages on offices and multi-family residential, retail and industrial properties, came to a standstill in mid-2008. The extension of eligible TALF collateral to include legacy CMBS is intended to promote price discovery and liquidity for legacy CMBS. The resulting improvement in legacy CMBS markets should facilitate the issuance of newly issued CMBS, thereby helping borrowers finance new purchases of commercial properties or refinance existing commercial mortgages on better terms.

To be eligible as collateral for TALF loans, legacy CMBS must be senior in payment priority to all other interests in the underlying pool of commercial mortgages and, as detailed in the attached term sheet, meet certain other criteria designed to protect the Federal Reserve and the Treasury from credit risk. The Federal Reserve Bank of New York will review and reject as collateral any CMBS that does not meet the published terms or otherwise poses unacceptable risk.