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U. S. bailout of banks morphs into investment
(Buffalo News, The (NY) Via Acquire Media NewsEdge) Nov. 30--As the parade of banks accepting money from the federal government continues to grow, consumers are wondering if their banks are in trouble.
After all, why would a perfectly healthy bank take government bailout money? And why should the government support them?
The answer is complex, but it boils down to the government program being much different than originally envisioned. Rather than aiming at sick banks, it's now aimed at the healthy ones.
"This is no longer a bailout, or maybe it never was a bailout," said David Nasca, president and CEO of Angola-based Evans Bancorp and Evans Bank. "It's an investment by the government in banks to free up credit liquidity, and make sure that banks are lending."
And with today's troubled economy and financial markets, it's hard for a bank to turn down the money, even when it gives the government a front-row seat to a bank's inner workings.
"Capital is key, capital is important, and the economic benefits of this are too compelling," said John Koelmel, CEO of First Niagara Financial Group in Lockport. "It would be silly for us to not tap into and access that."
Neither Evans nor First Niagara has experienced any problems. Both are well-capitalized, with strong earnings and growth. And both are participating.
The reversal in purpose shows the degree to which the current financial crisis has forced government officials to think and act fast. Throughout the last several weeks, officials have tried one strategy after another to prop up the financial system.
At the same time, officials have struggled to explain to the public why financial institutions need the help first, when several million homeowners are facing the loss of their homes.
"On the surface, it certainly looks unfair that the banks are getting bailed out while the consumers are left out to dry," said Sandler O'Neill & Partners LP analyst Joseph Fenech.
"But to have any chance of recovery, you need functioning credit markets and a functioning banking system. And the way we were headed in October, it looked like we might not have that for much longer. It's kind of an effort to stem the tide, which you need before you see any sustainable recovery."
When Congress first passed the $700 billion Troubled Assets Relief Program, the primary goal was to buy up bad or "toxic" debt and other assets from banks, getting them off the institutions' balance sheets.
Such assets, including loans and securities backed by loans, had caused more than $500 billion in losses for financial services companies since early 2007, severely sapping their capital resources. As a result, worries had almost grown to mistrust and panic, banks cut back or even stopped some lending to customers and each other, and the capital markets on Wall Street shut down.
The goal of the TARP program was to remove that burden, restore investor and customer confidence in banks, and encourage banks to start lending and investing again. That would abate fears of a severe credit crunch and a recession.
But Wall Street didn't buy into it, and the negative reaction caused Treasury Secretary Henry Paulson to switch gears.
Together with other Bush administration officials, he announced the Capital Purchase Program, diverting $250 billion of the TARP program. The goal was to strengthen healthy banks by injecting more capital into their coffers, enabling them not only to weather losses but also to help their communities recover by making more loans. As such, it's seen not as a bailout of bad banks but a support program for the good ones.
He cajoled the nation's nine largest financial institutions -- including former brokerage firms-turned-com m e r c i a l banks Morgan Stanley & Co. and Goldman Sachs & Co. -- to take the first $125 billion. And then the government opened the program up to the rest of the industry, with regulators actively encouraging banks to participate.
To date, 53 banks have received $161.5 billion, with at least 25 more being approved for $6 billion more. Hundreds of others applied by the Nov. 14 deadline.
Among local institutions, Bank of America Corp. was one of the first to get money, receiving $15 billion plus another $10 billion for Merrill Lynch & Co., which it is acquiring. KeyCorp received $2.5 billion, and First Niagara just got its $184 million.
M&T Bank Corp. was approved for $600 million, while Evans, Lake Shore Bancorp and Northwest Bancorp applied. HSBC Bank USA and Citizens Financial Group, as foreign-owned banks, are not eligible.
How does it work?
Under the voluntary program, participating banks sell newly issued, non-voting senior preferred shares to the U. S. Treasury in exchange for an amount of capital equal to at least 1 percent of a bank's "risk-weighted" assets and no more than 3 percent of those assets. The shares pay an initial annual dividend of 5 percent for the first 5 years, and then 9 percent, giving banks an incentive to raise more money to buy back the shares from the Treasury quickly.
The banks also give Treasury "warrants" or rights to buy shares of common stock in an amount equal to 15 percent of the preferred stock investment. The warrants are good for 10 years, and Treasury will not exercise any voting power.
In today's environment, the capital is viewed as extremely cheap. The 5 percent pretax dividend translates to about 8.5 percent after taxes. By contrast, the effective cost of raising common stock in a public offering today is more than 13 percent.
"I don't see it getting any cheaper in the near future," Koelmel said. "The cost of capital is only going to be more expensive in the foreseeable future."
That means it's an opportunity to cheaply bolster capital levels to weather the storm, maintain those levels, and advance a company's strategy.
And there either won't be a second chance, or any new program adopted in the future may not be as generous to banks. "I personally think banks should take all they can," said analyst Fenech.
Yet, taking the money is a defensive move. Banks don't want to let their competitors get low-cost cash that could give them an edge unless they get in on it, too. They also expect regulators will insist banks hold more capital anyway.
Those banks that join say they're doing so to express support for the government's efforts. "The government can't get this wrong. They have to get this right," Koelmel said. "All the big and most of the best are involved, and hence I have every confidence that we need to collectively and collaboratively work with the government to stimulate the economy."
Comes with strings
On the other hand, there also are significant limits imposed on the bank's normal activities, which have given pause to many banks. "A healthy bank would most likely not participate in the TARP plan as currently written," said David Mancuso, CEO of Lake Shore Bancorp and Lake Shore Savings Bank in Dunkirk.
Lake Shore applied for TARP money just in case, but it still has at least 30 days after approval to reconsider. "There are too many apparent restrictions," Mancuso said. "Their plans to save the economy almost changes daily."
For one thing, as long as Treasury owns the shares, a company cannot raise its common stock dividend or repurchase shares without permission.
"We're a fairly good yielding stock, which we need to be as a small player. Those dividend restrictions were onerous," said Nasca of Evans Bank. "And stock buybacks are a way to return capital to shareholders and that is a concern."
And there are restraints on how much the bank can pay its executives, especially for any severance or "golden parachutes."
Worst of all for many is a provision that allows Congress to change the rules in the future. While banks currently have the option to buy out Treasury at almost any time by raising fresh equity, some observers worry that the next Congress could remove that and lock banks in.
Ultimately, what customers thought of the whole process was important to the banks.
On one side, banks thought consumers would angrily view it as a bailout or worry why a bank was taking the money. On the other hand, consumers might also worry why a bank didn't take the money, or wonder if it had been turned down.
"This is not to shore up bad banks. This investment is being made in strong organizations," Nasca said. "That's part of the reason a lot of people applied. The perception of not being strong enough to get the money was dangerous."
jepstein@buffnews.com
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