The TARP Deadbeats

by: Rolfe Winkler, CFA

Thirty-three TARP recipients missed a scheduled dividend payment to taxpayers last month, according to the Treasury Department, including 18 banks that missed a payment for the first time. It’s a powerful indication that the U.S. banking system remains troubled. And it throws cold water on talk that taxpayers are “making money” on the bailout.

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“It’s too early to tell if we’re making money on TARP,” according to Eric Fitzwater, an associate director at SNL Financial in Virginia. “Certainly the vast majority of the bailout money is still outstanding. While a lot of larger recipients say they plan to pay it back, we’re still waiting.”

The 33 banks that missed dividend payments in August have received $4.5 billion of TARP money. The biggest is CIT (NYSE:CIT). Previously it paid $44 million of dividends, but with a bankruptcy filing looking likely, Treasury’s $2.3 billion investment seems headed toward zero.

A few of the banks may ultimately be able to pay what they owe, according to Fitzwater. These newer banks — “de novo” in regulator parlance — actually are not allowed to pay dividends.

Still, the bigger issue is the ultimate cost of the bank bailout, which we may not know for years.

When stronger banks including Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS) and American Express (NYSE:AXP) repurchased warrants at modest premiums after paying back TARP, most news reports suggested that taxpayers were profiting from the bailout. But those reports didn’t tell the whole story.

For one, they ignored adverse selection, the propensity for the best borrowers to exit the program first, leaving Treasury holding the poorest performing investments. According to the latest data from Treasury, 42 banks have paid back some or all of the cash they got from TARP’s Capital Purchase Program, $70.7 billion in total. But more than 600 banks remain in the CPP program. Together, they still owe $134 billion.

And this excludes other TARP bailout programs that are likely to cost billions. The automotive industry owes TARP $80 billion. And AIG (NYSE:AIG)owes TARP $69.8 billion. Much of that isn’t coming back.

It’s also myopic to view TARP in isolation. Take Citigroup (NYSE:C). After converting its preferred equity investment to 7.7 billion common shares at $3.25, Treasury is showing a paper profit of $11 billion. Sounds great, right?

But Citigroup’s common equity would long ago have fallen to zero if other bailouts, in particular FDIC’s debt guarantee program, weren’t insulating shareholders from losses.

Citigroup is the only large bank still using the FDIC’s program. Two weeks ago, the bank sold another $5 billion worth of guaranteed debt, bringing its total issued under the program to $49.6 billion.

The bottom line is that the government still stands behind the banking sector. While the cost of this “no more Lehmans” policy may not be known for years, our experience with Fannie Mae (FNM) and Freddie Mac (FRE) tells us that such implicit guarantees ultimately prove very expensive. The fact that more banks are falling behind on dividend payments reminds us the tab is growing.