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Midwest Bank Holdings (MBHI) was the latest recipient of the Troubled Asset Relief Program (TARP)’s funds to be seized by the Federal Deposit Insurance Corporation (FDIC). Most of its assets and deposits were sold to Firstmerit (NASDAQ:FMER), an Ohio based lender who escaped TARP early and has went on to a very profitable acquisition binge. The FDIC sales are largely made on attractive terms to the buyer to facilitate a quick transaction.

The taxpayers’ $84.8 million convertible preferred stock stake is all but certain to be wiped out. This is the fourth bank in the TARP’s Capital Purchase Program (CPP) for healthy banks that has been restructured in bankruptcy of FDIC receivership. It is the third largest bank to do so behind CIT Group and UCBH Holdings which received $2.33 billion and $298.7 million from taxpayers, respectively. MBHI received more taxpayer funds than Pacific Coast National which only received $4.12 million. MBHI was one of 82 banks that missed interest or dividend payments to the U.S. Treasury in February 2010, according to my paper “TARP’s Deadbeats”.

The Midwest Bank Holdings investment is yet another example of zero due diligence by the chief investment officer of the U.S. Treasury’s Office of Financial Stability and the other government officials approving the investment in this “healthy bank.” Any chief investment officer worth his salt would have bothered to notice that the yield on MBHI’s publically traded preferred stock was yielding 17.3 percent per year on the day before the investment was announced on November 3, 2008.

That cost of preferred stock is a lot higher than the 5 percent dividend that taxpayers received for their very risky investment. On the day the deal was announced, taxpayers could have expected to lose 55.5 percent of their investment or $47.1 million. (Now that investment is virtually worthless.) That is, taxpayers agreed to give Midwest Bank Holdings $84.8 million and received preferred stock and warrants worth $37.7 million on the day the investment was announced.

The preferred stock was worth $34.6 million and warrants were worth $3.1 million, according to my estimates. There was no reason to invest in the $3.6 billion asset Midwest Bank Holdings because the bank was not “healthy” and it posed no systemic risk. (MBHI had $3.6 billion in assets when the taxpayers’ capital infusion was announced.) The Capital Purchase Program (CPP) was supposed to only invest in “healthy” banks.

The U.S. Treasury’s attempt to convert the preferred stake into common in early March 2010 and take an 80 percent haircut was too little too late. The damage was already done in 2008 when the money was passed out. No private investment was made since March 2010 per the terms of the conversion agreement and the taxpayers’ preferred stock was not converted to common.

It does not matter anyways because both common and preferred stockholders generally expect zero recovery of their investments in FDIC receivership. At least the U.S. Treasury declined to put in new money into the failing bank.

Other banks that have convinced the U.S. Treasury to swap taxpayers’ TARP preferred shares for common shares are Pacific Capital Bancorp (NASDAQ:PCBC), Sterling Financial Corp. of Washington (NASDAQ:STSA), and IBCP)+Announces+Treasury+Exchange+Agreement/5501200.html" rel="nofollow">Independent Bank Corp. of Michigan (IBCP). All these banks have missed several TARP preferred stock dividends because of capital deficiencies. The preferred for common swaps make it easier to forestall bankruptcy and raise new private capital, but they mean that the U.S. taxpayers accept a fraction of the par value of their securities.

In February 2010, I identified thirteen other banks that had missed four straight TARP dividends since May 2009 besides MBHI. Thus, MBHI is not an extreme outlier. Anchor Bancorp of Wisconsin (NASDAQ:ABCW) is in danger of having the U.S. Treasury appoint two of its board members if it misses its sixth straight dividend in May 2010.

Ironically, the administration introduced draft legislation into the House Financial Services Committee on May 7, 2010, for a “Small Business Lending Fund” to give banks, like Midwest Bank Holdings, preferred stock with dividends as low at 1 percent. Hopefully, Congress will not be eager to gamble with the taxpayers’ money for miniscule rewards. They plan to hold hearings in Barney Frank’s (D-MA) House Financial Services Committee on Tuesday, May 18.

I appeared before a subcommittee of the House Financial Services Committee on Tuesday, May 11, 2010. I told the committee that this proposed expansion of the state ownership of the banking sector, the so called Small Business Lending Fund or TARP 2.0, represented a subsidy of $8.4 billion or a loss to taxpayers of 28 percent of every dollar invested.

Disclosure: I don't have any long or short positions in individual securities issued by the companies mentioned. I only have long positions in broad based index funds.

Source: Another 'Healthy' TARP Bank Seized