More News On The Troubled Banking System: The TARP Report

by: John M. Mason

Reports concerning the banking system keep popping up from time-to-time that continue to cause us to pause and wonder about the financial health of the banking system.

We do not get information directly from the Federal Reserve System or the Federal Deposit Insurance Corporation about the state of commercial banks.

However, we see that the Federal Reserve has pumped over $1.5 trillion in excess reserves into the banking system. The Fed tells us that the quantitative easy that has created these excess reserves is to help spur on economic growth. Yet, there still lingers a doubt about the real financial condition of the banking system and about the possibility that the Fed is keeping the banking system excessively liquid so as to keep banks, especially the smaller ones, afloat so that the FDIC can either close the weaker ones or assist others to merge into healthier banks in a smooth and orderly fashion.

The FDIC, at last count, still had well over 800 commercial banks on its problem bank list. So far this year the FDIC has closed about one bank per week. The information we don't have is the number of banks that have been merged out of existence this year. Last year about five banks left the banking system every week either through being closed or by being merged out of existence.

Now, Christy Romero, special inspector general for the Troubled Asset Relief Program (TARP), has released information indicating that "351 small banks with some $15 billion in outstanding TARP loans face a 'significant challenge' in raising new funds to repay the government."

This information was released in connection with her quarterly report to Congress.

The total of $15 billion is not a small number. If one looks at the FDIC statistics, as of December 31, 2011, there were 5,776 commercial banks that had assets of $1.0 billion or less. The total of 351 banks only represents about six percent of the commercial banks of this size, but the $15 billion debt to TARP is approximately 12 percent of the Total Equity Capital of these banks.

Why did these commercial banks need so much TARP money? Well, the TARP money was supposed to provide liquidity relief to these organizations so that they would not have to get rid of underwater assets that would threaten their solvency. They needed the TARP money because so many commercial banks had become "liability management" banks using purchased funds to support their asset portfolios.

The only commercial banks that used to be "liability management" banks were the larger banks that could go into the money markets and purchase funds at market rates. The larger banks purchased monies through the market for negotiable certificates of deposit and the Eurodollar market and similar other "liquid" markets.

Over the past twenty years or so almost all commercial banks, even some very small ones became "liability managers" as they used different forms of purchased funds to allow them to bid more aggressively for riskier assets or to grow faster than their local "communities" would allow. Government agencies, like the Federal Home Banks even encouraged this behavior by making loans available to smaller banks…and thrift banks…so that they could grow and build their asset portfolios.

I was just amazed this past year. Given a bank transaction I was involved in I had the opportunity to take a webinar on Asset/Liability management offered by the American Bankers Association. Within the material presented in this webinar was substantial information on how banks…small and smaller banks…could or should use purchased funds. Not demand deposits or savings deposits supposedly the bread-and-butter of community banks, but purchased funds from outside the "community."

Main Street was attempting to play the game like Wall Street!

This plays right into the TARP scenario. These "smaller" banks were using purchased funds to support assets of different flavors and assortments. As these assets dropped "underwater" and as the purchased funds had to be rolled-over, the banks, to avoid having to take losses by selling the assets, obtained TARP funds to allow them to keep the assets on their books.

This was exactly the purpose of the government troubled asset program.

Now, here we are a couple of years later. The assets are apparently still underwater which means that the TARP funds cannot be repaid. And, the banks are in such bad condition that they cannot even pay the quarterly dividends that are owed to the Treasury.

According to the Report, in the first quarter of 2012, 200 TARP banks failed to make their latest payment. The shortfall in dividend payments is $416 million!

So, we have some more evidence that the banking system is not "out-of-the-woods" yet in terms of its solvency issues. Given this conclusion it is understandable that the Federal Reserve and the FDIC are aiming to err on the side of too much ease and very strict oversight. One can guess that this posture will not end soon.

Furthermore, the bigger banks are just going to become a larger and larger part of the whole banking system.