U.S. Turning Profit on TARP, but Big Loans Remain in Banks' Hands

Email

The U.S. government is starting to see profits from the $750 billion Troubled Asset Relief Program (TARP), started last year to thwart the financial crisis. However, the two largest recipients of TARP money – Citigroup Inc. (NYSE: C) and Bank of America Corp. (NYSE: BAC) – have yet to pay back their loans and the government is still exposed to possible losses from those two heavyweights, as well as from smaller U.S. banks.

The government netted roughly $4 billion – the equivalent of a 15% annual return – from  eight of the biggest banks that have fully repaid their obligations to the government, according to calculations by The New York Times.

Those financial institutions consist of:

  • Goldman Sachs Group Inc. (NYSE: GS) – $1.4 billion in profit.
  • Morgan Stanley (NYSE: MS) – $1.3 billion in profit.
  • American Express Co. (NYSE: AXP) – $414 million in profit.
  • Northern Trust Corp. (NYSE: NTRS), The Bank of New York Mellon Corp. (NYSE: BK),    State Street Corp. (NYSE: STT), U.S. Bancorp (NYSE: USB) and BB&T Corp. (NYSE: BBT) – $100 million to $334 million in profit.
  • Fourteen smaller banks that have repaid their debt – $35 million in profit.

JPMorgan Chase & Co. (NYSE: JPM) and Capital One Financial Corp. (NYSE: COF) could yield an additional profit of more than $3.1 billion in the coming month, but the final number is dependent on how much they will pay to buy back their warrants, The Times said.

Additionally, the U.S. Federal Reserve earned $16.4 billion through the first six months of the year, thanks to a range of rescue programs – including loans to investment banks and purchases of mortgage-backed securities – while the Federal Deposit Insurance Corp. (FDIC) saw a profit of more than $7 billion on the fees it charged through a program that guaranteed debt issued by banks. Still, the FDIC has agreed to assume most of the risk on $80 billion in loans and other assets, and expects to eventually have to cover $14 billion in future losses on deals cut so far, according to The Wall Street Journal.

"Taxpayers should heave a sigh of relief that the investment in banks protected them from even more catastrophic losses from more bank failures," said Aswath Damodaran, a finance professor at the New York University's Stern School of Business.

The government said last year that its decision to purchase preferred shares from hundreds of banks ravaged by mortgage defaults would yield a positive return, including a 5% quarterly dividend and warrants to buy stock in the banks at a set price over 10 years.

As many banks stanched their losses and began to turn a profit, the government authorized them to buy back the preferred stock, make the dividend payments for each quarter since October. Banks also were permitted to buy back the warrants, which had a low fixed price – and which provided therefore provided a windfall for the government as the markets rallied.

The U.S. should consider imposing an automatic ban on dividend payments by lenders when "the bank stock price plummets and the banks aren't doing well," New York Federal Reserve Chairman William Dudley told CNBC, expressing concern over how the payouts could end up dissipating the banks' capital.

Should a bank lose capital because of a falling stock price, it could raise more capital by issuing debt that is convertible, Dudley said.

Had private investors taken matching stakes in the banks in October, they would have tripled their investment to roughly $12 billion, or 44% on an annual basis, according to University of Louisiana at Lafayette finance professor Linus Wilson, who analyzed the data for The Times. But there's a good reason for that. Under this hypothetical scenario, the private investors would have demanded a higher rate of return, bought in at a lower price, or both – because of the high risk that they would have been incurring.

But the government wasn't in this to make a profit – it was working to stabilize a financial system that was quickly losing the public's confidence, experts note.

"Had these banks tried to raise money any other way, they probably would have had to pay quite a bit more than the government received," Espen Robak, head of Pluris Valuation Advisors, which analyzes the value of large financial institutions, told The Times.

Threat Posed by Loss-Shares

Despite the encouraging news that taxpayers are getting strong returns on their reluctant investments, the loan guarantees invested in the two largest TARP recipients – Citigroup and Bank of America – have not yet been repaid. Citi received $50 billion in TARP funds, while BofA got $45 billion.

In the last month, Citigroup has seen its stock surge roughly 58%, along with a 19% return in the shares of BofA, which leaves the U.S. government sitting on a combined $18 billion of profits from the warrants it purchased last year.

Those banks also hold troubled mortgages and other loans that no one can put a value on – which is why these so-called "toxic assets" have yet to attract buyers.

"No one has a good handle how much is out there," Elizabeth Warren, the chairman of the Congressional Oversight Panel who acts as the so-called "TARP watchdog," told Reuters Television in an interview last month. "Here we are 10 months into this crisis…and we can't tell you what the dollar value is."

More than 50 deals brokered by the FDIC to absorb losses at small banks affected by the financial crisis still remain in place. These agreements to assume the risk of loans and other assets from the consolidation of failed banks are known as "loss-shares," and are an important inducement for healthy banks to take over busted institutions.

The FDIC brokered the sale of Alabama's Colonial BancGroup Inc.'s (OTC: CBCGQ) deposits to BB&T after Colonial failed. It also agreed to help BB&T buy Colonial's $15 billion portfolio of loans and other assets and absorb over 80% of any future losses. Under the deal, BB&T's losses are capped at $500 million and – in the unlikely event the entire portfolio becomes worthless – the FDIC is on the hook to cover the rest.

The FDIC sees these deals as a way to keep loans and other assets in the private sector, as well as mitigate the cost of cleaning up the industry.

It would cost the FDIC considerably more to simply liquidate the assets of failed banks, especially with more than 400 banks on its "problem list." Loss-share deals will cost $11 billion less than if the agency seized assets and sold them, The Journal said, citing the FDIC.

So far this year, 109 banks have failed – quadruple the amount of failures in 2008. The FDIC's recouping any lost money from the loss-share deals, many of which are in place for up to 10 years, is dependent on the recovery of the economy

Some worry that bankers may tire of the partnerships with the FDIC and not work toward fixing bad loans because the bulk of the losses will fall to the government. But agency officials maintain that because banks still have a "material" exposure, they will be reluctant to do this.

"There is certainly an incentive for the banks to play fair and do right, but there is never a limit on the ability of the private sector to shift cost to the government," former FDIC general counsel John Douglas told The Journal.

A typical deal has the FDIC agreeing to cover 80% of future losses on a big portion of the assets, and 95% on the rest. However, the FDIC does not expect to see the 95% scenario play out on any of the deals it has made so far.

News and Related Story Links:

Join the conversation. Click here to jump to comments…

  1. Stephen Delsol | September 1, 2009

    It has been a very long time that the Federal government has made a profit on investing tax payers money! Yet 8 months in office, President Obama, has done just that!
    Three cheers for the Presient, his economic team and Congress! Government involvement in the economy can be a profitable undertaking to the benefit of the tax payer! This also is a good omen for the government providing a 'public option' in the health care industry! The Federal Government can become an efficient, effective, profitable and necessary intervention in the economy, health care and education.
    We should have no fear of the Federal government, because President Obama is at the helm!

    1

  2. Jimmy | March 22, 2010

    Hey Stephen

    The TARP money was from George W. Bush NOT Obama. Here's something you should ask yourself; now that large portions of the TARP money is being repaid what is happening to that money? Is it being used to pay down the debt or is it now Obama's and this administrations personal slush fund? What about Obama's economic stimulus plan? Is that going to turn a profit? I dont think so. Get a clue this administration is a joke.

  3. Lou | April 9, 2011

    Those of you that believe that the TARP money was repaid from bank profits are sadly mistaken. Most of the TARP funds that have been repaid were from money that they received from borrowing against or selling the government worthless mortgage backed securities that they had on their books. These banks then took that money and paid back the TARP loans so that the bank officers could qualify for large bonuses. It was a real slight of hand.

    Also, if you would check the source of government income last month, you would find out that some of the money used to pay bills was from the TARP repayments. The TARP money is not being used to repay the national debt from which it came. The TARP money is being used for day to day government expenses as it is repaid. OUR NATIONAL BUDGET DEFICIT IS FAR LARGER THAN THE PROJECTED 1.7 TRILLION. THE CONGRESS MUST CUT SPENDING NOW!!!!!!!!!!! The minor amount just cut of 38 Billion from the budget was far to low. You would have thought Congress was going through child birth to get that piddly amount cut. AMAZING!!!!!

Trackbacks

Leave a Reply

Your email address will not be published. Required fields are marked *


6 − = three

Some HTML is OK