This article is part of the series

Banks May Get Smaller TARP Bills

Community banks that still owe billions of dollars to the Treasury Department’s bailout program may get a break, as Treasury may sell the stakes it got in the banks via its Troubled Asset Relief Program to third parties or restructure their bailout terms.

Continue Reading Below

But if Treasury doesn’t act, and struggling community banks still owe government-mandated TARP dividends, then market disruption could ensue, a government TARP watchdog has warned Congress.

The Treasury Department sent a letter asking about TARP exit plans to the smaller banks it bailed out, a letter which the Treasury has forwarded to FOX Business.

The letter, dated Nov. 30, 2011, notes that Treasury has hired private investment bank Houlihan Lokey “to explore options” for the “ultimate recovery of our remaining” TARP investments.

The letter notes that “Treasury can’t require banks to repay” their TARP funds. 

As of last month, 372 banks still owe $16.8 billion in TARP funds, the U.S. Treasury tells FOX Business. Most are community banks.

Continue Reading Below

Treasury’s letter to these banks comes on the heels of a tough report to Congress last fall from the acting special inspector general for TARP, Christy Romero.

In that report, Romero noted smaller banks still struggle to repay taxpayers.

The report said a "common misperception is that most of the 707 TARP banks have paid back TARP, when really only the largest banks have exited TARP,” such as Citigroup (C) and Bank of America (BAC).

Romero warned Congress that “community banks may face an uphill battle to exit TARP” due to “distressed commercial real estate related assets and non-performing loans.”

Moreover, Romero warned Congress that Treasury must give community banks “a clear exit path out of TARP that is put into action well before a scheduled jump in their TARP dividends."

Those dividends “are set to climb to 9% from 5%” next year, SIGTARP’s Romero says.

Of the 372 that still owe TARP loans, “nearly half are not paying their TARP dividend,” Romero says.

Market disruptions could occur if Treasury doesn't move now, Romero adds.

Specifically, the TARP watchdog says “these banks will scramble to raise capital in the markets at the exact same time,” meaning they would get “potentially less than favorable terms, which could flood the markets and have a destabilizing effect on communities.”

These banks may in turn “put enormous pressure on Treasury to agree to restructure or sell (at a steep discount) its investments in hundreds of banks during the same time period,” Romero adds.

That means “Treasury may have no other choice other than face a complete loss. This could put the taxpayers’ investment in these banks in jeopardy,” the official says.

That’s why "a clear and workable exit plan for community banks is crucial to [the] financial stability" of the communities where they operate, Romero says.

Those same banks and their communities “are the foundation of the U.S. economy,” Federal Reserve Chairman Ben Bernanke stated earlier this year.

What remains to be seen is whether the government sells these TARP stakes at a discount, possibly at auction, or banks get to pay back less than the face value of what they owe.

Such moves may arise if Treasury sells their TARP bank stakes to private equity firms. 

In Treasury’s Nov. 30, 2011, letter, the federal agency also notes that “replacing government capital with private capital is an important component of fully restoring financial stability.”

What do you think?

Click the button below to comment on this article.