TARP Resistance is Futile: Zombie Community Banks Targeted by Former Treasury Insiders

Submitted by EconomicPolicyJournal.com


Only days ago, we learned from the Financial Times that the 19 largest US banks are $50 billion short of meeting new capital requirements under Basel III accords, with their smaller lending cohorts needing an additional $10 billion.  Amazingly (or not), omniscient Fed officials have divined "that most banks should be able to reach the new levels by retaining earnings during the next few years rather than by raising capital in the market" (emphasis ours).


Presumably, this earnings retention would not include most of the aforementioned smaller community banks because Paulson's TARP has trapped them in a Zombiefied state of smothering debt and capital starvation (not unlike what the World Bank and IMF did to its pirated victems circa 1990-2008), aided and abetted by Fed-induced yield starvation .


Who wins?  No less than the Federal Reserve itself, because Treasury has recently been auctioning off its preferred stock in the smaller banks at firesale prices, which guarantees the state regulated banks will be folded into the Fed securitization and rehypothecation cartel.  Of course, well-connected former bank regulators, such as a former Comptroller of the Currency, will (and already are) profiting handsomely from these transactions, which we detail below, as well as recently in the second segment on Capital Account with Lauren Lyster:



Who loses?  While we're far from an endorsement of the Federal and State banking system in principle, the smaller community banks were the last vestige of the pre-securitization/unlimited moral hazard age, when lending meant "skin in the game" (as opposed to feeding mortgages through the GSE/JPM/Goldman slice-o-matic) and when depositors were seen as an asset (and not only as a balance sheet liability).


While it might be argued that many of these smaller banks would have otherwise been resolved by the FDIC in the 2008 maelstrom, ex-Goldmanite Treasury Secretary Hank Paulson put these mom and pop banks into a shotgun government cartel IPO--preserved in TARP salt, only to have the meat picked off their carcasses years later.


"TARP Provided Lifeline to Community Banks"


So reads a subheading in the most recent SIGTARP report.  Yet, what follows is a recitation of what happened when the banks grabbed the money (at the other end of Paulson's bazooka)--they discovered it was tied to an anchor thrown overboard.

"707 [banks] were accepted into CPP [Capital Purchase Program]; 351 small-and medium-sized banks remain, along with 83 financial institutions in CDCI [Community Development Capital Initiative], for a total of 434. Treasury describes CPP as a program to provide emergency support to “viable” banks.623 There are signs that some CPP banks face difficulty in exiting TARP. Despite the dramatic efforts to expedite the exit of the largest banks from TARP, there appears to be no corresponding plan for community banks’ exit from TARP. The only exit strategy for smaller banks that has been announced has been SBLF, through which 137 banks exited TARP. A SIGTARP analysis of the 351 banks that remained in CPP on March 31, 2012, shows one-third had missed five or more dividend payments, and 32% faced formal enforcement actions by their regulators."  

Hence the smothering spiral of debt and capital starvation.


Why smaller banks, shut out of the NYC securitization, re-hypothecation Collective, can't compete:

"Community banks’ lending to small businesses has decreased recently while large banks increased loans to small businesses. Small banks — those with assets under $1 billion — have steadily lost market share in small-business lending since 1995, according to an analysis of loan data by information provider SNL Financial LC (“SNL”).613 That group of banks now owns just 34% of commercial and industrial loans of less than $1 million that were secured by collateral other than real estate, down sharply from 51% in 1995, according to SNL. During that same period, bigger banks with more than $10 billion in assets doubled their market share of such loans, SNL reported."

Why the POMO tithing scheme is for Primary Dealers only:

"Once a loan is made to a small business or consumer, a community bank typically holds onto it rather than securitizing or selling it,” Timothy Koch, a professor of banking and finance at the University of South Carolina, said at that conference. 612 “Unlike big banks, community banks generate most of their earnings from net interest income on loans, and rely on core deposits by customers in the same community to fund lending,” he said."


"Community banks need capital to pay off CPP investments, and raising that capital has been a significant challenge along with weakened loan portfolios and slow economic growth."

With long term yields below inflation, government securities are already carry negative for banks who can't wash them at the Fed. Hence, Chairman Bernanke is aiding and abetting the executive branch in the destruction of community banks.


On how the TARP death ray "vaporized" an entire set of market choices whose purpose was to provide an alternative to the government agency known as the Federal Reserve:

"Industry experts say the amount of new capital needed by community banks nationwide is substantial. According to analysts with investment firms Raymond James and Barack Ferrazzano Financial Institutions Group, and consulting firm McGladrey & Pullen, LLP, it will take $23 billion in fresh capital for community banks to repay TARP or SBLF funds; to absorb credit losses and boost loan loss reserves; and to meet higher regulatory capital ratios.614 A higher estimate of $90 billion in community bank capital needs came from StoneCastle Partners, an asset management and investment banking firm. It included $43 billion for healthy institutions to acquire weak and failing banks; $28 billion for banks to clean up their balance sheets; $12 billion to boost loan loss reserves; and $7 billion for internal growth.615"

Why smaller banks cannot access the capital markets:

"Banks with assets under $1.5 billion do not have access to capital from private equity firms, mutual funds, foundations, and other institutional investors, according to some who follow the industry. “Capital offerings for less than $20 million to $30 million are often too small for many institutional investors regardless of structure or investment thesis. Institutional investors have fixed costs to cover and deal size minimums. They simply cannot monitor an unlimited number of small investments, no matter how promising,” the Conference of State Bank Supervisors said in a recent white paper.618 Institutional investors also want a bank to have a business plan that allows the investors to eventually realize gains through a stock offering or by selling the bank to a larger institution."  

10% of smaller banks in the US are at risk.

FDIC won't be bailing them out.

They will be assimilated:

"Some industry experts predict a wave of mergers and consolidation among community banks over the next three to five years. “Size matters, and a rule of thumb used by many industry experts is that most banks eventually will need to be $1 billion in assets or greater in order to achieve the scale necessary to operate as an independent entity,” according to a white paper published this year by FJ Capital Management, LLC. “The typical merger can save 20% to 40% in operating costs, thereby creating significant earnings accretion for the combined entity.”620 FJ Capital estimated 413 banks are potential merger candidates because they were trading below tangible book value, and had substandard capital levels and/or elevated asset quality issues.62"

A typical single case: Bank of Hamptoms Road (Norfolk, VA)


According to the American University School of Communication, this bank's Troubled Asset ratio has hovered near 100% since the crisis onset and shows no hope of ever going black. It has $115 million of capital and $72 million in reserves against $185 million of non-performing "assets." Note the $60 million of "other real estate." The best thing that can be said about it is that it has stemmed the bleeding from $(215) million to $(95) million in the last year. It's still losing deposits, capital, reserves, and assets at double-digit percentage rates year-over-year. 


As late as July 2009, common shares traded above $200 (1:25 split adjusted). The last trade June 8, 2012 was $1.21 (1:25 split adjusted).


The TARP "rescue" drove the shares down 80% over the first 6 months. Then Treasury converted its $84 million in TARP preferreds into common for a 74% notional loss, the board diluted in September 2010, missed the TARP dividend, diluted again in June of 2011, and has been selling off branches throughout.


The bank's recent 10-Q produced these gems. First, the asset attrition spiral continues:

"The Company reported a net loss of $7.9 million for the quarter, compared to losses of $21.4 million for the fourth quarter of 2011 and $31.6 million for the first quarter of 2011. First quarter 2012 results benefited fromlower provision for loan losses [ew: at exactly the moment when non-performing loans are skyrocketing] due to continued improvements in credit quality and reduced operating expenses due to continued progress from the Company's expense reduction initiatives."

Then, yield starvation:

"Net interest income for the first quarter of 2012 was $16.7 million, down from the $17.5 million in the fourth quarter of 2011 and $18.2 million in the first quarter of 2011."

Third, because old habits die hard, unwarranted risk taking:

"Noninterest income was $3.1 million during the first quarter of 2012 compared to ($1.1) million during the fourth quarter of 2011 and $2.1 million in the first quarter of 2011. Noninterest income benefitted fromstrong origination volumes in the Company's mortgage unit which saw revenues increase to $3.3 million from $2.4 million and $1.3 million in the prior year fourth and first quarters, respectively."

No doubt, someone will spin that as a "housing recovery." The increase in compensation costs related to bonuses to mortgage origination officers is relegated to a footnote.


A week ago, the bank holding company of Hampton Roads sold two of its failing branches to Bank of North Carolina (NASDAQ:BNCN), whose statement on the deal specifically mentioned the all-important $1 billion threshold, "Our goal of having a billion dollar presence in the Triangle will accelerate with this acquisition, and we are excited about offering our diverse product and service opportunities in both of these communities."  BNCN itself has a TARP ratio of ~50% and rising


As usual, it's the insiders who take over


The only money-good asset this dog [with fleas] (NASDAQ:HMPR) really holds is that "other real estate" line item, which is perhaps why the bank holding company is the target of a NY liquidation firm:

CapGen Capital Group VI LP and CapGen Capital Group VI LLC, both of New York, New York to increase their investment up to 49.9 percent of the voting shares of Hampton Roads Bankshares, Inc., Norfolk, Virginia, and thereby indirectly increase their investment in Bank of Hampton Roads, Norfolk, Virginia, and Shore Bank, Onley, Virginia.


This, and all the other TARP takeovers may be found in the Federal Reserve's H.2A report, "Notice of Formation and Mergers of, and Acquisitions by, Bank Holding Companies or Savings and Loan Holding Companies; Change in Bank Control."


Enter Eugene (Gene) Ludwig and the MF Global Connection


CapGen's leader, Mr. Ludwig, is a former primary dealer officer (Deutsche Bank) and Comptroller of the Currency, and whose business is "turnaround specialists." He is also the founder and current CEO of Promontory Financial Group, which has been granted special review and recommendation privileges by various Federal regulators to Bank of America, USBancorp, Wells Fargo.  Promontory is also a registered lobbyist for several prominent financial firms, including General Motors Acceptance Corporation (GMAC).


Last, but not least, Promontory was engaged by MF Global after a $110 million rogue trader debacle to provide, in part, "a comprehensive review of MF Global’s risk management and internal controls," according to Trustee Giddens' report of June 4, 2012.  The report explains:

"On May 26, 2010, Promontory reported to Holdings’ Audit Committee that MF Global had successfully and effectively implemented most of the Promontory recommendations and the CFTC undertakings and established an enhanced enterprise-wide risk management and compliance program and internal controls framework."

Of course, it would be internal controls that would be the demise of the firm, upon which former Crazy Eddie accountant, Sam Antar, recently commented, "All white collar criminals blame poor internal controls. I tried that trick at Crazy Eddie. The Feds were smarter back then."


While Promontory gave public cover for MF Global, Giddens' report reveals a few pages later that alarm bells were being simultaneously rung internally:

"Similar concerns surfaced in internal audit reviews. A Corporate Governance internal audit issued in May 2010 identified MF Global’s risk policies as not congruent with the changes to its broker-dealer business. Among the specific gaps identified by Internal Audit was liquidity risk reporting. Similarly, an Internal Audit report on Market and Credit Risk Management in October 2010 identified “High Risk” areas arising from the lack of controls over risk reporting. The report also reiterated that market risk policies had not been updated to reflect the current operating environment. The report attributed the failures to remediate gaps to staffing and budget constraints."

A land grab shrouded in a banking takeover, wrapped in a financial crisis "rescue."


The TARP zombie/takeover story is playing out with small variations throughout all the ~300 or so small banks which were trapped in TARP-assisted asset spirals. As stated above, many would have failed outright, further burdening the FDIC fund, perhaps to the point of exhaust, which may be the excuse of record. However, TARP gave Treasury a co-opt entry point to control the flow of equity on this sizeable section of community banking options. 


The Fed's merger notices are peppered with former officials using their insider positions and PE headhunters to profit from the "rescue." Whether the net result of killing off a whole tranche of Fed-free banking options was intentional, the combination of forced TARP and negative real interest rates will lead to fewer options and more Fed-centralized control of banking, as the process of slicing, dicing, and consolidating works its way up the food chain, aided and abetted by friends of Treasury. 


In future reports, we will detail other small bank merger and acquisition transactions by bank regulatory insiders, as well as develop the role of Promontory in the stress test/internal-policy-failure face-save kabuki that dominates the upper echelons of the extreme moral hazard tranche of the financial sector.


Special thanks to elliswyatt for serving as primary research contributor and TARP wordsmith.


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