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December 21, 2010 – A Stress Test for Community Banks

The $700 billion TARP program has failed for the majority of the community bank recipients.
TARP was given to about 700 community banks and now 123 are reneging on TARP Dividend
Payments. We are finding out the hard way that when you give money to “healthy” banks you don’t get
it back, primarily because they are not “healthy.” By my measures community banks that should never
have received TARP money in the first place if they were overexposed to C&D and CRE loans in
violation of the FDIC’s own guidelines. Many banks cannot make dividend payments because they are
choking on non-performing real estate loans established between 2003 and 2007.
The so-called “Small Business Lending Fund” is nothing more than a $30 billion Mini-TARP to provide
small-business lending funds to small community banks. Only banks with less than $10 billion in
assets are eligible-- and of these 90% have less than $1 billion in assets. Are these banks suitable
investments of tax payers’ money? I think not as most are not publicly-traded and if they were a
smart investor would never put her money at risk in them.
Under the “Small Business Lending Fund” banks would pay a 5% dividend, but that dividend would be
as low as 1% for banks that increase business lending relative to a 2009 base level. Banks that do not
increase small business lending in the first two years pay a 7% dividend. This will increase to 9% after
4.5 years.
Like most of our failed bailout programs, the $30 billion “Small Business Lending Fund” expires after
just one year. I see more of same here and believe that this program will encourage banks to take the
money, refuse to lend, and fail to re-pay the taxpayers. This will be a bigger boondoggle for small
banks than the original $700 billion TARP!
Given the current environment and state of balance sheets, how can policy makers and regulators
determine which of the small community banks qualify to participate in the “Small Business Lending
Fund” program?
In order eliminate the risk that this mini-TARP will prove to be as big a boondoggle as its big
brother; I propose the following guidelines for its implementation
The banking system is shrinking in terms of the number of banks, now 7,760 from 8,534 at the end of
2007, and the FDIC reports that 860 are “Problem Banks” which is 11.1%. The FDIC has closed 157
banks in 2010 even as the list of problem banks grows.
A recipient can not be overexposed to Commercial Real Estate Loans or have a exposed loan
pipeline.
My analysis shows 2,485 or 32% of all banks overexposed to Commercial Real Estate loans, and
3,938 or 50.7% of all banks with real estate loan pipelines that are 80% to 100% funded. This stress
needs to be addressed before jobs can be created on Main Street USA as housing and construction
drive local economies. These banks should not qualify for any additional tax payer money.
Reflecting this dilemma is the fact that Other Real Estate Owned (OREO) climbed to a record $53.2
billion, up 338.2% from the end of 2007. These properties are a hangover that needs to be cleared
before community banks can increase lending again.
Some may find these guidelines too restrictive, but if we take a look at the original TARP program we
find that some institutions that would have passed this test are still in default on their dividend
payments.
It is time to stop throwing good money after bad.
That’s today’s Four in Four. Have a great day.
Richard Suttmeier
Chief Market Strategist
ValuEngine.com, (800) 381-5576
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