Over 600 Small Banks May Default On Bailout Loans

July 15, 2010 – The Congressional Oversight Panel’s report on TARP loans to small banks has determined that many small banks  may find it difficult or impossible to repay funds borrowed from the U.S. Treasury.   The Treasury program to bailout banks, formally known as the Capital Purchase Program (CPP), was established during the height of the financial crisis to lend up to $700 billion to a banking industry on the verge of collapse.

Of the 19 largest American banks, with more than $100 billion in assets, 17 borrowed funds under the CPP, accounting for 81% of the total funds lent by the Treasury.  Of the 17 largest banks that borrowed money, 76% have already fully repaid the amounts borrowed. 

The story for small banks is dramatically different.  A total of 690 small banks, with assets of less than $100 billion, borrowed from the US Treasury and less than 10% have repaid the loans.  The Oversight Panel concludes that many of these small banks are now struggling to repay their loans to the taxpayers.   The Oversight Panel notes that small banks are more exposed to defaulting commercial real estate loans and have limited access to capital markets.

Small banks that cannot repay CPP funds within five years may face an even larger risk of default since the dividend rate payable to the Treasury rises from 5% to a punishing 9% after 5 years. 

The original intent of the CPP program was to stabilize the banking system and not to rescue unsound banks.  In theory, loans were made only to those banks that were judged sound enough to recover and repay the loans extended to them.  In practice, this was not the result.  One in seven small banks have missed a CPP dividend payment and less than 10% of small banks have repaid amounts borrowed.  The total amount due from small banks under the CPP program now amounts to $24.9 billion.

The Oversight Panel also questions the original goals of the CPP which was to restore stability to the banking system and expand lending.  The Panel notes that the smaller banks, in the aggregate, did not represent a systemic banking risk and there is no evidence that the CPP increased small bank lending.

The Panel concludes by recommending the Treasury take action to maximum recovery of CPP loans and to make plans to deal with the banks that cannot repay the taxpayer loans.