Should Banks Exiting TARP Still Pay Dividends to Government? (COF, USB, BK, BBT, STT, GS, MS, JPM, BAC)

It is no secret that the banks that can pay the money back want out from under the Troubled Asset Relief Plan, or the TARP.  It is also no secret that the Treasury, the Federal Reserve, and the politicians have not agreed to any terms yet take the TARP monies back from the major money center and larger institutions.  Capital One Financial Corp. (NYSE: COF), US Bancorp (NYSE: USB), Bank of New York Mellon Corp. (NYSE: BK), BB&T Corporation (NYSE: BBT), State Street Corp. (NYSE: STT), Goldman Sachs Group Inc. (NYSE: GS), Morgan Stanley (NYSE: MS), and J.P. Morgan Chase & Co. (NYSE: JPM) are among the larger banks that have said they want to or that have been reported about wanting to pay back those TARP funds immediately.

Even the troubled Bank of America Corporation (NYSE: BAC) has had its CEO Ken Lewis say that he wants to pay back the TARP, although the stress tests showed the need for more capital and ‘B of A’ has been raising capital over the last ten days or so.  Where a large dilemma comes up is regarding future dividends and the warrants held by the U.S. government.  Uncle Sam gets paid dividends every quarter from these same institutions, and Uncle Sam also has a 10-year warrant in each of these institutions.  It is very possible that the government wants more than just two quarters of dividends for the capital it put up.

It appears that the Fed is now setting a decision date of the week June 8, 2009 (according to Bloomberg) as the next review date with an announcement for what it will and/or will not allow for repayment.  But the New York Post has reported this could come as soon as next week.  The “when” may not be as big of an issue compared to “under what circumstances and at what price.”

These banks are paying out dividends on the preferred shares owned by the U.S. government, and the rest of the data herein is is from the Treasury website.  There had been (or is) a three-year non-redemption period for the Senior Preferred shares, with an exception of funds coming from a qualified equity offering.  The rate is 5% per year for five years, and then jumps to 9% per year thereafter.  Dividends are to be paid quarterly in arrears on the 15th day of February, May, August, and November.  These funds also require that there are no changes to other existing dividends (at least on higher dividends).  There is also the notion of the 10-year warrants.

Then there is the power struggle or political angle, which many would not find out of the ordinary any longer under the circumstances.  It was Treasury Secretary Paulson that made the banks take the TARP.  It could possibly be a matter up for debate as to whether the new Treasury Secretary Geithner wants to demonstrate the same power by making the banks keep the TARP funds.  Or there is the notion that Geithner or Bernanke could demand more dividend payments or just demand more money.  The banks that have raised the capital to pay back the TARP will effectively keep the money in escrow even if the “when” remains a question beyond the next couple of weeks.  Those funds will not be touched by the banks, and the government will still get to collect interest due or accrued on this money.

There are many more than two arguments in this case, and it might not be as simple as whether the banks should or should not be allowed to get out from under the TARP.  You could argue that there is a conflict of interest in the government even wanting to take this money back because it is earning a rate of return for taxpayers now.  For better or worse, the TARP did probably save the major banks even if the regulations and constraints that Jamie Dimon noted just today as “having morphed into something different.”  Sure, the government wants its money and the government may feel it is entitled to more.  For the risks it took, the government may also feel that it deserves much more than a couple coupon payments than two 5% annualized dividends plus warrants.

The government knows that if the TARP gets paid back it takes away some more of the current oversight and it also eliminates dividends it receives.  Since the government is the one holding all the cards, there are many outcomes that could come up in the quest to pay back the TARP.  For the money to be repaid, the government could demand a higher return for its risk.  It could demand that the warrants get repurchased at a different rate.  And there is the notion that the government could demand accelerated interest payments.  There is even an outside shot that the government won’t allow any rapid repayment.  What the terms and circumstances end up coming out as are still unknown, and the process and terms are above our pay grade of who gets to know what.

There are several other issues here.  What if the repayment weakens the capital base of these large banks?  No one wants to see even a remote shot that the banks might need to come back to Uncle Sam asking for loans if the economy’s free fall goes into a double-dip.  What if the government feels that the banks paying off the TARP is money that will not be up for loans from the banking system to the consumer?  The government wants loans to be made to the consumer.

It still seems more likely than not that the largest banks will be allowed to pay back the TARP money.  At what rate, at what penalty, and under what terms, that is where the real questions come into play.

JON C. OGG
MAY 19, 2009