TARP Becomes Trap for Many Small Business Lenders
As American small businesses continue digging out of the Great Recession, they may find their access to cash blocked in yet another way--community banks that have taken Troubled Asset Relief Program, known as TARP, funds from the U.S. Department of the Treasury.
Small businesses depend heavily on community banks for loans.
While the country's biggest banks have already repaid TARP funds with interest, about 300 community banks have yet to repay their Treasury loans four years after the bailout began. As Treasury starts to unwind the program, it is raising interest rates and selling its preferred bank shares to private investors. Such moves could further restrict bank lending to entrepreneurs as community banks look for ways to exit TARP.
"The need to repay TARP capital is what depresses [community banks'] lending ability," says Rob Klingler, an attorney for Bryan Cave, a global business litigation firm, in Atlanta. The law firm represents many community banks.
And community banks, of which there are more than 6,000 in the United States, depend on new loans to small businesses to make money.
Banks with less than $5 billion in assets made $336 billion in small business loans in the first quarter of 2012, compared to $311 billion by banks with greater than $5 billion in assets, according to the Federal Deposit Insurance Corporation. That amounts to nearly a quarter of all loans smaller banks made, compared to just 5% for the largest banks.
"Small banks are definitely the driver of small business," says Joshua Siegel, founder and managing principal at StoneCastle Partners, a financial firm that invests in community banks and is based in New York City.
But community banks, many of which are small businesses themselves, have gotten caught in something of a triple whammy. Unlike the largest banks, which can go to the public markets to raise money, most community banks can only tap local investors or their current shareholders. TARP was important to many, not because they needed a bailout, but because it provided a cheap source of new capital, experts say.
New regulations, stemming from the Dodd-Frank Act, have also forced community banks to increase their capital ratios to about 12% from 8%, which means banks need to have more cash on hand in case of emergencies. That coincides with TARP banks needing to pay dividends on Treasury money, as well as the principal and interest. All of these things cut into the ability of community banks in TARP to loan to small business.
"Because capital has been so hard to raise over the last four years, the simplest and most straightforward way has been to shrink assets, which means loans," says James Chessen, chief economist for the American Bankers Association. (Banks count the loans on their books as assets.)
The decline in loans is borne out by federal data. The number of small business loans, defined as loans of $1 million or less, declined 4.7% in 2011, according to the Federal Reserve Board of New York in its most recent survey of 544 small business owners. Forty-two percent of respondents said banks were not lending to their types of business, and nearly half of companies said they did not apply for bank loans because they did not think they would be approved.
Meanwhile the most credit-worthy small businesses are not borrowing, fearing a worsening economic situation, and the quality of small businesses that want loans has deteriorated, making them riskier bets, experts say.
"The vast majority of businesses we deal with, it is a harder environment for them to make money," Howard Hall, chief financial officer of Team Capital Bank, a community bank with 136 employees, based in Bethlehem, Pennsylvania, says.
Team Capital's bread and butter is small business lending, and more than 65% of its total $500 million loan portfolio is for small business loans. Though Team Capital was not a TARP recipient, last July the bank received capital from the Small Business Lending Fund worth $22 million. That program, also operated by Treasury, works much the same way TARP does, but it provides capital at interest tied to the volume of small business loans the bank makes.
Though many community banks in this program have, controversially, used this money to pay off TARP rather than lend to small business, Hall says the money will help Team Capital make $200 million in loans to local small businesses, and it has enabled it to loan out $40 million in the past year.
Still, Hall says Team Capital's loans to local small businesses could be stronger.
"We are only as healthy as the economies in which we operate," Hall says.