I got an interesting response from one reader to my post on whether healthy banks should be able to give back TARP funds. Here it is, with permission; the short version is basically "no".
The TARP preferred shares were extended to the major banks last year with a 5% dividend for the first 3 years, stepping up to 9% after the third anniversary. As orginially written, TARP preferred could only be repaid with the proceeds of equity issuances during the first 3 years. Apparently a clause slipped into the stimulus package gives the Treasury Secretary the option to waive that requirement. I think that TARP money should only be allowed to be repaid if fresh equity is raised from the market, and preferably in the form of common stock.
Let’s look at Goldman as an example of a bank that has expressed a desire to repay TARP funding. A few relevant facts:
1) At $100, Goldman has a $46 billion market cap. Assuming no placement discount, Goldman would have to issue 22% of new common shares to repay TARP, effectively telling the market that GS common shares at $100 are a cheaper form of capital than a preferred yielding 5%.
2) Use of proceeds of the equity deal should be properly disclosed as allowing insiders to enrich themselves with higher compensation without government scrutiny. Beyond that, there is no reason to accelerate repayment within the initial 3 years.
3) Based on the terms Buffett extracted on his preferred, GS could not issue 5% prefs today. Again, how could you justfiy paying a higher dividend on a new pref? Other than to facilitate executive looting, I cannot think of a reason.
4) If Geithner waives the equity issuance, where will the money have come from? According to Bloomberg, Goldman has issued about $22 billion of government-guaranteed debt this year. Given the fungibility of money, couldn’t one argue that the government has allowed Goldman to issue debt so that it could buy back its equity and weaken its balance sheet during a crisis? If markets dip again and Goldman needs help, what would we do?
5) Alternatively, one could argue that Goldman is taking its AIG proceeds to buy back TARP preferreds. I know that their CFO said they didn’t need the AIG bailout given their hedges. At the risk of sounding like Maxine Waters, Blankfein (current CEO) reportedly advised Paulson (prior CEO) during the AIG bailout process. To avoid the appearance of a conflict of interest, perhaps Goldman should voluntarily disgorge its AIG hedge profits since the government made them whole on their contracts (based on Blankfein’s counsel).
6) If Goldman escapes the TARP program’s scrutiny after a waiver, they will have a competitive advantage in recruiting, and other, potentially weaker banks would seek the same waiver. It would set off an arms race to repay TARP preferreds, weakening the balance sheets of large banks. And the primary reason would be to allow executive looting to resume without scrutiny. Again, if we dip again what does Treasury do?
7) Goldman is now a bank holding company but I see little evidence of a stable deposit base or other implementation of a bank holding company business plan. Shouldn’t we evaluate that before we allow them to weaken their equity base?
8) Shouldn’t we have a regulatory structure in place before we allow banks to reduce their capital cushion?
I am a portfolio manager following emerging markets stocks. I have no dog in this fight other than being a participant in equity markets and an American taxpayer.
This all makes perfect sense to me, and can be applied mutatis mutandis to any other bank thinking of paying back its TARP funds too. The government recapitalized the banks with TARP funds because the equity markets were closed. The equity markets are still closed. So for the time being, any talk of paying back TARP funds is surely premature.