Bank Stocks: The Trouble with TARP

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Who Calls the Shots?

Finally, there is the power that the TARP investment gives federal policymakers over bank operations.

With so much of BofA owned by the taxpayers, "we are concerned that common equity is no longer the dominant form of capital at Bank of America," FBR's Miller warned on Jan. 20.

"It is reasonable to assume that political pressure will only mount on [BofA] to do things that may not be in the best interests of its common shareholders," Mutascio wrote on Jan. 20. The arrival of the Obama Administration only adds to the uncertainty.

Standard & Poor's equity analyst Erik Oja raised his rating on shares of BancorpSouth (BXS) in part because the regional bank hasn't needed to take TARP funds. Banks don't know all the disadvantages of taking the TARP bailout, Oja says, because "the government does reserve the right to tweak some of the rules going forward."

For example, analysts warn banks may be forced by the government to loan out money. That may help the U.S. economy recover more quickly, but it could hurt bank balance sheets if they're forced to lend to people and businesses just as their finances are being hurt by a serious recession.

In some cases, banks could be forced to eliminate dividends to common shareholders, Oja warns. While others could be forced to boost lending, even though it's difficult to find creditworthy borrowers in a recession. "Taking that money and putting it to work right now is tough," Oja says.

According to a Keefe, Bruyette & Woods (KBW) analysis, 262 firms have announced they've received TARP capital. Another 121 institutions say they won't seek bailout funds. Most of those refusing TARP money are smaller regional banks, including BancorpSouth, New York Community Bancorp (NYB), and Union Bankshares (UNB).

Investment Pariah or Buying Opportunity?

Many of those who took TARP money simply had no choice as credit losses mount. Those losses remain banks' biggest concern, because they are the reason banks must seek federal bailouts despite the strings attached and the disadvantages to shareholders.

"Credit losses are the key to earnings for any financial company," Miller says. Losses in the housing market, commercial real estate, and other investments and loans are leaving banks dangerously short of capital, analysts warn. "We would avoid not only [BofA's] shares, but also shares of most financial institutions until the companies are better capitalized," Miller adds.

Some analysts look at the cheap stock prices for major banks and see buying opportunities.

Raymond James analyst Anthony Polini rates Bank of America a "strong buy." The bank's "core" annual earnings power is something like $4 per share. "Although it may take three or four years to regain this level of earnings, longer-term investors should be well rewarded for their patience," Polini writes.

One of those long-term investors is the U.S. taxpayer. The Congressional Budget Office on Jan. 16 estimated that, using one method of analysis, the U.S. Treasury's $247 billion in TARP investments made as of Dec. 31 have lost 25% of their value.

Uncle Sam, like ordinary stockholders, can only watch, and wince.

Steverman is a reporter for BusinessWeek's Investing channel.