Why some small banks still love TARP

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NEW YORK (CNNMoney.com) -- When it comes to TARP, it's better late than never for some banks.

Many community banks are still seeking funds through the government's controversial Troubled Asset Relief Program -- despite all the baggage that comes with a TARP loan.

Last week, the Nebraska-based State Bank of Bartley became the latest recipient of the program, accepting $1.7 million in government aid, according to the latest Treasury Department's transaction report.

And in late August, a trio of privately-held firms heralding from rural Louisiana, Detroit and Hilton Head Island, S.C. all issued preferred stock and warrants to the government in exchange for a combined $40 million in fresh capital.

So far, Treasury has invested more than $204 billion in about 600 different financial institutions through TARP. Roughly two thirds of those lenders are community banks, according to estimates by the American Bankers Association.

Banking experts said a main reason for the continued interest in TARP is because small banks are facing intense pressure from regulators to raise new capital to withstand future loan losses.

Unfortunately for many of these lenders, it is still difficult to secure private capital through traditional means.

Closely-held institutions, for example, have had little luck convincing existing stakeholders to invest more, particularly as loan losses continue to climb.

And while TARP is hardly cheap, for many lenders it is the "least worst" option, especially since other capital-raising methods, such as issuing trust-preferred securities or subordinated debt, are just not feasible.

"It's not the cost we wanted to pay [for capital], but it was an acceptable amount," said one community bank CEO whose firm accepted TARP funds earlier this year, but who declined to speak publicly on the matter.

"If you did go to the capital markets, it would be extremely expensive," the CEO added.

As a group, banks and thrifts have raised a little over $300 million in subordinated debt so far this year, according to research firm SNL Financial. That's a fraction of the $12.7 billion during the same period in 2007.

That has left many lenders with little choice but to ask for TARP funds.

"A good chunk of the banks are being asked to have higher capital levels than the regulations require," said Doug McClintock, a partner at law firm Sonnenschein Nath & Rosenthal.

The rush to ask for more TARP funds by small banks comes at a time when larger rivals are looking to exit the program and the Treasury Department is talking of winding down some of the support for the financial services sector.

Many big banks have expressed concerns about the price of government support. Others worry that regulators could change the terms tied to taking TARP loans as they saw fit in the future. Specifically, there were plenty of fears about the compensation restrictions on banks accepting bailout funds.

Once the government outlined the terms for TARP repayment this spring, several banks raced to pay it back. JPMorgan Chase (JPM, Fortune 500), BB&T (BBT, Fortune 500) and Capital One (COF, Fortune 500) led the charge.

Chris Cole, senior regulatory counsel at the Independent Community Bankers of America, said many small banks have also resisted TARP out of fear of similar restrictions and due to the program's unpopularity with taxpayers.

"Some customers don't like it," he said. "Banks have responded to that by saying we don't want to turn to TARP because of what the response will be."

Despite this, there has been talk in Washington of broadening the program even further to help banks that might otherwise be rejected for a loan because of their poor health. Under that proposal, banks would be eligible for TARP funds as long as they could raise matching funds from private investors.

This initiative, which appears to have the backing of community banking industry, would expand the list of program recipients. And as more banks realize they have few other options than government aid, it almost seems certain that the number of TARP takers will only climb from here.