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It was only about fifteen months ago that, in an effort to restore confidence in the ailing banking sector and jump start loan growth, the U.S. Treasury launched its $700 billion TARP, or Troubled Asset Relief Program. The first $250 billion was used to inject funds into the sector via purchases of preferred stock and warrants, first from nine of the largest banks in the U.S., followed by similar investments in hundreds of smaller banks. The money came with increased government oversight and, from the start, the banks vowed to repay the funds as soon as possible.  Since last June, a number of the stronger banks---JPMorgan Chase (JPM) was one the the first---have done just that, after obtaining permission from their regulators and fortifying their balance sheets by selling additional common stock. Even still-struggling Citigroup (C) obtained permission to repay the TARP funds in December.

Did the TARP program accomplish its goals? Yes and no. On the one hand, the government infusion appears to have stabilized the bank sector. Bank stock prices have recovered some of the ground lost since the financial crisis erupted in September  of 2008, as investors became convinced that the larger banks wouldn’t be allowed to fail. On the other hand, the program wasn’t able to reignite loan growth.  Having made lots of bad loans during the housing boom, banks are now confining new lending to their most credit-worthy customers. Although the economy may be strengthening, the housing market isn’t back on its feet yet and the banks fear that continued high unemployment increases the chances of  a new wave of mortgage and small business loan defaults.  At the same time, the recent recession has put companies in a more conservative mood, and many are repaying bank loans or cutting back on using lines of credit. It probably will take progress on both the housing and employment fronts before new loan generation picks up.  At the end of September,  Regions Financial’s (RF) loan balances were down 6% year to year; KeyCorp’s (KEY)  loans fell nearly 15% over the same period. The declining loan balances are bound to depress net interest revenue in 2010, even if rising interest rates later this year give banks the opportunity to expand their lending margins.

Are the banks that have repaid the TARP investments now free of government involvement in their operations?  We don’t think so.  Banks have always been more regulated than most other industries because of their role in providing the financial wherewithal to keep the economy running smoothly. In the wake of the recent financial crisis, pressure to avoid future meltdowns could result in increased regulation of almost every aspect of banking. Consumer safeguards probably will affect the service fees that banks can charge.  Efforts to limit bank executive pay, or link pay inversely to the amount of risk a bank takes, may enjoy partial success.

What opportunities do the stronger banks have as the industry heals itself? Some have been making acquisitions of small troubled banks or their assets at attractive prices. Bankruptcy filings by small banks, which don’t have the range of revenue sources of the larger ones, have been on the rise. U.S. Bancorp (USB), one of the strongest banks in the nation, recently acquired, in an FDIC-assisted transaction,  some of the assets and deposits of a company with nine subsidiary banks, thereby expanding its distribution network in high-growth markets like California and Texas. Loss protection on most of the loans acquired was part of the deal. Many more such transactions are likely as the bank industry moves further along the recovery path.