Banks Leave the Bailout Behind

Treasury Secretary Timothy Geithner and regulators gave 10 of the country's largest banks the OK to repay bailout funds, creating banking haves and have-nots.
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Updated from 1:11 p.m. EDT

Now that the guessing game over the first round of bailout repayments is over, the real games will begin.

The Treasury Department confirmed on Tuesday that 10 of the country's largest banks will be allowed to repay $68 billion worth of government funds from the Troubled Asset Relief Program. As those firms move toward independence, nine other banks that underwent regulatory stress tests still have more work to do before fully recovering their competitive edge.

The Treasury did not disclose which banks gained approval, but those that confirmed or were widely expected to be among the 10 include

JPMorgan Chase

(JPM) - Get Report

,

Goldman Sachs

(GS) - Get Report

,

American Express

(AXP) - Get Report

,

Morgan Stanley

(MS) - Get Report

,

Bank of New York Mellon

(BK) - Get Report

,

State Street

(STT) - Get Report

,

US Bancorp

(USB) - Get Report

,

BB&T

(BBT) - Get Report

,

Capital One

(COF) - Get Report

and

Northern Trust

(NTRS) - Get Report

.

The announcement comes after the

Federal Reserve

said on Monday evening that it had

approved plans from 10 banks that were required to outline how they would raise more capital to cope with a severe economic scenario. Among those firms were the country's biggest bank,

Bank of America

(BAC) - Get Report

, as well as

Wells Fargo

(WFC) - Get Report

and

Citigroup

(C) - Get Report

, which all seem to have a longer road to recovery ahead.

"These repayments are an encouraging sign of financial repair, but we still have work to do," Treasury Secretary Tim Geithner said in a statement.

House Financial Services Committee Chairman Barney Frank (D., Mass.) called the announcements "good news," since it showed that several banks have started down the road to recovery. He also noted that they have paid the government $4.5 billion in preferred dividends and that more than one-third of taxpayers' initial investment is soon to be recovered.

For the banks returning bailout money, the good news is getting out from under the government's thumb. With Uncle Sam's capital infusions came executive-compensation limits, regulatory reviews, management shake-ups and political pressure to lend to businesses and consumers at low interest rates. None of that bodes well for bank operations or the managers butting heads with regulators while trying to hold onto their jobs. As a result, banks rushed to the market to raise new capital above and beyond required targets to repay government funds as swiftly as possible -- with remarkable success.

"Getting government money by its very nature implies government meddling," says Roger Young, portfolio manager for Miller/Howard Investments. "The fact that TARP has been taken means the camel's nose is under the tent."

BB&T CEO Kelly King put it bluntly in a statement, saying that repaying TARP funds would give the bank "greater flexibility" and allow it to become "more focused on the business of serving our clients, rather than dealing with government distractions." But firms that did not gain approval to get out from beneath what JPMorgan CEO Jamie Dimon called the "scarlet letter" of TARP are facing a double-edged sword.

The perception alone of being a bank on the government's dole does not bode well for business. And while the added support could help those firms get through extreme headwinds, it also stands to hinder their competitive advantage and ability to make wise business decisions if those decisions stoke public outrage.

The brouhaha over bonus payments at Bank of America's

Merrill Lynch

and

American International Group

(AIG) - Get Report

provided evidence of how powerful populist backlash can be. Clashes with politicians over decisions at

Freddie Mac

(FRE)

and

Fannie Mae

(FNM)

, which are largely owned by the government, have also led executives to bristle or walk away.

Bank of America has undergone several changes to management and its board stemming from a compulsory review, led by newly minted Chairman Walter Massey. He was put in place in late April after shareholders voted to strip CEO Ken Lewis of the chairman's title at the annual meeting.

But while BofA has fresh blood on its board and expects to exceed regulators' demands to raise $33.9 billion in capital, the firm has $45 billion in TARP funds to repay, not including a buyback of government stock warrants. While trying to accomplish that feat, the bank is still working through the mammoth integrations of two troubled firms, Countrywide Financial and Merrill Lynch, not to mention related shareholder animosity and government inquiries.

As the largest bank in the country, BofA also faces continued stress in its normal business operations as the economic crisis persists - struggles that Citigroup and Wells Fargo also face.

For its part, Citi is undergoing a huge restructuring plan to get back to basic banking after exposure to toxic financial products led it to seek more than $45 billion in government bailouts. Because of its huge losses and lack of tangible capital, the government is set to become the biggest shareholder in Citi, owning more than 35% of the company once it completes a preferred-to-common equity swap in coming days.

The case of Wells Fargo is less clear. The firm has touted its financial might, asserted that it didn't need government funds to begin with, and insisted that its legacy assets have been written down so far that they stand to gain value, not lose more. However, worries persist that its acquisition of

Wachovia

, and its heavy exposure to West Coast markets undergoing severe economic strain, will weigh on results. The government told Wells that it would need to raise $13.7 billion, despite its insistence to the contrary.

Besides the BofA-Wells-Citi triad, others that were required to raise tens of billions in fresh capital include

Fifth Third

(FITB) - Get Report

,

PNC

(PNC) - Get Report

,

KeyCorp

(KEY) - Get Report

,

SunTrust

(STI) - Get Report

and

Regions Financial

(RF) - Get Report

-- whether because of asset mix, asset quality or regional exposure.

Needless to say, these banks are in a less-than-ideal position when competing against the managerial prowess of Dimon, who has charmed regulators and investors alike, or the market savvy of Goldman Sachs and Morgan Stanley. Firms are competing for investor dollars, deposits, loans to creditworthy consumers, and top talent that is also being scouted by hedge funds and private equity firms that don't have to deal with as much regulatory scrutiny.

In order to repay the funds, firms had to prove they can access the equity and debt markets without government assistance, that their capital levels will remain strong while lending prudently, and that the management in place is prepared and experienced enough to handle a worst-case economic scenario.

Bart Narter, senior banking analyst at Celent, says it's "mostly a good thing" to repay the TARP funds quickly, but notes that there is one downside.

"It gives them a leg up in that they have more flexibility, they can pay better," says Narter. "But they also have a leg down in that they don't have as much capital."

However, few seem to be concerned about capital levels for the healthiest banks, which have had great success in tapping the markets for necessary funds and have become incredibly prudent about lending standards. The industry is certainly not concerned. Steve Bartlett, president and CEO of lobbying group The Financial Services Roundtable, said banks were "well-capitalized" and called the repayments "a positive sign for the industry and the economy."

Young goes a step further, saying "the good guys, so to speak, had to raise far more capital than was necessary." While that might be a positive thing down the line when economic conditions improve, he notes that loan demand today "isn't really sucking up that excess capital."

Young also notes that given the regulatory overhaul underway, including executive-compensation guidelines expected to be unveiled by Geithner any day, getting out from under TARP will not be a panacea to what some consider excessive oversight.

"Anybody who has taken TARP will experience the camel's nose under the tent phenomenon," says Young. "That's going to last awhile until this tarp thing disappears from the headlines. Even the good guys are going to experience the nose under the tent."