Oct. 29 (Bloomberg) -- The U.S. government's $160 billion handout to banks from Niagara Falls to Beverly Hills is going mostly to lenders that need it least, putting weaker rivals at risk of being shut down or taken over, analysts say.

``This has the unintended effect of making the strong stronger and the weak weaker,'' said Gray Medlin, founder of Carson Medlin Co., a Raleigh, North Carolina, investment bank focused on banking deals. ``Banks that are getting bad exams and are under intense pressure from regulators won't be successful in applying.''

The government buying spree has so far targeted two dozen regional lenders. One, PNC Financial Services Group Inc., immediately bought a competitor, National City Corp. Another, Saigon National Bank, had almost four times the minimum level of capital before selling a $1.2 million stake.

Treasury Secretary Henry Paulson is doling out cash to recapitalize lenders and jump-start takeovers. Besides PNC and Saigon National, regional lenders that have accepted government stakes in exchange for cash include SunTrust Banks Inc., Capital One Financial Corp. and KeyCorp. They also include City National Corp., in Beverly Hills, and First Niagara Financial Group Inc., in upstate New York.

``The goal with this over time is to drive consolidation,'' said Ron Farnsworth, chief financial officer of Umpqua Holdings Corp. in Portland, Oregon, which expects to sell a $246 million stake to the government. Takeovers, either independently or helped by the Federal Deposit Insurance Corp., are ``definitely one of the opportunities we have,'' Farnsworth said.

Boehner's Letter

House Minority Leader John A. Boehner, an Ohio Republican, today questioned the program, saying in a letter to Paulson that ``funds made available under the economic rescue package should not be used to pay for bank acquisitions, raises, and executive bonuses.'' His letter came as House Speaker Nancy Pelosi, a California Democrat, and Majority Leader Harry Reid, a Nevada Democrat, told Paulson to restrict pay at firms that get government money.

Banks that haven't yet joined the government's Troubled Asset Relief Program, or TARP, include Colonial Bancgroup Inc., a Montgomery, Alabama-based lender that lost $71 million in the third quarter and had its credit rating reduced Oct. 27 to BBB-by Fitch Ratings, the lowest investment-grade rating. Colonial has a Tier 1 capital ratio of 10 percent, compared with the 6 percent level deemed ``well-capitalized'' by regulators.

High Exposure

``I'd view their approval in the TARP as unlikely,'' said Adam Barkstrom, an analyst at Sterne Agee & Leach Inc. in Baltimore. ``They have a high exposure to Florida residential construction loans and there is a perception that they have been dragging their feet in addressing their problems.''

Colonial Chief Financial Officer Sarah Moore said the lender was ``interested'' in the funding, and that it could be eligible for as much as $570 million. Banks have until Nov. 14 to apply to the Treasury's program.

Some lenders, including International Bancshares Corp., Trustmark Corp. and Park National Corp., have said they intend to apply for Treasury funds. IBC and Park National both said shareholders must vote to permit issuing preferred shares.

Of 60 banks followed by Sterne Agee, five may not qualify for government help, the firm said in a report yesterday. Four of those are in Alabama or Florida, states hurt by the housing- market meltdown. The government money ``amounts to a sort of `seal of approval' from the Treasury,'' CreditSights Inc. analysts led by David Hendler wrote in a note Oct. 27.

Struggling the Most

``Those struggling the most probably aren't going to participate,'' said Karen Dorway, president of BauerFinancial, a Coral Gables, Florida-based research firm that studies the financial health of banks. She included as examples Downey Financial Corp., BankUnited Financial Corp. and Vineyard National Bancorp.

All three are operating under regulatory enforcement orders, and Downey earlier this month reported its fifth consecutive quarterly loss, bringing the total to $680 million. Downey said on Sept. 5 it had until Oct. 20 to submit a long-term plan to the Office of Thrift Supervision. Elizabeth Stover, Downey's spokeswoman, said on Oct. 22 that the company wouldn't discuss the plan publicly.

The government isn't forthcoming on explaining the purchase program because of concern it may spark bank runs, said Randy Dennis, president of DD&F Consulting, a Little Rock, Arkansas, firm that advises banks. ``Banks that are left out will have to deal with the PR effect of not being included,'' he said.

Good Deal

Some lenders say the deal was too good to refuse. The preferred shares that banks are selling to the U.S. Treasury yield 5 percent annually for the first five years before increasing to 9 percent.

``The program is so attractive that even though we have a fairly strong capital ratio, we just felt that it was an opportunity to get capital at a very attractive rate,'' said Roy Painter, chief financial officer at Saigon National, based in the Orange County, California, community of Westminster. ``We're a small organization, we expect to grow, and we'll need the additional capital down the road.''

Being early to attract Treasury's attention is an advantage, Farnsworth said in an interview Oct. 28. ``In the next few weeks, smaller banks are going to be reaching out to the FDIC saying, `Hey, we'd like some.'''

To contact the reporters on this story: David Mildenberg in Charlotte at dmildenberg@bloomberg.net; Linda Shen in New York at lshen21@bloomberg.net

Last Updated: October 29, 2008 12:59 EDT