Small Banks Say 'No Thanks' to U.S. Bailout Money

Healthy small bankers would like the boost to lend more, but fear regulations and conditions attached to the Treasury Dept.'s rescue program

When Smithtown Bancorp (SMTB) applied for money last year from the U.S. Treasury's $700 billion rescue program, CEO Bradley E. Rock figured the Hauppauge (N.Y.) bank could use the cash to boost lending. Then politicians started pushing for conditions on the capital they were offering, and Rock decided the money wasn't worth it. In late January he refused a $37.8 million investment from the government. "I would never agree to let Congress tell us which loans we should and shouldn't make," says Rock.

While many of the nation's largest banks are asking for second helpings of aid, a growing number of small and regional banks are refusing the government's help altogether. The concern among the healthy lenders is that regulators will dictate how they structure dividends, compensate managers, or make acquisitions. Worse, they worry that the government will impose lending quotas or force them to make loans that may not be in the banks' best interests.

The fear is so pervasive that it could hamper the government's ability to revive the economy. By injecting cash directly into banks, regulators are hoping to jump-start the credit markets. But the government probably didn't anticipate that some of the strongest lenders—those most likely to funnel federal funds directly into new loans—would take a pass. Meanwhile weaker banks, which need cash just to stay afloat, can't afford to plow all of the fresh capital into loans.

The difference between the nation's largest banks and their smaller brethren is stark. The big banks grabbing the headlines have roughly $9 of capital for every $100 of assets, says researcher SNL Financial. Small and regional players have more than $13 in capital for every $100 in assets. With a better capital cushion and less exposure to risky debt, those banks can use the cash to bolster lending. "If we don't fix Main Street banks, it ain't gonna make a lot of difference on Wall Street," says Walter G. Moeling, a consultant at law firm Bryan Cave.

It doesn't help that healthy banks are also concerned about the stigma of seeking government assistance. Ever since the rescue plan was announced back in the fall, investors have been thrashing the stocks of lenders that take aid. "There were a number of banks that were torn by whether to apply or not," says New York Superintendent of Banks Richard H. Neiman, one of the regulators overseeing the bailout program.

In all, more than 50 banks have decided not to take money. Legacy Bancorp (LEGC) of Pittsfield, Mass., was approved for $20 million last month, but said it wouldn't accept the money. Mechanics Bank of Richmond, Calif., withdrew its application for $60 million.

NewAlliance Bank (NAL) CEO Peyton R. Patterson didn't even bother to fill out the form. She didn't want to risk restrictions on the bank's share repurchases and dividend payouts. The New Haven bank, which maintained high lending standards during the boom, had the luxury of walking away. Unlike peers dealing with historic losses, NewAlliance's earnings almost doubled to $45.3 million last year, as lending increased 38.5%. Says Patterson: "We quickly understood that the money would not have any benefits to us."

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