Capital Purchase Program Research Articles

The Carrot and the Stick: Bank Bailouts and the Disciplining Role of Board Appointments

We empirically examine the Capital Purchase Program (CPP) used by the US government to bail out distressed banks and its implications for regulatory policy. We find strong evidence that a feature of the CPP—the government’s ability to appoint independent directors on the board of an assisted bank that missed six dividend payments to the Treasury—had a significant effect on bank behavior. Banks were averse to these appointments—the empirical distribution of missed payments exhibits a sharp discontinuity at five. Director appointments by the Treasury were associated with improved bank performance and lower CEO pay. (JEL G21, G28, G32, G34, G35, G38, H81)

The Carrot and the Stick: Bank Bailouts and the Disciplining Role of Board Appointments

This paper empirically examines the Capital Purchase program (CPP) under TARP that was usedby the U.S. government to bail out distressed banks with equity infusions. We hypothesize that a feature of the CPP, namely the ability of the government to appoint directors on the assisted bank’s board in case it missed six quarterly dividend payments, was a governance intrusion that banks would wish to avoid. Therefore, it would address both (i) the ex ante moral hazard that banks would take actions that increased the likelihood of a future government bailout as well as (ii) the ex post moral hazard that banks would undertake actions after receiving bailout funding that would increase the government’s risk exposure. We find evidence consistent with this hypothesis: in the empirical distribution of missed payments there is a sharp discontinuity at five and the probability of a sixth missed payment after missing five payments is sharply lower than the other transition probabilities. The appointment of government directors improves the bank’s profitability and reduces its risk. As a special case, the firing of Citicorp’s CEO in the third quarter of 2012 after the appointment of new directors on its board, pursuant to government participation in its common equity, induced a sharp exodus of assisted banks from the CPP.

Impact of Government Bailout on Banks’ Cost of Equity: Additional Evidence from the Financial Bailout of 2008–2009

The Capital Purchase Program (CPP) was the first and most significant program under the Troubled Asset Relief Program (TARP) during 2008–2009 financial crisis. This study evaluates the effect of the CPP during this period on the cost of equity of 170 publicly listed banks in the United States that received funding. To control for the potential effects of endogeneity on our results, we use a propensity score matched sample of non-CPP banks. Using this approach, we document robust evidence that the liquidity provided by the government bailout reduced the cost of equity for recipient banks, especially for those banks that repaid their bailout funds in full. This decrease in the cost of equity is particularly significant for banks with high market-to-book ratios, low concentrations of institutional ownership, and those banks with at least one large blockholder. Our findings have important implications for the assessment of government bailout programs and the future regulation of financial institutions.

How Do Banks Use Bailout Money? Optimal Capital Structure, New Equity, and the TARP

Between October 28, 2008 and June 30, 2009 over 600 banks and bank holding companies accepted money from the United States government in exchange for preferred shares and warrants. Based on a matched sample of banks participating and not participating in this Capital Purchase Program (CPP), of each dollar of new government equity, on average participants levered roughly 13 cents to support increased lending while they used roughly 60 cents to increase their regulatory capital ratios. Over the previous business cycle, 2000–2008, allocation of new capital to support lending was higher than in 2008–2009 by nearly 30 cents per dollar of new capital. Moreover, in the previous downturn, 2000–2001, allocation to new lending was higher by an even greater amount. Banks’ exposure to past-due loans, which was higher in 2008 than in 2000 or in any other sample year, negatively predicts allocation of new capital to new lending. Characteristics of CPP participants suggest they were of two types: those with high commitments and opportunities for new lending, and those with exposures to certain troubled loan classes. Banks with high leverage and high expected costs of regulatory downgrades also were more likely participants. All of these results are consistent with banks having an optimal, target capital structure based on some form of tradeoff theory.

The Carrot and the Stick: Bank Bailouts and the Disciplining Role of Board Appointments

We empirically examine the Capital Purchase Program (CPP) used by the US government to bail out distressed banks with equity infusions during the Great Recession. We find strong evidence that a feature of the CPP - the government's ability to appoint independent directors on the board of an assisted bank that missed six dividend payments to the Treasury - helped attenuate bailout-related moral hazard. Banks were averse to these appointments - the empirical distribution of missed payments exhibits a sharp discontinuity at five. Director appointments by the Treasury led to improved bank performance, lower CEO pay, and higher stock market valuations.

The impact of government assistance on banks' efficiency

AbstractThis study investigates the impact of the Capital Purchase Program (CPP) on recipient banks' efficiency. While the related literature typically relies on the Difference‐in‐Differences (DiD) approach, which has considerable limitations in this context, we conduct Instrumental Variable analyses by adopting three innovative instruments based on the influence of donations to political campaigns on receiving government support. Using data from 2000 to 2017, we find that CPP assistance has a significant negative causal relationship with recipient banks' efficiency. Our results are robust to alternative sample specifications and estimation methods.

The cohabitation of institutional investors with the government: A case study of the TARP–CPP program

We take advantage of a unique setting taken place in the U.S. during the financial crisis of 2007–2009 to examine institutional investors’ investment behavior surrounding government investments. We examine 202 publicly-listed banks that received bailout funds through the Troubled Asset Relief Program Capital Purchase Program (TARP–CPP). We document that banks with higher existing institutional ownership, especially long-term oriented institutional ownership, were more likely to receive CPP funding. These banks were also more likely to pay back bailout funds in a shorter timeframe. We argue that the institutional investors profitably exploited the market signals emanating from TARP–CPP. Initially, they supported banks’ access to cheap TARP–CPP funding from the U.S. Treasury, which also benefits them as shareholders. Next, they espoused the recipient banks’ decision to repay the CPP funds expeditiously by issuing new shares to manifest their capital-raising ability to the U.S. Treasury which causes a dilutive effect.

Impact of Government Bailout on Banks' Cost of Equity: Additional Evidence from the Financial Bailout of 2008-2009

This study evaluates the effect of the Capital Purchase Program during the 2008-2009 financial crisis on the cost of equity of 170 publicly listed banks in the United States that received funding. We document robust evidence that the liquidity provided by the government bailout reduced the cost of equity for recipient banks, especially for those banks that repaid their bailout funds in full. The decrease in the cost of equity is particularly significant for banks with high market-to-book ratios, low concentrations of institutional ownership, and those with at least one large blockholder. Our findings have important implications for the assessment of government bailout programs and future regulation of financial institutions.

The effect of TARP on loan loss provisions and bank transparency

Abstract We empirically investigate the effect of the Capital Purchase Program under the Troubled Asset Relief Program (TARP) on the transparency of participating banks by examining changes in their loan loss provisions. We demonstrate that TARP banks reduced transparency to a greater extent than non-TARP banks did by recognizing smaller and less timely loan loss provisions for changes in nonperforming loans and increasing discretionary loan loss provisions more after receiving TARP funds. While the reduced timeliness was mainly observed in large TARP banks and banks with low tier 1 capital or high earnings, small TARP banks and banks with low earnings significantly increased their discretionary provisions. In addition, the decreased timeliness and increased discretionary provisions were mainly driven by TARP banks that did not repay their funds. TARP banks’ reduced transparency, which inhibits the accurate assessment of bank risk by outsiders, is consistent with moral hazard in disclosing their financial reporting information.

A test of the feasibility of a common risk accounting metric for enterprise risks

The risk accounting technique proposed by Grody and Hughes introduces a common enterprise risk measurement framework and a new risk metric — the risk unit (RU) — to express all forms of enterprise risk. The method’s creators contend that the application of an additive, common risk metric enables the consistent and comparable calculation and reporting of exposure to enterprise risks. The method’s alignment with accounting systems provides a single source of risk data derived from official accounting records and a common framework for the control and reporting of both financial and operational risk information. This paper describes the methodology formulated to test the feasibility of the proposed common risk metric, the RU. Fundamental to the approach is the restatement in RUs of publicly available US bank call report data provided by the Federal Reserve Bank of Chicago. Given the exceptionally large volume of data to be examined, non-parametric conditional density analysis will be applied to both call report (US Generally Accepted Accounting Principles (GAAP)) and RU data to conclude on the feasibility of providing complete, accurate, comparable and timely enterprise risk reporting in RUs using the risk accounting method. The existence of inherent predictive properties in RUs will be tested by examining trended data in RUs in the period leading up to and beyond the global financial crisis of 2007/08 and analysing the correlations between RUs and unexpected losses. For this purpose, amounts applied by the US government to purchase equity from banks under its Capital Purchase Program (CPP) as part of the Troubled Assets Relief Program (TARP) will be used as proxies for unexpected losses.

The distribution of the Capital Purchase Program funds: Evidence from bank internal capital markets

AbstractWe investigate the role played by the internal capital markets of bank holding companies in the distribution of the Capital Purchase Program funds to subsidiaries. We find that while all banks used a similar internal capital allocation to support their subsidiaries, program participants transferred more capital to their subsidiaries than nonparticipants. Smaller bank subsidiaries with lower capital and earnings received more capital than other subsidiaries. Our results support the argument that the distribution of capital was done in accordance with regulatory requirements that mandate bank holding companies to act as a source of strength for their subsidiaries.

Tarp Warrants: How Much to Bid?

In 2009, Tim Laramy, a portfolio manager, was trying to decide what amount, if any, to bid for TARP warrants soon to be up for auction by the U.S. Treasury. This case discusses the 2008 Wall Street bailout, the Capital Purchase Program, and the histories of three major banks. It has been used in a first-year MBA program. Excerpt UVA-F-1642 Rev. Feb. 16, 2016 TARP Warrants: How Much to Bid? For once we'd like to get a fair value when we come into contact with the banking system. We don't want a ruthless bargain. —U.S. Congressman Brad Miller (D-NC), May 22, 2009 In the wake of the 2008 financial crisis, Laramy Capital Management had managed to rebound nicely. Scooping up beaten-down financial stocks that had become out of favor following the broad market meltdown, portfolio manager Tim Laramy recouped a healthy share of his fund's 30% loss from 2008. . . .

The Impact of Capital Purchase Program on the Capital Ratio of U.S. Banks

The Impact of Capital Purchase Program on the Capital Ratio of U.S. Banks

US bank failure and bailout during the financial crisis

Purpose This paper aims to examine the characteristics of banks that were the target of intervention in the form of bailout or failure during the financial crisis and, of those subjected to intervention, what characteristics distinguish those that received bailout funds from those that were deemed failures. Design/methodology/approach The study estimates a series of logit regressions in an effort to identify the causes of regulatory intervention while controlling for bank-level characteristics and the economic and regulatory environment. Findings The empirical results indicate that many of the same characteristics associated with banks receiving bailout funds are similar to the characteristics associated with failed banks. However, non-performing loans increased the likelihood of failure, but reduced the likelihood of a bank receiving Capital Purchase Program (CPP) funds, suggesting that regulatory authorities discriminated in their use of CPP funds based on the quality of a bank’s asset portfolio. Further, those banks located in states with limits on de novo branching and those banks that are part of a multi-bank holding company structure were less likely to fail but were more likely to receive CPP funds. Originality/value This paper provides a comprehensive analysis of regulatory intervention in the banking industry during the late 2000s financial crisis and the impact of different banking organizational structures, economic circumstances, and financial fragility on the likelihood of a bank failing or receiving bailout funds.

The effectiveness of TARP-CPP on the US banking industry: A new copula-based approach

Following the 2008 financial crisis, regulatory authorities and governments provided distressed banks with equity infusions in order to strengthen national banking systems. However, the effectiveness of these interventions for financial stability has not been extensively researched in the literature. In order to understand the effectiveness of these bailouts for the solvency of banks this paper proposes a new model: the Longitudinal Binary Generalised Extreme Value (LOBGEV) model. Differing from the existing models, the LOBGEV model allows us to analyse the temporal structure of the probability of failure for banks, for both those that received a bailout and for those that did not. In particular, it encompasses both the flexibility of the D-vine copula and the accuracy of the generalised extreme value model in estimating the probability of bank failure and of banks receiving approval for capital injection. We apply this new model to the US banking system from 2008 to 2013 in order to investigate how and to what extent the Troubled Asset Relief Program (TARP)-Capital Purchase Program (CPP) reduced the probability of the failure of commercial banks. We specifically identify a set of macroeconomic and bank-specific factors that affect the probability of bank failure for TARP-CCP recipients and for those that did not receive capital under TARP-CCP. Our results suggest that TARP-CPP provided only short-term relief for US commercial banks.

TARP and the long-term perception of risk

The Capital Purchase Program (CPP) was intended to enhance capital and preserve lending capacity of banks, but the role of this program in affecting the risk of participating banks has been unresolved. We address this issue by investigating the market’s long-term perception of risk for financial institutions participating in the CPP. Leading up to and including the crisis, the systematic and idiosyncratic variances of the stock returns of all financial firms increased; following CPP, the relative idiosyncratic risk of CPP participants remained higher than for those not participating in CPP for four years following CPP.

Commercial Bank Small Business Lending Pre and Post Crisis

We analyze small business lending at U.S. commercial banks, how it has changed over time and how it differs by bank size. Specifically, we examine the impact of government policy intervention on small business lending in the aftermath of the financial crisis. We find several important results. First, we find that the Troubled-Asset Relief Program’s (TARP) $200 billion Capital Purchase Program (CPP) had little impact on the banks that received capital injections’ small business lending. Second, the Small Business Loan Fund (SBLF) lending program appears to have been a success as banks participating in the loan fund increased their lending to small businesses. Finally, we find that financial turmoil had a substantial negative impact on lending to small businesses at community banks but not their large bank counterparts. This result suggests that the larger banks may have behaved in a manner consistent with too big to fail. Collectively, these results provide important insights for policy makers as they continue to deal with the credit access issues of small firms.

Decision-making during the credit crisis: Did the Treasury let commercial banks fail?

Abstract Limited attention has been paid to the comparative fate of banks benefiting from Capital Purchase Program (CPP) funding and less fortunate banks subject to FDIC resolution. We address this omission by investigating two core issues. One is whether commercial banks that ended up being subject to FDIC resolution received CPP funds. The other is whether the non-allocation of CPP funds made FDIC receivership more likely for viable commercial banks. Our findings show almost no overlap between CPP-funded and FDIC-resolved commercial banks, but we provide evidence that a significant number of FDIC-resolved banks could have avoided receivership if they had been allocated CPP funding. By comparing estimated funding and resolution costs we also show that bailing out more banks would have been cost-efficient. While our results do not allow for any policy suggestion on the optimality of bailouts per se, they suggest that once a bailout program is already on the table, it is better to err on the side of rescuing too many rather than too few banks.

The value relevance of “too-big-to-fail” guarantees

Purpose – This paper aims to analyze the impact of conjectural “too-big-to-fail” (TBTF) guarantees on big and small US financial institutions’ stock prices during the 2008-2009 banking crisis. Design/methodology/approach – The paper analyzes shocks to stock market investors’ expectations of government aid to banks in distress and respective spillover effects using an event study approach. We focus on three major events in late 2008, namely, the Lehman bankruptcy, the Citigroup bailout and the first announcement of the Capital Purchase Program (CPP) by the US Government. Findings – The authors found significant differences in market reactions to the respective events between small and large banks. For both the Lehman and the CPP event, abnormal returns on big banks’ stocks are negative, while small banks’ stocks tend to generate positive abnormal returns. In contrast, large banks strongly outperform small banks in the case of the Citigroup bailout. Results for a control group of non-financial firms indicate that this behavior may be specific to the banking industry. The authors observed significant spillover effects to both competitors and non-competitors of Lehman and Citigroup, and concluded that while the Lehman event shook the widely held belief in an implicit TBTF subsidy to large banks, the TBTF doctrine was reinstated shortly thereafter. Originality/value – This paper shows that conjectural TBTF guarantees are priced in by equity investors. While government aid to large banks in distress may prevent negative effects on the stability of the financial system, it may also create negative externalities by putting small banks at a competitive disadvantage. The findings suggest that US and European regulators’ recent policy measures directed at establishing reliable bank resolution schemes should be a step in the right direction to level the playing field for small and large financial institutions.

Media Coverage and the Stock Market Valuation of TARP Participating Banks

We examine the impact of media coverage of the Capital Purchase Program (CPP) under the Troubled Assets Relief Program on the equity market valuation of participating bank holding companies (CPP banks). We document substantial negative coverage of the CPP and its participants over the five quarters following the program's initiation. We find that the extent of negative media coverage about the CPP exerted substantial downward pressure on the stock returns of CPP banks, decreasing their valuation relative to bank holding companies not participating in the program. We show that our findings cannot be explained by differences in the banks’ financial viability at the CPP's initiation, new information about their performance being released to the market after the CPP's initiation or preceding stock returns causing the negative media coverage. Our findings highlight the importance of investor sentiment, as reflected by the tone of media coverage, in banks’ valuation during a period of high uncertainty in financial markets.