Why Small Banks Still Struggle to Pay Back the Bailout

Remember how all the big banks rushed to pay back their bailout money at the end of last year? Lots of small ones didn't. In fact, many are having trouble even keeping up with the quarterly dividend payments they owe the government for the government money they received through the bailout. There are three central reasons why these banks continue to struggle while the big banks are nearly back to business as usual.

First, Brady Dennis at the Washington Post provides the grim news:

The latest report from the agency shows that more than 120 institutions - nearly all of them small banks - have missed their scheduled quarterly dividend payments, which is more than a sixth of the banks that received federal aid during the financial crisis.

In addition, five banks that received capital injections from the controversial $700 billion Troubled Assets Relief Program have failed altogether, making it highly unlikely that taxpayers will recover the nearly $3 billion poured into those institutions.

Harder to Get Capital

For starters, it's harder for small banks to acquire new capital than big ones. If you're a large, publicly traded firm, you have lots of options at your disposal. One way is to simply offer more stock. Another would be to find a wealthy investor who likes your business to buy a chunk of equity. Smaller financial institutions don't find gathering capital nearly easy. Meanwhile, their business is heavily dependent on loans, and interest rates are at historic lows. So until loans are more profitable again, they won't have much excess cash to pay the government what they owe.

Portfolios Lack Diversity

Because their main business is writing mortgages and commercial loans, small banks' assets are less diverse than those of larger financial institutions. Some small banks might have managed to securitize such loans in the past, but lots didn't. As a result they still have a lot of problem loans to deal with, which continue to create losses as foreclosures continue and some firms struggle. Meanwhile, big full-service banks like JPMorgan and Citigroup have far more diversity to their assets so that their losses from the mortgage and commercial assets that they haven't securitized and sold off or hedged can be overshadowed by other lines of business performing better.

No Trading Revenue

In fact, some such divisions that big financial institutions have are investment banking and securities trading. Although these business lines aren't doing as well since spring, the year before that trading and advisory revenues provided large windfalls for most banks that participated in these functions, which both helped provide additional capital for their own stability and convince investors they were a safe bet going forward. Smaller banks didn't have the same benefit.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

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