U.S. banks face tough time, in or out of TARP

NEW YORK (Reuters) - Letting 10 of the biggest U.S. banks repay $68 billion to the government may loosen Uncle Sam's grip on an industry still far from a recovery, but it also doesn't mean the banking industry is out of the woods.

Analysts believe the sector is at best in the middle stage of deterioration in several key areas of lending, including credit cards, commercial loans and commercial real estate.

And even if much of the slump in housing prices is in the past, interest payments on millions of adjustable-rate mortgages are expected to lurch higher between now and 2012.

"Now we have to go back on focusing on credit quality," said Nancy Bush, managing member of NAB Research LLC, an independent research firm.

Repaying TARP will free JPMorgan Chase & Co, Goldman Sachs Group Inc, Morgan Stanley and others from rules on what they can pay top performers and shareholders in the form of dividends.

The banks joined at least 22 smaller banks allowed to repay some or all of their taxpayer money. Most must still negotiate terms to buy back or extinguish the government's warrants to buy their common stock.

Nine other banks that underwent "stress tests" of their ability to weather a deep recession, including Bank of America Corp and Citigroup Inc, plus some 600 other lenders still have TARP money outstanding.

Bank of America has indicated it would like to begin repaying its infusion this year, while Citigroup is preparing to give the government a possible 34 percent equity stake.

"We're going to have the 'haves' and the 'have nots,'" said Robert Lutts, chief investment officer of Cabot Money Management in Salem, Massachusetts.

NOT HOME FREE

Analysts said banks allowed to repay TARP may have advantages over their weaker rivals, both in perception and the ability to drum up new business.

Jamie Dimon, JPMorgan's chief executive, called being subjected to TARP a "scarlet letter."

The seemingly healthier banks, however, are not home free.

"There is still risk," said Brad Hintz, an analyst at Sanford C. Bernstein & Co and former Lehman Brothers chief financial officer. "Part of that is the delayed effect of a slowdown in the economy."

Treasury Secretary Timothy Geithner on Tuesday said the Obama administration will soon announce reforms to financial services pay to discourage excessive risk taking.

New pay rules on TARP recipients may be outlined Wednesday. Geithner also said the U.S. Securities and Exchange Commission may seek new powers to limit pay.

Banks still in TARP, meanwhile, may come to appreciate having their capital buffered if the economy were to take a fresh leg downward. Regulators want to avoid having banks repay money now, only to come back later for more aid.

"There are some significant downsides to being outside TARP," said Daniel Alpert, managing director at investment bank Westwood Capital in New York.

"Banks are making a bet that things will not get materially worse," he went on. "We think material losses are still coming. And if banks do come back for more capital, their hubris will count against them."

NUMBERS HEAD SOUTH

Congress is by common consent in no mood to throw even more taxpayer money at a sector pilloried for its past excesses, and which may generate lower profits in normal times in the future as they ratcheted down risk.

Elizabeth Warren, a Harvard Law School professor and head of the Congressional Oversight Panel overseeing the bank bailout program, on Tuesday said the stress tests should be repeated and toughened.

She noted that the 9.4 percent U.S. unemployment rate is already higher than the 8.9 percent that regulators assumed in a "worst-case" scenario for 2009.

"Let's face it, the numbers are bad and they're heading in the wrong direction," she told a Congressional committee.

Wells Fargo & Co, which chafed against taking $25 billion from TARP last fall, on Tuesday said it has not yet applied to repay that sum.

Regulators have approved its plan to raise a $13.7 billion capital buffer, to help it withstand a potential $86.1 billion of losses in 2009 and 2010 found under its stress test.

Bankruptcies have risen to the highest since 2005, and large business collapses such as at General Motors Corp and Chrysler LLC could subject hundreds of thousands of consumers to job losses or lower pay and benefits, hurting their ability to keep up with creditors.

"When sales are off 15, 20, 30 percent, something has to give," said Leonard Goldberger, a lawyer and former vice president of the American Bankruptcy Institute. "There is a downward spiraling ripple effect."

(Reporting by Elinor Comlay, Steve Eder, David Lawder, Glenn Somerville, Jonathan Stempel, Dan Wilchins and Karey Wutkowski; Editing Bernard Orr)