Many Washington banks that received TARP money are keeping their powder dry, reluctant to lend aggressively in a deteriorating economy and worried about discovering fresh problems in their portfolios.

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Since last fall, the federal government has pumped more than $1 billion into 16 Northwest banks as part of its controversial rescue plan. And as the regional economy totters its way into recession, the calls for banks to put that money to work — lending to businesses, relieving mortgage-laden homeowners — have risen.

But while a few regional banks say they’ve begun to boost lending, most are effectively stashing their federal investments in the vault, waiting for signs of an upturn or hedging against an even grimmer future.

The bottom line: Don’t expect local banks to use their slivers of the $700 billion bailout fund to lead the region out of recession anytime soon.

“There has never been a day in my life as a banker when I didn’t want to make every loan I prudently could,” said Roy Whitehead, chief executive of Seattle-based Washington Federal, which in November got $200 million from the U.S. Treasury Department.

“We’re ready, willing and anxious to make every good loan we possibly can, but that’s at odds with what’s going on in the economy now,” Whitehead said. “Today, it is pushing on a string.”

According to the financial report it released last week, WashFed made fewer new loans in the last quarter of 2008 than it did in each of the previous three quarters.

Whitehead, like other bankers interviewed, said the worsening recession has eroded demand for new loans and shriveled the number of creditworthy borrowers. At the same time, nervous regulators are tightening their scrutiny of banks’ financial health and pushing them to tighten up lending standards.

Alan Hess, a University of Washington finance professor, offered another scenario: Many of the supposedly healthy banks that got federal money may be holding onto it because they fear they’ll need it to plug fresh holes in their existing loan portfolios. In a sense, the government may be shoveling cash into an ever-deepening hole.

The continuing credit shortage has led to growing criticism of the bailout, known formally as the Troubled Asset Relief Program or TARP, and how the Treasury has managed it so far.

In a report issued earlier this month, the congressional oversight panel set up to monitor the TARP also faulted Treasury for not using any of the money to prevent foreclosures, not tracking lending by recipients, and for an overall lack of transparency.

The panel wrote that it “still does not know what the banks are doing with taxpayer money… So long as investors and customers are uncertain about how taxpayer funds are being used, they question both the health and the sound management of all financial institutions.”

Some added lending

A few of the 16 Northwest banks that have received TARP money do say they’re using the extra cushion to expand lending.

Banner Bank, of Walla Walla, which got $124 million, has begun taking out ads soliciting small businesses to apply for loans. “The public perception is that credit has frozen up,” marketing director Doug Bayne said. “We want to get the word out that business needs to continue.”

Sterling Financial, of Spokane, whose $303 million in TARP money makes it the largest Northwest participant, channeled $25 million to Golf Savings Bank, its Mountlake Terrace-based subsidiary.

Golf Savings has used the money to boost its home-loans business. Last month, said Sterling CEO Harold Gilkey, Golf issued $400 million worth of home loans, compared with $100 million in November; two-thirds of the new loans were refinancings. (Leverage rules allow banks to lend out several dollars for each new dollar of capital in their vaults.)

Another $200 million of Sterling’s TARP money went to its biggest subsidiary, Sterling Savings Bank, for making consumer and business loans. Such loans have risen by about $100 million above normal levels, Gilkey said; that’s about 40 percent more than during the quarter ended Sept. 30.

But finding uses for the rest of the money has been harder, he said. In part that’s because, under regulatory pressure, Sterling has tightened its lending standards.

“It’s one thing to say, ‘I’ve got money to loan,’ ” Gilkey said. “It’s another thing to find people who want it.”

TARP’s full of holes

Congress and the new Obama administration have pledged that the second $350 billion installment of TARP money, approved earlier this month, will be more transparent and geared more toward preventing mortgage foreclosures and extending credit to consumers and small businesses.

Last week, the Treasury said it would require monthly reports from the 20 largest recipients of TARP funds.

Part of the acrimony surrounding TARP stems from the way it was rushed into existence last fall.

As its full name suggests, the original idea behind the Troubled Asset Relief Program was for the government to buy up the murky mortgage-backed securities and other questionable assets that were rapidly losing value, forcing banks to post billions of dollars in losses and scaring them from doing business with each other.

But shortly after the bailout law was enacted, Treasury abruptly shifted course, choosing instead to inject new capital directly into banks and other financial institutions.

The government is doing so by buying preferred stock and warrants for common stock in hundreds of banks. The preferred stock pays a 5 percent dividend, while the warrants — rights to buy shares in the future at a preset price — are supposed to let taxpayers benefit once bank stocks recover.

The dividend rate on the preferred stock jumps to 9 percent in five years, giving banks a strong incentive to repay the government before then.

So far, nearly 300 financial-services companies (not counting those linked to the automakers) have received $273.8 billion in TARP money. Most of that aid has gone to the largest firms: The 20 largest recipients have gotten all but about $26 billion of the funds expended so far.

One of the many questions surrounding TARP is whether it’s intended to rescue struggling banks or bolster relatively healthy ones. So far, the answer seems to be both.

Local bank executives bristle at the idea that they needed to be bailed out, as behemoths such as Citigroup and Bank of America have been.

“The bigger banks were the ones throwing money up against the wall to see if it stuck,” said Michael Sand, CEO of Hoquiam-based Timberland Bank. “By and large, community banks didn’t get involved in that kind of activity.”

Another question has been whether participation in the TARP has been voluntary or not. Again, the answer varies.

“We were asked in a direct way to apply,” Sterling’s Gilkey said. “We weren’t told to apply, but it’s kind of like your mother when she says, ‘Can you take the garbage out?’ “

TARP’s main purpose remains the biggest question: Was it to stabilize the banks, or help move the economy out of recession?

Back in October, when the TARP legislation was being cobbled together, several major financial institutions had failed in the space of a few weeks, including Seattle’s own Washington Mutual. The overriding concern then was to keep the entire financial system from collapsing on itself.

By that measure, at least, TARP so far has succeeded: No major institutions have failed since it began, said the UW’s Hess, who teaches at the Foster School of Business.

“Think where we’d be without it!” he said. “We wouldn’t have a solvent major bank left.”

How much the TARP money has fortified the finances of local banks, and whether they’ve increased lending as a result, should become clearer in the next few days, as several banks report fourth-quarter and year-end results.

Already, Sterling Financial has warned of a fourth-quarter loss and set aside another $230 million to cover expected future loan losses. WashFed last week reported a $20.2 million profit for the last quarter of calendar year 2008, but said it was setting aside $35 million for bad loans, up from $1 million a year ago.

“Nobody knows what the depth and breadth of this economic downturn will be,” Whitehead said. “We think we have enough capital to ride out whatever the storm may bring, but one never knows.”

Drew DeSilver: ddesilver@seattletimes.com