Disentangling U.S. banks from the federal government, and vice versa, is well and truly under way. And, mercifully, exiting the Troubled Asset Relief Program involves far less drama than obtaining the debt relief.
In the fall of 2008, you may recall, Treasury Secretary Henry Paulson Jr. dropped to one knee in an appeal to House Speaker Nancy Pelosi to support a measure to provide struggling banks with emergency funds. In his memoir, On the Brink, Paulson recalls that his begging routine was a calculatedly over-the-top gesture to lighten a tense moment, but he is dead serious when he says that the bill was essential to save the U.S. banking system.
That will be debated for decades. Perhaps easier to establish is how Washington fared, in strictly P&L terms, in its foray into the banking business. There, a fiduciary highlight is the performance of warrants. These long-dated call options, in effect, were issued to the government by 707 financial institutions participating in the $700 billion TARP program in return for the Treasury’s purchasing these mainly banks’ securities.
The idea of the warrants was that the government and, by extension, taxpayers would get to share in the banks’ capital appreciation as a result of the bailout. To clear TARP obligations, banks had to either buy back the warrants or, in the event of an impasse over the price, let the government auction them.
In a coup, Deutsche Bank got itself appointed auctioneer for the warrant sales. What no doubt helped the bid was that the German bank had not taken TARP funds and thus would be viewed as a more or less neutral adviser. (Deutsche stands to make more than $10 million for its TARP work.)
The bank’s first auctions, which included 88.4 million JPMorgan Chase & Co. warrants, came in December and went better than expected. Washington collected more than $1 billion. Investors quickly became comfortable with the Dutch auction format: A minimum bid is set, and investors bid on both price and volume; the ultimate price is the one at which the entire offering sells.
Last month it was Bank of America Corp.’s turn. The troubled bank was told last year that it needed to raise $33.9 billion in fresh equity to earn a passing grade on Treasury Secretary Timothy Geithner’s capital stress test. In response, BofA has collected some $19 billion and arranged to raise an additional $5 billion or so. In early December the Charlotte, North Carolina, bank felt confident enough to repay its entire $45 billion TARP debt.
BofA had issued 272 million TARP warrants expiring on October 28, 2018, including 150 million Class A warrants with a strike price of $13.03 per share and 122 million Class B warrants with a strike price of $30.79. BofA shares were trading at $16.37 on March 3, the day before the auction prospectus was issued.
But could BofA stock be trading for more than $31 by 2018? Timothy Freeman, head of U.S. equity derivatives sales with New York–based broker dealer Capstone Global Markets, had a hunch it might be. He liked the Class B securities — but only at the right price. Freeman’s analysis indicated they were worth $1.50 to $1.70.
Apparently agreeing, Deutsche recommended that the government set a minimum price of $1.50. The eventual sale price: a far richer $2.55, implying that investors were feeling positive indeed about BofA’s prospects. The Class B auction raised about $310 million. When combined with the proceeds of the Class A warrants, which were priced at $8.35, this gave the Treasury $1.54 billion from the BofA warrant sale. “There was some enthusiasm for this bank risk, and as a result the auction went very well for the government,” notes Freeman.
So far, more than 42 of the warrant issues have been auctioned or bought back by financial institutions. The Congressional Budget Office recently estimated that Washington could make a $7 billion profit from bank bailouts, but that might be a low-ball number. Late last month the Treasury mandated Morgan Stanley to sell the government’s 7.7 billion shares in Citigroup; analysts estimate the Feds could make $7 billion on that sale alone.
