TARP Warrants: Follow the Volatility

Yesterday, we got another update as to the mechanics of the TARP program. While we have heard many of the too big to fail "TBTF" banks say they want to repay TARP, we have seen two (that Boneyard is aware of) actually do so.

Yesterday was Iberiabank Corp (IBKC - a $5.5B assets bank). Trying to discern what the future holds for TBTF banks repayment of TARP and repurchase of warrants, a closer look at the details was taken.

IBERIABANK Corporation announced today that it has repurchased the warrant to purchase 138,490 shares of common stock issued to the U.S. Department of the Treasury on December 5, 2008. The Company repurchased the warrant for $1.2 million.

As the statement says, the bank repurchased the warrants for approximately $8.66 each. Again, being curious a closer look had to be taken. How was this value arrived at? First the warrant was valued using a Black-Scholles option model (on BBRG) using default inputs with historical volatility. The result:

The value arrived at: $22.23 or a total value of approximately $3.1MM. Well, that had BoneYard confused - valued in this manner, the option is worth approximately $1.9MM more than the company paid. How was value arrived at?

Digging a little in the most recent 10Q, we potentially find the answer. What does the company use as the inputs for their stock option valuation for their stock option plans? The answer: 24.1% volatility (this is for a 7 year expected term).

Using this volatility estimate (instead of the historical volatility of 58% and the Nov 50 - yes, I understand the term difference - call implied volatility of 56%) we arrive at:

The price result: $8.61. This is a whopping $0.05 different than the company paid the government.

Looking at the Securities Purchase Agreement, we find that the value of the warrat will be determined as follows (section 4.9):

“Appraisal Procedure” means a procedure whereby two independent appraisers, one chosen by the Company and one by the Investor, shall mutually agree upon the Fair Market Value. Each party shall deliver a notice to the other appointing its appraiser within 10 days after the Appraisal Procedure is invoked. If within 30 days after appointment of the two appraisers they are unable to agree upon the Fair Market Value, a third independent appraiser shall be chosen within 10 days thereafter by the mutual consent of such first two appraisers. The decision of the third appraiser so appointed and chosen shall be given within 30 days after the selection of such third appraiser. If three appraisers shall be appointed and the determination of one appraiser is disparate from the middle determination by more than twice the amount by which the other determination is disparate from the middle determination, then the determination of such appraiser shall be excluded, the remaining two determinations shall be averaged and such average shall be binding and conclusive upon the Company and the Investor; otherwise, the average of all three determinations shall be binding upon the Company and the Investor. The costs of conducting any Appraisal Procedure shall be borne by the Company.

So, $8.66 was mutually agreed upon? Sounds eerily familiar to the banks supplying the inputs to the stress test, no? If you think this is good, wait for the TBTF to redeem their warrants.

If this isn't enough, the same 10q referenced earlier states:

The fair value allocation of the $90,000,000 proceeds between the preferred shares and the warrant resulted in $87,779,000 allocated to the preferred shares and $2,221,000 allocated to the warrant.

At the time, the bank allocated $2.2MM to the value of the warrant. So they sold it to the Treasury for their allocated value of $2.2MM and bought it back for $1.2MM. Tidy little gain. Again wait for the big guns at TBTF banks to get started, ought to make their quarter.

Disclosure: no positions

Comments

[Tom Armistead:]

Good article, using the bank's internal estimate of volatility for their stock option plans is a nice touch.

May 21 08:55 AM

[XRTrader:]

I agree. Great article. And again, for those who claim the goverment should extract every penny from the banks at the back end of the TARP cycle, keep in mind that bailing them out only to fleece them now (and render them under-capitalized) would be stupid. Lets be happy if and when the tax payer gets their money back...they dont need windfall profits. The goverment, after all, was doing this for the common good.

May 21 04:52 PM