State Street: TARP Still Positive for Taxpayers

In an article here last month, we noted that the Federal government’s TARP-related investment in America’s banks had become a sweet investment for taxpayers. In particular, we estimated the government earned an average annualized return of nearly 18% on its investments in the 10 banks that had repaid TARP funds. And we argued that rather than being the bailout the administration and Congress continually insist that it is, the TARP program was really a way for the government to hedge itself on the downside in amid the financial panic, with taxpayers reaping the rewards.

Now, State Street Corporation (STT) reports that it has repurchased its associated warrants for $60 million; the company is first large-cap financial to come to terms with the U.S. Treasury. When we last ran the numbers, we estimated that State Street’s warrants were worth $68.8 million. What’s changed? Did State Street pay a fair price? And given recent controversies (pricing transparency, complexity, worries that the government wouldn’t be repaid its full due), what are the indicated values of the other companies’ outstanding warrants?

On July 10, the Treasury’s valuation methodology was disclosed in a recent Congressional Oversight Panel report. Treasury uses a 20-day average stock price starting 15 business days after the preferred stock repurchase (when companies must notify the Treasury of their intent to repurchase warrants), the 10-year average of the 60-day historical volatility, the current 10-year Treasury yield, and the 10-year average dividend yield. Also, the report indicates that the Treasury applies a liquidity discount of 10% to 50% on the final warrant valuation.

Apply all this to State Street, then, and we have a stock price of $46.35, a risk-free rate of 3.405%, volatility of 42.9%, and a dividend yield of 1.15%, all of implies a value for the warrants (after accounting for the elimination of one-half of the warrant shares from State Street’s qualified equity offering) of $66.4 million. A liquidity discount of 10% reduces the value to approximately $60 million, a fair price given the Treasury’s methodology. Our previous estimate used a higher (but then-current) risk-free rate, a 5-year average volatility of 45.5%, the current stock price of $47.73, a lower dividend yield of 0.84%, and no liquidity discount.

Applying the methodology consistently to the ten companies that have announced their intention to repay TARP and repurchase warrants, the government’s annualized return of 12.4% remains handsome, even if somewhat less robust than we had first estimated.

So was the TARP a “bailout”? Or was it an apt hedge of downside risk after a financial panic? If the former, let’s agree never to travel that route again. But if the latter, we should take time enough to understand how the TARP helped stem the wealth destruction so widespread last fall and spring.

Comments

[Egg:]

Did you seriously just write an article saying TARP was a "sweet" investment for taxpayers because of the 10% or so of banks that repaid their loans? Are you forgetting about the other 90% of the TARP money? Or how about just the AIG portion that is long gone (to Goldman)?

Anyways, I must have misread since it's the middle of the night. I know you didn't say what I thought I read since it's so ludricrous. My apologies.

Jul 16 03:32 AM