TARP Warrants Revisited: Opportunities Exist For Long-Term Investors

Includes: BAC, C, CMA, JPM, SBNY, WFC
by: Randall Hsu, CFA

Below is a list of publicly traded TARP warrants, with data as of December 20, 2011. The goal of this article is to re-visit TARP warrants auctioned off by Treasury and see what has happened since then, in addition to identifying potential opportunities that will preform handsomely against the index in the coming years.

Warren Buffett in his 2008 letter to shareholders pointed out deficiencies with the Black Scholes model in regards to long dated options (or warrants in this case), in particular the misuse of implied volatility as a tool to price options. Therefore, implied volatility should only be used as a first step in identifying opportunities. A number of other factors, such as earning power and value of underlying assets should be considered. For example, some financial institutions’ tangible book is being marked down by almost half of stated value in today's market.

Based on current market's implied volatility, there are few TARP warrants that appear to be attractively priced, namely Citigroup (NYSE:C), Signature Bank (NASDAQ:SBNY), and Comerica (NYSE:CMA). Of these three, if you are a patient investor who is willing to wait for the eventual fruition, Citigroup's TIP warrant appears to offer the best return for investor's money because its underlying assets and potential earning power that should continue to accumulate up to January 2019 when the warrant expires. On the other hand, investors should feel cautious about Signature Bank's recent run-up and it's appeared low implied volatility.

Finally, despite the high implied volatility shown with Bank of America's (NYSE:BAC) TIP warrant. This security is actually attractively priced. Given its stated tangible book value and earning power going forward, Bank of America is more than likely to have over $20 in tangible book value per share at the end of 2018. Any hint of optimism will make this class of security outperform its common share sibling.

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Tarp Warrant Auctions by Institution NameClick to enlarge

(Link to modeled valuation)

Disclosure: I am long BAC.