Linus Wilson's  Instablog

On Monday, May 11, 2009, with little fanfare, Old National Bank (ONB) became the first publicly traded bank to pay back the TARP’s Capital Purchase Program warrants.  Warrants are call options that create new shares of stock when exercised.  Privately held banks like Centra Bank, which repurchased its warrants before Old National Bank, signed an agreement to repurchase their warrants at 5 percent of the par value of the U.S. Treasury’s investment.  Publicly traded banks, according to the terms of their TARP investment, can either negotiate to repurchase the warrants at “fair market value” or let the U.S. Treasury sell the warrants to third party investors. Thus, the Old National Bank transaction is the first example we have of the U.S. Treasury’s (in)ability to negotiate the fair market value of the TARP warrants.

My analysis suggests that the U.S. Treasury accepted a lowball offer.  My paper “Valuing the First Negotiated Repurchase of the TARP Warrants” estimates that the fair market value of these warrants should have been between $1.5 million and $6.9 million.  It is too bad that the U.S. Treasury agreed that they were worth only $1.2 million.  That is, the U.S. taxpayers only got 71 percent less than the median of my lowest and highest estimates, $4.2 million, and $.3 million or 20 percent less than my lowest estimate.  These results indicate that the management at Old National Bank represented their shareholders well.  I am not sure that the U.S. Treasury represented taxpayers quite so well. 

Taxpayers bore a lot of risk providing capital to the banks, and they deserve to get the fair market value of the warrants that they purchased.  Hopefully, if Goldman Sachs (GS) and JP Morgan (JPM) try to repurchase their warrants, Tim Geithner and company will do a better job.  I estimate in my paper “The Goldman Sachs Warrants” that TARP warrants at that firm alone could be worth between $250 million to $1.2 billion. 

The U.S. Treasury should avoid negotiated repurchases if at all possible.  The U.S. Treasury seems to be pretty good at selling bills, notes, and bonds to investors all over the world.  The U.S. Treasury should try selling the taxpayers’ warrants to third party investors.  That would free the banks of TARP and get taxpayers the best price.  

Disclaimer:  This is not investment advice.  The author does not guarantee the accuracy of the estimates or the data.  Interested readers should read the papers to fully understand the assumptions of those valuations. Option values can vary substantially from models, and there are many assumptions in my analysis that may not be borne out.  I do not have any long or short positions in any banks' securities except long positions in broad-based index funds.