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Dividends4Life (27.49)

TARP Investment ROI Significantly Down



January 22, 2009 – Comments (3) | RELATED TICKERS: USB , BAC , WFC

When the government wants to spend pork, but not call it pork they rebrand it as an “investment” in our future. Such is the case with the Troubled Asset Relief Program (TARP). So, as taxpayers and “investors” how have we fared with our “investment” and how does TARP fit into our dividend portfolios?

In a report issued last Friday, the Congressional Budget Office (CBO) concluded that the Treasury lost more than 25% of the $247 billion it spent as of Dec. 31 bailing out banks, according to a report released on Friday.

The CBO used a modified Black-Scholes option pricing model to value the TARP assets. The calculation was based on the present value of the dividends banks are required to pay taxpayers on the warrants issued in exchange for the funds received. The present value of the warrants was only $183 billion at December 31st, resulting in the Treasury providing a “subsidy” to the banks of $64 billion.

Terms of the TARP agreement require banks to pay back 5% annually in dividends for the first five years, and 9% after that if taxpayers haven’t been repaid. The warrants expire in 10 years. Last Thursday, Lawrence Summers, President-elect Barack Obama’s chief economic advisor, promised that the incoming administration would take steps to improve returns on TARP funds for taxpayers, in part by limiting dividend payouts to shareholders.

Prominent financial companies participating in TARP include:

 - American Express Company (AXP)

 - Bank of America Corporation (BAC)

 - BB&T Corp. (BBT)

 - U.S. Bancorp (USB)

 - Wells Fargo & Co. (WFC)

Some institutions, such as Bank of America, have returned to the trough to feed again off TARP funds. As dividend investors, we must carefully consider whether or not banks participating in the TARP program should be included in our income portfolios.

Full Disclosure: Long BBT, USB

Related Posts:

 - Bank of America Headed Back to the TARP ATM

 - Investment Winners and Losers in an Obama Administration

 - Financial Melt-down Continues

 - Charlie Munger’s 10 Rules for Investment Success

 - Tools To Calculate Investment Returns

3 Comments – Post Your Own

#1) On January 22, 2009 at 7:45 AM, rd80 (95.94) wrote:

The valuation needs to cover both sides of the balance sheet.  Treasury is borrowing money at 2-3% to buy the preferred stock. If the model values the incoming cash stream from the preferred at less than face value, it should also carry the outgoing cash stream servicing the bonds at less than face value.

There should also be some value to the warrants.

"...improve returns on TARP funds for taxpayers, in part by limiting dividend payouts to shareholders"

Mr. Summers needs to go back to school if he said that.  Limiting dividend payouts to shareholders would reduce risk of default on the TARP preferred, but does nothing to improve returns on it.

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#2) On January 22, 2009 at 9:40 AM, MikeMark (28.97) wrote:

TARP Investment ROI Significantly Down

Isn't "TARP Investment" like "genuine lawyer", an oxymoron?

How can you have an ROI on burning money?

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#3) On January 22, 2009 at 5:04 PM, oneupper (< 20) wrote:

Whoever wrote this note never took a finance course in her/his life. Did you read the report? Did you understand it?

Did you know that the discount rate used by the CBO for its NPV calculations is the yield on "actively trade preferred" of those same banks. That rate is abnormally high at present. This calculation turns the asset's value into a "market value". If so, where's the market?

 The warrants were valued by Black-Scholes, which isn't very good for long-term options.

As pointed out by rb80...the goverment's opportunity cost is NOT the yield of bank preferred because they are not in the business of buying preferred stock. It is the 2-3% it costs them to issue Treasuries. The NPV of the TARP investments in banks is tremendously positive and that's precisely why bank common tanked after the nature of it was changed in November. It's not a bailout, it's death-spiral financing.

 This kind of BS put out by some newbie MBA at the CBO, picked up by the ignorant financial press and commentators such as whoever wrote this, has the potential ultimately to hasten the demise/nationalization of the financial system. Very sad.  




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