TARP Warrants...Deal or No Deal?
I came across two very interesting articles on special situations yesterday that I wanted to share with everyone.
The first involves the TARP warrants that were issued to the government when it provided aid to a number of banks at the height of the credit crisis.
Francis Chou - An Interesting Way To Invest In Banks (Warrants That Were Issued To The U.S. Treasury)
A blogger called CanadianValue published an article on GuruFocus about hedge fund manager Francis Chou's write-up of TARP warrants.
For anyone who isn't familiar with warrants, they're essentially like long-term options or LEAPs. They provide holders with the option to purchase a share of a company's stock at a certain price on a certain date. One can figure out what level the stock has to be trading at for them to break even by adding the price that the warrant is going for to its strike price.
Let's look at theBank of America Class A warrants as an example. They are currently trading at $7.12 perwarrant and their strike price is $13.30/share. That means that in order for warrant-holders to break even on their investment, Bank of America's common stock, BAC, must be trading at or above $20.42 on January 16, 2019.
BAC closed yesterday at $12.46/share. In order for the warrants to be worth anything, this stock must rise by $7.96 over the next eight years and change. That's a total gain of nearly 64%, or approximately 8% per year. That's looking at things a little simplisticly because it doesn't include compounding...i.e. of BA rose 8% this year it wouldn't have to rise by quite as much in future years because the next 8% would be coming off of a higher level.
The great part about the TARP warrants is that unlike most normal warrants. the government negotiated a clause in them that any dividends over a certain level that are paid to shareholders must be subtracted from the strike price. For the BAC warrants, that level is $0.01. That means that if Bank of America recovers to the point that it pays shareholders a decend dividend in the future, anything over a penny per share, the dividends would lower the level that the stock needs to climb to for the warrants to break even. This can make a huge difference in the profitability of this investment.
The question is, are these TARP warrants a good deal? I certainly am intrigued by them. I have seen them described in several different places, by some very smart people as a solid bet. I am still somewhat skeptical about the current economic "recovery" and the health of many banks. As such I haven't been able to bring myself to pull the trigger on this trade yet. Still seven to eight years is a long time, even for someone who is a fairly long-term investor like myself.
If the economy really slows down and the market takes it on the chin, perhaps the prices of some of these warrants will fall to truly attractive levels. That would make the trade much more enticing from my perspective. I might have been inclined to pick up some of these warrants in CAPS if they were available, but I don't believe they are. Perhaps I'll request that they be added.
I'd love to hear others' thoughts on the TARP warrants.