What about all those warrants?
I had what I thought was a great blog topic and idea for how Treasury could dispose of the bank warrants acquired through the TARP Capital Purchase Program (CPP). Then, as often happens, facts got in the way and the direction changed a bit.
First, as most readers are aware, when the US Treasury (UST) made all those TARP investments in bank preferred stock, we got warrants for common stock as part of the deal. The exercise price was the average of the 20-day trailing market price, total value was 15% of the TARP investment and the warrants are good for 10 years from date of issue. Banks can repurchase the warrants after they’ve repurchased the preferred. The warrant repurchase price is determined by two evaluators, one representing the bank and one representing UST. If they can’t agree, the two evaluators pick a third evaluator and they average the results.
With a few banks now having repurchased TARP preferred and the warrants, there have been a number of pieces discussing whether UST got a fair price for the warrants. Matt Koppenheffer published Banks Are Getting a Great Deal at Our Expense! for TMF earlier today. The issue is also addressed in TARP Warrants Show Banks May Reap ‘Ruthless Bargain’ by Mark Pittman at Bloomberg. On Seeking Alpha, Linus Wilson published Treasury Accepts Lowball Price for TARP Warrants, which does a good job of showing how wide the valuation range for these long-term options can be. Dr. Wilson’s work also shows that even compared to his lowest valuation for the warrants, UST got a lowball price for Old National’s warrants.
One kicker that isn’t well covered in these and other articles I’ve seen is that the number of options gets cut in half if the banks complete equity offerings equaling the amount of the TARP investment by the end of 2009. So, if GS completes $10 billion worth of equity offerings, the warrant for 12.2 million shares turns into a warrant for 6.1 million shares. Recall last fall UST wanted to encourage banks to raise private capital and this was one incentive. Based on that incentive, UST cannot execute or transfer more than half the warrants before the end of 2009.
The fact that got in the way was in a Treasury Frequently Asked Questions document. The response to ‘What will happen to the warrants…?’ concludes with ‘The warrants cannot be sold to an investor until the bank has had an opportunity to repurchase them.’ I did not find anything in the term sheet or Securities Purchase Agreement supporting that restriction – doesn’t mean it isn’t there, just that I didn’t find it.
Dr. Wilson’s article and some others I’ve read recommend UST sell the warrants to third party investors and, assuming the warrants can be sold without first offering them to the banks, I’d like to propose a framework for doing just that.
The rationale behind it is simple:
- Government officials have consistently told us they don’t want to own these institutions
- We’ve been consistently told taxpayers are supposed to participate in the upside
- President Obama is on record stating the US long-term debt load is unsustainable
Treasury is sitting on assets they don’t really want to own (or so they say), our government could use the money to reduce borrowing and recent capital raises by banks have shown markets have some appetite for bank securities. Simple answer – sell off the warrants. Auctioning the warrants won’t magically balance the budget, but a few billion will make a tiny dent in the need for bond auctions.
A key to the auction framework is that individuals be able to participate. How many times have you seen an IPO or secondary and wished you could be part of it? The Government is supposed to work for the people. This shouldn’t be a Wall St. only party and with current internet auction technology, it doesn’t need to be. Besides, wider participation brings better prices.
Treasury already has TreasuryDirect for individuals to purchase bonds; it shouldn’t be a big deal to add warrant auctions to the menu and come up with a mechanism to transfer the warrants to brokerage accounts. The UST warrants would need to be split into manageable pieces. Bidders could bid on as many warrants as they want in blocks of 100 with some minimum number of shares and/or dollar value – minimum 100 share units or $100 bids. It doesn’t have to be that low, but shouldn’t be out of reach for a typical individual investor. Open the bidding for a reasonable amount of time, maybe two weeks to a month. Allow hedge funds, banks, brokerages, individuals, US and foreign investors, as many as bidders as possible, to participate. At auction close, the highest bid for each bank gets filled, then second highest, flowing down until all available warrants are sold.
Given the number of banks that took TARP, an auction might need to be done in tranches (I think that’s the first time I’ve used that word). Best time frame to start is early 2010. The window for banks to cut the warrants in half by completing equity raises will be closed and UST will know how many warrants they have available to sell.
The potential spoiler for an otherwise great plan is the apparent restriction from the FAQ requiring Treasury to give the banks first shot at buying back the warrants. That’s not necessarily a show stopper, but a bank’s warrants could only be auctioned if they declined to repurchase them. If the FAQ is wrong, just sell them; no need to waste time or resources with valuations – an open auction will provide the best possible valuation.
If the government can’t figure out how to do it with TreasuryDirect, they can always put ‘em on E-bay.
OK Fools, what have I missed?
Before I go tilting at windmills and start writing letters, help me make the plan better.