On May 8, 2009 the Department of the Treasury disposed of warrants it received through the Capital Purchase Program (CPP) of TARP for the first time. In that transaction, the warrants were repurchased by their issuer, Old National Bancorp of Evansville, Indiana. Since then, there have been many other dispositions; through March 11, 2010, Treasury received nearly $4.4 billion by disposing of warrants it purchased through the CPP.1
Warrant disposition can be executed in multiple ways. After a bank repays its CPP funds to Treasury, it has the option to repurchase its warrants, as in the previously mentioned case with Old National Bancorp. When a bank chooses to repurchase its warrants, the bank has 15 days to negotiate an estimate of fair market value with Treasury. The bank must follow Treasury’s valuation process, which uses four inputs: comparable market data, warrant pricing models (such as Black-Scholes), fundamental company analysis and an outside consultant’s appraisal.2
If a bank chooses not to repurchase its warrants, Treasury may then dispose of warrants by selling them to a third party in a private sale or through a public auction. The warrants issued through the CPP expire in 10 years, allowing Treasury a full decade to make decisions regarding warrant disposition.
According to a July 2009 Congressional Oversight Panel (COP) report, open market transactions, such as auctioning, “are the only way to determine true—'fair' market value” for warrants and to maximize the return on investment.3 The reason for this is that Treasury is able to sell the warrants to the highest bidder and the competition is likely to drive prices up. Treasury held the first auction of warrants on December 3, 2009, to auction the Capital One Financial Corporation’s warrants.4 For more on Treasury’s warrant valuation and auction processes, see here.
COP performed its own analysis of the warrants repurchased by banks through July 2, 2009, and found that Treasury only received 66 percent of the panel’s best estimate of fair market value for those 11 transactions.5 In other words, the panel found that Treasury had been selling warrants back to banks below COP's determination of fair market value.
COP notes that these transactions represented less than a quarter of the value of the total warrant portfolio at that time, and therefore may not be predictive of future transactions. However, COP also notes that the rate of return earned by Treasury on these transactions (12 percent) is likely to be higher than the average rate it will receive on rest of the warrants, given that the early repaying banks were among the healthiest of the TARP recipient banks.6 COP reports that in its conversations with Treasury representatives about the valuation of the warrants, they sought “correct and reasonable valuation[s], not valuation[s] that [would] maximize taxpayer returns.”7
The Special Inspector General overseeing the Department of Treasury's Troubled Asset Relief Program (TARP) presents data on the warrants that taxpayers now hold as a result of the government's bailout of financial institutions. Treasury also receives preferred stocks from a company in exchange for TARP funding.
The purchase of warrants to infuse capital into banks is one piece of Treasury's larger investment through TARP. As the Congressional Oversight Panel (COP) notes, the value of the warrants was small relative to the value of the preferred stock in most instances. (See this page for more on the total estimated subsidies to the companies involved, including both preferred stocks and warrants.)
A warrant is an option to buy shares in a company’s common stock at a fixed price at any point over a set period of time; Treasury’s warrants through TARP generally expire in 10 years. The agreed-upon fixed price is referred to as the strike price. Click here for more information on Treasury’s policy determining the strike price.
This page has been substantially edited and updated. To view the previous version of this page, you may do so here.
