Pluris offers our clients an excellent independent source of valuations for embedded derivatives, convertible preferred, and warrants.

Mike Boswell
TriPoint Capital Advisors, LLC

Banks Are Sold on Warrant Auctions


By: Matt Monks (Cheyenne Hopkins contributed to this story) | February 18, 2010

The Treasury Department said Thursday it will auction off warrants it took in four major banking companies as part of the industry bailout. They probably will not be the last warrants to go on the auction block. Under the Troubled Asset Relief Program, the Treasury took warrants in more than 280 companies that got federal aid.

The warrants give the holder the right to buy common shares of the company at a fixed price for up to 10 years from their date of issuance. Once a bank repays Tarp, it has two weeks to decide whether to buy back its warrants directly or let the Treasury auction them off.

Complying with the banking companies' wishes, the Treasury said it will sell during the next month its warrants in Bank of America Corp. [BAC], Washington Federal Inc., Texas Capital Bancshares and Signature Bank, obtained through Tarp's Capital Purchase Program.

Observers said they expect PNC Financial Services Group Inc. [PNC], Wells Fargo & Co. [WFC], Valley National Bancorp and other companies that have recently returned their Tarp money to follow suit. If the companies bid on their own warrants at auction, they may end up paying less than if they bought them directly from the government, market watchers said. Also, auctions give lenders looking to preserve capital right now the option to buy their warrants at a later date in the secondary market.

"I don't have any confidence that the Treasury is able to price these warrants" at levels banks would find enticing, said Gary Townsend, the chief executive of Hill-Townsend Capital LLC. "I think that they'll all end up sold to market because of capital constraints. [Banks] have the ability to, later on, effectively buy back these shares through capital management."

So far, most lenders that repaid their Tarp funds have repurchased their warrants directly from the government. Market watchers said this was bound to change after sales in December of warrants in JPMorgan Chase & Co. [JPM], Capital One Financial Corp. and TCF Financial Corp. established a market value for these securities.

The decision to buy from the government, or not, comes down to a number of factors, including how much capital a lender has, how comfortable it feels about diluting its stock and, of course, the price.

The warrants that have been auctioned have fetched surprisingly low prices, though the Treasury has said it is satisfied with the results. Nobody knew for sure how much the warrants would command at auction; the only security comparable to 10-year warrants is long-dated stock options. Investors priced warrants at a discount to stock options, given their need to book a return while assuming the risk of these securities.

JPMorgan Chase's warrants were auctioned at $10.75 apiece on Dec. 10 and by month's end were trading at well over $13, suggesting they were sold at a discount. The Capital One and TCF Financial warrants have also fetched higher prices in secondary trading.

"The values that the Treasury got in these auctions were less than what we had expected," said Espen Robak, president of Pluris Valuation Advisors LLC, an options valuation firm. "According to our modeling, at least, Treasury did seem to get better prices when they did negotiate directly with the banks, with a few exceptions."

A recent report suggests that the Treasury — under political pressure to deliver the best possible returns on the taxpayer money it doled out to banks — is driving a hard bargain in negotiating over warrant prices.

In January, the Treasury said in that report that it received $2.9 billion from the 31 lenders that had repurchased their warrants by yearend. These proceeds were about 70% more than the government would have received had it accepted the banks' initial offers, and about 11.5% higher than its financial models said the warrants were worth, the Treasury said.

Capital is precious right now. Banks wary of being taken to the cleaners may be wiser to let the markets decide how much their warrants are worth, rather than relying on complex and possibly subjective computer models, experts said. They can bid in the auction or let institutional investors buy the warrants and make a play for them later after their fortunes improve.

"Given the precedent already set with these companies' going to auction, my guess is you are probably going to see more of [them] unless the Treasury starts offering better prices," said Al Savastano, an analyst at Macquarie Capital.

Brent Beardall, the chief financial officer of Washington Federal in Seattle, said he trusts the market to deliver a more accurate price than the Treasury's. His company returned $200 million in bailout money last year and decided to let its 1.7 million warrants go to auction. It may participate, depending on how they price and how the company feels at the time about its capital position.

"Models can be manipulated," Beardall said before the Treasury announcement Thursday. "We're much more inclined to go with an open-market process to get the true value of something."

Other lenders have been less clear on what they plan to do about their warrants. Once negotiations start, they can last for an indeterminate period. A spokesman for PNC, which repaid $7.6 billion on Feb. 10, said the company would not comment on its intentions. A spokeswoman for Wells Fargo, which returned $25 billion on Dec. 23, said the company does not comment on "conversations" with its regulators. A Valley National spokesman said it was "still in negotiations" over its warrants after returning $300 million on Dec. 23.

Citigroup Inc. repaid $20 billion of its aid in December. The Treasury holds warrants for 255 million shares in connection with that transaction, in addition to others connected with other aid. A spokesman said the fate of the warrants is unclear.