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Was last fall’s Troubled Asset Relief Program (TARP) a bailout as the Congress and administration insist endlessly? In a recent interview, Sandler O’Neill’s Jimmy Dunne described the TARP as “more of an income-producing hedge for government … than a bailout.” It’s an intriguing argument, and one borne by the numbers, too. By my calculation, the Federal government’s annualized return on investment approaches a weighted average 18% for the 10 banks approved to repurchase their government-owned preferred stock and warrants, including dividends paid through this June. Results are summarized in the accompanying table.
Warrants were valued using a binomial option pricing model, with strike prices and other valuation attributes as in the original purchase agreements, as reported in company 8-Ks. Estimated volatility is based on a 5-year average, consistent with the method used to value the Old National Bancorp and IberiaBank warrants that were recently redeemed.
The substantial variance in company-to-company investment returns is largely due to the warrants. Warrant valuation is a function of share price and the historical volatility of the common equity. If stock prices rose since the TARP, warrant valuation is higher (e.g., Goldman Sachs and Morgan Stanley). Similarly, stocks with higher average volatilities (e.g., Morgan, Goldman, and American Express) have correspondingly higher warrant valuations.
So, was the TARP a “bailout”? Or is the better analysis that the Federal government aptly hedged the downside risk of financial panic, and the taxpayer now reaps rewards for its timely actions?
What do you think? Let me know! |