On Friday, Treasury released details regarding its policy for “the disposition of the warrants received in connection with investments made under the Capital Purchase Program (CPP).” The policy statement applies only to publicly traded financial institutions – warrants issued by privately held institutions were immediately exercised by Treasury for additional shares of preferred stock and are no longer outstanding. Under the terms of the original contract between a publicly traded financial institution and Treasury, when the institution repays Treasury’s investment under the CPP it has the “right to repurchase the warrants at fair market value” under an “independent valuation process.” The valuation of CPP warrants has been the focus of intense interest in the wake of the announcement that 10 large CPP participants were permitted to repurchase the preferred stock they issued to Treasury.
Treasury’s new policy statement sets forth a four-step process for the repurchase of the CPP warrants:
- Within 15 days of repayment, the institution repurchasing warrants submits to Treasury a proposed determination of the warrants’ fair market value.
- Treasury has 10 days to decide whether or not to accept the institution's proposed valuation.
- If Treasury objects to the initial valuation of the warrants and cannot otherwise reach an agreement with the financial institution as to their value, the terms of the investment contract provide for an independent appraisal process. The financial institution and Treasury both select independent appraisers who attempt to come to an agreement as to the warrants' value.
- If the appraisers cannot agree, a third appraiser is hired and a composite of the three appraised values, subject to certain limitations, is used to establish the warrant’s fair market value.
Treasury’s policy statement also provides insight into the three inputs it will utilize in determining its valuation of the warrants: (i) market prices; (ii) financial modeling; and (iii) the use of outside consultants and financial agents. Each of these inputs will be used to varying degrees depending on the nature of the financial institution repurchasing warrants. For example, while it is possible that some of the larger financial institutions will have securities with similar characteristics to the warrants held by Treasury and observable market prices, it is unlikely that many of the smaller institutions will. Treasury will utilize financial modeling and input from outside consultants to value the warrants of these smaller institutions. Examples of the financial modeling techniques Treasury will use include the binomial and Black-Scholes option-pricing models. Treasury has already obtained three asset managers and will use other outside consultants to assist it in the independent appraisal of warrant values.
Following repurchase of Treasury’s CPP investment, a financial institution may choose not to repurchase the outstanding warrants. In that event, “Treasury has the discretion to dispose of the warrants as it sees fit over time. In these instances, Treasury will sell the warrants through an auction process over the next few months.” Guidelines regarding the auction process are forthcoming. Treasury’s use of the auction process is an attempt to meet the President’s stated objective of disposing “of the government’s investments in individual companies as quickly as is practicable” while maintaining transparency and protecting the interests of American taxpayers.