Banks' Bailout Escape Not So Simple

Several major banks have applied to repay government bailout funds, but must first strike a deal to repay government warrants for common stock.
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Several major banks have applied to repay government bailout funds, but doing so may not be as simple as writing a multibillion-dollar check.

When the Treasury Department injected hundreds of billions of dollars into the country's biggest banks through the Troubled Asset Relief Program, it received not just preferred stock, but warrants to purchase common shares as well. While TARP agreements outlined specific terms for the warrants' exercise price, there is a heated debate over how much banks should have to pay to get out from under the government's wing.

The initial exercise price for the warrants was set at the 20-day trailing average market price of common shares, subject to anti-dilution adjustments. The price would be reduced by 15% on each six-month anniversary of the warrants' issue date, with a maximum reduction of 45%.

Bank executives, of course, would prefer to pay less, especially those that say they were pressured into accepting TARP dollars and didn't need them in the first place. For example,

JPMorgan Chase

(JPM) - Get Report

Chairman and CEO Jamie Dimon has asserted that the government should extinguish half of the warrants "out of fairness."

On the other hand, the government would prefer to receive more for its investment. Advocates argue that taxpayer dollars rescued some firms from utter collapse, and others from more severe damage. As investors, taxpayers deserve heady profits for the risks they were taking.

Twenty-one smaller firms have already repaid TARP dollars and extinguished related warrants, according to SNL Financial. An analysis by

Bloomberg

found that in the case of one such bank,

Old National Bancorp

(ONB) - Get Report

, the Treasury sold warrants at $4.6 million below market value. If extrapolated to the rest of the TARP recipients,

Bloomberg

found that taxpayers could leave $10 billion sitting on the table.

The Senate passed an amendment in early May to allow the Treasury to exercise warrants at a later date, when bank stocks might have recovered even further, offering bigger profits for taxpayers. Sen. Jack Reed (D., R.I.), who serves on the Senate Banking Committee, has been a champion of such a move.

"Taxpayers should not be forced to assume all the risk and then let the companies get all the reward," Reed said in a statement at the time. "That is not fair in any kind of deal."

However, no official guidance has been issued yet for over two dozen financial firms that have applied to repay TARP funds, or have stated intentions to do so. Given lobbying efforts by the banking industry and the ample reserves of populist rage awaiting any decision that seems to benefit bailout recipients, the decision will probably not be as simple as writing out 25 checks for the $160.7 billion in direct funds they received.

Among those that have applied to redeem the TARP investment are JPMorgan,

Goldman Sachs

(GS) - Get Report

,

Morgan Stanley

(MS) - Get Report

,

American Express

(AXP) - Get Report

,

BB&T

(BBT) - Get Report

,

State Street

(STT) - Get Report

,

Northern Trust

(NTRS) - Get Report

and

HF Financial Corp.

(HFFC)

. Among others that have indicated interest in paying back funds as soon as possible are

Bank of America

(BAC) - Get Report

,

Wells Fargo

(WFC) - Get Report

,

Fifth Third

(FITB) - Get Report

,

Bank of New York Mellon

(BK) - Get Report

,

PNC Financial Services

(PNC) - Get Report

,

KeyCorp

(KEY) - Get Report

,

Capital One

(COF) - Get Report

,

US Bancorp

(USB) - Get Report

,

SunTrust

(STI) - Get Report

, and several others.

While changing the rules in midstream again may not bode well for some of the smaller banks that have already redeemed TARP funds, one idea that has gained ground is conducting an auction to sell the warrants to private investors. Given

voracious demand for bank stocks, such a move would likely inspire higher prices in competitive bidding.

Setting a price in the private market through an auction might be preferable to the government setting an arbitrary price, or having the price decided by outside analysts. Though banks might chafe at higher market prices, valuation expert Espen Robak, president of Pluris Valuation Advisors, is one advocate.

"They got very cheap money from the government, and so the government deserves a little upside," says Robak.

As for sour grapes from CEOs like Dimon, he adds: "He signed the deal and issued the warrants so it is what it is. You can call it unfair if you want...but at that point you discover what the price is, because the market would set it for you."