Comments on: TARP Warrants: Linus Wilson Analysis Flawed

By: Espen Robak

Espen Robak — Fri, 10 Jul 2009 02:17:25 +0000

As an update from the initial Linus Wilson report, you may be interested in knowing that our analysis shows that, with the exception of Old National Bancorp, bank warrant repurchases have been made at close to “fair value” prices.

Pluris Valuation Advisors has just completed a study valuing the warrants of all 265 public banks participating in TARP using data accumulated from several years worth of TARP transactions.

A copy of the study is available here: http://www.plurisvaluation.com/site/liquistat.html#2.

You can also download a white paper on valuing warrants here: http://www.plurisvaluation.com/site/pressroom/whitepapers.html.

Espen Robak, President

By: ER

ER — Tue, 02 Jun 2009 13:38:43 +0000

Addendum: the haircuts depend on the time left, the vol, and (most important) the moneyness.

By: ER

ER — Tue, 02 Jun 2009 13:37:19 +0000

The main reason why illiquid (untraded) warrants are worth less than their Black-Scholes values is their illiquidity. And the TARP warrants are illiquid even if they’re registered for resale. The registration does not create an active market for these instruments, or any market at all. So these are “tradable” only in private transactions no matter what. The B-S model was never designed for valuing warrants; it applies to continuously traded options on continuously traded shares only (otherwise, the hedging “delta” assumptions don’t hold). Non-tradable illiquid warrants generally sell in private transactions at 20-80% haircuts from the B-S formula value. See http://www.plurisvaluation.com/site/LiquiStat-WP.pdf

By: jck

jck — Mon, 25 May 2009 11:45:53 +0000

Linus:
THX for your comments. I still think your low estimate as high given that using the recent historical record results in an upwards bias due to the unusual circumstances seen lately.
The 37.10% vol drops to 34% over 10 years and 30% over 15 years still including the recent period, and ex that recent period, you would be challenged to find any 10 year period over the mid to high 20s.
I agree your estimate gives the Treasury the benefit of the doubt and that a market derived price would be much better.
I don’t use the conventional model as I don’t think it works for long dated options/warrants first because it assumes the bank will survive to the term with 100% probability, something that is unrealistic, and second in the real world, arbitrage dictates the use of a “risk-free” rate where you can borrow and lend so swap rates are what I would use not treasuries.
Regarding the Bloomberg article, not very clear what the method/assumptions are except for volatility: “On May 11, the day the U.S. announced the sale, the stock’s option-implied volatility, derived from market prices of stock options that are traded daily, was 61 percent, according to data compiled by Bloomberg.”
I suspect the writer is using very short-term options to evaluate volatility and that doesn’t make any sense.

By: Linus Wilson

Linus Wilson — Sun, 24 May 2009 19:40:10 +0000

There was a typo that was repeated in the descriptions of the tables 2, 3, and 4. That typo has been corrected now at http://ssrn.com/abstract=1404069. Nevertheless, my paper correctly said on page 6 of the first and current draft,

“The low-end estimate of volatility was 37.10 percent. It was derived from daily closing stock prices and quarterly dividends paid from January 1, 2002, to May 8, 2009.”

Thus, there was over 7 years of historic prices behind that estimate. I have updated the description of the tables so there will no longer be any confusion about the time interval used to generate the 37.10 percent number.

I never used the historic volatility from January 1, 2009, to May 8, 2009. If I had done so, I would have found that the historic volatility over that period was 87.74 percent. That is higher than the high-end estimate of volatility that I used of 72.89 percent in the paper. I think my estimates gave the U.S. Treasury the benefit of the doubt. For example, my estimates are also much lower than Bloomberg’s at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ae2fQFMrDer4

Ultimately, I would like private investors decide what the warrants are worth. It is private investors who determine what the fair market price is. I don’t think the TARP warrants should be an exception.

By: jck

jck — Fri, 22 May 2009 22:45:41 +0000

Sandrew:
I misspoke, the bank exercise rights are for the preferreds, not the warrants.

By: jck

jck — Fri, 22 May 2009 22:44:29 +0000

Linus:
I think we have had an unusual period of high volatility for a while and I don’t expect that to last 10 years or at least very long shot that it will. But basically agree that a market price or public auction would be better than behind closed doors negotiation to set the price. Also the warrants can hardly be said to have been issued at a fair price, at least 0 isn’t a fair price for me.

By: Sandrew

Sandrew — Fri, 22 May 2009 20:49:36 +0000

“the banks have the exercise rights”

Huh?

By: Linus Wilson

Linus Wilson — Fri, 22 May 2009 20:10:24 +0000

Dear Alea,

I will look for the typo. I calculated daily instantaneous returns from January 1, 2008 to May 8, 2009 for the high estimate. For the low estimate, I calculated daily instantaneous returns from January 1, 2002 to May 8, 2009. If you don’t like my historic volatility estimates, you could always choose another time period. The methodology for calculating historic returns is explained in more detail in my paper “The Goldman Sachs Warrants” at http://ssrn.com/abstract=1400995. Perhaps you could calculate a different time period that would give you a lower historic volatility estimate. I am always open to suggestions about how to obtain better estimates.

By: jck

jck — Fri, 22 May 2009 15:25:19 +0000

CapVandal:
“I’m not sure that Black Scholes gives reasonable answers for long term options”
Pretty unlikely to give the right answer, specially since the seller (bank) has the exercise right.