Government Sells Stake in Bank of America (BAC)

Perhaps the US Treasury department should start its own hedge fund.

The government, guided by the Treasury, sold its warrants to purchase shares of Bank of America (BAC) stock for $1.5 billion on Thursday. The Treasury was granted warrants to purchase stock in the company as a means of maximizing return on the TARP bailout, which cost $700 billion, to rescue a number of financial institutions during 2008 and early 2009. Warrants grant the holder the option to purchase stock at a pre-determined price, much like an option.

The amount is the most Treasury has earned from selling its warrants in any one financial institution. However, “Treasury Capital Management” still has warrants in a number of other institutions that benefited from TARP, including Citigroup (C), Wells Fargo (WFC) and PNC Financial Services (PNC). Apparently the Wells Fargo position could yield an even higher profit for the Treasury given the huge comeback in that company’s stock price since the investment.

The warrants that Treasury sold were received in two tranches, firstly when it provided money to Bank of America in 2008 and then again when it provided more cash last year.

The Treasury sold 150.4 million warrants with a strike price of $13.30 a share for $8.35 each. The warrants expire in January 2019. The investors who bought those warrants are betting Bank of America’s stock price will exceed $21.65 on or before January 2019, in which case they will have the option to purchase shares at $13.30. The premium ($8.35) explains why $21.65 is the break-even price (less transaction costs and taxes, of course).

The other deal saw Treasury sell 121.8 million warrants with a strike price of $30.79 for $2.55 each. Those warrants expire in October 2018. The profits were lower on those warrants because of the much higher strike price. Investors who bought these warrants are betting that Bank of America will close at or above $33.34.

The previous record was set when Treasury earned $1.1 billion by selling warrants to purchase shares in Goldman Sachs (GS). The Treasury has also sold its warrants to purchase stock in rival JP Morgan (JPM), for which it earned $936 million.

Treasury has been actively trying to reduce it’s exposure to financial services companies and the motor vehicle production firms after rescuing both sectors from the brink mainly during 2008. While it’s early days yet, the profits enjoyed by the Treasury so far accrue to taxpayers, who funded the bailouts with much anguish mainly in the latter stages of 2008. With higher profits rolling in from Treasury, taxpayers could possibly be made whole on their investment. There is even a very small probability that taxpayers will make an overall profit on government’s investments – in which case we could look forward to lower taxes and a lower fiscal deficit. Are you willing to buy a warrant on that?