In the fall on 2008, in the wake of the greatest financial crisis in over three quarters of a century, the
United States Congress approved and President Bush signed into law the Troubled Asset Relief Program.
TARP was used to shore up balance sheets of bank by infusing
equity into them. In return for the much needed equity infusion, the banks issued preferred stock to the
US Treasury and supplemented them with warrants as an additional kicker. As warrants go, these TARP
Warrants are highly unusual and heavily favor the investor (over the issuer).
Over the last few quarters, the US Treasury has been a seller of these warrants and many of them trade
like stocks. In addition TARP-like warrants were issued by the likes of AIG and General Motors as part of
their bailouts. It is clear from reading the fine print on the TARP warrants that the documents were
prepared by treasury staff. The institutions were pretty much told where to sign.
Take the example of the GM Class B Warrants. Besides the US Government, GM creditors got some of
these warrants in lieu of their claims in bankruptcy court. A single GM Class B Warrant gives one the right
to acquire one share of GM stock at a price of $18.33 anytime until July 10, 2019. In addition, the exercise
price gets adjusted downward if there are dividends or stock splits. The dividend adjustment is an unusual
feature and very much pro-investor. These warrants were issued with a ten-year life, which is also
unusual.
GM stock is presently changing hands at around $24.45/share. The Class B
Warrants are also publicly traded and can be bought for about $9.40/warrant. The warrant is $6.12 in the
money. If one has a view that GM is significantly undervalued, the warrant is likely to yield a higher return.
For example, if GM were to trade at $50, $75 or $100 in 2019, an investor in GM stock would end up with
a gross return of 105%, 207% or 309%, respectively. An investor in the warrant would end up with a
return of 137%, 503% and 770%, respectively. Once GM gets past $30, the warrant delivers a higher
return. Of course, should GM languish below $29, holding the stock would be a better bet.