I receive “must-read” articles from Seeking Alpha every day, but I often skim through them as I do not find them particularly interesting or enlightening. While one of today’s articles, Bank of America’s Gain is Taxpayers’ Loss, is not particularly enlightening, I found it interesting nonetheless.
According to the Treasury, the initial deal was that the
Treasury, the FDIC, and the Fed would guarantee losses on a $118 billion portfolio of assets; B of A would absorb the first $10 billion and 10% of any further losses, so the government’s maximum exposure would be about $97 billion. Part of that guarantee was a non-recourse loan commitment from the Fed, basically meaning that the Fed would loan money to B of A, take the assets as collateral, and agree to keep the assets in lieu of being paid back at B of A’s option. In exchange, the government would get:
(a) An annual fee of .2% on the Fed’s loan commitment … The loan commitment could be interpreted to be only $97 billion, so this comes to $194 million per year.
(b) $4 billion of preferred stock with an 8% dividend. That’s a dividend of $320 million per year; B of A can buy back the preferred stock by paying $4 billion.
(c) Warrants on $400 million of B of A stock. B of A was at $7.18 the day the bailout was announced and yesterday it closed at $17.61, so if Treasury had gotten an exercise price of $7.18, those warrants would be worth about $580 million now.
Without delving into specifics, it turns out B of A paid the government $425 million in light of the government’s recommended payment of “300 million to 500 million.” However, B of A actually owed the government $4.965 billion. This discrepancy was enabled by a line in the contract that said “[B of A] has the right to terminate the guarantee at any time (with the consent of USG), and the parties will negotiate in good faith as to an appropriate fee or rebate in connection with any permitted termination.”
Simple math can be done to show the ridiculousness of this deal:
1) B of A ended up paying $425 million to receive guarantees from the government on $97 billion of assets, this represents .44% of the total assets.
2) B of A ended up paying $425 million instead of $4.965 billion, this represents 8.56% of the total payment.
It looks to me like B of A hit the jackpot.Published in