BAC-WT - Bank of America Warrants

[ERICOPOLY]

Well, in both cases you wind up with 1/7 more ownership. 

 

In the case of the dividend:

you still have a market value of $8 with your $1 reinvested in the stock and price at $7. 

However if the stock goes up to $8 again you are sitting on a gain even if you exclude the capital gain on your reinvested dividend.

 

So that's why the warrant has both the strike adjustment as well as the increase in share conversion.  The warrant too should benefit from just the stock going back to a pre-dividend price without counting the capital gain from the increase in share conversion.

 

So this aspect of the warrants is not too good to be true.  The common has essentially the same benefit.  I find it makes them easier to compare to one another, because we can think of the cost of the warrant as the cost of the leverage, without worrying about how the cost of the leverage changes depending on when dividends get paid and potentially reinvested etc...

 

The part that's "too good" is the fact that the dividends are being essentially reinvested without the drag of taxation (and that dividends normally count against regular options holders), and that these are long term contracts that aren't available otherwise (once the TARP warrants expire, it isn't likely that we'll find long term leverage like this again).  I can compare the cost of the leverage in the warrants against the cost of financing the leverage through other means (such as margin), but margin is quite scary in quantity and has market swing risks that the warrants don't carry. 

[Rabbitisrich]

Unfortunately, I don't think that the strike adjustments are tax deferred. There are a few mentions of warrant holders being liable for taxes. Check the risk factors portion.

[ERICOPOLY]

The warrant is a vehicle where your dividend effectively gets reinvested in the stock no matter what the price.  It's somewhat like an option with a built in DRIP that you can't opt out of.

[Rabbitisrich]

The warrant is a vehicle where your dividend effectively gets reinvested in the stock no matter what the price.  It's somewhat like an option with a built in DRIP that you can't opt out of.

 

Maybe even better than reinvestment because the adjustment refers to the full holding, not just the marginal shares issuable (each subsequent reinvestment). Perhaps the best comparison is between reinvesting at market versus the expected ending strike.

 

But look at this risk factor from the prospectus:

You may be subject to tax upon an adjustment to the number of shares of our common stock underlying the warrants or the exercise price of the warrants even though you do not receive a corresponding cash distribution.

 

The number of shares of our common stock underlying the warrants and the exercise price of the warrants are subject to adjustment in certain circumstances. To the extent any such adjustment or failure to adjust results in an increase in your proportionate interest in our assets or our earnings and profits, you will be deemed to have received for U.S. federal income tax purposes a taxable dividend to the extent deemed paid out of our earnings and profits without the receipt of any cash.

 

 

SDo any FFBC warrant holders want to chime in? Those warrants have a similar tax provision and have paid dividends above the threshold.

[Rabbitisrich]

 

Eric,You're right, but it's probably a little less than 2.28$, because 2.28 assumes they have nothing at all to do with the money they distributed, but they will surely have something to do with it which could yield a few percent, and that's lost.

 

At any rate, if the adjustments are both a reduction in strike price and an increase in warrant shares (This still just seems too good to be true to me) then it is much more powerful than a dividend. Even if it's only one or the other- I'd prefer it to a regular dividend.

 

It depends on the stock price relative to the strike price. Ericopoly's point is that you would be better off simply reinvesting a dividend into the stock price if it's below the strike.

[ERICOPOLY]

 

Eric,You're right, but it's probably a little less than 2.28$, because 2.28 assumes they have nothing at all to do with the money they distributed, but they will surely have something to do with it which could yield a few percent, and that's lost.

 

At any rate, if the adjustments are both a reduction in strike price and an increase in warrant shares (This still just seems too good to be true to me) then it is much more powerful than a dividend. Even if it's only one or the other- I'd prefer it to a regular dividend.

 

It depends on the stock price relative to the strike price. Ericopoly's point is that you would be better off simply reinvesting a dividend into the stock price if it's below the strike.

 

I am sort of leaning towards retracting my stance on that because of the fact that the depth of the warrant adjustment depends on the dividend yield at the time that the dividend is distributed.  This is done to make sure the warrant holder in some sense fully captures the gain in intrinsic value per initially allocated dollar (at time of first warrant or common purchase) that the common stock holder enjoys.

 

But anyways, some of you guys still believe that it matters at what price a buyback occurs vs paying a cash dividend instead (I actually don't believe it makes any difference whatsoever, not to me anyway) so I wanted to point out that if you go the warrant path you might be twisting in your chairs and gnashing your teeth to see that your dividend is being plowed back into the stock at prices that aren't considered cheap anymore.  You see, since it matters what the yield is at the time of the warrant adjustment, if the common shares recover in price to some sort of fully valued level then you will be effectively stuck with a dividend that gets reinvested in fully valued shares.  Anyhow, perhaps by then you would like to just sell and move on, but the leverage in the warrant and the tax implications might tempt you to want to hold on despite relatively full valuation.  Maybe not.

[xazp]

I think in the $1 dividend scenario, BAC would trade at $20 or so.  Currently every Dow component trades below a 5% dividend yield, and I don't think BAC will average above a 5% yield over a lengthy period (your example has a 12.5% yield).  I think the price will move up to keep the dividend yield in check. 

 

If/when BAC pays a $1 dividend, today's common buyer will feel like they are receiving a 12.5% dividend payment over and over.  But with the warrant, they will experience the benefits as the then-dividend yield, which I believe will be substantially below 12.5%.  I like the idea of locking in the yield today, because I don't think the common's price will be in the single digits if they announce a $1 dividend. 

 

To continue with your example, suppose BAC averages a $1 dividend from 2014-2018, and a 5% dividend yield.  Today's common buyer @$8 would receive $5 of dividends, so their 'cost basis' end 2018 would be $3.  Today's warrant buyer @ $3 would also have a $3 cost basis, in addition to a strike price of around $10 if they wanted to continue to hold the stock.  Note that the advantages of dividends accrue unevenly.  While the common shareholder has received $5 in dividends, the warrant holder has only seen a $3 reduction in the strike price. 

 

OTOH the warrants have long-term leverage, as Eric says, so there are situations in which the warrants might do better.  But I'll be pretty content with the common's returns then too.

 

 

Isn't the warrant the real winner if the stock remains low? A 50% dividend will reduce the strike price by 50%, and I can't even imagine what will happen with a 50c dividend on a 50c stock. This adjustment alone is enough to compensate for the ability of the stock holder to buy more, but now I understand there are actually another source of leverage I haven't noticed - the adjustment of number of shares.

 

Regarding the adjustment of number of shares per warrant- Right now that number is one, correct? So, let's say the stock price is 8$, the strike is 13$ and the stock pays a 1$ dividend.

 

For the stock holder- he will have a 7$ stock and 1$ dividend, he will invest it in the stock and will be in a similar situation to before.

 

for the warrant holder- the strike price will be reduced by 1/8 of the previous strike price + the number of shares issuable per warrant will increase by 1/7 (previous strike price divided by new one, and considering the previous sentence- this will be something like 8/7 in my example, since the price was reduced by 1/8 and the formula for number of shares will be 8/7 X old shares per warrant). So, now he has a lower strike and more shares per warrant, but the stock price is 1$ lower.

 

This is great for the warrant holder if, and only if, the price of the stock at 2019 after all those dividends will be above the strike price, but then again- as long as the stock is lower than the strike, a 10% decrease in strike price is necessarily larger than the 10% the share holder gets- like a catch 22- if the stock is above the strike price the warrant holder is happy, and if not- he gets leverage. So, as I see it, the share number adjustment is a bonus- and a really great one.

 

This seems too good to be true-Do you believe you get an adjustment to the strike price AND more share per warrant? It would be great if the paragraph explaining the adjustment were clearer.

[Rabbitisrich]

 

 

 

I am sort of leaning towards retracting my stance on that because of the fact that the depth of the warrant adjustment depends on the dividend yield at the time that the dividend is distributed.  This is done to make sure the warrant holder in some sense fully captures the gain in intrinsic value per initially allocated dollar (at time of first warrant or common purchase) that the common stock holder enjoys.

 

In an earlier post, I wondered whether the appropriate strike to look at is the expiry strike. If the stock is at $8 and issues a $0.40 dividend, then the common can get 1.05X ownership assuming a skeptical market, whereas the warrant gets 1.05X ownership at $12.64 (ignoring the $0.01 threshold). Let's say the stock trades flat and keeps the 5% yield for nine more payouts until the strike is below the market price. At this point, the common reinvestor has increased his share by 55%, and the warrant holder increases ownership by almost 59% and the strike is similar to the common. The interesting thing about the warrants is that you don't average down or up. The adjustment applies to your whole inventory, not simply the reinvested yield.

[ERICOPOLY]

The interesting thing about the warrants is that you don't average down or up. The adjustment applies to your whole inventory, not simply the reinvested yield.

 

Let's say somebody bought the stock at $13.30 (same price as the warrants' initial strike price), and later the stock dropped to $8 per share at which dividends were paid (and reinvested in the stock).  The investor would then have an average cost basis somewhere between $13.30 and $8.

 

Now, with the warrants in the same scenario the adjusted strike (and adjusted shares) would wind up being the same as that of the average cost basis the common shareholder in my prior paragraph enjoys.

 

I think -- please tell me if the calculations do not wind up the same.

[Rabbitisrich]

 

To continue with your example, suppose BAC averages a $1 dividend from 2014-2018, and a 5% dividend yield.  Today's common buyer @$8 would receive $5 of dividends, so their 'cost basis' end 2018 would be $3.  Today's warrant buyer @ $3 would also have a $3 cost basis, in addition to a strike price of around $10 if they wanted to continue to hold the stock.  Note that the advantages of dividends accrue unevenly.  While the common shareholder has received $5 in dividends, the warrant holder has only seen a $3 reduction in the strike price. 

 

 

The warrant holder also ends 2018 with a 29% increase in shares per warrant at a $10.29 strike (ignoring the $0.01 threshold). So the common holder starts with $8 and ends with +$12 in addition to whatever you did with the $5. The warrant holder starts with $3 and ends with +$15.56. Without the dividends, you arrive at +$12 for an $8 common purchaser versus +$6.70 for a $3 warrant purchaser. Ignoring taxes, it only works out better for the common if you can reinvest the dividends at a higher rate than what is provided by the strike adjustments.

 

Edit: Accounting for the strike price of new shares issued, the warrant holder ends at +$9.55 after dividends.

[Rabbitisrich]

The interesting thing about the warrants is that you don't average down or up. The adjustment applies to your whole inventory, not simply the reinvested yield.

 

Let's say somebody bought the stock at $13.30 (same price as the warrants' initial strike price), and later the stock dropped to $8 per share at which dividends were paid (and reinvested in the stock).  The investor would then have an average cost basis somewhere between $13.30 and $8.

 

Now, with the warrants in the same scenario the adjusted strike (and adjusted shares) would wind up being the same as that of the average cost basis the common shareholder in my prior paragraph enjoys.

 

I think -- please tell me if the calculations do not wind up the same.

 

It depends on the price of the warrants. Do you mean that the dividend is issued at $8? So at an $0.80 dividend, you get 1.1X shares at $14.10, or $12.18/share. The warrant receives a strike reduction to $11.97 strike for 1.11X shares, or $10.78/share.

 

Edit: If the strike applies to adjusted shares, then it's just $11.97 per share for the adjusted warrant.

 

[ERICOPOLY]

The interesting thing about the warrants is that you don't average down or up. The adjustment applies to your whole inventory, not simply the reinvested yield.

 

Let's say somebody bought the stock at $13.30 (same price as the warrants' initial strike price), and later the stock dropped to $8 per share at which dividends were paid (and reinvested in the stock).  The investor would then have an average cost basis somewhere between $13.30 and $8.

 

Now, with the warrants in the same scenario the adjusted strike (and adjusted shares) would wind up being the same as that of the average cost basis the common shareholder in my prior paragraph enjoys.

 

I think -- please tell me if the calculations do not wind up the same.

 

It depends on the price of the warrants. Do you mean that the dividend is issued at $8? So at an $0.80 dividend, you get 1.1X shares at $14.10, or $12.18/share. The warrant receives a strike reduction to $11.97 strike for 1.11X shares, or $10.78/share.

 

I was looking for a logical way of thinking about them which isn't there.  I thought it made sense and skipped the math -- well, I should be more rigorous before thinking out loud.

[kevin4u2]

 

To continue with your example, suppose BAC averages a $1 dividend from 2014-2018, and a 5% dividend yield.  Today's common buyer @$8 would receive $5 of dividends, so their 'cost basis' end 2018 would be $3.  Today's warrant buyer @ $3 would also have a $3 cost basis, in addition to a strike price of around $10 if they wanted to continue to hold the stock.  Note that the advantages of dividends accrue unevenly.  While the common shareholder has received $5 in dividends, the warrant holder has only seen a $3 reduction in the strike price. 

 

 

The warrant holder also ends 2018 with a 29% increase in shares per warrant at a $10.29 strike (ignoring the $0.01 threshold). So the common holder starts with $8 and ends with +$12 in addition to whatever you did with the $5. The warrant holder starts with $3 and ends with +$15.56. Without the dividends, you arrive at +$12 for an $8 common purchaser versus +$6.70 for a $3 warrant purchaser. Ignoring taxes, it only works out better for the common if you can reinvest the dividends at a higher rate than what is provided by the strike adjustments.

 

I just ran some quick conservative numbers and the warrants yield a 610% gain or a ROR of around 35%.  The ROR on the DCF of the common and dividends (same assumptions) is about 28.5% (409% gain).  For reference berkowitz mentioned a theoretical gain on the warrants of 592% in his Q2 commentary.  I had the number of underlying warrants increasing to 1.21 and strike price of just under $11/shr. 

 

Some assumptions include dividends of $0.04/shr per qtr in 2013, ramping upward after.  Return on TCE gradually increasing to 13% over the period and P/TBV gradually increasing to 1.6 times.  Terminal share price is just over $30/shr and cumulative dividends of $4.5/shr over the warrant period.  I never had the dividend rate over 50%.  Some may think these are too conservative.  It's likely a muddle through scenario.

[ERICOPOLY]

 

To continue with your example, suppose BAC averages a $1 dividend from 2014-2018, and a 5% dividend yield.  Today's common buyer @$8 would receive $5 of dividends, so their 'cost basis' end 2018 would be $3.  Today's warrant buyer @ $3 would also have a $3 cost basis, in addition to a strike price of around $10 if they wanted to continue to hold the stock.  Note that the advantages of dividends accrue unevenly.  While the common shareholder has received $5 in dividends, the warrant holder has only seen a $3 reduction in the strike price. 

 

 

The warrant holder also ends 2018 with a 29% increase in shares per warrant at a $10.29 strike (ignoring the $0.01 threshold). So the common holder starts with $8 and ends with +$12 in addition to whatever you did with the $5. The warrant holder starts with $3 and ends with +$15.56. Without the dividends, you arrive at +$12 for an $8 common purchaser versus +$6.70 for a $3 warrant purchaser. Ignoring taxes, it only works out better for the common if you can reinvest the dividends at a higher rate than what is provided by the strike adjustments.

 

I just ran some quick conservative numbers and the warrants yield a 610% gain or a ROR of around 35%.  The ROR on the DCF of the common and dividends (same assumptions) is about 28.5% (409% gain).  For reference berkowitz mentioned a theoretical gain on the warrants of 592% in his Q2 commentary.  I had the number of underlying warrants increasing to 1.21 and strike price of just under $11/shr. 

 

Some assumptions include dividends of $0.04/shr per qtr in 2013, ramping upward after.  Return on TCE gradually increasing to 13% over the period and P/TBV gradually increasing to 1.6 times.  Terminal share price is just over $30/shr and cumulative dividends of $4.5/shr over the warrant period.  I never had the dividend rate over 50%.  Some may think these are too conservative.  It's likely a muddle through scenario.

 

So that's a terminal share price of just over $30 a share for the warrant returning you a 610% gain.

 

The common (dividends reinvested so that you have 1.21x shares) yield 400%.

 

So 610% instead of 400%.  The man with the warrants will have 40% more money at the end under those assumptions.

[xazp]

The warrant holder starts with $3 and ends with +$15.56.  >>

 

In your example, wouldn't the warrants end up with ($20 - $10.29) * 1.3 - $3 = +$9.63?  Which would be a 320% return.  The stock, with non-reinvested dividends, would return +$17/8 = 210%.  The warrants do better in that scenario.  So if that is your baseline case, prefer the warrants. 

 

My baseline case is that BAC will favor buybacks over dividends as long as the stock is below TBV.  I think they will average below $1/share in dividends from 2014-2018.  And, I think the stock will trade at below a 5% dividend yield on average from 2014-2018.  My baseline case partially lowers the upside of the warrants. 

 

But really my hesitation is with the downside of warrants.  Look at Buffett's Goldman warrants.  5-year strike at $115.  They are $12 underwater today with one year remaining.  So, I can't say with absolute certainty that BAC will be in the double digits in 2018, so I'm content with the stock. 

 

 

 

 

 

The warrant holder also ends 2018 with a 29% increase in shares per warrant at a $10.29 strike (ignoring the $0.01 threshold). So the common holder starts with $8 and ends with +$12 in addition to whatever you did with the $5. The warrant holder starts with $3 and ends with +$15.56. Without the dividends, you arrive at +$12 for an $8 common purchaser versus +$6.70 for a $3 warrant purchaser. Ignoring taxes, it only works out better for the common if you can reinvest the dividends at a higher rate than what is provided by the strike adjustments.

[Rabbitisrich]

 

 

In your example, wouldn't the warrants end up with ($20 - $10.29) * 1.3 - $3 = +$9.63?  Which would be a 320% return.  The stock, with non-reinvested dividends, would return +$17/8 = 210%.  The warrants do better in that scenario.  So if that is your baseline case, prefer the warrants. 

 

 

Unhappily, you are likely right. I had hoped that you exercise by paying the strike per warrant, and then receive adjusted shares + cash in lieu, but then the stock split adjustment wouldn't make sense. Does anyone have an opinion on the exercise procedure? The main reason why I think that Xazp is correct is that the split adjustment wouldn't also reduce the strike if you only pay the warrant strike, and if the purpose is to maintain the economics before/after split.

[ERICOPOLY]

Earlier this year (back in April or so) there was a comment by Soros suggesting that the Euro (common currency) could be broken up in two more years without a financial crisis.  He elaborated by saying the banks had been preparing for it for two years and were only about halfway through.

 

BAC should see a lot of upside by 2015 if that's true.

 

[Arden]

I wonder if after a dividend or two, there would be an announcement or some kind of contact we could talk to about the new strike price and up to date warrant shares. Otherwise, I fear the true value just might reveal itself only when redeeming the warrant.

[Grenville]

I wonder if after a dividend or two, there would be an announcement or some kind of contact we could talk to about the new strike price and up to date warrant shares. Otherwise, I fear the true value just might reveal itself only when redeeming the warrant.

 

Fairholme's reports break out the details (strike/conversion) for the warrants they own. I imagine they'll be well informed given their large positions in the warrants.

[MVP444300]

Fairholme's reports break out the details (strike/conversion) for the warrants they own. I imagine they'll be well informed given their large positions in the warrants.

 

Do you know where I can find a link to the strike/conversion on Fairholmes website?

 

Thank you

[Grenville]

Fairholme's reports break out the details (strike/conversion) for the warrants they own. I imagine they'll be well informed given their large positions in the warrants.

 

Do you know where I can find a link to the strike/conversion on Fairholmes website?

 

Thank you

 

p.23-24 see footnote (b)

http://www.fairholmefunds.com/sites/default/files/352975_051.pdf

[MVP444300]

p.23-24 see footnote (b)

http://www.fairholmefunds.com/sites/default/files/352975_051.pdf

 

Thank you Grenville I appreciate it. 

[MrB]

I wonder if after a dividend or two, there would be an announcement or some kind of contact we could talk to about the new strike price and up to date warrant shares. Otherwise, I fear the true value just might reveal itself only when redeeming the warrant.

You can look at the AIG warrant prospectus for formulas; that document actually have written out formulas.

Speak to First Financial IR re the adjustments; they are already going through the process.

[MrB]

"Everybody" hates the banks

http://www.bloomberg.com/news/2012-08-20/wall-street-leaderless-in-rules-fight-as-dimon-diminished.html

[BargainValueHunter]

O/T but this thread seems to be the main BAC thread going right now.  :P

GKK related as well (obviously)...

 

http://finance.yahoo.com/news/gramercy-capital-corp-announces-formation-113000734.html

 

The portfolio totals 5.6 million square feet of which approximately 81% is leased to Bank of America, N.A. for a term ending in June 2023. Total portfolio occupancy equals approximately 88%. The projected 2012 net operating income for the portfolio is approximately $41.5 million. The portfolio was previously part of the Company’s Gramercy Realty division, beneficial ownership of which was transferred to KBS pursuant to a collateral transfer and settlement agreement dated September 1, 2011. Bank of America, N.A. senior unsecured debt is currently rated A by Standard & Poor’s and Fitch and A3 by Moody’s.