Funds run by John Paulson, Bill Miller among winners as warrants rally Django Davidson, pictured here on Nov. 3 in London, is a founding partner at Hosking Partners, which bought about $200 million of the warrants for banks. PHOTO: NIALL MCDIARMID FOR THE WALL STREET JOURNAL By Rachel Louise Ensign Nov. 6, 2017 5:30 a.m. ET 23 COMMENTS The U.S. banking industry is booming—a development that is bringing windfall gains to a small group of investors who had the gumption to buy esoteric bank securities when the outlook for financial firms and the economy was far less clear-cut. After years of banks grappling with the fallout of the crisis and low interest rates, the bets on what are known as TARP warrants are finally paying off. The investors, which include fund managers John Paulson and Bill Miller, bought these warrants for bank stocks secondhand, after they were initially issued to the government during the 2008 bank bailout. The investors’ unpopular view at the time was that banks and their stock prices would recover to precrisis levels. By betting on warrants, a high-octane security similar to an option, the fund managers basically doubled down on that opinion, risking their entire investment if it didn’t happen by 2018 or 2019. “If the subprime credit-default swaps were this asymmetric, beautiful investment to express what was wrong with American capitalism…, these securities are the opposite,” said Django Davidson, a founding partner at London-based Hosking Partners LLP, which bought about $200 million of the warrants for banks including Bank of America Corp. Warrants WinningGains since 2016 U.S. electionTHE WALL STREET JOURNALSource: SIX Financial (warrants) FactSet (shares)Note: Bank of America 2009 'A' Warrants %WarrantsCommon sharesBank of AmericaWells FargoJ.P. MorganPNC0255075100125150175200225250 The warrants date back to the financial crisis, when the government invested about $250 billion in about 700 banks as a part of the Troubled Asset Relief Program, or TARP. As part of the program, which aimed to shore up bank capital and restart lending, the government got warrants to buy shares in the banks. The Treasury Department started getting rid of the warrants in 2009, a process that included selling some off to investors. For years after the crisis, many investors hated bank stocks, comparing them to heavily regulated utilities no longer able to take risks and grow. The warrants also slumped; some of Citigroup Inc.’s fell so much they were delisted from the New York Stock Exchange in 2016. But since last November’s presidential election, bank stocks have helped lead a broad stock-market rally tied to renewed confidence and hopes of tax and regulatory overhaul. Meanwhile, banks’ crisis-era legal problems have subsided and interest rates have started to rise, making lending more profitable. The change in sentiment has made the warrants a turnaround story. Some from big banks have surged 65% to 1470% since the election, easily outpacing the 36% rally in the KBW Nasdaq Bank stock index. One group of Bank of America’s warrants, once left for dead, are up the most in the group. With the recent jump, J.P. Morgan Chase & Co. warrants are up 429% since they started trading in late 2009, compared with a 148% increase for the bank’s stock. The warrants give investors the right to buy a stock at a predetermined price. If the stock rises far above that “strike price,” the warrant is like a winning lottery ticket. If it stays below that price, the warrant ends up worthless. While exchange-traded stock options usually go out only a couple of years, warrants often last longer. “We were lucky it was a 10-year warrant,” said Philippe Jabre, a Geneva-based fund manager who bought warrants in SunTrust Banks Inc., among others. He said the recovery took longer than he had expected. Late RallyZions Bancorp performanceTHE WALL STREET JOURNALSource: FactSet %SharesTARP warrants2013’14’15’16’17-200-1000100200300400500600700800 “There were good days and other days when I felt like crying,” said John Hadwen, a portfolio manager at CI Investments’ Signature Global Asset Management, which has held TARP warrants since 2010. When his J.P. Morgan warrants fell in value after the bank’s 2012 London whale trading loss, Mr. Hadwen pushed to buy the rest available, but the Canadian asset-manager’s chief investment officer said no. Mr. Davidson said he learned about the warrants a few years ago at an Omaha bar where he was mingling with attendees at Berkshire Hathaway ’s annual meeting. Warren Buffett, the conglomerate’s chairman, got warrants unrelated to TARP as a part of Berkshire’s crisis-era investments in Goldman Sachs Group and Bank of America. The Miller Opportunity Trust mutual fund said it has notched gains of about $77 million on a $24 million investment in J.P. Morgan warrants. When the fund bought the warrants, “the market hated financials and was pricing in pretty dire scenarios,” said Samantha McLemore, co-manager on the portfolio with Mr. Miller. Mr. Paulson, who made billions of dollars betting against subprime mortgages a decade ago, turned a roughly $100-million profit on about $600 million in bank warrant investments, according to a person familiar with the matter. But he could have earned more if his funds hadn’t sold their J.P. Morgan warrants in 2012. Mr. Miller’s fund similarly lost out by selling Bank of America warrants around that time, though Ms. McLemore says the fund has done well by hanging onto the bank’s common stock. Mr. Davidson said he learned about the warrants a few years ago at an Omaha bar where he was mingling with attendees at Berkshire Hathaway’s annual meeting. PHOTO: NIALL MCDIARMID FOR THE WALL STREET JOURNAL Investors got the warrants only because the U.S. government didn’t want to hold on to them. By late 2009, the biggest banks had paid TARP money back and the Treasury started auctioning the warrants. By the end of 2012, it had made about $5 billion auctioning them off to investors. In other cases, Treasury sold the warrants back to the banks. That has transferred the rest of the gains to private hands. The TARP warrants still trading in Bank of America, J.P. Morgan, Wells Fargo & Co. and PNC Financial Services Group Inc., for example, are worth more than $2 billion more on paper than when the government sold. At banks such as J.P. Morgan that hit their strike price a while ago, investors have likely netted additional profits by exercising the warrants. New York-based Maltese Capital Management bought 2.2 million TARP warrants in Salt Lake City-based Zions Bancorp . from the government for about $1.35 apiece and held on to most of them. Today, they are worth about $11.30 per share, a return of around 740%. “We’d like a few more of those,” said Terry Maltese, the firm’s founder.
"Mr. Davidson said he learned about the warrants a few years ago at an Omaha bar where he was mingling with attendees at Berkshire Hathaway’s annual meeting. PHOTO: NIALL MCDIARMID FOR THE WALL STREET JOURNAL
"Mr. Davidson said he learned about the warrants a few years ago at an Omaha bar where he was mingling with attendees at Berkshire Hathaway ’s annual meeting. Warren Buffett, the conglomerate’s chairman, got warrants unrelated to TARP as a part of Berkshire’s crisis-era investments in Goldman Sachs Group and Bank of America." did Buffett eventually participate?