TARP Warrant Repurchase Process Overview and Valuation. August 2011

Transcription

1 TARP Warrant Repurchase Process Overview and Valuation August 2011

2 Table of Contents Section I II III IV V VI Repurchase Process Overview What to Expect if Treasury Rejects Initial Repurchase Offer Treasury s Three-Prong Valuation Methodology Warrant Value Considerations with Respect to Financial Modeling Previous Warrant Repurchases with Process Insight Financial Modeling Warrant Valuation of Community Partners Page 2

3 Section I Repurchase Process Overview Page 3

4 Repurchase Process Overview If an institution wishes to repurchase warrants from Treasury, it must first take steps 1 through 4, to the extent required, of the 5 steps below: Step 1 Notification to Treasury of intent to repurchase accompanied by repurchase offer with determination of fair market value Step 2 Treasury evaluates the repurchase offer Step 3 Resolution period Step 4 Appraisal procedure Step 5 Alternative disposition Step 1 Notification to Treasury with Determination of Fair Market Value Any institution wishing to repurchase its warrants may notify Treasury within 15 days of repayment of TARP funds. According to the CPP SPA (Capital Purchase Program Stock Purchase Agreement), the notification must include the number of warrants to be repurchased and the offer terms. Moreover, the board of directors must be acting in good faith with reliance on an independent investment banking firm. The independent investment banking firm must be hired by the TARP recipient. CPP banks may buy back the warrants at any time after the preferred shares have been repurchased Source: Office of the Special Inspector General for the TARP Page 4

5 Warrant Repurchase Process Overview Step 2 Treasury Evaluates the Repurchase Offer Treasury has 10 days to evaluate the TARP recipient s offer. Treasury uses three different valuation methodologies to determine their composite value and to evaluate the offer: Market Quotes - The warrants that Treasury holds are not listed on a securities exchange. Accordingly, Treasury uses market prices of securities with similar characteristics to assess the market value of the warrants. Securities with similar characteristics include publicly traded long duration warrants and options of similar institutions. Treasury gathers quotes from 3-10 market participants, such as brokers, investment banks and asset management firms Treasury s Financial Models Treasury conducts valuations based on common financial models, such as Black-Scholes (a closed-form model) and a lattice model (such as a binomial model). The models use various known inputs as well as assumptions about the future volatility and future dividends of the underlying stock to calculate the value of the warrants Third-Party Valuation Treasury uses eight external asset managers that it has hired to manage TARP assets to assess warrant valuation The composite value is the Treasury analyst s opinion of the fair market value after plotting the ranges of the three valuation methodologies and taking into consideration other factors Note: The use of fundamental analysis as a 4 th valuation methodology was abandoned in June, 2009 Source: Office of the Special Inspector General for the TARP Page 5

6 Repurchase Process Overview Step 3 Resolution Period Should Treasury reject the repurchase offer, the bank and a representative of Treasury meet to discuss Treasury s objections to the valuation proposed and attempt to reach an agreement. Additional negotiation and offers to repurchase the warrant can be submitted to Treasury in an attempt to reach an agreement Step 4 Appraisal Procedure If no price is agreed upon, and subsequent offers are not submitted, either the institution or Treasury may invoke the Appraisal Procedure. Each party shall deliver a notice to the other appointing its appraiser within 10 days after the appraisal procedure is invoked. This involves Treasury and the TARP recipient each choosing an independent appraiser to agree upon the fair market value of the warrants. If the two appraisers are not able to agree upon a fair market value after 30 days, then a third independent appraiser will be chosen with the consent of the first two appraisers. The third appraiser has 30 days to make a decision, and, subject to limitations such as if one of the three valuations is significantly different from the other two a composite valuation of the three appraisals is used to establish the fair market value originally stated in the SPA to be binding by both the bank and Treasury Treasury will be bound by this price determination, but Treasury has stated that if the recipient is not satisfied with this price it may withdraw its notification to repurchase the warrants. Under the CPP SPA, the costs of conducting any appraisal procedure shall be borne by the Company Source: Office of the Special Inspector General for the TARP, CPP SPA documents Page 6

7 Repurchase Process Overview Step 5 Alternative Disposition If neither the institution nor Treasury invoke the Appraisal Procedure, or if the institution decides not to seek to repurchase its warrants, Treasury has various options as to how it manages these investments over the 10-year exercisable period it may sell them at auction, exercise them, or hold them as it sees fit to otherwise maximize benefit to the taxpayers. However, Treasury has stated that it generally would publicly auction warrants in cases where it could not reach agreement upon a fair market value Source: Office of the Special Inspector General for the TARP Page 7

8 Repurchase Process Flow Chart Start: Publicly held institution repays TARP CPP a Step 1: Notification - Bank notifies Treasury of intent to buy its warrants b and submits an offer c Step 2: Evaluate - Using three pricing methods, Treasury decides to accept or reject the Bank's offer Accept Reject End: Warrants transferred to Bank Step 3: Negotiations - Treasury and Bank discuss to resolve objections; Bank may submit additional offers Step 5: Auction - Via a public auction, Treasury sells warrants e to the highest bidders if Treasury accepts the clearing price after the auction closes End: Warrants sold to winners Bank submits multiple offer(s) Bank does not invoke appraisal or elects to forgo its right to directly buy warrants from Treasury End: Warrants transferred to Bank Bank invokes appraial and agrees with price Bank does not submit multiple offer(s) Step 4: Appraisal - Either party can invoke appraisal d to determine fair market value Notes: a. For privately held institutions and S-Corporations, Treasury immediately excercised the warrants at the time of the initial CPP transaction and receives additional preferred shares or subordinate debt as a result b. If the institution does not wish to repurchase the warrants, Treasury will generally auction the warrants c. The board of directors must certify to Treasury that they acted in good faith to arrive at the fair market value determination d. The determination by the independent appraisers is binding on Treasury if the institution chooses to proceed with the sale e. At any time throughout this process, the institution may revoke its intent to repurchase its warrant, at which point Treasury proceeds to the auction process Source: Office of the Special Inspector General for the TARP interpretation of the Securities Purchase Agreement Page 8

9 Section II What to Expect if Treasury Rejects Initial Repurchase Offer Page 9

10 What to Expect if Treasury Rejects Initial Repurchase Offer The Assistant Secretary for Financial Stability ultimately decides whether to accept or reject an offer. If the Assistant Secretary rejects the initial offer, Treasury typically sends a rejection letter to the bank. The letter includes information for the bank to contact a Treasury analyst to start the process of resolving differences. The bank decides whether it wants to continue discussions if Treasury rejects its offer With respect to Treasury s approach before holding conversations with an institution after the rejection of an initial offer, the CPP staff told the Special Inspector General for the TARP that the valuation team analysts meet in advance of the discussion and agree on their strategy and approach on what will be discussed with the institution. Treasury stated that the amount of information it discloses to each institution is a result of where the bank is within these stages of negotiation, although none of this information is reflected in formal guidelines The stages of negotiation: 1. Discovery Phase 2. Post-Discovery Phase 3. Post-Warrant Committee 4. Assistant Secretary Conversations Source: Office of the Special Inspector General for the TARP Page 10

11 The Stages of Negotiation Discovery Phase (#1) Treasury stated that the first discussions revolve around process. In this phase Treasury communicates how the values were derived from three different methods of market quotes, model valuation, and third-party estimates. A Treasury official stated that you can tell from the beginning who understands the process and who doesn t. According to Treasury, some banks do not understand or are confused by the contractual element of TARP and the warrants repurchase process. With such banks, Treasury has to educate them on the process. Treasury told the Special Inspector General for the TARP that it does not tell banks where their offer falls within the three price ranges and what they can do to get it accepted. From time to time, Treasury might share more information on assumptions to get the institution moving in the right direction, but only after Treasury senses that the institution has come to an understanding regarding Treasury s three-pronged valuation methodology. According to Treasury, it does not provide counteroffers at this stage. One Treasury official stated that at this stage, what is discussed is approach, not numbers. Source: Office of the Special Inspector General for the TARP Page 11

12 The Stages of Negotiation Post-Discovery Phase (#2) On subsequent calls and once the offer is somewhat closer to Treasury s determination of fair market value, Treasury might engage in a more detailed discussion. Treasury has commented that it discusses reactions to extenuating circumstances during these calls with the banks. For example, Treasury stated that, if a bank is tremendously off from the composite value, it lets the bank go back to the drawing board to figure out what the value is. In such cases, Treasury indicated that it would not provide as much detail regarding the inputs and outputs of the valuation. Once the bank is within a closer range, however, Treasury stated that it may provide valuation input enhancements to the bank that might eliminate the differences between Treasury s value and the bank s price. According to Treasury, it does not want to disadvantage the smaller banks, as they might not be equipped or staffed to arrive at a sophisticated valuation. However, Treasury commented that the level of information they provide is not based on whether the bank is big or small, and they will not give detailed information to those banks that are far off Source: Office of the Special Inspector General for the TARP Page 12

13 The Stages of Negotiation Post-Warrant Committee (#3) Once Treasury officials receive feedback from the Warrant Committee, they might provide to the bank a fair market value with which the Warrant Committee would be comfortable. Treasury makes it clear that these suggestions are not a commitment to accept that price Assistant Secretary Conversations (#4) The Assistant Secretary told the Special Inspector to the TARP that sometimes when he is deciding whether to accept or reject an offer, financial institutions call him to feel him out. The Assistant Secretary told the Special Inspector to the TARP that he does not negotiate on these calls, but rather just listens to the pitch made by the banks and conveys Treasury s position. The Assistant Secretary indicated that Treasury s policy was not to provide specific numbers to institutions, on the theory that the banks could bid more than Treasury s composite value Source: Office of the Special Inspector General for the TARP Page 13

14 Section III Treasury s Three-Prong Valuation Methodology Page 14

15 Treasury s Three-Prong Valuation Methodology Treasury s Valuation Team and Composite Value Treasury s valuation team consists of three to five Treasury analysts and one supervisory analyst. This team prepares Treasury s assessment of offers from banks. Treasury assigns an analyst whose role is to determine the warrant s value using three pricing methods: market quotes, financial modeling outputs, and third-party estimates (the three-prong valuation methodology). These inputs drive Treasury s composite value, which is the analyst s opinion of the appropriate price for the warrants Market Quotes Treasury seeks observable market prices for a bank s 10-year warrants a difficult task given the scarcity of warrants that have such a long term. If a market price for a specific bank s warrants is unavailable, Treasury surveys the market for parties that are willing to provide voluntary indicative values. Treasury s process requires a minimum of three market valuations (Treasury continues to solicit market quotes from market participants until a minimum of three prices are obtained). According to Treasury, firms receive no confidential information from Treasury and must rely on publicly available information in making their quotes Market quotes have typically generated the lowest valuations of Treasury s three pricing methods Source: Office of the Special Inspector General for the TARP Page 15

16 Treasury s Three-Prong Valuation Methodology Financial Modeling Outputs The Treasury analyst uses two financial models to estimate the fair market value of the warrants. These models a Black-Scholes model and a binomial model are generally accepted as option valuation tools. These models produce a range of potential values based on known inputs such as the maturity date of the warrant and the warrant s strike price, and on assumptions of future activity such as the future volatility of the underlying stock price and future dividend payments Because it is difficult to predict the future activity of prices, dividend payments and other events, two modelers who use the same models may arrive at very different prices because of varying assumptions. Differing assumptions about the volatility of the institution s common stock price, for example, can result in significantly different values After Treasury computes an estimated value using the financial models, the Treasury analyst may also apply a liquidity discount (approximately 0%-50%) based on, among other things, the volume of warrants, options or underlying shares traded, the ease of which the instrument can be sold in the market, and a potential buyer s ability to hedge its warrant position by shorting the company s stock This discount attempts to quantify the markdown that the market would apply to the value of the warrants because of the difficulty of selling infrequently traded securities (such as long-maturity warrants in small banks) in the market. For large institutions with similar instruments that are considered liquid, Treasury does not apply a liquidity discount. Additional discounts may be applied for insolvency risk and other risks over the ten year period Source: Office of the Special Inspector General for the TARP, Congressional Oversight Panel Page 16

17 Treasury s Three-Prong Valuation Methodology Third-Party Estimates To provide an independent price assessment, Treasury employs one of eight asset managers to run its own proprietary valuation process to arrive at an independent price to use for Treasury s analysis. According to Treasury, each of these eight firms is assigned a group of banks to cover for purposes of warrant valuation. When banks are starting the process to buy back their warrants, Treasury contacts one of the eight firms to obtain a third-party valuation For the first 11 warrants analyzed, the Special Inspector for the TARP found that the thirdparty estimates generally tended to be the highest of the three pricing methods. After the first 11 banks, third-party estimates have become more closely aligned with Treasury s financial modeling estimates Source: Office of the Special Inspector General for the TARP Page 17

18 Treasury s Three-Prong Valuation Methodology Composite Value Treasury officials describe the composite value as what the analyst believes the warrants are worth. Treasury does not have formal guidance or written policies on how the analyst determines the composite value, and, according to Treasury s CPP staff, this determination of fair market value is largely done on a case-by-case basis, depending on the analyst s subjective weighing of the three price estimates and the following factors: Spreads of the ranges of the three fair market value estimates Existence of outliers within the pricing methodologies Market volatility of the underlying stock price Size of the institutions for purposes of measuring liquidity of the underlying stock The preparer compares the three valuation metrics and decides where the most agreement between the three price ranges regardless of whether the point incorporates prices from all three ranges. Where the composite value line is drawn within these three ranges is a judgment call because the valuation process has multiple subjective inputs. Thus, the composite value may depend on which analyst works on a particular warrant In an analysis of the first 33 warrants repurchased, the Special Inspector of the TARP found that Treasury s financial model estimate tended to be in the middle of the three pricing methods and was generally the one closest to the final negotiated price Source: Office of the Special Inspector General for the TARP Page 18

19 Treasury s Three-Prong Valuation Methodology The Warrant Committee Treasury established a CPP Warrant Committee to recommend to the Assistant Secretary whether an offer should be accepted or rejected. When the Warrant Committee convenes, the Treasury analyst who performed valuation presents his or her value assessment to the Warrant Committee. Each member of the Warrant Committee and the Assistant Secretary weighs the three valuation ranges as they deem appropriate. In addition, they consider the following factors: Comparison of the offer to Treasury s valuation metrics Significant movements of the current stock price Deviations of the current stock price from the 20-day trailing average of the stock price Trading volume of the underlying stock Size of the institution Potential investor interest in the warrants Potential auction costs For example, if a bank s offer is only slightly below Treasury s composite value, Treasury may accept the offer in order to save the costs associated with an auction (approximately the greater of $150,000 or 1.5% of the proceeds) Source: Office of the Special Inspector General for the TARP Page 19

20 Treasury s Three-Prong Valuation Methodology Warrant Committee Meeting Minutes Insight The Special Inspector General of the TARP found that the warrant committee minutes often focus on how close the offer is to Treasury s determination or range and do not document the factors the warrant committee members reportedly considered when recommending whether to accept or reject an offer. As a result of the lack of detailed documentation of the warrant committee s considerations, the Special Inspector General of the TARP could not determine the extent to which the warrant committee made decisions consistently or objectively across institutions, and it is difficult to determine from the documentation why Treasury accepted prices for some institutions but rejected similar bids from others Source: Office of the Special Inspector General for the TARP Page 20

21 Treasury s Three-Prong Valuation Methodology Example of Treasury s Composite Value Analysis The figure below demonstrates the three elements of Treasury s warrant valuation analysis together with an institution s bids for the warrants. First Niagara is the example The black bars indicate the range of value with respect to the methodology utilized. The red points indicate the average market quote or estimated value. The bank s final bid accepted by Treasury is indicated by the green bar. Treasury s composite value for First Niagara is not specifically disclosed, although through graphical data compiled from Treasury data, the composite value appears to be slightly less than the accepted offer Source: Office of the Special Inspector General for the TARP, Treasury Page 21

22 Treasury s Three-Prong Valuation Methodology - Takeaways Treasury does not have established guidelines or internal controls over how the negotiations proceed or how much information is shared with recipient institutions Treasury has over time been more consistent in obtaining negotiated prices at or above its estimated composite value Treasury s composite value is subjective and generally not disclosed to recipient institutions Treasury s financial model estimate is most likely to be in the middle of the three pricing methods and may be the one closest to the final negotiated price Treasury has stated that it is willing to accept a bid that is lower than its composite price due to the cost associated with an auction (the greater of approximately $150,000 or 1.5% of the proceeds) to maximize the return to taxpayers Entering negotiations with Treasury, with the ability to submit additional offers, is a benefit to recipient institutions and an incentive to submit an initial offer towards the low end of the reasonable range (less estimated Treasury transaction costs) and incrementally increase subsequent offers so as not to over-bid the composite price Generally, smaller recipient institutions with relatively small warrant positions should be able to repurchase the warrant at a favorable price due to the costs associated with an auction Source: Office of the Special Inspector General for the TARP Page 22

23 Section V Warrant Value Considerations with Respect to Financial Modeling Page 23

24 Factors Affecting TARP Warrant Value Factors That Affect the Value of TARP CPP Warrants Factor Affect on Warrant Value Reason Time until warrant expiration The longer the time until warrant expiration, the the value of the warrant higher With more time to trade, the underlying stock has a greater chance of surpassing the warrant exercise price Dividend yield Volatility Stock price Pricing of comparable company securities at auction Strike price The higher the dividend yield, value The more volatile the underlying stock, valuable the warrant the lower the warrant The higher the price of the underlying stock, valuable the warrant the more the more The higher the auction prices for comparable companies, the more valuable the warrant The higher the strike price compared to the present market value of common stock, the lower the warrant value Dividends tend to reduce the growth rate of the underlying stock price The more the underlying stock price has to the ability to change, the more likely it is that the warrant will expire in the money An increase in the underlying stock price increases the intrinsic value of the warrant; redeeming the warrant while stock price is low (immediately after a public offering) results in lowest price Auction pricing is the best indication of true FMV and the best indication of what the UST will take (although UST may consider other factors such as third party and model valuations) The greater the strike price-market price differential, the greater the chance that the warrant will expire out-of-themoney Page 24

25 Factors Affecting TARP Warrant Value Factors That Affect the Value of TARP CPP Warrants Factor Affect on Warrant Value Reason Risk-free interest rate The higher the risk-free interest rate, warrant value the higher the Higher risk-free rates tend to increase the growth rate of the underlying stock price Dilution Trading volume Common stock offering The larger the ratio of warrants held by Treasury to shares outstanding, the lower the value of the warrant Warrants on thinly traded stock may receive a liquidity discount, thus lowering the value of the warrant Common stock offerings may reduce the value of the underlying stock, thus lowering the value of the warrant Since exercising a warrant causes an increase in the number of outstanding shares, diluting common equity holders, the underlying stock is worth less after the exercise of a warrant than it was before exercise For thinly traded stocks, Treasury believes that its warrant positions are too large to be sold for their model value on the open market Common stock offerings tend to reduce the growth rate of the underlying stock price* Note: The number of shares subject to the warrants is decreased by 50% if the issuer engaged before December 31, 2009 in a qualified equity offering in which it received gross proceeds of at least 100% of the liquidation price of the preferred shares Page 25

26 Warrant Value Considerations with Respect to Financial Modeling A warrant is an option that grants the holder the right to buy another security at a specified price on a specified date or during a specified period of time. A warrant is similar to a call option, but differs in that the firm itself is the seller of the option, rather than an outside party, which has a dilutive effect not associated with typical call options Several models are available to value options, and thus, TARP warrants: Black-Scholes (a closed-form model) Extensions have been added to account for the integration of dividends into the Black-Scholes model (Merton), and for the dilutive effect that exercising warrants have on a stock value A lattice model (such as a binomial model) The ability to add different variables at discrete periods of time within the model results in a more complicated and less reproducible model as a result Monte Carlo methods (simulation through repeated random sampling) A type of lattice model requiring significant computing resources to simulate thousands of random price paths producing a normal probability distribution of expected returns The choice between using the Black-Scholes or the binomial method does not matter, because, given the same inputs, the binomial method converges on Black-Scholes as the number of nodes in the binomial tree grows In fact, the Black-Scholes equations are merely the closed form solution of the binomial model in the special case that inputs are constant and that the number of nodes is taken to the limit From this, any difference in the valuations of warrants is due not to the choice of the binomial or Black-Scholes model, but rather the input assumptions that are made Source: Office of the Special Inspector General for the TARP, Treasury, Congressional Oversight Panel Page 26

27 Various Models Available to Determine Warrant Value Black-Scholes Adjusted for Dividends (Merton) and Dilution (Galai-Schneller) Binomial and Trinomial Lattice Monte Carlo Simulation Mechanics Equation that considers the relationship between the warrant exercise price, the market value of the underlying stock, the term of the warrant, the expected volatility of the underlying stock, the expected dividend yield of the underlying stock, and current risk-free interest rate Uses a decision-tree approach to determine warrant value creates a tree of possible future outcomes, assumes exercise at each of the different possible outcomes, and then calculates the value of the warrant at that point; after the values are computed for each possible outcome, they are averaged into a single value Ease of Replication Easy Somewhat difficult; generally requires proprietary software Ease of Use Simple Complex Very complex Inflexible assumptions remain constant over life of warrant; cannot accurately Flexible can account for varying volatility, Flexibility account for early exercise early exercise, and other complications Flexible Popularity Widely used Emerging as alternative to Black-Scholes models Time to Calculate Fairly quick Difficult to evaluate quickly Lengthy process Valuing European-style exchange-traded Originally options (i.e., options that can only be Valuing American-style exchange traded options Developed exercised at maturity); intended to value (i.e., options that can be exercised at any time For short-term options prior to maturity) Type of lattice-based model that generates thousands of random price paths for the underlying stock via simulation, and then calculates the associated exercise value (i.e. payoff ) of the warrant for each path; these payoffs are then averaged and discounted, arriving at the value of the warrant Very difficult; uses a computer program into which users enter information and the system utilizes pre-programmed logic to return output to the user Not widely used for valuing American-style exchange traded options Valuing Asian-style options (i.e., option whose payoff depends on the average price of the underlying stock over a certain period of time) Source: Office of the Special Inspector General for the TARP, Treasury, Congressional Oversight Panel Page 27

28 Assumptions that Significantly Affect Warrant Value Volatility The input that is the least defined in the Black-Scholes model and has the largest effect on the price of the warrant is the assumed future volatility of the underlying stock price Volatility is defined as the standard deviation of the continuously compounding returns of a stock Treasury uses two measures of volatility to generate its assumption of future volatility: Historical volatility Treasury uses the average 60-day trailing volatility for the last ten years to determine a stock s historical volatility The option-implied volatility Some larger publicly-traded institutions have existing short-dated options and longer-dated options (with maturities of up to two years) that provide data on option-implied volatility Most small recipient institutions do not have options currently traded on their stock Where necessary, adjustments will be made for the expected mean-reversion of volatility over time Future Dividend Yield Future dividend yield represents an investor s return on investment if the stock is not sold. Dividends create a premium for holding the underlying stock compared to the warrant. A marginal borrowing cost may be added to the dividend yield for modeling purposes As a result, all other things being equal, the higher the dividend yield of the underlying stock, the lower the value of the warrant Treasury assumes that dividends normalize over time and thus uses a constant yield based on historical observations Liquidity Discount A discount (Treasury applies 0%-50%) to account for an investor holding shares that are not easily sold in the secondary market The discount depends on, among other things, the size of the warrant position, the average trading volume of the underlying stock, and the liquidity of the equity underlying the warrants Page 28 Source: Office of the Special Inspector General for the TARP, Treasury, Congressional Oversight Panel

29 Section V Previous Warrant Repurchases with Process Insight Page 29

30 Warrant Repurchases in 2009 Repurchased TARP Warrants to Date Name of Institution Purchase Date State Investment Amount Capital Repayment Date Institutions highlighted in yellow are discussed in further detail Disposition Investment Description Final Disposition Date Final Disposition Proceeds 31 Trustmark Corporation 11/21/2008 MS 215,000,000 12/9/2009 Warrants 12/30/ ,000, Flushing Financial Corporation 12/19/2008 NY 70,000,000 10/28/2009 Warrants 12/30/ , Union First Market Bankshares Corporation 12/19/2008 VA 59,000,000 11/18/2009 Warrants 12/23/ , WesBanco, Inc. 12/5/2008 WV 75,000,000 9/9/2009 Warrants 12/23/ , Wainwright Bank & Trust Company 12/19/2008 MA 22,000,000 11/24/2009 Warrants 12/16/ , LSB Corporation 12/12/2008 MA 15,000,000 11/18/2009 Warrants 12/16/ , Bank of the Ozarks, Inc. 12/12/2008 AR 75,000,000 11/4/2009 Warrants 11/24/2009 2,650, Centerstate Banks of Florida Inc. 11/21/2008 FL 27,875,000 9/30/2009 Warrants 10/28/ , CVB Financial Corp 12/5/2008 CA 130,000,000 8/26/2009 Warrants 10/28/2009 1,307, Manhattan Bancorp 12/5/2008 CA 1,700,000 9/16/2009 Warrants 10/14/ , Bancorp Rhode Island, Inc. 12/19/2008 RI 30,000,000 8/5/2009 Warrants 9/30/2009 1,400, Old Line Bancshares, Inc. 12/5/2008 MD 7,000,000 7/15/2009 Warrants 9/2/ , Northern Trust Corporation 11/14/2008 IL 1,576,000,000 6/17/2009 Warrants 8/26/ ,000, Morgan Stanley 10/28/2008 NY 10,000,000,000 6/17/2009 Warrants 8/12/ ,000, The Bank of New York Mellon Corporation 10/28/2008 NY 3,000,000,000 6/17/2009 Warrants 8/5/ ,000, American Express Company 1/9/2009 NY 3,388,890,000 6/17/2009 Warrants 7/29/ ,000, The Goldman Sachs Group, Inc. 10/28/2008 NY 10,000,000,000 6/17/2009 Warrants 7/22/2009 1,100,000, BB&T Corp. 11/14/2008 NC 3,133,640,000 6/17/2009 Warrants 7/22/ ,010, U.S. Bancorp 11/14/2008 MN 6,599,000,000 6/17/2009 Warrants 7/15/ ,000, State Street Corporation 10/28/2008 MA 2,000,000,000 6/17/2009 Warrants 7/8/ ,000, HF Financial Corp. 11/21/2008 SD 25,000,000 6/3/2009 Warrants 6/30/ , First Niagara Financial Group 11/21/2008 NY 184,011,000 5/27/2009 Warrants 6/24/2009 2,700,000 9 Somerset Hills Bancorp 1/16/2009 NJ 7,414,000 5/20/2009 Warrants 6/24/ ,000 8 Berkshire Hills Bancorp, Inc. 12/19/2008 MA 40,000,000 5/27/2009 Warrants 6/24/2009 1,040,000 7 SCBT Financial Corporation 1/16/2009 SC 64,779,000 5/20/2009 Warrants 6/24/2009 1,400,000 6 Alliance Financial Corporation 12/19/2008 NY 26,918,000 5/13/2009 Warrants 6/17/ ,000 5 Independent Bank Corp. 1/9/2009 MA 78,158,000 4/22/2009 Warrants 5/27/2009 2,200,000 4 FirstMerit Corporation 1/9/2009 OH 125,000,000 4/22/2009 Warrants 5/27/2009 5,025,000 3 Sun Bancorp, Inc. 1/9/2009 NJ 89,310,000 4/8/2009 Warrants 5/27/2009 2,100,000 2 Iberiabank Corporation 12/5/2008 LA 90,000,000 3/31/2009 Warrants 5/20/2009 1,200,000 1 Old National Bancorp 12/12/2008 IN 100,000,000 3/31/2009 Warrants 5/8/2009 1,200,000 Source: Treasury Page 30

31 Warrant Repurchases in 2010 and YTD 2011 Repurchased TARP Warrants to Date Name of Institution Purchase Date State Investment Amount Capital Repayment Date Disposition Investment Description Final Disposition Date Final Disposition Proceeds 50 Sandy Spring Bancorp, Inc. 12/5/2008 MD 83,094,000 7/21/2010 Warrants 2/23/2011 4,450, East West Bancorp 12/5/2008 CA 306,546,000 12/29/2010 Warrants 1/26/ ,500, Susquehanna Bancshares, Inc 12/12/2008 PA 300,000,000 4/21/2010 Warrants 1/19/2011 5,269, Huntington Bancshares 11/14/2008 OH 1,398,071,000 12/22/2010 Warrants 1/19/ ,100, First PacTrust Bancorp, Inc. 11/21/2008 CA 19,300,000 12/15/2010 Warrants 1/5/2011 1,003, Central Jersey Bancorp 12/23/2008 NJ 11,300,000 11/24/2010 Warrants 12/1/ , TIB Financial Corp 12/5/2008 FL 37,000,000 9/30/2010 Warrants 9/30/ , South Financial Group, Inc. 12/5/2008 SC 347,000,000 9/30/2010 Warrants 9/30/ , The Bancorp, Inc. 12/12/2008 DE 45,220,000 3/10/2010 Warrants 9/8/2010 4,753, Fulton Financial Corporation 12/23/2008 PA 376,500,000 7/14/2010 Warrants 9/8/ ,800, Columbia Banking System, Inc. 11/21/2008 WA 76,898,000 8/11/2010 Warrants 9/1/2010 3,301, Citizens & Northern Corporation 1/16/2009 PA 26,440,000 8/4/2010 Warrants 9/1/ , Bar Harbor Bankshares 1/16/2009 ME 18,751,000 2/24/2010 Warrants 7/28/ , Discover Financial Services 3/13/2009 IL 1,224,558,000 4/21/2010 Warrants 7/7/ ,000, SVB Financial Group 12/12/2008 CA 235,000,000 12/23/2009 Warrants 6/16/2010 6,820, First Litchfield Financial Corporation 12/12/2008 CT 10,000,000 4/7/2010 Warrants 4/7/2010 1,488, Umpqua Holdings Corp. 11/14/2008 OR 214,181,000 2/17/2010 Warrants 3/31/2010 4,500, Monarch Financial Holdings, Inc. 12/19/2008 VA 14,700,000 12/23/2009 Warrants 2/10/ , OceanFirst Financial Corp. 1/16/2009 NJ 38,263,000 12/30/2009 Warrants 2/3/ ,797 Source: Treasury Page 31

32 Somerset Hills (SOMH) Page 32

33 Previous Warrant Repurchases with Process Insight Somerset Hills (SOMH) On June 17, 2009, Somerset Hills agreed to pay $275,000 for the warrant after an initial offer of $193,000 submitted on June 4, 2009, was rejected by Treasury The bank told the Special Inspector of the TARP that during the first phone call, Treasury shared its valuation approach and general process. For the second call, the bank executives stated that they clearly understood what Treasury s valuation range was. Treasury did not give the inputs to the model, but provided bank officials a dollar range approximate. With the new information, the bank submitted a second offer of $275,000 which was accepted by Treasury Treasury s disclosed composite value was $275,000 Somerset Hills was the 9 th institution to repurchase the TARP CPP warrants Company Name Exchange Ticker State Somerset Hills Bancorp NASDAQ SOMH NJ Total Assets ($000) at the time of Repayment $ 316,418 Average Daily Volume (Shares) 6,209 Transaction Date 6/17/2009 Actual Total Cost of Warrant Redemption $ 275,000 Treasury's Disclosed Composit Price $ 275,000 Liquidity Discount Utilized by Treasury 40% Source: Office of the Special Inspector General for the TARP, Treasury Page 33

34 Previous Warrant Repurchases with Process Insight Somerset Hills (SOMH) Treasury has communicated several key pieces of information regarding the modeled valuation of Somerset Hills A liquidity discount of 40% was applied to the modeled value That the warrant position was very small (under 400,000) and that the fixed costs of running the auction and legal fees (a minimum of $150,000) would significantly reduce the real return to the taxpayer (thus, justification for accepting the second bid) Being that the composite price Treasury was looking to receive was $275,000, and Treasury may have accepted $150,000 less, it is difficult to understand why Treasury did not accept Somerset s initial bid of $193,000. Regardless, it appears to be in the recipient institution s best interest to bid low and incrementally increase subsequent bids so as not to over-bid the composite price Source: Office of the Special Inspector General for the TARP, Treasury Page 34

35 Previous Warrant Repurchases with Process Insight Somerset Hills (SOMH) The Black-Scholes-Merton model, using general assumptions not provided by Treasury (average 60-day trailing volatility of 24% after an adjustment for expected mean reversion, and a dividend yield of 1.00% for the middle value), for Somerset Hills results in a valuation, after applying the disclosed 40% liquidity discount for financial modeling, of approximately $278,000 with a low-end and high-end range of $224,000 and $334,000, respectively Treasury accepted $275,000, which was its composite price The annualized return on investment to Treasury was 13.6% One reason for the difference between Treasury s valuation and the results of the Black-Scholes model may be differences in the assumptions used for volatility and dividend yield The results of this Black-Scholes-Merton model and the model valuation results disclosed on the previous page are very similar, although these results produce a slightly larger range Black-Scholes Results Low Middle High Assumed Dividend Yield 1.50% 1.00% 0.50% Assumed Volatility 19.36% 24.36% 29.36% Number of Warrants 163, , ,065 Common Shares Outstanding (Actual) $5,180,012 $5,180,012 $5,180,012 Warrant Value $2.28 $2.84 $3.41 Warrants Oustanding $163,065 $163,065 $163,065 Estimated Undiscounted Warrant Value $372,572 $462,676 $556,074 Assumed Liquidity Discount 40% 40% 40% Warrant Value Adjusted for Liquidity Discount $1.37 $1.70 $2.05 Estimated Warrant Value $223,543 $277,606 $333,644 Percentage of Treasury's Disclosed Composite Value 81.29% % % Source: Office of the Special Inspector General for the TARP, Treasury, SNL Financial Page 35

36 SCBT Financial Corp. (SCBT) Page 36

37 Previous Warrant Repurchases with Process Insight SCBT Financial Corporation (SCBT) On June 16, 2009, SCBT Financial Corporation agreed to pay $1.4 million for the warrant held by Treasury after an initial offer of $694,060 submitted on June 3, 2009, was rejected by Treasury According to SCBT officials, in subsequent telephone conversations, Treasury told SCBT that the liquidity discount applied by the bank was too large and suggested that a smaller discount be applied. It is assumed the final liquidity discount utilized was 35% Treasury s disclosed composite value was $1.4 million SCBT Financial was the 7 th institution to repurchase the TARP CPP warrants Company Name Exchange SCBT Financial Corporation NASDAQ Ticker SCBT State SC Total Assets ($000) at the time of Repayment $ 3,594,791 Average Daily Volume (Shares) 35,614 Transaction Date 6/15/2009 Actual Total Cost of Warrant Redemption $ 1,400,000 Treasury's Disclosed Composit Price $ 1,400,000 Assumed Liquidity Discount 35% Source: Office of the Special Inspector General for the TARP, Treasury Page 37

38 Previous Warrant Repurchases with Process Insight SCBT Financial Corporation (SCBT) The Black-Scholes-Merton model, using general assumptions not provided by Treasury (average 60-day trailing volatility of 33% after an adjustment for expected mean reversion, dividend yield of 2.40%, and liquidity discount of 35% for the middle value), for SCBT Financial results in a mid-range valuation of approximately $1.3 million and a low-end and high-end range of $1.0 million and $1.6 million, respectively Treasury accepted $1.4 million, which is its composite value The annualized return on investment to Treasury was 10.0% One reason for the difference between Treasury s valuation and the results of the Black-Scholes model may be differences in the assumptions used for volatility and dividend yield The results of the Black-Scholes-Merton model and the model valuation results disclosed on the previous page are very similar, although these results produce a slightly larger range Black-Scholes Results Low Middle High Assumed Dividend Yield 2.90% 2.40% 1.90% Assumed Volatility 28.43% 33.43% 38.43% Number of Warrants 303, , ,083 Common Shares Outstanding (Actual) $13,922,855 $13,922,855 $13,922,855 Warrant Value $4.91 $6.56 $8.28 Warrants Oustanding $303,083 $303,083 $303,083 Estimated Undiscounted Warrant Value $1,486,660 $1,987,161 $2,510,966 Assumed Liquidity Discount 35% 35% 35% Warrant Value Adjusted for Liquidity Discount $3.19 $4.26 $5.39 Estimated Warrant Value $966,329 $1,291,655 $1,632,128 Percentage of Treasury's Disclosed Composite Value 69.02% 92.26% % Source: Office of the Special Inspector General for the TARP, Treasury, SNL Financial Page 38

39 HF Financial Corp. (HFFC) Page 39

40 Previous Warrant Repurchases with Process Insight HF Financial Corp (HFFC) On June 29, 2009, HF Financial Corp agreed to pay $650,000 for the warrant held by Treasury after an initial offer of $464,987, and a second bid of $600,000, were rejected by Treasury A review of the Warrant Committee minutes regarding the second offer from HF Financial reveal that the Treasury analyst presented HF s revised offer of $600,000. He recommended that UST ask for a final offer of $650,000 and conditionally accept that offer, if made by HF. This recommendation was accepted 3-0 Treasury s composite value was not disclosed and Treasury did not release any additional information regarding the negotiation process, although through graphical data compiled from Treasury data, the composite value appears to be significantly below the second offer from HF, which was rejected by Treasury HF Financial was the 11 th institution to repurchase the TARP CPP warrants, it is unclear why Treasury did not accept HF s second offer of $600,000 Company Name Exchange HF Financial Corp. NASDAQ Ticker HFFC State SD Total Assets ($000) at the time of Repayment $ 1,226,033 Average Daily Volume (Shares) 4,165 Transaction Date 6/28/2009 Actual Total Cost of Warrant Redemption $ 650,000 Treasury's Disclosed Composit Price Undisclosed Assumed Liquidity Discount 50% Source: Office of the Special Inspector General for the TARP, Treasury Page 40

41 Previous Warrant Repurchases with Process Insight HF Financial (HFFC) The Black-Scholes-Merton model, using general assumptions not provided by Treasury (average 60-day trailing volatility of 35%, dividend yield of 3.05%, and liquidity discount of 50% for the middle value), for HF Financial results in a midrange valuation of approximately $552,000 and a low-end and high-end range of $437,000 and $669,000, respectively Treasury accepted $650,00, well in excess of its composite value The annualized return on investment to Treasury was 9.3% The results of this Black-Scholes-Merton model and the model valuation results disclosed on the previous page are very similar, yet a slightly larger range Black-Scholes Results Low Middle High Assumed Dividend Yield 3.55% 3.05% 2.55% Assumed Volatility 29.57% 34.57% 39.57% Number of Warrants 302, , ,419 Common Shares Outstanding (Actual) $6,978,561 $6,978,561 $6,978,561 Warrant Value $2.89 $3.65 $4.43 Warrants Oustanding $302,419 $302,419 $302,419 Estimated Undiscounted Warrant Value $874,784 $1,103,481 $1,338,858 Assumed Liquidity Discount 50% 50% 50% Warrant Value Adjusted for Liquidity Discount $1.45 $1.82 $2.21 Estimated Warrant Value $437,392 $551,740 $669,429 Source: Office of the Special Inspector General for the TARP, Treasury, SNL Financial Page 41

42 CenterState Banks, Inc. (CSFL) Page 42

43 Previous Warrant Repurchases with Process Insight CenterState Banks, Inc. (CSFL) On October 20, 2009, CenterState Banks agreed to pay $212,000 for the warrant after an initial offer of $168,053 was rejected by Treasury Treasury did disclose a 20% liquidity discount was utilized in financial modeling Treasury s composite value was not disclosed and Treasury did not release any information regarding the negotiation process, although through graphical data compiled from Treasury data, the composite value appears to be slightly higher than the accepted offer CenterState was the 23 rd institution to repurchase the TARP CPP warrants Company Name Exchange CenterState Banks, Inc. NASDAQ Ticker CSFL State FL Total Assets ($000) at the time of Repayment $ 2,063,319 Average Daily Volume (Shares) 93,453 Transaction Date 10/28/2009 Actual Total Cost of Warrant Redemption $ 212,000 Treasury's Disclosed Composit Price Undisclosed Liquidity Discount Utilized by Treasury 20% Source: Office of the Special Inspector General for the TARP, Treasury Page 43

44 Previous Warrant Repurchases with Process Insight CenterState Banks, Inc. (CSFL) The Black-Scholes-Merton model, using assumptions provided by Treasury (average 60-day trailing volatility of 40%, and dividend yield including marginal borrowing cost of 1.30% for the middle value), for CenterState Banks results in a mid-range valuation, after applying the stated 20% liquidity discount, of approximately $225,000 and a low-end and high-end range of $165,000 and $289,000, respectively Treasury accepted $212,000 The annualized return on investment to Treasury was 5.8% One reason for the difference between Treasury s valuation and the results of the Black- Scholes model may be differences in the assumptions used for volatility and dividend yield Black-Scholes Results Low Middle High Assumed Dividend Yield 1.80% 1.30% 0.80% Assumed Volatility 34.79% 39.79% 44.79% Number of Warrants 125, , ,413 Common Shares Outstanding (Actual) $30,004,761 $30,004,761 $30,004,761 Warrant Value $1.64 $2.24 $2.88 Warrants Oustanding $125,413 $125,413 $125,413 Estimated Undiscounted Warrant Value $206,088 $280,978 $360,934 Assumed Liquidity Discount 20% 20% 20% Warrant Value Adjusted for Liquidity Discount $1.31 $1.79 $2.30 Estimated Warrant Value $164,870 $224,782 $288,747 Source: Office of the Special Inspector General for the TARP, Treasury, SNL Financial Page 44

45 Section VI Financial Modeling Warrant Valuation of CPBC Page 45

46 Financial Modeling Warrant Valuation of CPBC Third-Party Estimates Recently, third-party estimates are more closely aligned with Treasury s financial modeling estimates (see the UMPQ example below of Treasury s 3 fair value estimates for UMPQ s warrant, and the multiple bids UMPQ submitted to repurchase the warrant) Market Quotes Market quotes have typically generated the lowest estimates of Treasury s three pricing methods Indicative market bidders the firms that provide the price quotations may tend to price the warrants as much as they are willing to pay for them and not necessarily fair market value This may lead to Treasury s composite price to be less than the mid-point of the financial modeling range Financial Modeling In an analysis of the first 33 warrants repurchased, the Special Inspector General for the TARP found that the financial modeling estimate was generally the closest to the final negotiated price, and the composite price was within the financial modeling range Financial modeling is the valuation analysis utilized by Griffin to value CPBC s warrant Note: For discussion purposes only Source: Office of the Special Inspector General for the TARP, Treasury, SNL Financial Page 46

47 Financial Modeling Warrant Valuation of CPBC Community Partners (CPBC) Treasury currently holds warrants in connection with the TARP that provides it with the right to purchase 311,972 shares of common stock at a strike price of $4.33 There are approximately 7.65 million CPBC shares outstanding, if the warrants were to be converted to common shares, they would represent approximately 4% of pro forma shares outstanding Company Name Exchange Ticker State Community Partners Bancorp NASDAQ CPBC NJ Total Assets ($000) $ 652,676 Average Daily Volume (Shares) 2,378 Number of Warrants 311,972 Warrant Strike Price $4.33 Stock Price $5.02 In/(Out) of Money $0.69 Valuing the warrants using the Black-Scholes model should produce a value that is near the final negotiated price and near Treasury s composite value Note: For discussion purposes only Source: SNL Financial, Treasury Treasury s composite value may be significantly higher or lower than the value produced using the Black-Scholes model for reasons previously discussed. If Treasury s composite value is higher than the first bid, and the first bid is unacceptable, this would be discovered after entering into the negotiation phase with Treasury Page 47