Buffett Swarms the Bank of Opportunity

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In a move straight out of October 2008, Warren Buffett's Berkshire Hathaway (NYSE: BRK-B  ) announced that it will inject $5 billion into Bank of America (NYSE: BAC  ) . The bank's shares had been falling apart in recent weeks, amid speculation that it would have to raise capital.

The premium for Buffett's love? B of A is up 25% as I write.

The structure of the deal is similar to what Buffett received for investing in Goldman Sachs (NYSE: GS  ) and General Electric (NYSE: GE  ) during the 2008 financial crisis, though terms aren't quite as attractive. In exchange for $5 billion:

  • Berkshire will receive $5 billion in B of A preferred stock yielding 6%, redeemable at any time for a 5% premium (the Goldman and GE preferred yielded 10% with a 10% redemption premium).
  • It also receives warrants to buy 700 million B of A common shares at a strike price of $7.14. It has 10 years to exercise the warrants.

Just like the Goldman and GE deals, the preferred are the investment, and the warrants are the kicker. Even if B of A's common stocks plunges, and the warrants expire worthless (an unlikely outcome), the preferreds would still be a decent use of Berkshire's capital. It's a fairly safe bet on Berkshire's part.

Two points stick out:

First, a 6% yield on B of A preferred stock is actually below the going market price. Some existing B of A preferred stock can be purchased on the open market yielding more than 9%; some of B of A's short-term debt yields close to 6%. The warrants, of course, juice Buffett's overall return potential (and by a lot), but it's clear he wasn't gunning to shoot the lights out on the preferred. Last month, Berkshire co-boss Charlie Munger recited a key of Berkshire's philosophy: "How nice it is to have a tyrant's power, and how wrong it is to use it like a tyrant." That may include not acting as a loan shark.

Second, B of A in recent days insisted it doesn't need capital. This morning, it still insists. "I remain confident that we have the capital and liquidity we need to run our business," CEO Brian Moynihan said in a press release. "At the same time, I also recognize that a large investment by Warren Buffett is a strong endorsement in our vision and our strategy." This is, then, a symbolic investment. Buffett is essentially renting his name to a bank trying to regain the market's confidence.

As B of A plunged in recent weeks, analysts speculated that Moynihan would eventually do something big. This is pretty big.

Fool contributor Morgan Housel owns shares of B of A preferred and Berkshire. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Berkshire Hathaway and Bank of America. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (18) | Recommend This Article (34)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 25, 2011, at 10:41 AM, hiddenflem wrote:

    He should have just let it die. B of A has THE WORST customer service of any bank I've ever used.

  • Report this Comment On August 25, 2011, at 10:45 AM, cycorp89 wrote:

    Damn! Why didn't I trust you Gut Instinct! Why!!! BAC was too cheap NOT to be missed!

    What a day...

  • Report this Comment On August 25, 2011, at 11:12 AM, dag154 wrote:

    This is one hell of a deal:

    - He just bought an option on 700 million shares, exercizable over 10 years, at a really low call price.

    - How much did thid cost him? Well not much, he is actually making money from this! 6% a year + a 5% bonus.

    I bow to the great master.

  • Report this Comment On August 25, 2011, at 11:27 AM, marketmaker2100 wrote:

    ^ Totally agree. Unreal.

  • Report this Comment On August 25, 2011, at 11:42 AM, foonchip wrote:

    The 700 million shares @ 7.14 seem the most unbelievable part of this to me.

  • Report this Comment On August 25, 2011, at 12:17 PM, idahogeo wrote:

    OK, so I'm kind of new at investing beyond the basic index fund (and talking about it online), but this Berkshire investment strikes me as a bit peculiar. I suppose a BRK shareholder can't be too upset about the BAC investment at one-third of book value, a reasonable yield, and a decade to recover the warrants; however, this begs the question: What, exactly, does Buffett, et. al. have left in their "too hard"? I'd be curious to know if these guys actually got to see the books and evaluate, for themselves, what the remaining mortgage default and derivatives exposures look like? I've been under the impression that the home team doesn't even know what kind of mess they're in.

    I'm long BRK.B, but skeptical of this least it wasn't more BYD...

  • Report this Comment On August 25, 2011, at 12:19 PM, flight20three wrote:

    The Oracle of Omaha came thru in the clutch....In my opinion, we are Humans and sometimes some of us actually help others, no matter the situation from a dollar on the street to 5 billion to a bank.....All-American he is!

  • Report this Comment On August 25, 2011, at 12:34 PM, DoctorLewis4 wrote:

    Another smart move. Why should we be surprised?

    BRK is a strong buy today.

  • Report this Comment On August 25, 2011, at 1:04 PM, Eerkes wrote:

    If BAC can manage 8% gains in share price over 10 years, the options are worth like $10B. That is incredible upside. No downside risk unless BAC goes under. what a deal

  • Report this Comment On August 25, 2011, at 1:07 PM, arizonamike303 wrote:

    Sure wish I was a multi-billionaire so I could get a 6 percent return too.

  • Report this Comment On August 25, 2011, at 1:17 PM, hbofbyu wrote:

    (In my most sarcastic voice): Warren Buffet has done it again! He invested in BAC and instantly gets a 17% return. I bow to the great master who takes these humongous risks for humungous returns. (*sigh*)

    Don't people know that it doesn't take a genius to do what he does anymore? He is a walking self-fulfilling prophecy. Where he puts his money, the doors will open and the sheep will follow. Once you get on his iconic level (the Oprah Winfrey level) you could take a dump on the sidewalk and people will call the movement sublime.

  • Report this Comment On August 25, 2011, at 2:15 PM, vidar712 wrote:

    @hbofbyu - He took a dump on the sidewalk? Argh! I've missed the boat again. Just yesterday I was thinking that I should take a dump on the sidewalk but I talked myself out of it. If I had only trusted my instincts my dump would be up 33% today!

  • Report this Comment On August 25, 2011, at 3:43 PM, hbofbyu wrote:

    I wish Warren would tell me before he makes these moves. "Socialism never took root in America because the poor see themselves not as an exploited proletariat but as temporarily embarrassed millionaires."

    — John Steinbeck

    I am just a temporarily embarrased millionaire.

  • Report this Comment On August 25, 2011, at 5:42 PM, whyaduck1128 wrote:

    I think hbofbyu has it right. The fortunate few selected by the Great Oz--I mean, the Great Oracle--go up not necessarily because they're great investments but because He Himself has bought them. I think he enjoys it, too. He probably says to himself, "I don't have to buy great companies--I just have to buy something. The sheep will reward me no matter what."

    What I don't quite get is that I keep reading articles on MF extolling the virtues of dividend-paying companies, while at the same time almost everyone drools over the slightest "dump on the sidewalk" by a man who treats possible dividend payment by his company as heresy.

    Meanwhile, our BRK.B shares continue to decline. I'm not selling, but I'm not rushing to buy more, either.

  • Report this Comment On August 25, 2011, at 6:05 PM, randallw wrote:

    "He is a walking self-fulfilling prophecy. Where he puts his money, the doors will open and the sheep will follow. Once you get on his iconic level (the Oprah Winfrey level) you could take a dump on the sidewalk and people will call the movement sublime."

    Correct, but he (and Oprah) started from nothing and obviously did something very unique and very smart to get to that level. And that is the point.

  • Report this Comment On August 25, 2011, at 9:22 PM, WhidbeyIsland wrote:

    "He is a walking self-fulfilling prophecy."

    Indeed. Does he ever get bored as such? Does he ever feel like seeing if he can do it with a penny stock or an obscure African country's bonds? (How many small countries in the world good Buffet just buy outright, if he felt like it?

    Bill Gates has decided he will see if he can save the world with his billions. Buffer is aboard the Gates' charity bandwagon, so I am not criticizing him, but it would be interesting to see him dabbling in something as creative and perhaps helpful and inspiring.

  • Report this Comment On August 25, 2011, at 9:59 PM, skypilot2005 wrote:

    Interesting angle:

    Doug Kass: Brian Moynihan Got Fleeced By Buffett's BofA Bet

    Published: Thursday, 25 Aug 2011

    Bank of America CEO Brian Moynihan got fleeced by famed investor Warren Buffett, renown strategist Douglas Kass said Thursday.

    "Buffett is a savvy wolf, who apparently stepped out of his bathtub wearing sheep's clothing and got Bank of America to do a deal at an extraordinarily heavy cost to capital," explained Kass, who serves as founder and president of Seabreeze Partners.

    By his estimates, Kass said the cost of capital of Buffett's $5 billion of preferred stock is roughly 11 percent a year. Considering BofA [BAC 7.65 0.66 (+9.44%) ] borrows in the intra bank market at nearly 0 percent, Kass called the Buffett deal "ludicrous."

    "It's far too expensive to prove to the markets that a smart investor, like Berkshire [BRK.A 103491.00 -2859.00 (-2.69%) ] is confidant in the banks futures," Kass continued. "So either Moynihan lied a few days about about Bank of America's need for capital or he's plan stupid for doing the deal."

    Investors should sell Bank of America and buy Berkshire, Kass said. Berkshire is a company that buys low and sells high. Kass himself sold his Bank of America shares Thursday and put the profits to work in other financial names

  • Report this Comment On August 26, 2011, at 12:10 AM, Clint35 wrote:

    Moynihan is full of crap. If BAC really has enough capital to keep running things then why do a deal like this which costs them a lot of money. If everything was so rosy they'd just get a loan from another bank at far less expense.

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