Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



Warren Buffett's Genius Plan to Milk Millions Out of Bank of America

While Warren Buffett cultivates an easygoing and downhome demeanor, make no mistake about it: He's a ruthless negotiator.

This is why my interest was piqued when I came across an unusual paragraph in Bank of America's (NYSE: BAC  )  annual report explaining that Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) has agreed to give the Charlotte-based bank the equivalent of a $2.9 billion break.

According to the filing, Berkshire and Bank of America have entered into an updated agreement with respect to the former's already lucrative $5 billion investment in the bank.

Under the amended terms, Berkshire's $2.9 billion position in a specific series of the bank's preferred stock (1) will no longer accrue dividends in the unlikely event they aren't paid, (2) is subject to a fixed dividend rate of 6%, and (3) cannot be redeemed by Bank of America earlier than the fifth anniversary following approval of the amendment by the bank's shareholders.

The net result is twofold.

For Bank of America, its Tier 1 capital will increase by approximately $2.9 billion, which will benefit both its Tier 1 capital and leverage ratios.

This is because under new capital rules set to go into effect over the coming years, cumulative preferred stock -- i.e., preferred stock, which accrues unpaid dividends -- does not qualify as Tier 1 capital because the "instruments that allow for the accumulation of interest payable are not likely to absorb losses to the degree appropriate for inclusion in Tier 1 capital."

At first glance, the $2.9 billion addition appears to be merely a drop in the bucket, given that Bank of America reported a total of $161.5 billion in Tier 1 capital as of Dec. 31. The amended agreement with Berkshire, in turn, would only increase this by 1.8%.

But critically, it would ratchet up Bank of America's Tier 1 capital ratio by 22 basis points. Using the current figures as a guide, this important metric would increase from 12.44% to 12.66% once the $2.9 billion is included.

For a bank as big as Bank of America -- its balance sheet boasts a staggering $2.16 trillion in assets -- this isn't small potatoes.

So, what does Berkshire get out of the deal?

In short, it gives the Omaha-based company another five years to reap profits from the investment. Under the original terms, Bank of America could have redeemed the preferred stake at any time so long as it paid a 5% premium. Under the amended terms, as I've already noted, the bank won't be able to do so until 2019.

This possibility has been at the forefront of Buffett's mind lately. "Buffett has even joked with Berkshire shareholders that he's made a point of avoiding the phone for fear companies are calling to give him his money back," noted a writer with the San Francisco Business Times.

On top of this, it's worth observing that Berkshire effectively gave up nothing in return for Bank of America's concession, as it's highly unlikely at this point that the nation's second largest bank would miss a dividend payment on its preferred shares.

Once again, in other words, Buffett has quietly made out like a bandit.

Warren Buffett shares his best advice
Warren Buffett has made billions through his investing and he wants you to be able to invest like him. Through the years, Buffett has offered up investing tips to shareholders of Berkshire Hathaway. Now you can tap into the best of Warren Buffett's wisdom in a new special report from The Motley Fool. Click here now for a free copy of this invaluable report.

Read/Post Comments (1) | Recommend This Article (6)

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 March 17, 2014, at 11:44 AM, Tallen00001 wrote:

    Why would Mr. Buffett be trying to milk MILLIONS when just the exercising of the 700 million shares he has would double the stock and his already staggering investment. If the public knew that Buffett was bullish on the stock instead of just standing by and waiting, they too, would invest all they had. Why would Warren just wait? He no longer cares about making money?

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2857210, ~/Articles/ArticleHandler.aspx, 8/29/2015 7:58:21 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

John Maxfield

John is The Motley Fool's senior banking specialist. If you're interested in banking and/or finance, you should follow him on Twitter.

Today's Market

updated 22 hours ago Sponsored by:
DOW 16,643.01 -11.76 -0.07%
S&P 500 1,988.87 1.21 0.06%
NASD 4,828.33 15.62 0.32%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

8/28/2015 4:02 PM
BAC $16.36 Down -0.08 -0.49%
Bank of America CAPS Rating: ****
BRK-A $205344.00 Up +404.00 +0.20%
Berkshire Hathaway… CAPS Rating: ****
BRK-B $135.74 Down -0.49 -0.36%
Berkshire Hathaway CAPS Rating: *****