Warren Buffett's Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) has made tens of billions of dollars investing in America's biggest banking institutions. But when it comes to banks, America's best-known value investor usually wants an especially good price, buying in times of crisis for individual banks and the industry at large.
Here's a timeline of Buffett's bank investments through the years, and how American Express (NYSE:AXP), Wells Fargo (NYSE:WFC), M&T Bank (NYSE:MTB), Goldman Sachs (NYSE:GS), and Bank of America (NYSE:BAC) became part of the Oracle of Omaha's vast stock portfolio.
1964 -- American Express
American Express was one of the Buffett partnership's last bet-the-farm investments.
AmEx shares were battered by investors' belief that it would incur large losses from fraudulent loans made during the now-infamous "salad oil scandal." But a unique detail of the story is often missing from historical descriptions of the event: American Express shareholders could lose everything, and more, from holding AmEx stock.
American Express wasn't your typical corporation. It was organized as a joint stock company, which gave its owners unlimited liability for its losses. If the company suffered excess losses that threatened its solvency, its shareholders could be called on to contribute more capital. (It operated under this joint stock company structure until converting to a typical corporate structure two years after the scandal.)
In the book The Snowball: Warren Buffett and the Business of Life, author Alice Schroeder writes of the event and how AmEx's structure impacted market prices for its shares, quoting Buffett himself:
So every trust department in the United States panicked," recalls Buffett. "I remember the Continental Bank held over 5 percent of the company, and all of a sudden not only do they see that the trust accounts were going to have stock worth zero, but they could get assessed. The stock just poured out, of course, and the market got slightly inefficient for a short period of time.
Buffett went long and in size, investing as much as 40% of his partnerships' assets into American Express, and more than doubling his investors' capital in a span of less than two years. It was a quick trade for Buffett, who later made AmEx a big position in Berkshire's portfolio in 1994, when Berkshire purchased nearly 10% of the bank's outstanding stock. American Express remains in the portfolio today, despite the fact that Buffett and Munger have both opined that the future will be more difficult for AmEx than the the past.
1969 -- Illinois National Bank & Trust Company
Though it wasn't publicly traded, the oft-forgotten Illinois National Bank & Trust Company acquisition fits the Berkshire mold for buying banks. At the time, Buffett described it as the "most profitable bank he had ever seen."
Berkshire got a good price, to be sure, but it was no clear bargain. As explained in The Snowball, Buffett managed to get a slightly better price, and keep its key man, Eugene Abegg, by agreeing to acquire in a quick transaction -- no audits, no fundamental changes to the business model. Berkshire just wanted to own the bank, little more.
Gene had already made a deal to sell the bank to somebody else. But the buyer had started criticizing it, or they wanted an audit and he'd never been audited and he wanted out. He was pretty dominant, and everything he did was unbelievably conservative[...]So I went out there, and I named a number that turned out to be about a million dollars less than the other guy. And Gene, who owned a quarter of the stock, called up his biggest shareholder, who owned more than half the stock, and said, 'This young guy from Omaha's come here and offered this. I'm tired of those guys at XYZ Company. If you want to sell to them, then you come run this bank, because I won't.'
Berkshire didn't own the bank very long. New bank holding company regulations came into effect ten years after the Berkshire acquisition, which made Berkshire a forced seller. That said, I have little doubt that it would still be in the Berkshire portfolio today if not for a changing regulatory landscape.
1987 -- Salomon Brothers
This is perhaps the only bank deal that Buffett would prefer to forget. In 1987, Berkshire Hathaway became the investment bank's largest shareholder. Warren Buffett took a spot as a director on Salomon Brother's board.
Buffett was brought in to save the company from a takeover. Buffett and Berkshire Hathaway played the role of Salomon's "white knight," with Berkshire investing $700 million to buy convertible preferred stock in the investment bank. That investment was Berkshire's largest ever in a single company.
Salomon quickly became the bank that Buffett had to save twice. In August 1991, it was revealed that Salomon had broken securities laws in its trading of government securities.
A Fortune article explains a hairy phone call between Buffett and Salomon's top ranks:
Speaking calmly, they said that a Wachtell Lipton investigation commissioned by Salomon had discovered that two of its government securities traders, including the top gun, managing director Paul Mozer (a name Buffett didn't know), had broken the Treasury's bidding rules on more than one occasion in 1990 and 1991.
Salomon, and other investment banks, were forbidden from buying up more than 35% of U.S. Treasuries at any given auction. But the bank found ways around this limitation, using customer accounts to purchase Treasuries on the bank's behalf. It was not just a case of bending the rules; it put Salomon on the brink of failure.
Salomon was banned from trading in U.S. Treasuries, a change that Buffett believed was certain to send Salomon into a tailspin. (He later said that they were preparing documents to file for bankruptcy if its pleas to turn over the ban were ignored).
Buffett took the helm as Salomon CEO, cleaned house of those responsible for the crimes, and stood before Congress to use his reputation to help save the bank. He was successful, but it's a black spot in his otherwise excellent record as a bank investor.
1990 -- Wells Fargo
Warren Buffett's love of Wells Fargo goes all the way back to 1989 and 1990, when a downturn in California real estate prices allowed him to buy a sizable chunk of the California-based bank at discount prices.
Buffett explained his investment in his 1990 letter to shareholders:
Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks. The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled -- often on the heels of managerial assurances that all was well -- investors understandably concluded that no bank's numbers were to be trusted. Aided by their flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than five times after-tax earnings, and less than three times pre-tax earnings.
The investment was mostly a quiet winner in the portfolio until 2016, when news of Wells Fargo's fraudulent account scandal broke. Buffett and Charlie Munger chastised the bank for the scandal at its most recent annual meeting, but they have seemingly little intention of parting with the stock in Berkshire's portfolio. Berkshire remains a 10% owner of Wells Fargo, though it dropped an application that would allow it to acquire even more shares of the bank that many call "America's largest community bank."
1991 -- M&T Bank
This New England bank joined the Berkshire Hathaway portfolio when a unique deal arose from the Savings and Loan Crisis of the late 1980s and early 1990s. In 1990 and 1991, Buffalo, New York's largest thrifts, Empire of America and Goldome, were seized by regulators. Their depositors needed a new home, and neighboring banks were more than eager to pick them up.
M&T Bank and KeyCorp divvied up the failed institutions' branches, growing their deposit market share and lending power in the Buffalo, NY metropolitan area. M&T Bank worked directly with Buffett, who invested $40 million in the form of preferred stock owned by Berkshire Hathaway. Buffett later converted that preferred stock into common stock, and has held on ever since.
This unique deal was the second transaction in which Buffett collected a "Buffett Premium" for being ready to invest when others might not have. M&T Bank's CEO, Robert Wilmers, later said, "He and Berkshire Hathaway being shareholders gives an aura to the bank that we wouldn't have otherwise." To this day, Buffett remains one of Wilmers' biggest fans, and M&T Bank shares sit comfortably in the Berkshire portfolio.
2008 -- Goldman Sachs
As the financial crisis unfolded in September 2008, Buffett threw a $5 billion lifeline to Goldman Sachs by working a special deal to buy preferred stock and get stock warrants for providing a much-needed slug of capital and credibility.
It was a treacherous period for any bank, let alone a highly levered investment bank. All signs pointed to the imminent demise of America's largest banking institutions, even prominent firms like Goldman Sachs, which had earned outsize profits in the boom years leading up to the Financial Crisis of 2008.
Just follow the timeline to see just how quickly the crisis was unfolding in the fall of 2008:
- September 7 – Fannie Mae and Freddie Mac enter government conservatorship.
- September 15 – Lehman Brothers files for bankruptcy.
- September 17 – Government seizes control of AIG.
- September 21 – Goldman Sachs and Morgan Stanley get approval to become bank holding companies.
- September 24 – Berkshire invests $5 billion in Goldman Sachs' preferred stock.
- September 25 – FDIC takes over Washington Mutual.
- September 29 – House of Representatives rejects the first bank bailout plan.
Ultimately, the bank bailouts were approved, some semblance of stability returned, and Buffett's investment in Goldman Sachs worked out just fine. By 2013, Buffett converted Berkshire Hathaway's warrants into common stock, generating more than $3 billion in profit. Goldman Sachs shares remain in the company's portfolio today as a trophy of Buffett's ability to score a premium price when capital and credibility are scarce.
2011 -- Bank of America
Buffett said he dreamed up the Bank of America deal from his bathtub, drawing up a plan to invest $5 billion into Bank of America preferred stock in 2011 as the European Debt Crisis rattled the markets. Many investors believed that Bank of America was soon to be insolvent, fearing that outsized losses from Countrywide acquisition and European market jitters would cripple the bank.
A short thesis from that era captured the widely held belief that Bank of America was headed to zero.
Bank of America equity is worthless. [Countrywide]-related liquidation is going from bad to worse, it can lead to violent erosion of shareholders' equity[...]I believe this is a terminal short.
Berkshire's preferred stock investment gave Bank of America fresh capital, in addition to much-needed credibility. The company slowly worked through crisis-era fines that tallied to more than $91 billion, and has since emerged as a very profitable banking institution.
Less than six years after inking the deal, Berkshire Hathaway will become the bank's largest shareholder when it converts its warrants it received with the preferred stock investment into common stock. Berkshire's investment proved well-timed, earning the company more than $12 billion of gains on the initial investment of just $5 billion.
2017 -- Home Capital Group
After a six-year hiatus as the banking industry's backstop, Berkshire is back at the table to do bank deals at privileged prices. In June, Berkshire agreed to lend and invest $2 billion and $400 million (Canadian) into a stressed Canadian subprime lender, Home Capital Group.
The investment is a unique one for Berkshire due to its super-safe structure. Berkshire's loan was effectively made against a portfolio of mortgages valued at more than $5 billion Canadian dollars at a steep 9% interest rate. It seems almost impossible for Berkshire to lose. The equity investment -- one part immediate, one part requiring the approval of Home Capital Group shareholders -- was made at a price a third less than the current market price at the time of the investment.
Berkshire is effectively renting out its reputation at a very high price, far higher than it ever charged when it made emergency investments in America's biggest banks via preferred stock and common stock warrants. Some have appropriately labeled Berkshire a "loan shark," given that it has substantial collateral backing its investment, something it never received in previous deals.
With the ink still yet to dry on this emergency capital injection, only time will tell how it ultimately works out. But based on Berkshire's record in bank stocks, and its collateral protections, it's likely to be a big winner for Berkshire, regardless of the outcome for Home Capital Group.
Buying banks like Buffett
While Berkshire is always buying companies, it's rarely buying banks. In between the S&L Crisis-era investments in Wells Fargo, Salomon, and M&T Bank, and its 2008 deal with Goldman Sachs, a period that spans roughly 17 years, Berkshire made only one substantial bank stock investment (American Express, in 1994).
It stands to reason that Buffett sees the industry as a place for thoughtful and intermittent investment, rather than a place for continuous capital deployment.
Individual investors should view the industry similarly. When bank stocks are flying high, it's easy to forget about the industry's inherent cyclicality. Instead of looking at the 2008 financial crisis as a lost opportunity, consider it a reminder for what good bank investing looks like. Investors will get another chance to swing big, provided that they have the patience to sit on the sidelines in the mean time.