By Ben Berkowitz and Joe Rauch
NEW YORK/CHARLOTTE (Reuters) – Warren Buffett will invest $5 billion in Bank of America, stepping in to shore up the company in the same way he helped prop up Goldman Sachs and General Electric during the financial crisis.
Bank of America shares rose 12.3 percent to $7.85 in early trading, erasing some part of the stock’s August losses. The jump also makes the warrants for Bank of America shares that Buffett gets in the deal instantly profitable.
Buffett and Bank of America said he made an unsolicited call to the bank on Wednesday morning, offering to make an investment. Even though the bank has said it did not need to raise capital, investors widely believed Bank of America needed more money and to show it could raise funds easily.
The deal proved again that Buffett has become something of a lender of last resort to the financial system, as he did with Goldman and also GE. Buffett’s role in aiding the economy and the financial system has become symbolically important given the lack of policy options left for the U.S. government and the Federal Reserve to stimulate demand.
“This proves to the market that if the bank needs additional capital, which we don’t believe they do, but if they needed to calm the market by raising capital, they could do it within 30 minutes with a quick call to Uncle Warren,” said Sean Egan, managing principal of Egan-Jones Ratings.
INSTANT RETURN
Buffett’s Berkshire Hathaway will in many ways make out even better financially than Bank of America did in the deal. Berkshire had a position in the bank that he sold in the fourth quarter of 2010 when the stock had an average price of $12.24.
The warrants to buy 700 million shares of common stock he gets in this deal are priced at just over $7.14 per share, with an unusually long 10-year exercise period.
One long-term Berkshire shareholder said the warrants were the best part of the deal by far.
“He could well make a 100 percent return on his investment in a few years,” said James Armstrong, president of Henry H. Armstrong Associates. “It’s amazing how much a little hug from Buffett is worth these days.”
Bank of America will also sell Berkshire 50,000 shares of cumulative perpetual preferred stock with a 6 percent annual dividend, it said. Bank of America can buy back the investment at any time by paying Buffett a 5 percent premium.
It is virtually a mirror of the deal Berkshire did with Goldman in the depths of the crisis in fall 2008, except in Goldman’s case it paid a 10 percent dividend. The Goldman deal paid Berkshire $15 a second in dividends until Goldman bought Buffett out earlier this year.
“It’s a reasonably priced deal for Buffett. It’s opportunistic,” said Tom Russo, a portfolio manager at Gardner, Russo & Gardner who holds Berkshire shares.
Russo said any concern about the Bank of America deal tying up Berkshire capital would be more than offset by the relative lack of other good investment opportunities available.
BANK’S WOES
Investors have battered Bank of America’s stock on fears that the largest U.S. bank by assets has yet to overcome billions of dollars in problem mortgage loans, as well as inestimable legal liabilities from mortgage securities sold by its Countrywide unit.
Earlier this month, a $10 billion lawsuit over soured mortgage securities by bailed-out insurer AIG helped spur those fears, as well as questions around how the bank would pay for any more losses.
In recent weeks, investors have sold shares, worrying that the bank might need more capital — as much as $50 billion by some estimates — to cope with losses and meet new industry capital rules. Investors feared some portion of that might come from selling new shares.
Bank of America Chief Executive Brian Moynihan said on an August 10 conference call that the bank could add to its capital through earnings and asset sales. The call, organized by Fairholme Funds, one of the bank’s largest shareholders, happened two days after shares plunged by 20 percent.
But many were not convinced. On Tuesday, analyst-turned-blogger Henry Blodget said the bank could face $100 billion to $200 billion in write-offs and balance sheet issues, a claim the bank denied, but one which nonetheless helped push shares to early 2009 lows.
“This helps with the credibility gap that I think has existed in the minds of some shareholders. It reiterates the point that the balance sheet is healthy. They needed an endorsement in the market and they got it,” said Jon Finger, managing partner of Finger Interests in Houston. Finger’s family sold its bank to Bank of America years ago.
Bank of America shares lost roughly a third of their value in August before this deal, and half their value since the beginning of the year.
The cost of insuring Bank of America debt against default has also been rising, but contracted on Thursday after the Buffett deal, narrowing 68 basis points to 305 basis points. That means it would cost $305,000 a year for five years to insure $10 million in debt.
Source: Reuters
