Buffett Swarms the Bank of Opportunity

In a move straight out of October 2008, Warren Buffett's Berkshire Hathaway (NYS: BRK.B) announced it will inject $5 billion into Bank of America (NYS: BAC) . The bank's shares had been falling apart in recent weeks amid speculation 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 (NYS: GS) and General Electric (NYS: 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:

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 wron g it is to use it like a tyrant." That may include not acting as a loan shark.

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 Moynihan would eventually do something big. This is pretty big.

At the time this article was published 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.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Increase your money and finance knowledge from home

Forex for Beginners

Learn about trading currencies and foreign exchange transactions

View Course »

Investing in Emerging Markets

Learn to invest in a globalized world.

View Course »

Add a Comment

*0 / 3000 Character Maximum


Filter by:

buffet is losing his mind investing in an bad stock like BOA. i'm glad i sold my berkshire hathaway stock 6 months ago and bought visa.

August 26 2011 at 1:37 PM Report abuse rate up rate down Reply

I have always invested in Buffet and currently Berkshire is all that i have in the Market. NOW he is into politics!!!! I am out I selling it all TODAY.
Warren you have forgotten what the difference is between a strugleing business person and his billionaire able to sleep well at night life.

August 26 2011 at 11:23 AM Report abuse +1 rate up rate down Reply

Sounds like a quid pro quo .. now that is " Change We Can Believe In "

August 26 2011 at 8:44 AM Report abuse +1 rate up rate down Reply

I wouldn't invest 1 cent in boa. They were the bank that gave ILLEGALS credit cards without a social security card. I cancelled my account and the wanted my ss#, I told them since ILLEGALS didn't need one why should I have to give them mine.

August 26 2011 at 8:38 AM Report abuse rate up rate down Reply

BOA is one of the biggest criminal enterprises in America!I've lost all respect for Warren Buffett.

August 26 2011 at 8:09 AM Report abuse +1 rate up rate down Reply

Buffet supports obama because somehow someway his policies are going to make him a lot of money, certainly somewhere in the banking industry.

August 26 2011 at 7:41 AM Report abuse +2 rate up rate down Reply

You can bet that Obama's plan that he is going to announce in Sept. will include big breaks for banks that help homeowners refinance, hence Buffetts stake in Bof A. Remember he got exemptions on bonds! Wants the rich to pay more, but says they will have to take it from him. He can donate, but won't. Bof A has the worst record on it's foreclosure side of realestate. Most Realtors don't want to deal with them in foreclosure sales. They lay off hundreds and how will this improve it's service?

August 26 2011 at 7:27 AM Report abuse +2 rate up rate down Reply
1 reply to sadams8174's comment

Fire Obama.

August 26 2011 at 3:00 PM Report abuse +1 rate up rate down Reply

While the terms of Buffetts deal seem good for him, lets remember, despite what BofA says, it needs money. The 5 Billion is not much compared to the money it needs. I think the deal is one which attempts to make people and investors think, WOW, Buffets buying, so things must be going well, maybe we've turned the corner, and things will be better. Its a 5 Billion dollar bluff. Things arent better, but it could sucker more common folk money into the markets before the inevitable next plunge.

BofA and Buffets deal should fool many, but not all, and only the markets briefly. Buffet's credibility will be severely damaged when BofA turns out to be the next Lehman's moment. Fraud bookkeeping is coming to an end, and the markets know this, but they are still trying to hang on a bit longer, and keep their bad debt off the books.

Bad businesses should not be propped up any longer with bailout (taxpayer) money. The loses keep getting worse, as does the economy, which is also in bad shape. Less people are working, more come to the work force each month, newly unemployed seeking benefits has risen, and those who no longer look for work or whose benefits have been exhausted also continues to rise. 70% of our economy is consumer spending, just raising the costs of things we buy won't make up the difference, although the administration thinks it will. That is whats been happening since 2009, bailout money used by big banks to rally stocks, foods and energies. We all have been paying more, for less.

The bubble popping is just around the corner, so be prepared. Oh and what are those bubble markets you ask, well its oil, foods, gasoline, stocks, (especially Big Bank stock), and just about everything else. Who blew the bubbles? Wall St, and the Big Banks, in their desperate attempt to hold off collapse, if their big debts were to see the light of day.

August 26 2011 at 6:30 AM Report abuse +1 rate up rate down Reply

Mr. Buffett, Is no different than obarfa or bushwacker when it comes to bailing out his rich buddies, the only difference is he used his own money and not tax dollars. Will he make money? Probably, but in the end I hope BOA tanks big time!!!

August 26 2011 at 5:38 AM Report abuse +1 rate up rate down Reply

walmart suck

August 26 2011 at 1:43 AM Report abuse rate up rate down Reply