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.

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