Bank of America Corp., seeking to snap this year’s stock plunge, will pay billionaire Warren Buffett $300 million annually to do what he did for Goldman Sachs Group Inc. during the credit crisis: bolster confidence.
The $5 billion sale of preferred equity, which initially sent the shares up 26 percent, may improve investor perceptions without meaningfully affecting the source of their concern, the bank’s capital, according to analysts including William Tanona at UBS AG. The deal gives Buffett’s Berkshire Hathaway Inc. warrants that could make it the lender’s largest stockholder.
Bank of America lost almost half its value on the New York Stock Exchange this year through yesterday as investors speculated that costs linked to soured mortgages may force the company to tap public markets for more capital. The slide accelerated this month, even as Chief Executive Officer Brian T. Moynihan, 51, cut jobs, sold assets and said the firm didn’t need to sell shares to meet new international capital standards.
“Concerns around Bank of America had hit a point where they were driven more by emotion than logic,” Tanona wrote in a research note to clients today. “This should temper those emotions, at least for now.”
Bank of America’s trading floor in New York erupted in cheers and applause when the news was announced this morning, said a person at the company who witnessed the reaction but wasn’t authorized to speak publicly.
‘Modest’ Capital Improvement
Buffett helped prop up Goldman Sachs Group Inc. in 2008 with a $5 billion investment that was repaid this year. The billionaire’s intervention helped New York-based Goldman Sachs restore market confidence after its stock tumbled and borrowing costs jumped following the Sept. 15, 2008, collapse of Lehman Brothers Holdings Inc.
For Bank of America shareholders, the cash injection may have little impact on the firm’s capital base and doesn’t resolve mounting legal claims linked to mortgages, much of which stem from the 2008 acquisition of Countrywide Financial Corp. Shares of the Charlotte, North Carolina-based bank pared their initial gains today, rising 10 percent to $7.04 at 2:04 p.m. in New York.
“He’s buying credibility,” Richard Bove, an analyst at Rochdale Securities in Lutz, Florida, said of Moynihan.
The investment will “modestly improve” Bank of America’s Tier 1 capital ratio, which was 11 percent as of June 30, Edward Najarian, head of bank research at International Strategy & Investment Group Inc., wrote in a note to clients today. The lender had $153.1 billion of Tier 1 capital at the end of the second quarter. The cash injection won’t improve the Tier 1 common ratio, which was 8.23 percent, Najarian wrote.
“This investment certainly improves the perception of BAC stock in the eyes of investors,” he wrote, referring to the company by its stock ticker. It also may be enough to address the bank’s immediate capital needs and assuage regulators, he said. “And if that is true, it is a clear win for the company and its shareholders.”
The cost to protect against a default by Bank of America plunged. Credit-default swaps on the company, which surged to a record this week, dropped 53 basis points to 320 basis points as of 1:55 p.m. in New York, according to broker Phoenix Partners Group. The contracts earlier traded as low as 275 basis points, Phoenix prices show.
Under the deal, Omaha, Nebraska-based Berkshire will buy cumulative perpetual preferred stock that pays an annual dividend of 6 percent, plus warrants to buy 700 million shares at about $7.14 each, according to a statement from the companies.
Buffett conceived of the investment while in the bathtub yesterday morning and had his assistant contact Moynihan’s to get the banker’s private number, CNBC reported, citing an interview with Buffett.
“Bank of America is a strong, well-led company, and I called Brian to tell him I wanted to invest in it,” Buffett said in a statement. “I am impressed with the profit-generating abilities of this franchise, and that they are acting aggressively to put their challenges behind them.”
Still, Moynihan cut a “bad deal for Bank of America shareholders,” said Bove.
“It’s an excessive price to pay if, in fact, he didn’t need capital,” he said. “There’s no way in hell that he can make 6 percent after tax on any investment he can make.”
If Buffett immediately exercised the warrants at the stock price of 7.72 at 1:54 p.m. in New York Stock Exchange composite trading, he would book a $404 million gain.
“Anybody would be dumb not to take those terms,” said Keith Davis, an analyst at Farr, Miller & Washington LLC in Washington. “I don’t think those terms would be available to anyone else except Warren Buffett, because he’s able to give that kind of boost to the stock.”
Buffett is taking “no risk at all,” said Paul Miller, a former examiner for the Federal Reserve Bank in Philadelphia and an analyst with FBR Capital Markets in Arlington, Virginia. “It’s a great deal for Berkshire Hathaway.”
Berkshire previously held the lender’s common stock for three and a half years -- a span in which Bank of America lost more than two-thirds of its value. Buffett’s firm bought 8.7 million shares in the second quarter of 2007, and sold its remaining 5 million shares during the fourth quarter of 2010.
Buffett has publicly criticized Moynihan’s predecessor, Kenneth D. Lewis, for management missteps including the purchase of Merrill Lynch & Co. in 2008, a deal struck the same day Lehman Brothers Holdings Inc. filed for bankruptcy. Lewis “paid a crazy price, in my view,” Buffett said in remarks released Feb. 10 by the Financial Crisis Inquiry Commission. “He could have bought them the next day for nothing.”
The bank took a $20.7 billion charge in the second quarter as it covered costs to settle claims from institutional investors that Countrywide used false or missing information to create mortgages that later defaulted. Bank of America is also trying to negotiate a settlement with state attorneys general, who have been investigating the company’s foreclosure practices over the last year.
“At this point, it’s a political hot potato more than it’s a fundamental hot potato, said Josh Rosner, an analyst at Graham Fisher & Co. in New York. “There’s no way to predict the outcomes of the settlement talks with investors and the states.”
To bolster capital, Moynihan agreed to sell the bank’s Canadian card unit, with about $8.6 billion in loan balances, and plans to leave the U.K. and Irish card markets. The bank has been forced to write down credit-card and mortgage units acquired by Lewis. Bank of America has sold more than 20 assets or units since Moynihan took over last year.
For his Goldman Sachs investment, Buffett received a 10 percent annual dividend and a 10 percent premium when the bank redeemed the stock. He also got warrants that gave him the right to purchase $5 billion of common stock at a strike price of $115 at any point within five years.
Goldman Sachs also rose on the day Buffett made that investment.
“It’s tremendously important from a psychological standpoint for the market to see that Buffett’s willing to step in,” said Davis, the Farr, Miller analyst.
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