Bank of America shares rose 12.3 percent to $7.85, 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.
Bank of America has been plagued by fears that bad mortgage loans and legal liabilities from loans packaged into bonds by its Countrywide unit could drag it into tens of billions of dollars in fresh losses that would stretch its capital.
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 Omaha-based Berkshire Hathaway could make out even better financially than Bank of America did in the deal. Berkshire had a position 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 Berkshire holder 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.
Buffett told CNBC he had never spoken to Bank of America CEO Brian Moynihan before Wednesday, and that he dreamed up the idea while taking a bath.
BANK'S WOES
Earlier this month, a $10 billion lawsuit over soured mortgage securities by AIG helped spur fears about Charlotte-based Bank of America's liabilities, as well as questions around how it would pay for 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 capital rules.
For shareholders who have watched the bank take two government bailouts and also seen the government step in earlier this year to block a planned dividend raise, further dilution would have been a bitter pill to swallow.
Moynihan said on an August 10 conference call the bank could add to its capital through earnings and asset sales. The call, organized by Fairholme Funds, one of the bank's largest investors, came two days after shares plunged by 20 percent.
But many were not convinced. On Tuesday, 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 pushed 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.
Moynihan has said the bank is targeting a 6.75 to 7 percent tier 1 common capital ratio by the end of 2013 under the new Basel III rules. Currently, the bank has $400 billion in total excess liquidity, and the company could meet all of its unsecured debt obligations within 22 months.
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.
Sources : http://www.reuters.com/article/2011/08/25/us-bankofamerica-idUSTRE77N4J420110825
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