At the close of trading on August 24, 2011, Bank of America (BAC - Free Value Line Research Report on Bank of America) had a credibility problem, if not a financial one. On the morning of August 25, 2011, Warren Buffett’s Berkshire Hathaway (BRKA) put its credibility, and $5 billion dollars, behind the beleaguered bank.
The deal calls for Bank of America to sell Berkshire Hathaway 50,000 shares of Cumulative Perpetual Preferred Stock with a liquidation value of $100,000 per share in a private offering. The preferred stock pays a 6% dividend and is redeemable by the company at any time at a five percent premium. Berkshire Hathaway will also receive warrants to purchase 700 million shares of Bank of America common stock at an exercise price of just under $7.15 per share. Berkshire has the right to exercise the warrants in whole or in part at any time during the 10-year period following the closing date of the transaction. Bank of America is to be paid $5 billion in cash.
Buffett was quoted in a Bank of America press release as saying, “Bank of America is a strong, well-led company, and I called Brian [Moynihan] to tell him I wanted to invest in it. I am impressed with the profit-generating abilities of this franchise, and that they are acting aggressively to put their challenges behind them. Bank of America is focused on their customers and on serving them well. That's what customers want, and that's the company's strategy."
Clearly, Buffett is not only putting his shareholders’ money behind Bank of America, he is putting his reputation behind the company, too. This deal is similar to the one Berkshire Hathaway entered with Goldman Sachs (GS) when that financial giant was suffering through both financial troubles and a public relations issue. Although the Goldman Sachs deal came with a higher dividend yield, the Bank of America investment is very generous to Berkshire Hathaway, assuming that the bank remains solvent.
On that front, Bank of America has been working to solidify its capital structure of late and, seemingly, has been doing a good job. The issue is that righting the ship is not a simple or quick process. The $5 billion in added capital clearly helps, but more so in buying time for the bank’s other efforts. Continued progress is an almost definite, but it could be a bumpy ride over several years.
So, while Buffett is clearly swooping in to rescue Bank of America, he is also ensuring that he does so for a profit. Moreover, the deal is not all that large for Berkshire, so if it were to take an extended period of time or, in an absolute worst case scenario, not work out, Buffett and his shareholders wouldn’t be too worse for the wear.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.