A vote of confidence from Buffett
Just when it seemed as though Bank of America Corp. could not buy a friend, the struggling financial giant did exactly that.
Bank of America acquired a very influential ally in investor Warren Buffett, who agreed yesterday to put $5 billion of Berkshire Hathaway Inc. cash into the banking giant.
The terms were certainly generous to Buffett, but they remain open ended.
Regardless of the ultimate price, the transaction was important for the bank and its chief executive with Boston roots, Brian Moynihan.
The bank may or may not have needed the money but a big vote of confidence in its stock was important. Bank of America shares climbed 65 cents to $7.65 yesterday.
Take a look at the details: Berkshire will be paid 6 percent interest annually for its investment in $5 billion worth of preferred stock, which the bank can redeem at any time by paying a 5 percent premium.
The real kicker: Warrants to buy 700 million Bank of America common shares for a price of $7.14 each whenever it suits Berkshire during the next decade.
If Bank of America shares were to roughly double in price - say to $14.50 each - Berkshire could earn a 100 percent gain on its $5 billion.
The stock traded for slightly more than that just five months ago. Based on Bank of America’s closing price of $7.65 yesterday, those warrants were already worth $350 million on paper.
A transaction for 700 million shares is big. The bank’s largest current shareholder - State Street Corp. of Boston and all the index funds it runs for customers - own 640 million shares.
This deal looks a lot like another high-profile Buffett transaction, his $5 billion investment in Goldman Sachs Group in the darkest days of 2008.
Again, Berkshire bought preferred shares (paying 10 percent interest that time) and warrants to buy $5 billion worth of Goldman stock at a price of $115 each.
Goldman shares rose in value to as much as $192.28 in October of 2009 - creating a paper profit of about $3.4 billion for Berkshire. But the stock has since fallen sharply and Berkshire’s warrants aren’t worth a dime at the moment.
Goldman redeemed the preferred shares earlier this year. Berkshire’s warrants were only good for five years - half what Buffett squeezed out of Bank of America - so they will expire in 2013.
Buffett’s vote of confidence in Bank of America comes at an anxious time for the company and Moynihan.
The bank had been getting beaten up by a small mob of critics who believed the company needs more capital.
Those critics pointed to two problems - assets on the books they believe were overvalued and the seemingly endless litigation exposure the bank faces in home loan cases, headaches mostly inherited from mortgage giant Countrywide in one of the worst corporate acquisitions of all time.
The extent of Bank of America’s asset problems are debatable and many people outside the bank think they are no big deal. The legal issues are real and expensive but will ultimately be paid out over years.
Meanwhile, the global economy and the European debt crisis have been taking a toll on bank stocks.
Even so, Bank of America has been the worst single performer in the leading index of big American bank stocks for 2011 - losing nearly half its value - before yesterday.
Then Warren Buffett called and told Moynihan he wanted to invest.
At least that’s the official story (executives had been insisting the bank did not need to raise capital, so how could they have been the ones who picked up the phone first?).
One thing Buffett surely knows: A friend in need is a friend indeed.
Steven Syre is a Globe columnist. He can be reached at email@example.com.