Berkshire Invests $5 Billion in Bank of America

Arthi Gupta
25 Aug, 2011
New York City

Berkshire Hathaway Inc. announced to invest $5 billion in Bank of America. The conglomerate will buy 50,000 preferred shares at 6% dividend with a buyback clause at 5% premium. With the deal Buffett will become one of the largest shareholders of Bank of America.

[R]1:20 PM New York – Berkshire Hathaway Inc. announced to invest $5 billion in Bank of America. The conglomerate will buy 50,000 preferred shares at 6% dividend with a buyback clause at 5% premium. With the deal Buffett will become one of the largest shareholders of Bank of America.[/R]

Berkshire Hathaway Inc., the Omaha-based conglomerate holding company announced to invest $5 billion in Bank of America. The conglomerate will buy 50,000 preferred shares at 6% dividend with a buyback clause at 5% premium.

Under the terms of the deal, Berkshire will buy $5 billion of preferred stock, plus warrants for 700 million shares at an exercise price of $7.14 per share. The warrants may be exercised in whole or in part at any time, and from time to time, during the 10-year period following the closing date of the transaction.

Over the last decade, Bank of America ((BAC)) transformed itself from a regional institution into the nation''s largest brokerage house and consumer banking franchise. But during the financial crisis, it suffered huge losses and the controversial acquisition of Merrill Lynch and the subprime lender Countrywide.

Earnings over the past quarters were quite dismal. Bank of America Corporation reported a net loss of $8.8 billion, or $0.90 per diluted share, for the second quarter of 2011 compared with net income of $3.1 billion, or $0.27 per diluted share, in the year-ago period.

For the first quarter of 2011, Bank of America Corporation reported net income of $2 billion, or $0.17 per diluted share compared with $3.2 billion, or $0.28 per diluted share, in the year-ago period.

The financial services provider further announced cutting 3,500 jobs in the current quarter and also planned a broader restructuring that could eliminate thousands of positions.

The firm has done deals of nearly $100 billion in the last four years including the purchase of $48 billion of Fleet Boston Financial in 2004, purchase of MBNA in 2006 $34.2 billion, U.S. Trust from Charles Schwab for $3.3 billion, and LaSalle Bank in Chicago for $21 billion.

On January 11, 2008, Bank of America purchased Countrywide Financial for $4.1 billion making it the leading mortgage originator and servicer in the U.S., controlling 20% to 25% of the home loan market.

The Countrywide deal is the reason of most of the troubles at the bank today. The portfolio of subprime mortgages has declined sharply in value and spawned several lawsuits that may cost the bank more than $20 billion.

On September 14, 2008, Bank of America purchased Merrill Lynch & Co., Inc. in an all-stock deal worth approximately $50 billion to become the biggest financial services company in the world.

However, none of these acquisitions helped Bank of America and it received $20 billion in the federal bailout from the U.S. government through the Troubled Asset Relief Program on January 16, 2009. This was in addition to the $25 billion given to them in the fall of 2008 through TARP.

The additional payment was part of a deal with the US government to preserve Bank of America''s merger with the troubled investment firm Merrill Lynch.

Buffett has also invested in General Electric ((GE)) and Goldman Sachs ((GS)) during the worst of the 2008 financial crisis. But, those investments do not come cheap. Buffett is eager to provider his seal of approval to large companies with stable franchises to bail them out of a temporary problems as long as financial gains outweigh the risks.

Goldman Sachs Group, Inc. in September 2008 at the depth of financial crisis received a $5 billion investment from billionaire investor Warren Buffett''s Berkshire Hathaway, Inc.

Goldman Sachs agreed to sell $5 billion of perpetual preferred stock to Berkshire in a private offering. The preferred stock had a dividend of 10% and callable at any time at a 10% premium.

Berkshire also received warrants to purchase $5 billion of common stock with a strike price of $115 per share, exercisable within five years.

In October 2008, Warren Buffet came to the rescue of General Electric Company. GE had reached agreement to sell $3 billion of perpetual preferred stock to Berkshire Hathaway, Inc. at a dividend of 10% and callable after three years at a 10% premium.

Berkshire Hathaway received warrants to purchase $3 billion of common stock with a strike price of $22.25 per share, exercisable at any time for a five-year term.

Shares of Bank of America surged 79 cents or 11.3% to $7.78 at 12:05 PM EDT today.

The stock slumped 21.93% over the last one month and plunged 38.27% in trading in the last one year.

Buffett’s investment in Goldman Sachs and General Electric have been largely structured to provide him a certain minimum level of returns and warrants offer him a way to participate if the business improves in the next five to ten years.

Investors looking to ride on the coattails of Buffett have not been that fortunate, at least in these rescue investing. Goldman Sachs and General Electric are both trading below the strike price of warrants even after three years.