Bank of America Strikes Deal for Buffett’s Endorsement

by Trefis Team
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In what is undoubtedly the best news for Bank of America (NYSE:BAC) and its investors in some time, Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A) offered to inject $5 billion into the company. This sent the bank’s shares soaring before settling around $7.65 at the end of Thursday – nearly a 10% gain. [1] This also gave investors some renewed confidence that BoA might not be as bad off as some of the vociferous sell side analysts have claimed in the last few weeks. Bank of America competes with other major banking groups including JPMorgan Chase (NYSE:JPM), Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS), Deutsche Bank (NYSE:DB), Citigroup(NYSE:C) and Wells Fargo (NYSE:WFC).
We maintain our price estimate for Bank of America’s stock at $10.90 and believe that the market, which was over-reacting due to the building negative sentiment since the bank’s Q2 2011 results, will correct the stock’s price with time.

Struggling to keep investor confidence

Investors have been openly expressing concerns over Bank of America’s health in recent months with the uncertainty about the quality of its legacy mortgage portfolio being the biggest source of worry. The bank had already recognized charges of more than $20 billion in the second quarter of this year due to this portfolio, and the $10 billion lawsuit by AIG (NYSE:AIG) over mis-selling of mortgage-backed securities by the bank and its now subsidiaries Merrill Lynch and Countrywide only added fuel to the fire.

And the view held by analysts that Bank of America will have to issue more shares to stabilize its doubtful capital structure resulted in more frantic selling of the bank’s stock by investors in the market only a few days ago. (See Bank of America Shares Jumpy on Capital Adequacy Fears)

The BofA-Berkshire deal looks like a win-win for both parties

As a part of the deal, Berkshire Hathaway receives 50,000 cumulative perpetual preferred shares from Bank of America paying a 6% annual dividend and with a liquidation value of $100,000 each. Additionally, Berkshire also gets warrants to buy 700 million common shares at a strike price of $7.14 each. ((Buffett’s BofA Stake Nets $1.3B on First Day, Bloomberg, Aug 25 2011)) With the preferred shares worth $3.5 billion and the warrants worth an additional $2.7 billion considering yesterday’s closing price of $7.65, Berkshire could have made a notional profit of $1.26 billion in the deal according to CIO Phillip Jacoby at Spectrum Asset Management. [2]

As for Bank of America, the need to boost confidence in the market was clearly one of the goals as Buffett reassured management that this was a long-term investment and not a short-term fix. If the bank really did need capital urgently, its depressed share price before the announcement would have made going to the market to raise more money a really expensive affair. The deal inked with Berkshire gives Bank of America some more flexibility and time for it to show investors that its capital and outlook are in good shape. We discussed these items in a note Buffett Takes Advantage of Market Jitters with Bet on Bank of America.

See our full analysis for Bank of America

Notes:
  1. Instant view: Warren Buffett buys into Bank of America, Reuters, Aug 25 2011 []
  2. Buffett’s BofA Stake Nets $1.3B on First Day, Bloomberg, Aug 25 2011 []
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