Warren Buffett has come to the aid of Bank of America with a $5-billion (U.S.) cash injection, giving a boost of confidence in the United States' largest bank that repeated assurances from its CEO failed to provide.
Investors have been worried that Bank of America might have to raise major amounts of capital and dilute its shareholder base, a notion that Bank of America has fought against. On Tuesday, the bank took the highly unusual step of sending out a detailed rebuttal to a blog post that suggested it might need hundreds of billions of dollars of fresh capital.
The fears about its financial cushion stem from concerns that more big mortgage-related writedowns could be in the cards. Shareholders have also been fretting about the toll that the lethargic U.S. economy will take on the lender.
Under the deal with Mr. Buffett's Berkshire Hathaway , the billionaire investor's company is acquiring preferred stock in the bank with an annual dividend of six per cent, which Bank of America can redeem at any time for a five-per-cent premium. Berkshire also receives warrants to buy 700 million common shares of the bank for about $7.14 a share.
The deal sent Bank of America's long-suffering shares soaring Thursday, immediately providing big paper gains for Berkshire. The bank's stock gave up much of its morning gains, but ended 9.4 per cent higher to close at $7.65 on the New York Stock Exchange. Berkshire's shares dropped 2.5 per cent, closing at $68.99.
"Bank of America is a strong, well-led company, and I called [chief executive officer Brian Moynihan]to tell him I wanted to invest in it," Mr. Buffett said. "I am impressed with the profit-generating abilities of this franchise, and that they are acting aggressively to put their challenges behind them." He told CNBC that the idea came to him while he was taking a bath, and he subsequently called Mr. Moynihan out of the blue Wednesday morning.
The move is reminiscent of the height of the financial crisis, when Mr. Buffett stepped in to aid both Goldman Sachs Inc. and General Electric Co. with multibillion-dollar infusions. But in a sign that the level of trauma in the financial system today remains below that of the crisis, the Oracle of Omaha settled for somewhat less-attractive dividend rates from Bank of America compared with the previous two deals.
Bank of America shares lost more than a quarter of their value this month. Market participants said many investors who brushed off the concerns about Bank of America, which has more than $1-trillion in customer deposits worldwide, sold the stock anyway because one of the lessons of 2008 is that fear alone – whether justified or not – is enough to drag a financial institution down.
"I think Bank of America has almost ceased to be a bank stock, in the traditional sense, and is now basically a barometer of perceived financial risk," said Rob Wessel, managing partner of Hamilton Capital Partners.
Shares of Bank of America traded at $9.81 at the start of this month, and at $51.53 at the start of August, 2006, before the subprime mortgage crisis reared its head and before Bank of America's ill-timed takeover of mortgage-lender Countrywide Financial Corp. That deal has plagued Bank of America, which posted an $8.8-billion second-quarter loss this summer as it sought to put some of its Countrywide-related headaches behind it.
Mr. Moynihan is still in the process of carrying out a turnaround strategy for Bank of America that he embarked on when he took over the bank at the start of last year. It involves cutting costs, reducing risks and selling non-core assets. Last week, Toronto-Dominion Bank bought Bank of America's $8.5-billion Canadian credit card portfolio for $8.6-billion. At the same time, the U.S. bank revealed plans to trim 3,500 jobs.
Mr. Moynihan is looking to scale back a formerly deal-hungry company that, in addition to Countrywide, bought MBNA Corp., U.S. Trust, LaSalle Bank and Merrill Lynch between 2006 and 2008.
He has been telling shareholders for months that his plan is bearing fruit and the bank remains on track. "We're in a multi-year transformation in a very difficult environment where we had to really reposition the company dramatically," he told investors a couple of weeks ago. "Our capital levels are among the highest they've ever been in this institution's history."
But skepticism remained, with some analysts questioning why Mr. Moynihan and his team weren't buying more Bank of America shares themselves if they felt that the stock was really that cheap.