BofA ‘Buying Credibility’ With Buffett $5 Billion Investment

Bank of America Corp. (BAC), seeking to snap this year’s stock plunge, will pay billionaire Warren Buffett $300 million annually to do what he did for Goldman Sachs Group Inc. during the credit crisis: bolster confidence.

The $5 billion sale of preferred equity, which initially sent the shares up 26 percent, may improve investor perceptions without meaningfully affecting the source of their concern, the bank’s capital, according to analysts including William Tanona at UBS AG. The deal gives Buffett’s Berkshire Hathaway Inc. (BRK/A) warrants that could make it the lender’s largest stockholder.

Bank of America lost almost half its value on the New York Stock Exchange this year through yesterday as investors speculated that costs linked to soured mortgages may force the company to tap public markets for more capital. The slide accelerated this month, even as Chief Executive Officer Brian T. Moynihan cut jobs, sold assets and said the firm didn’t need to sell shares to meet new international capital standards.

“Concerns around Bank of America had hit a point where they were driven more by emotion than logic,” Tanona wrote in a research note to clients today. “This should temper those emotions, at least for now.”

Bank of America’s trading floor in New York erupted in cheers and applause when the news was announced this morning, said a person at the company who witnessed the reaction but wasn’t authorized to speak publicly.

Goldman Sachs

Buffett helped prop up Goldman Sachs Group Inc. (GS) in 2008 with a $5 billion investment that was repaid this year. The billionaire’s move helped New York-based Goldman Sachs restore market confidence after its stock tumbled and borrowing costs jumped following the Sept. 15, 2008, collapse of Lehman Brothers Holdings Inc.

Buffett called Moynihan with the idea yesterday morning. Moynihan initially told Buffett that the bank didn’t need extra capital, according to a person familiar with the discussion who asked to remain anonymous because the call was private. Buffett said that was exactly why he was calling, because he thought the bank was a good long-term investment, this person said.

There was no negotiation, said another person familiar with the talks. Moynihan, 51, agreed to the terms late yesterday, and Bank of America’s board met today to approve, both people said.

“There’s one Warren Buffett and when Warren Buffett calls and says he wants to invest in your company, you take it seriously,” said Jerry Dubrowski, a spokesman for the bank.

Bank Supervision

The Federal Reserve, which supervises the bank, was notified of the investment, Dubrowski said. The Fed, which hasn’t allowed Bank of America to raise its common-stock dividend above a penny a share, doesn’t review capital-raising investments representing less than 10 percent of voting stock.

The Bank of America cash injection may have little impact on capital and doesn’t resolve mounting legal claims linked to mortgages, many of which stem from the 2008 acquisition of Countrywide Financial Corp. Shares of the Charlotte, North Carolina-based bank pared their initial gains today, rising 9.4 percent to $7.65 in regular New York trading.

“He’s buying credibility,” Richard Bove, an analyst at Rochdale Securities LLC in Lutz, Florida, said of Moynihan.

The investment will “modestly improve” Bank of America’s Tier 1 capital ratio, which was 11 percent as of June 30, Edward Najarian, head of bank research at International Strategy & Investment Group Inc., wrote in a note to clients today.

Cash Injection

The lender had $153.1 billion of Tier 1 capital at the end of the second quarter. The cash injection won’t improve the Tier 1 common ratio, which was 8.23 percent, Najarian wrote.

“This investment certainly improves the perception of BAC stock in the eyes of investors,” he wrote, referring to the company by its stock ticker. It may be enough to address the bank’s immediate capital needs and assuage regulators, he said. “And if that is true, it is a clear win for the company and its shareholders.”

The cost to protect against a default by Bank of America plunged. Credit-default swaps on the company, which surged to a record this week, dropped 45 basis points to 327.6 basis points as of 4 p.m. in New York, according to data provider CMA. The contracts earlier traded as low as 275 basis points, prices from broker Phoenix Partners Group show.

Berkshire, based in Omaha, Nebraska, will buy cumulative perpetual preferred stock that pays an annual dividend of 6 percent, plus warrants to buy 700 million shares at about $7.14 each, according to a statement from the companies.

Buffett’s Idea

Buffett conceived of the investment while in the bathtub yesterday morning and had his assistant contact Moynihan’s for the banker’s private number, CNBC reported, citing an interview with Buffett, Berkshire’s 80-year-old CEO and chairman.

“Bank of America is a strong, well-led company, and I called Brian to tell him I wanted to invest in it,” Buffett said in a statement. “I am impressed with the profit-generating abilities of this franchise, and that they are acting aggressively to put their challenges behind them.”

Still, Moynihan cut a “bad deal for Bank of America shareholders,” Bove said.

“It’s an excessive price to pay if, in fact, he didn’t need capital,” he said. “There’s no way in hell that he can make 6 percent after tax on any investment he can make.”

If Buffett exercised the warrants at today’s closing price of 7.65 at 4 p.m. on the New York Stock Exchange, he would book a $355 million gain. At one point today, that initial gain was worth more than $1 billion.

‘Dumb’ to Refuse

“Anybody would be dumb not to take those terms,” said Keith Davis, an analyst at Farr, Miller & Washington LLC in Washington. “I don’t think those terms would be available to anyone else except Warren Buffett, because he’s able to give that kind of boost to the stock.”

Buffett is taking “no risk at all,” said Paul Miller, a former examiner for the Federal Reserve Bank in Philadelphia and an analyst with FBR Capital Markets in Arlington, Virginia. “It’s a great deal for Berkshire Hathaway.”

Berkshire previously held the lender’s common stock for three and a half years -- a span in which Bank of America lost more than two-thirds of its value. Buffett’s firm bought 8.7 million shares in the second quarter of 2007, and sold its remaining 5 million shares during the fourth quarter of 2010.

Buffett has publicly criticized Moynihan’s predecessor, Kenneth D. Lewis, for management missteps including the purchase of Merrill Lynch & Co. in 2008, a deal struck the same day Lehman filed for bankruptcy.

‘Crazy Price’

Lewis “paid a crazy price, in my view,” Buffett said in remarks released Feb. 10 by the Financial Crisis Inquiry Commission. “He could have bought them the next day for nothing.”

The bank took a $20.7 billion charge in the second quarter as it covered costs to settle claims from institutional investors that Countrywide used false or missing information to create mortgages that later defaulted. Bank of America is also trying to negotiate a settlement with state attorneys general, who have been investigating foreclosure practices.

“It’s a political hot potato more than it’s a fundamental hot potato,” said Josh Rosner, an analyst at Graham Fisher & Co. in New York. “There’s no way to predict the outcomes of the settlement talks with investors and the states.”

Selling Assets

To bolster capital, Moynihan agreed to sell the bank’s Canadian card unit, with about $8.6 billion in loan balances, and plans to leave the U.K. and Irish card markets. The bank has been forced to write down credit-card and mortgage units acquired by Lewis. Bank of America has sold more than 20 assets or units since Moynihan took over last year.

For his Goldman Sachs investment, Buffett received a 10 percent annual dividend and a 10 percent premium when the bank redeemed the stock. He also got warrants that gave him the right to purchase $5 billion of common stock at a strike price of $115 at any point within five years.

Goldman Sachs also rose on the day Buffett made that investment.

“It’s tremendously important from a psychological standpoint for the market to see that Buffett’s willing to step in,” said Davis, the Farr, Miller analyst.

To contact the reporters on this story: Dawn Kopecki in New York at dkopecki@bloomberg.net; Christine Harper in New York at charper@bloomberg.net; Michael J. Moore in New York at mmoore55@bloomberg.net.

To contact the editor responsible for this story: David Scheer at dscheer@bloomberg.net

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