Buffett Bets $5 Billion on BofA

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The Wall Street Journal
By: Dan Fitzpatrick
August 26, 2011

Investment Boosts Stock and Confidence in Bank, But Comes at Steep Price.

Bank of America Corp. said it will get a $5 billion infusion from Warren Buffett, giving the nation's biggest bank a desperately needed jolt of confidence at a time when investors are questioning its health.

Warren Buffett's Berkshire Hathaway will invest $5 billion in Bank of America, giving the nation's biggest bank a key vote of confidence. As Colin Barr tells us on The News Hub, the move could save the bank's foundering chief executive, Brian Moynihan.
.The deal allies the bank with a billionaire investor known as an astute judge of value, who emerged during the financial crisis as an outspoken advocate of investing in America's future.

But Mr. Buffett's investment won't necessarily ease the pressure on the bank to boost profits amid a softening economy and growing mortgage-related costs. And it comes at a steep price. Mr. Buffett will get a large stream of cash dividends and the right to buy more stock near its two-year low, which could turn him into the bank's largest shareholder.

The transaction came about after Mr. Buffett's administrative assistant placed a call Wednesday to the Midtown Manhattan office of Bank of America's chief executive, Brian Moynihan. When Mr. Moynihan returned the call shortly after 11 a.m., Mr. Buffett proposed the investment.

.At first, Mr. Moynihan was skeptical, telling the Berkshire Hathaway Inc. chief that "we really have the capital we need," according to someone familiar with the conversation. But Mr. Buffett persisted. The two reached an agreement following more conversations, this person says. The bank's board, after meeting by phone, approved the agreement around 8:30 a.m. Thursday, according to a person familiar with the meeting.

Reaching out to Bank of America is a somewhat unusual move for Mr. Buffett, who sometimes professes to find deals mainly by answering unsolicited calls to his Omaha, Neb., offices. During the 2008 financial crisis, for example, representatives of Goldman Sachs Group Inc. and General Electric Co. came to him seeking capital, along with his stamp of approval. This time, Mr. Buffett reached out to Bank of America.

His decision to invest temporarily quieted questions about the Charlotte, N.C., bank, whose shares have fallen 43% this year. Mr. Buffett implicitly endorsed Mr. Moynihan on Thursday, calling the bank a "well-led" company. "I am impressed with the profit-generating abilities of the franchise and that they are acting aggressively to put their challenges behind them," he said in a statement released by the bank.

The news sent Bank of America shares up 10% and boosted the stock of other big banks, including Citigroup Inc. and Wells Fargo & Co., on a day when the broader stock market was down 1.5%.

"This is a vote of confidence by a savvy investor," Bank of America's chairman, Chad Holliday, said in an interview Thursday afternoon. "We've got some work to do. We understand that. He understands that."

The deal is structured in two parts. Berkshire will spend $5 billion on "cumulative perpetual" preferred stock in the company. Those shares aren't convertible into Bank of America common stock, but pay a 6% annual dividend.

Berkshire also will get warrants granting it the right to buy $5 billion worth of Bank of America common stock at $7.14 a share, which is below the stock's closing price Thursday of $7.63. If Mr. Buffett exercises those warrants, which expire in a decade, he could end up with a 6.5% stake in the bank.

Bank of America said it won't go to market to sell more stock in the wake of the deal. Both Goldman Sachs and GE raised additional funds in public offerings at the time they announced their deals with Berkshire.

The preferred-share investment agreement doesn't restrict Mr. Moynihan or Bank of America executives from selling stock, unlike the Goldman deal, which limited executive share sales.

Although Mr. Moynihan called the investment "a strong endorsement in our vision and our strategy," he still faces a mountain of challenges.

No U.S. bank is more closely tied to the performance of an ailing U.S. economy and none has more exposure to mortgage-related losses and lawsuits. Mr. Moynihan inherited those problems when he became chief executive last year, and they have gotten worse with U.S. economy's recent weakening.

Mr. Moynihan told investors he would be able to raise the bank's dividend in this year's second half, but the bank's request was rejected by the Federal Reserve. He also was forced to revise estimates that he had made about mortgage-related losses.

A bank spokesman said Mr. Moynihan "has been making steady progress against a range of activities that he laid out for investors when he first became CEO."

The biggest question weighing on investors is whether the bank has sufficient capital to meet future regulatory requirements and cover mortgage liabilities. Investors worry that if the bank issues new stock to raise capital, it will dilute the value of existing shares. Mr. Moynihan has said he can raise enough with sales of noncore assets.

Some analysts said the Berkshire deal could help silence calls to raise more capital, and that the bank doesn't need to sell more stock at the moment.

"BofA may not be out of the woods and could take a while to put its troubled balance sheet behind it, but this may be a turning point for it," said Whitney Tilson, managing partner of T2 Partners LLC, which owns shares in Berkshire Hathaway and recently looked closely at Bank of America.

But the preferred-stock sale won't help the bank's most important capital ratio, known as Tier 1 common capital, because regulations don't permit counting proceeds from such sales.

Analysts at Keefe, Bruyette & Woods said in a note Thursday that the $5 billion "will most likely not change the view of the bears that believe [the bank] needs significantly more capital."

.For now, Mr. Moynihan is sticking to a strategy of selling noncore holdings, trying to clean up mortgage-related problems stemming from the 2008 acquisition of Countrywide Financial Corp., and repositioning the balance sheet to withstand future economic shocks. He agreed this month to sell the bank's Canadian card portfolio to TD Bank Group and to exit the credit-card businesses in the U.K. and Ireland. He also announced 3,500 job cuts and is working on a larger restructuring that may slice at least 10,000 more this fall.

"We've just got to put our heads down and grind it out," said one executive. "That is how we are going to get it fixed. There is no silver bullet."

From the time Mr. Moynihan interviewed for the CEO job in the fall of 2009, he has had to fight questions about whether he was the right choice. His predecessor, Ken Lewis, recommended someone else, and board member William Boardman held out for hours during a final board meeting, saying an outsider was needed.

Mr. Moynihan appears to be listening to the criticism about his management style. In a call with investors, he admitted to a misstep earlier this year when he hinted to investors they could expect a dividend increase in the second half of 2011. He later backed away from the idea.

As the bank's stock plunged this month, dropping as much as 20% in one day, he called his board together several times in consecutive days to talk through issues and strategy, not wanting any directors to feel they were out of the loop. He now understands the "optics" of keeping his board "over informed," said a person close to him.

Amid all the scrutiny, however, Mr. Moynihan has grown "frustrated" at being blamed for issues that he sees as largely out of his control, such as the fallout from the Countrywide acquisition, this person said.

--Serena Ng contributed to this article.
Write to Dan Fitzpatrick at dan.fitzpatrick@wsj.com

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