A 'Good Deal' For BofA, A 'Great Deal' For Buffett

Aug 25, 2011

Warren Buffett came to the rescue of Bank of America, the giant financial services company that faces a range of legal and financial problems. Buffett said Thursday he would invest $5 billion in the company and could buy more shares down the road. Buffett's decision to buy into Bank of America sent its share price higher, though the company still has to contend with big challenges.

Warren Buffett told CNBC Thursday morning that he got the idea to invest in Bank of America just the morning before, while sitting in the bathtub. He called the bank to discuss terms, and 24 hours later the deal was announced.

"It is an important vote of confidence in the Bank of America franchise, and I think in Brian Moynihan, the CEO," says Nancy Bush, a bank analyst and a contributing editor at SNL Financial.

For Bank of America, the deal comes at the end of a tumultuous few weeks when its stock price had slid near levels not seen since the 2008 financial crisis. Anthony Plath is an associate professor of finance at the University of North Carolina at Charlotte, where the bank is based.

"There have been all kinds of crazy rumors swirling in the past week about the bank putting itself up for sale, about JPMorgan coming in and buying Bank of America. I mean, Buffett's investment will put an end to those kinds of crazy rumors," Plath says.

Many of the bank's problems stem from its purchase of the subprime mortgage lender Countrywide Financial. It faces a rash of lawsuits from disgruntled mortgage investors. It's also been accused of foreclosing on properties without proper documentation and is negotiating a settlement with state officials. Plath says Bank of America has aggravated its troubles by sending mixed signals to the markets.

"Management has had to reverse itself on a couple of occasions with respect to some of the things they've said about mortgages, about dividends, about losses the bank faces, about the strength of the consumer economy," he says, "and so as a question there's been this crisis of credibility that sort of surrounded management."

At the same time, the banking industry itself is under pressure due to the weakening economy and the debt crisis in Europe.

"So they have these problems with their acquisitions that continue to plague them at a time when the banking industry itself is rather out of favor," says Tony Russo with Gardner Russo & Gardner.

Bush says Buffett is betting that Bank of America will resolve its legal problems and that the economy will improve, and when that happens, the company will be sitting pretty.

"The deposit-gathering companies like Bank of America, like JPMorgan Chase, like Wells Fargo, are going to be hugely profitable in their deposit-gathering networks, and I think that's pretty much probably what he was seeing," she says.

If things work out, Buffett stands to make even more money. Under the deal, he will be buying 50,000 shares of stock that pay a dividend of 6 percent. Down the road, he will have the option of purchasing an additional 700 million shares of stock at the very low price of a little more than $7 each, says Plath of University of North Carolina.

"This is a good deal for Bank of America, but it's a great deal for Warren Buffett," he says.

Just how great could be seen Thursday morning. After the announcement, shares of Bank of America jumped, netting Buffett a profit of $250 million within minutes. By the end of the day, that had increased to well over $1 billion.

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