Warren Buffett invests in BofA

Banking on America

by M.V. | NEW YORK and J.R. | LONDON

AMERICAN banks have had a torrid few months; their revenues are flat or falling, interest margins are being squeezed and their investment-banking divisions are in a funk. Investors have also had a rough ride. American bank stocks are lower now than they were at the end of 2009; and until the Federal Reserve lifted a ban on dividends earlier this year, most had not made any payments to shareholders since the crisis of late 2008.

One bank shareholder did pretty well during the crisis and its aftermath: Warren Buffett, the world’s best-known investor. In the storm whipped up by the collapse of Lehman Brothers in September 2008, two of the biggest names in American finance were able to steady the ship with investments from Mr Buffett. For Goldman Sachs and GE, the injections were a crucial vote of confidence at a perilous time. For Mr Buffett, both investments proved to be highly profitable, cementing his reputation as one of the world’s wiliest moneymen.

Now it is the beleaguered Bank of America’s turn to lean on the Sage of Omaha. America’s largest bank by assets, saddled with piles of duff mortgages, has faced growing doubts this year about its ability to raise sufficient capital to meet new Basel 3 requirements. The share price tumbled recently after a blogger wrote that the shortfall could exceed $100 billion. At its lowest, the bank was down by almost half this year and was trading at about one-third of the value of its assets. While other banks seized the opportunity to raise capital when times were good, BofA has spent the past months telling investors it has plenty. The more the bank has insisted that it will be fine, the less inclined markets have seemed to believe it. Hence the hurriedly arranged $5 billion capital injection from Mr Buffett announced today.

Once again, Mr Buffett has negotiated attractive terms. The 50,000 preferred shares he is buying carry a 6% dividend and can be redeemed at a 5% premium. Even more alluringly, he gets the right, through warrants, to buy 700m BofA shares for $7.14 at any time over the next 10 years. If this latest crisis of confidence abates and the share price rebounds and settles in a range between $10 and $20, as some analysts feel sure it will, Mr Buffett would make another fortune from being greedy when others are fearful.

Still, it is a risk. America’s housing market remains sickly. If the country where BofA does three-quarters of its business slips back into recession, it will find its earnings power greatly compromised. The bank’s share price jumped by more than 10% on news of the deal, but the longer-term prognosis remains worrying.