For the last several months, as its stock has collapsed, Bank of America has insisted it had plenty of capital–and thrown rocks at anyone who suggested the contrary.Well, it seems those who were worried had a point.
This morning, Bank of America announced that Warren Buffett is injecting $5 billion into the company in the form of preferred stock. This apparently much-needed injection has reassured Bank of America’s clobbered shareholders, and the stock is up 25% on the news.
For the sake of the country (and fellow Bank of America shareholders), we’re glad Bank of America’s management finally acknowledged reality and took steps to deal with it.
Now, of course, Warren Buffett is no fool, so he didn’t just go and buy Bank of America common stock. He bought preferred stock, which will pay him a nice 6% dividend. By holding preferred stock, he is also senior to common stock in the capital structure. So if Bank of America does have to take huge write-offs of inflated asset values in the future, Buffett and Berkshire won’t get hit.
For his $5 billion, Buffett is also getting the right to buy a staggering 700 million Bank of America common shares at $7.14 a share–options that are already in the money. This represents 7% dilution to Bank of America’s common stockholders.
In other words, Buffett is getting a preferred security paying 6% a year that is protected from dilution from future capital raises AND an option to buy 7% of the company–all for $5 billion. That’s expensive money. But given that Bank of America waited too long to raise capital, it’s also clearly the best deal they could get.
Measured against Bank of America’s massive $2 Trillion balance sheet, $5 billion is a drop in the bucket. But when Buffett bets on your company, he’s giving you more than money. And hopefully this injection will restore some confidence in Bank of America’s management and company.