Buffett’s bargain BofA deal | FT Alphaville

Buffett’s bargain BofA deal

By John McDermott, Cardiff Garcia, and Joseph Cotterill

BofA’s Buffett bounce was at 13 per cent at pixel time, paring gains from a 20 per cent high earlier on Thursday. Part of this may be due to a reverse torpedo-like situation, according to the experts at Data Explorers. There was a 16 per cent increase in the amount of shares out on loan (a proxy for shorting) this week, which may have been partly due to hopes for profit taking on a rebound.

Therefore it’s too early to tell what this really means for Bank of America. We reckon this won’t put an end to worries over BofA’s balance sheet. Warren’s warrant exercise price — a Fibonacci-esque $7.142857 — is already in the money, which suggests to us that BofA was dothing to protest too much about its undervaluation and its incredibly low price to book ratio.

Then there’s the staggering size of the exercise deal: 700 million warrants; what must John Paulson be thinking?

Sure, BofA  is getting a sweeter deal on its dividend payments — 6 per cent per annum compared to 10 per cent in the cases of General Electric and Goldman Sachs — than other all-he-can-eat-Buffett-deals, but if the intention was to put a floor under the share price, isn’t this an awfully low floor?

Or is the highest it thought it could get away with before a subsequent capital raise? A BofA spokesperson ruled out the possibility of tapping the public markets, but it’s not entirely in their gift of course.

The spokesperson also declined to discuss how Buffett and Bank of America arrived at the terms of the agreement, saying only that the deal provided the bank with a combination of the Buffett name and added financial flexibility.

None of this changes the bank’s underlying problems, and the smart analysts chose to focus on the confidence-boosting aspects of the deal rather than the material elements. Nomura’s Glenn Schorr struck this tone in a quick response note:

Buffett’s imprimatur should provide needed boost of confidence The injection of $5 billion from Buffett should dampen the heightened volatility in recent trading of BAC stock and its CDS, and we think it is a clear vote of confidence for the stability of Bank of America’s franchise.

We assume the regulators have approved this investment and importantly are comfortable with the investment in preferred stock as opposed to injection of common. We would note that when Buffett invested $5 billion in Goldman back in 2008 Goldman raised common equity in conjunction with that deal. We think this underscores Bank of America’s ability to meet the prescribed Basel minimum capital requirements via organic capital generation and continued reduction of non-core assets.

Good news for BAC and all financials (we still prefer C and JPM) We continue to prefer JPM (Buy) and C (Buy) to BAC (Neutral). However, we think this news is clearly a positive for the entire group as Buffett’s investment injects confidence into the system and BAC in particular following its consistent erosion in recent trading. While macro overhangs remain, investors should feel a bit better about financials post this announcement.

Or in other words, Buffett has sprinkled his magic fairy dust on another key part of the US financial system. And you might be intrigued by this factoid: At June 30, financial sector equity investments represented about 39% of Berkshire’s equity investments (on a cost basis), according to S&P Equity Research.

For it’s also a vote of confidence in the US government’s willingness to bail out the bank, should it slide further. Indeed, a more caustic interpretation of the deal would point out that a 6 per cent yield isn’t so bad for a firm that’s all-but government backed. 10-year US Treasuries yield a mere 2.3 per cent, of course.

(A more cynical interpretation would mull over the Obama-Buffett phone call earlier this week. A Bank of America spokesperson said the US government had nothing to do with the deal, and that Buffett’s call yesterday was both unsolicited and completely unexpected.)

Related links:
Warren Buffett’s magical fairy dust lands on BofA – Felix Salmon
THE TRUTH ABOUT BANK OF AMERICA: Here’s Another Thing Some Investors Are Freaking Out About… – Business Insider