Don’t call it a bail-out.
Our apologies for another BofA post but analyst reaction has been coming in and though most it can be summed as “confidence boost that changes little”, we think there’s a couple of extra points worth mentioning.
Mike Mayo of CLSA has a good breakdown of how the purchase will be accounted for:
Berkshire’s $5bn investment will show up on BAC’s 3Q11-end balance sheet as a $3bn increase in preferred equity and $2bn in common equity, reflecting the accounting rules for preferreds and warrants. Over time, the $2bn in common equity accretes into the preferred line item. If and when Berkshire exercises the warrants, any residual amount of the original investment that is still listed as common will be converted into preferred, and the value of the exercised warrants (700m @ $7.15 exercise price = $5bn) will be classified as common equity.
In summary, the deal in the near term raises BAC’s total equity by 2% (to $223bn), and exercising the warrants would add another $5bn of common (or 4% of Tier 1 common to $120bn). Using Basel 3 rules, this improves the company’s Tier 1 common ratio by approximately 30bps. The warrants represent 7% of total shares outstanding and, if exercised immediately, we estimate would reduce BAC’s tangible common per share by 3% to about $12.30.
The dividend yield on Buffett’s cumulative preferred stake is 6 per cent, meaning it is roughly 250 – 300 bps below the market rate. In another note, KBW analysts estimate that means a value of around $3.5bn for that portion of the deal.
But it is Warren’s Warrants that are rightly attracting attention. To recap, he has warrants to purchase 700m BofA shares at $7.14, which were priced at a 2 per cent premium to yesterday’s close and equate to another $5bn or so of options on top of his initial stake.
All of which seems a little familiar, according to KBW:
The accounting of the preferred and warrant will be similar to TARP in that a portion of the $5 billion in value will be allocated to tangible common equity and a portion to preferred equity. The distribution will be more pronounced than TARP (which was ~95% preferred/~5% warrant) as with TARP the warrants were 15% of the preferred and here it’s 100% or an equal amount, suggesting closer to a 50%/50% split.
Okay, it’s a bit of a stretch (BofA received $45bn in Tarp funding) but it’s a neat comparison given Buffett’s position as the pawnbroker of the US financial system.
KBW goes on to estimate the value of the warrants at $3bn – $3.5bn suggesting that Buffett got $6.5bn – $7bn worth of BofA for $5bn. With the warrants very much in the money already (BofA was up 10 per cent at pixel time) it’s a pretty nice day’s business for the Nebraskan. He’s estimated to have made a paper profit of $1.4bn on Thursday’s price movement. It brings to mind his reported comment two decades ago about Solomon Brothers being a Treasury bill with a lottery ticket. BofA looks a lot like that.
And just about the most expensive PR contract ever signed.
Update (5:13pm, New York time): BofA’s 8K filing that details the terms of the deal can be found here.
Related links:
How Much Did Warren Buffett Pay For BofA Anyway? – Dealbreaker
Buffett’s bargain BofA deal – FT Alphaville
That Warren Buffett Confidence Boost Doesn’t Come Cheap – Marketplace