Signalling Optimism in Financials, Buffett Becomes Bank of America’s Top Shareholder

SMITH BRAIN TRUST – Berkshire Hathaway has announced it will exercise its warrants for 700 million Bank of America shares. David Kass, clinical professor of finance at the University of Maryland's Robert H. Smith School of Business, has closely followed the so-called Oracle of Omaha's investments and philosophy for more than 35 years. He offers the following insights: 

Bank of America, the second largest bank in the country by assets, received permission from the Federal Reserve on June 28 to increase its per-share dividend to 48 cents a year. Warren Buffett is exercising these warrants and swapping its preferred stock into the common stock since Berkshire will receive annual dividends of $336 million from the common stock, which exceeds the $300 million it currently receives on its $5 billion of 6% preferred stock that it purchased in August, 2011.

Berkshire will be purchasing the 700 million shares of Bank of America common stock at $7.14 per share, or $5 billion. At Bank of America’s closing price yesterday of $24.32, Berkshire’s investment is valued at $17 billion, which results in Berkshire being its largest shareholder with a 7 percent stake.

Upon the exercise of these warrants, Berkshire will be the largest shareholder of both the second and third largest U.S. banks. Berkshire’s 10 percent stake in Wells Fargo, which is the third largest bank, is currently valued at $27 billion.

Warren Buffett had previously stated that as soon as Bank of America (BAC) increased its dividend on its common stock to a level that Berkshire's annual dividend would exceed that of its preferred he would convert the preferred into the common stock and exercise Berkshire's BAC warrants.  So, Berkshire's announcement this morning was expected.  

It confirmed Buffett's confidence in Bank of America and its management that he expressed in August, 2011 when he made his investment. At that time, Buffett's "seal of approval" gave an important boost to Bank of America's stock and the market's perception of the company. Bank of America had been experiencing large losses from its troubled mortgage portfolio and it was facing several investigations and lawsuits with large potential legal liabilities. Questions were raised as to whether BAC had sufficient capital.

Buffett’s latest move should have an overall positive impact on the financial sector.  Warren Buffett's endorsement of Bank of America, as expressed in his surrendering the safety of the BAC preferred stock for the upside potential of the underlying common stock, signals his continuing confidence in the U.S. economy in general, and the financial sector in particular.