Billionaire Warren Buffett would invest $5 billion in Bank of America Corp. (NYSE:BAC), expressing his biggest vote of confidence in the banking giant.
"Bank of America is a strong, well-led company, and I called Brian to tell him I wanted to invest in it," Buffett said in a release. "I am impressed with the profit-generating abilities of this franchise, and that they are acting aggressively to put their challenges behind them.
"Bank of America is focused on their customers and on serving them well," he added. "That's what customers want, and that's the company's strategy."
The investment from Buffett, a legendary investment magnate, is a huge brand endorsement for Bank of America -- one of the world's largest financial institutions.
Buffett issued a statement explicitly endorsing the bank's senior management and strategy, but more importantly, he is putting his capital behind both Bank's capital position and his view of the upside in the company's common shares.
Buffett, through his company Berkshire Hathaway, would buy $5 billion of preferred shares with a dividend of 6 percent a year, lower than the dividend rate on preferred shares issued by Goldman Sachs and Morgan Stanley during the worst of the financial crisis three years ago. Bank of America can redeem the preferred shares at any time for a 5 percent premium.
Berkshire's real upside will come from the warrants for 700 million common shares, or about 6.5 percent of the company on a fully diluted basis. The warrants are exercisable for 10 years at $7.14 and are already in the money, based on Thursday's market reaction to the Berkshire investment in Bank of America.
"In the current market environment, perhaps the biggest positive sign is that Buffett was willing to be a junior unsecured creditor of BAC as an owner of the 6 percent preferred shares," Susquehanna Financial analyst David Hilder wrote in a note to clients.
"We have viewed recent market concerns about BAC's mortgage liabilities and plans to meet Basel 3 capital requirements as overblown, but such market concerns had recently become self-reinforcing, as BAC's credit default swap costs recently neared record levels and where one-year credit default swap (CDS) protection cost more than five-year protection.
Bank of America's CDS five-year protection dropped approximately 45 basis points to approximately 340 basis points at the end of the trading day.
"We believe that BAC CDS spreads will continue to tighten and trend back to more normal levels as investors digest the Berkshire investment and receive more clarity over potential mortgage litigation," Hilder wrote.
Hilder, who has a "positive" rating and $21 price target on Bank of America stock, said the risks to his investment thesis include a slower than expected economic recovery, which would slow the anticipated improvement in credit loss provisions and delay a sustained rebound in investment banking revenue.
In addition, a longer-term risk is that the implementation of various provisions in the Dodd-Frank financial regulation bill will have a larger negative impact on revenue or costs.
Bank of America, one of the largest banks in the US by assets, serves approximately 58 million consumer and small business relationships with about 5,700 retail banking offices and approximately 17,800 ATMs. In 2009, it bought Merrill Lynch to become one of the world's leading wealth managers with more than $2 trillion worth of assets under management.
In 2010, it earned revenues of $52.6 billion, but reported a loss of $2.24 billion as it incurred a massive goodwill impairment charge. Excluding charges, it reported earnings of $10.16 billion.
On the investment news, shares of Bank of America soared 66 cents, or 9 percent, to end Thursday's trading at $7.65. In the pre-market hours Friday, they were up 7 cents, or 1 percent, at $7.72.