Buffett's Sweet BofA Deal: Why You Can't Get It

Last Updated Aug 25, 2011 10:59 AM EDT

Warren Buffett is investing $5 billion in Bank of America on behalf of Berkshire Hathaway, injecting capital and optimism into the beleaguered banking giant. BAC shares jumped 18 percent on the announcement, but is this enough to lure ordinary shareholders? I'm not so sure.

I have followed Bank of America closely over the years and have paid particular attention since CEO Brian Moynihan took over. I met Moynihan years ago, when he was managing the wealth management division at Bank of America. I have been interested to see how he was going to undo the unwieldy behemoth that Ken Lewis created. As the stock price cratered over the past month, I put BAC on my watch list for a potential short-term trade, but the more I sniffed around, the less interested I was.

The incomparable Yves Smith at Naked Capitalism has been all over B of A's travails. She notes that the bank has a laundry list of problems with its balance sheet, including: massive exposure to second liens, whose value the bank puts at $80B, but are probably are worth closer to $50B; goodwill, which the bank pegs at $78B, a pretty rich number considering the current environment; and exposure to Europe, which the company says "is hedged," but that's what the banks all said about their sub-prime exposure. Taken together, it's understandable why many have suggested that the bank needs to come up with $45-50 billion in a hurry.

So why is Warren Buffett investing in this hot mess of a financial institution? Don't blame the government for this one--Buffett told CNBC's Becky Quick that the idea came to him while he was in the bathtub on Tuesday (what is it with the bathtub? Supposedly Greenspan spent hours in the tub too!).

The answer is that Buffett once again negotiated a deal that the rest of us mortal investors can't touch. Under the deal's terms, Berkshire will receive 50,000 BAC preferred shares, with a dividend of 6 percent a year and which are redeemable at a 5 percent premium AND warrants to purchase 700 million Bank of America shares at strike price of $7.14, which as of today, are in the money. The warrants may be exercised in whole or in part in the 10 years following the closing of the deal.

This is a similar structure that Buffett negotiated with Goldman Sachs at the height of the financial crisis in September 2008, though in that transaction, the dividend was 10 percent. Goldman redeemed Buffett's preferred stock in March for $5.5 billion plus a one-time dividend of $1.64 billion, so that part of the deal was a total score for Buffett. The GS warrants, which entitle a purchase at $115 a share, are not looking so hot at the moment, but Warren is in this game for the long-term.

I wouldn't use Buffett's action as a signal for anyone to jump into the stock. While the injection of $5 billion is great, the same difficult issues exist for the bank and Warren Buffett's checkbook alone can't overcome them.

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    Jill Schlesinger, CFP®, is the Emmy-nominated, Business Analyst for CBS News. She covers the economy, markets, investing and anything else with a dollar sign on TV, radio (including her nationally syndicated radio show), the web and her blog, "Jill on Money." Prior to her second career at CBS, Jill spent 14 years as the co-owner and Chief Investment Officer for an independent investment advisory firm. She began her career as a self-employed options trader on the Commodities Exchange of New York, following her graduation from Brown University.