How Warren Buffett bagged a $12 billion profit on bank deal

Warren Buffett famously said investors should be "fearful when others are greedy and greedy when others are fearful." His prescient investment in Bank of America (BAC) lives up to that contrarian credo.

The storied investor announced Friday that his holding company, Berkshire Hathaway (BRK.B), had become the largest stockholder in the financial giant. That allowed Buffett to turn a farsighted investment he made in 2011, when BofA was reeling from the aftermath of the financial crisis, into a $12 billion paper profit. 

At the time, Buffett bought $5 billion worth of the company's warrants, which gave him the right to buy a certain amount of its common stock in the future. Each warrant cost him $7.14, but the common shares were worth more than three times that when he moved to exercise them this week, trading Friday afternoon at $24.30.

The maneuver also brings Buffett a richer dividend payout. The warrants paid Berkshire about $300 million annually, and the common stock will generate an estimated $336 million, a 12 percent boost in dividend income.

Things are looking up for the banking industry of late. One reason the Federal Reserve is raising short-term interest rates is that banks seem to be on firmer ground eight years after the global financial meltdown. BofA, for instance, saw its net income grow by 11.7 percent in 2016.

Buffett's action gives him an approximately 7 percent  stake in BofA, the second-largest U.S. bank by assets behind JPMorgan Chase (JPM). Bank of America's next largest shareholder is asset manager BlackRock (BLK). In addition to the BofA holding, Berkshire also is the top investor in the nation's third-largest bank, Wells Fargo (WFC), with a 9.6 percent position.

While Buffett showed nerve investing in BofA as it was coping with the financial and reputational impact of the housing bust, a coup like the BofA arrangement isn't available to the average investor -- or even to most Wall Street pros. 

"Warren Buffett has tens of billions of dollars and access to information and resources that the rest of us don't have," University of Chicago professor Harold Pollack told PBS NewsHour last year. "Also, because he is a marquee name, people are offering him deals, because he really is Warren Buffett."  

The Bank of America transaction isn't the first time Buffett has profited from special deals he made with ailing financial titans in connection with the 2008-09 financial crisis. His $3 billion investment in the financial arm of General Electric (GE) netted him $1 billion. Similarly, he made a $5 billion loan to Goldman Sachs (GS), which garnered him $1.7 billion in profit.

BofA's improving fortunes led to Buffett's latest foray. When he acquired the warrants, he was providing the bank with much-needed capital. In 2011, Bank of America was trying to extricate itself from a quagmire stemming largely from its January 2008 purchase of Countrywide Financial, a lender of subprime mortgages. 

Back in early 2008, the housing crisis was just getting under way. Bank of America figured mounting subprime defaults were a temporary problem, and it could pick up a valuable company for cheap, laying out a little more than $2 billion for Countrywide. But cleaning up the lender's ensuing toxic mortgage mess cost Bank of America more than $50 billion. It would end up paying a roughly $17 billion fine to the federal government for its mortgage lending practices. 

On Wednesday, however, the Federal Reserve said that industry fundamentals had improved so much that BofA and 33 other big banks could increase their dividends and buy back stock. After subjecting them to so-called stress tests, the Fed decided  their financial conditions were now sufficiently strong to weather a serious economic slide. 

In Buffett's annual letter to shareholders, released in February, he wrote that Berkshire would consider converting its Bank of America warrants into common stock if the bank hiked its dividend payout to 44 cents per share. At the time, the bank was paying 30 cents. The Fed's ruling allowed the bank to raise its payout to 46 cents, thus triggering Buffett's interest in converting the warrants.   

  • Larry Light

    Larry Light is a veteran financial editor and reporter who has worked for the Wall Street Journal, Forbes, Business Week, Money, AdviceIQ and Newsday.