On Wednesday August 30, Bank of America shares (NYSE:BAC) surged after Warren Buffett’s Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) exercised its right to purchase a mega 700 million shares of common stock. In intra-day trading BAC stock jumped almost 2% after the news!
On an asset basis, Bank of America is the second largest bank in America. Now with Buffett’s purchase of 700 million shares, Berkshire Hathaway is now the biggest shareholder of this iconic American company. After the deal, Berkshire now owns a larger stake that any of the other major shareholders, including BlackRock, Vanguard and State Street, in a position that is now worth approximately 6.6% of the company.
But just what did the Bank mean when it said Buffett ‘exercised his right to purchase’?
Well, back in 2011, Berkshire Hathaway made a $5 billion investment in Bank of America’s preferred stock. Warren Buffett had made the deal back around the time of the financial crisis, to help a troubling bank become financially steady on its feet because he liked the Bank’s prospects. By injected $5M into BAC into preferred stock in 2011, Berkshire also bought the right to buy common stock shares for $7.14 each, to be exercised at any point in the subsequent 10 years. So, by purchasing the 700 million dollars in stock in 2017, Berkshire executed the purchase not by injecting new funds into Bank of America, but by converting its existing $5 billion worth of preferred stock into common stock.
Earlier in 2017, in the annual letter to Berkshire Hathaway Shareholders, Buffett had alluded to the deal taking place if certain conditions were met:
[Bank of America’s preferred] stock, which pays us $300 million per year, also carries with it a valuable warrant allowing Berkshire to purchase 700 million common shares of Bank of America for $5 billion at any time before September 2, 2021. At yearend, that privilege would have delivered us a profit of $10.5 billion. If it wishes, Berkshire can use its preferred shares to satisfy the $5 billion cost of exercising the warrant.
If the dividend rate on Bank of America common stock — now 30 cents annually — should rise above 44 cents before 2021, we would anticipate making a cashless exchange of our preferred into common. If the common dividend remains below 44 cents, it is highly probable that we will exercise the warrant immediately before it expires.
In June of this year, Bank of America raised its dividend to 48 cents per share that accordingly prompted Berkshire Hathaway to convert its preferred stock into common stock.
This deal is great news for Bank of America: Buffett is one of (if not the most) revered investors in Americs, who has accumulated an impressive track-record for the Berkshire Hathaway conglomerate. Therefore, having Berkshire as the Bank of America’s biggest shareholder gives the bank an all-important and valuable Buffett stamp of approval.
About the deal, Bank of America Chairman and CEO Brian Moynihan had the following to say:
“In 2011, we welcomed Berkshire Hathaway as a shareholder, and we appreciate their continued support now as our largest common shareholder.”
And, of course, Buffett didn’t do too badly either and has almost tripled his initial investment! He spoke very favorably of the deal and of Bank of America as a company in a recent CNBC interview:
“It will be a long, long time before we sell a share of Bank of America. I’m very happy. We have 700 million shares. I like the business. I like the valuation. And I like the management very much. So I think you see that for a long time in our holdings.”
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