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Warren Buffett's Berkshire Hathaway will invest $5 billion in Bank of America, stepping in to shore up the company in the same way he helped prop up Goldman Sachs and General Electric during the financial crisis.
Bank of America shares (BAC-N) rose in early trading, erasing a large part of the stock's August losses. The jump also makes the warrants for Bank of America shares that Berkshire gets in the deal instantly profitable.
Berkshire Hathaway (BRK.B-N) is a holding company controlled by Buffett.
Buffett and Bank of America said he made an unsolicited call to Bank of America. Berkshire had a position in the bank that he sold in the fourth quarter of 2010 when the stock had an average price of $12.24.
The warrants to buy 700 million shares of common stock he gets in this deal are priced at just over $7.14 per share, with an unusually long 10-year exercise period.
Bank of America will also sell Berkshire 50,000 shares of cumulative perpetual preferred stock with a 6 percent annual dividend, it said. Bank of America can buy back the investment at any time by paying Buffett a 5 percent premium.
It is virtually a mirror of the deal Berkshire did with Goldman in the depths of the crisis in fall 2008, except in this case the dividend is less. The Goldman deal paid Berkshire $15 a second in dividends until Goldman bought Buffett out earlier this year.
"It's a reasonably priced deal for Buffett. It's opportunistic," said Tom Russo, a portfolio manager at Gardner, Russo & Gardner who holds Berkshire shares.
Russo said any concern about the Bank of America deal tying up Berkshire capital would be more than offset by the relative lack of other good investment opportunities available.
Investors have battered Bank of America's stock on fears that the largest U.S. bank by assets has yet to overcome billions of dollars in problem mortgage loans.
In recent weeks, investors have sold shares, worrying that the bank might need to raise outside capital -- as much as $50 billion by some estimates -- to cope with losses and meet new industry capital rules.
Bank of America Chief Executive Brian Moynihan said on an August 10 conference call with investors and analysts that the bank could add to its capital through earnings and asset sales. The call, organized by Fairholme Funds, one of the bank's largest shareholders, happened two days after shares plunged by 20 percent.
"This helps with the credibility gap that I think has existed in the minds of some shareholders. It reiterates the point that the balance sheet is healthy. They needed an endorsement in the market and they got it," said Jon Finger, managing partner of Finger Interests in Houston. Finger's family sold its bank to Bank of America years ago.
Bank of America shares lost roughly a third of their value in August before this deal, and half their value since the beginning of the year.