Sage of Omaha rescues Bank of America

WARREN Buffett thinks he should pay more tax, but failing that he’ll find other ways of using his money to help the US government. Yesterday, he was doing his bit by investing $5bn in Bank of America, whose share price has been battered by fears the company lacks the sufficient capital to fight or settle lawsuits associated with mortgage-backed securities it sold prior to the crisis.

The deal is almost identical in structure to the $5bn investment he made in Goldman Sachs in September 2008, although the six per cent annual dividend on BofA’s preferred stock is less eye-watering than the 10 per cent Goldman was paying before it bought him out in March.

Buffett is likely to make a huge amount of cash from the dividend; at one point, the Goldman shares were paying out something like $15-a-second.

Along with the $5bn investment in preferred BofA stock, Buffett is receiving warrants to purchase $500m worth of common stock at an exercise price of $7.14. Again, this mirrors the Goldman deal, where Buffett bought warrants worth $5bn at a strike price of $115. Effectively, he is setting a floor-price for the shares; if they are trading any lower when he has to exercise the warrants (within five years) he will be out of pocket.

At yesterday’s close price of $7.65, those Bank of America warrants were in the money to the tune of $357m.

A similar thing happened – at first – with the Goldman warrants, which generated a paper profit of £782m within just two days. In October 2009, he could have made $3.3bn by exercising the options (he didn’t).

Yesterday, however, Buffett was actually sitting on a paper loss of around $224m on the Goldman warrants, after the bank’s stock closed at $109.84 – below the $115 floor-price. So while the Sage of Omaha has spoken, and the market listened, there is no guarantee that the boost will last.