At the height of the financial crisis, Warren Buffett stepped in to shore up the capital reserves of General Electric and Goldman Sachs with billions of dollars invested in preferred shares.
His asking price? A juicy 10% yield. Of course, one could argue that 10% was cheap, considering the state of the credit market at the time.
Either way, the investment has paid off in spades. When I went to the Berkshire Hathaway annual meeting in 2010, Buffett said this about his preferred investment in Goldman Sachs:
"Every day that Goldman doesn't call our preferred is money in the bank. That's $15 a tick. Tick, tick, tick. I don't want those ticks to go away."
Although the position eventually declined, it paid back the principal in March of this year . . . in addition to a one-time special dividend of $500 million.
Unfortunately, most investors can’t get the kind of sweetheart deals that Buffett gets. He keeps billions in cash for special situations. But the real secret is Buffett’s reputation. An investment by Buffett is a signal to the investment world. If your company faces a significant, but solvable problem, having the backing of Warren Buffett goes a long way to reassure the market.
That’s why the Buffett’s recent investment, a $5 billion preferred stake in Bank of America, seems a bit bizarre.
That’s because Buffett’s only getting a 6% yield from Bank of America. At that yield, even individual investors can grab a higher yield in the beleaguered company.
For example, the current yield on Bank of America’s preferred U series (BAC-U), is over 7%. These preferred shares trade for less than $21, but the bank must eventually redeem the shares at $25. So in addition to a high initial yield, investors today can lock in a 19% upside as well.
In other words, individual investors have an opportunity to invest alongside Buffett andbank a higher yield along the way. They can also lock in a modest capital gain. They only thing individual investors won’t get are the warrants that Buffett also managed to snag as part of the deal.
Of course, many risks remain. By some estimates, Bank of America needs to raise at least $20 billion to shore up capital reserves, and the Buffett investment still leaves the company about $15 billion short. It’s clear holders of common stock are still in for a bumpy ride.
That’s also why Buffett’s warrants on BAC stock look like lotto tickets to me at this point: If the company really didn’t need capital as its CEO claimed, it certainly didn’t need it from Buffett.
In today’s low-yield world, an income-producing investment like Bank of America preferreds should perform well. And thanks to Buffett’s generous terms, today’s investors can ride on Buffett’s coattails and get higher income along the way. Just make sure to avoid the company’s common stock.
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