Warren Buffett’s Happy Doing Business With Bank of America

It’s always very popular to check in on Warren Buffett during the new year for whatever reason. One of the reasons is that many people potentially want to invest like Warren Buffett, and they make it a New Year’s resolution. That’s at least one potential reason why this happens. So how’s Buffett doing anyway?

Warren Buffett’s big bet on Bank of America, as well as a very generous buyback plan put into place, helps Berkshire Hathaway beat the S&P 500 index during 2012. He didn’t even make a major acquisition during this time.

Berkshire’s class a shares rose by 17% during 2012, and this beat out the 13% gain that the Standard & Poor’s 500 made. As well, an estimate made on December 31, 2012, says that book value rose to $113,579 per share. This estimate comes from Meyer Shields, who is an analyst at Stifel Nicolaus and Co. Based on this estimate, Berkshire Hathaway has earned a seven-point percent annual growth rate over the last five years ending in 2012. This is compared to the 1.7% growth rate of the S&P 500, and this includes dividends.

It’s also worth paying attention to that the Warren Buffett buyback was controversial when it was first announced just three weeks ago. But, the stock rose 6.5% since that time, earning Mister Buffett and company a $80 million profit in just three weeks.

Berkshire Hathaway also made a very large sum of money in their Bank of America investment in preferred shares and warrants during the year 2011. If you take a look at this passage from “Heard on the Street” where they go on about whether or not Bank of America should buyback the preferred stock from Buffett, you might learn some clues. Here’s why:

“Granted, retiring Mr. Buffett’s preferred shares might cause BofA to cut back on plans to ask for capital returns. That could cause unease for common shareholders, especially since Mr. Buffett’s preferred stock is also equity.

Yet the particular structure of the preferred shares means it doesn’t qualify toward the bank’s Tier 1 ratio under the new Basel rules. So it is akin to debt for capital purposes.

On that basis, 6% is expensive. The average yield on BofA’s long-term debt as of the third quarter was 3.07%. And the bank, awash with deposits, has been aggressively reducing long-term debt as it seeks to bolster its net interest margin.

So it wouldn’t be tough for BofA to replace Mr. Buffett’s preferred stock with cheaper, long-term debt. The catch: Any additional debt issuance chips away at the bank’s net interest margin, while the preferred payment doesn’t because it is deducted from net income.”

There is a very funny video on the Internet where Bill Ackman is talking about how he is going to open up a lemonade stand, and he mentions a fun exercise where he will try to explain exactly what it is that Bank of America is thinking about. But you really have to have financial knowledge in order to understand some of the terms that he’s talking about within the video. Some of the things being mentioned are: is Bank of America trying to bolster its net interest margin, or its tier 1 capital, or is it just looking to buy low and sell high?

If you have an a B Warren Buffett, you might wonder something like this: is buying the preferred shares a very good deal economically, when you compare to other things that Bank of America might choose to do with its money instead?

When reading the journal, you can’t get the sense that that isn’t a question they are going to be asking themselves anytime soon. But that doesn’t mean Bank of America is any less smarter than Warren Buffett. They just happen to be in the middle of many different accounting knots and regulatory tangles, and they can only unravel these issues one or two at a time. Mister Buffett on the other hand is a regulatory regime unto himself.

When looking at this from the perspective of Warren Buffett, the motives of Bank of America by trading their preferred shares to him are pleasantly uneconomic for the bank. The initial trade was actually conceived in a bathtub, and looking at it from an economic standpoint, this is a pretty big gift to Buffett. They give off the vibe of they are not going to vanish anytime soon.

So all in all, it looks like Warren Buffett really made out like a bandit on this deal. That doesn’t surprise me at all, since he was able to make hundreds of billions of dollars for himself and his clients over the years. This is nothing new, so why would anybody think otherwise?

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