How Buffett's Bank of America bet changes with the Fed stress test

By Rachel Louise Ensign and Nicole Friedman Markets Dow Jones Newswires

Warren Buffett's firm may soon become the biggest shareholder in Bank of America Corp.

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The Charlotte, N.C., bank, the second largest in the country by assets, is expected to get a stress-test result from the Federal Reserve Wednesday that would allow it to boost its dividend. A higher dividend is something Mr. Buffett has said could prompt his Berkshire Hathaway Inc. to swap its preferred shares in the bank into about $16 billion worth of common stock.

The move would make the famous stockpicker's firm the largest shareholder of the second and third largest U.S. banks -- the third being Wells Fargo & Co. -- while also providing a vote of confidence for Bank of America stock.

In February, Mr. Buffett said in his annual letter to shareholders that Berkshire planned to make the switch in its Bank of America stake if the bank could increase its annual dividend to 44 cents a share from its recent level of 30 cents a share. That is because a common-stock dividend of 44 cents would pay Berkshire more than the $300 million that the preferred stake gives the firm annually.

Berkshire bought its preferred shares in the bank in 2011, when the lender sorely needed to shore up investor sentiment. The $5 billion deal also included warrants to buy 700 million shares of Bank of America common stock for $7.14 apiece, far below the current price.

The preferred shares have little downside, so long as Bank of America stays solvent. But they have no upside either. With a change in Berkshire's shares, Mr. Buffett effectively would be saying that he would like to take part in possible gains on Bank of America's stock as well as enjoy a steady dividend.

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After an exchange, Mr. Buffett's firm would own about 7% of the bank's common shares, giving it a significant role in corporate governance issues from compensation to the election of new directors. Currently, the largest shareholder of Bank of America is Vanguard Group with a 6.6% stake, according to a FactSet analysis of recent regulatory filings.

Before his February letter, Mr. Buffett had said he would wait to exercise the warrants on common shares. The warrants last until 2021.

No matter what Mr. Buffett decides, a dividend boost would be positive for Bank of America Chairman and CEO Brian Moynihan. The 57-year-old lawyer has worked to restore the bank's relationships with shareholders after years of large mortgage fines and losses stemming from the bank's crisis-era purchases of Countrywide and Merrill Lynch.

Big banks need approval from the Federal Reserve to increase their dividends, a process that culminates in Wednesday's annual review of how the lenders would perform under severely stressed economic conditions.

Several analysts have predicted the bank would be allowed by the Fed to increase its dividend to 44 cents a share or more, while others see a smaller dividend increase. The bank hasn't discussed exactly what it is planning to request but in years past has updated shareholders about its plans shortly after the Fed's stress-test release.

It isn't clear how soon after a potential Fed approval that a Berkshire exchange could happen. Mr. Buffett couldn't be reached for comment.

When the Omaha-based investor bought the preferred shares, Bank of America was slumping, losing confidence among many investors. Mr. Buffett helped to change that narrative by agreeing to purchase $5 billion in preferred stock and calling the bank "well led," an important endorsement for Mr. Moynihan about 1 1/2 years after he had risen to the chief-executive role.

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The terms though were expensive for Bank of America. The preferred stock paid a chunky 6% annual dividend, or $300 million a year. Bank of America shares have tripled since the investment, from about $7.60 to $23.27, giving Berkshire a paper gain of around $11 billion. Berkshire also has made about $1.7 billion in dividends on the preferred shares.

Mr. Buffett, Berkshire's chairman and chief executive, amassed stakes in a number of lenders and financial services companies, sometimes at cut-rate prices around the financial crisis. Berkshire's other bank holdings include Wells Fargo, Bank of New York Mellon Corp., American Express Co., Goldman Sachs Group Inc., M&T Bank Corp. and U.S. Bancorp.

Bank of America shares are up about 91% over the past 12 months in large part because of a big rally right after the November election. But one issue for the bank is that profit gains from higher interest rates have slowed as long-term rates have remained low.

Write to Rachel Louise Ensign at rachel.ensign@wsj.com and Nicole Friedman at nicole.friedman@wsj.com

(END) Dow Jones Newswires

June 28, 2017 05:44 ET (09:44 GMT)

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