The stock price of Bank of America (ticker BAC) is up 17% since Warren Buffett, the Oracle of Omaha, announced his deal last week and I find that silly. After all, Warren Buffett used his reputation to extract a favorable fixed-income investment; he did not make an equity investment in BofA.
Why did BofA’s stock price go up? People say the stock jumped because the Oracle of Omaha has put his stamp of approval on the company and its management. Really? If I am correct and Mr. Buffett got a favorable deal, then BofA effectively did the deal to get Mr. Buffett as their new pitchman. Remember, BofA had already said they had enough capital to weather this storm.
Warren Buffett’s company, Berkshire Hathaway, purchased “cumulative perpetual” preferred stock from BofA and also received warrants to buy their common stock at $7.14 a share. “Cumulative perpetual” being the key words, showing this was a fixed-income investment. Cumulative preferred stock does not qualify as Tier 1 common capital, the important regulatory capital gauge. In the simplest of terms that says that this deal goes on BofA’s balance sheet as debt, not equity. Hence my statement above that Mr. Buffett made a fixed-income investment.
So why did Mr. Buffett do the deal? It’s an interesting question, considering that unlike the Goldman Sachs and GE deals during the 2008 meltdown, this time Mr. Buffett called BofA.
My guess is Mr. Buffett has learned that when he does one of these deals the bipolar Mr. Market drives the stock price up in a knee-jerk reaction. So he effectively got paid $3 billion for buying $5 billion of preferred stock; $3 billion being the lowest estimated value of the warrants I have found.
In the investment world, it’s nice to be Warren Buffett! But please do not confuse buying “BAC” in your personal account with the deal struck between Mr. Buffett and BofA.
Mr. Buffett’s Secretary
Warren Buffett can only hope his secretary does not read the Wall Street Journal. Their editorial yesterday morning, “Buffett’s Latest Tax Break,” points out that his fixed-income investment in BofA will have an effective tax rate of only 10.5%, which is even farther below what his secretary paid. The editorial stated the reason for that low rate is because “corporations can exclude from taxation 70% of the dividends they receive from an investment in another corporation.” The editors did point out that Mr. Buffett’s tax break is justified because dividends are normally double taxed, but would be triple taxed if they go from corporation to corporation to an individual.
But I’m sure his secretary will understand that his own editorial in The New York Times on August 14th was only addressing the difference in their personal effective tax rates. She is obviously free to start her own corporation to take advantage of the different tax rates on different types of income.
Oh wait, Mr. Buffett forgot to mention in his editorial that there are logical reasons for different tax rates on different types of income built into the tax code. Or, maybe he believes logic only applies to corporate taxes and not individual taxes?
No, he must understand the same logic applies to personal and corporate rates. If he didn’t he would have also demanded we stop “coddling” the retired people whose effective tax rate is even lower than his secretary’s because they are living off of the income they received from tax-free municipal bonds.
Come on, do you really believe the Oracle of Omaha doesn’t know the logical reasons for the different tax rates on his different types of income that result in his low personal effective rate of 17.4%? It must have slipped his mind when he quickly penned his two-and-a-half-page editorial comment.
After all, Warren Buffett learned about logic from the same guy he learned about Mr. Market.