Bank of America: The Godfather Comes Calling

The Godfather of American investing, Warren Buffett, came calling on Bank of America's CEO Brian Moynihan, who apparently told Godfather that his company didn't need the capital. Perhaps after some espresso and biscotti, Moynihan reconsidered and accepted the offer that couldn't be refused. The offer, a whited out rewriting of the Goldman Sachs proposition, was for 50,000 shares of cumulative 6% preferred shares at $100,000 each, for a total of $5 billion. Rich ten year warrants for 700 million shares at $7.14 were thrown in as a freebee. There was a one-time boost to the closing equity price.

I''m still struggling to see how this makes the case for the common equity. There is definitely a case for investing higher up the food chain, particularly in Bank of America's bonds. Looking at the June 30th, report for Dodge & Cox Income Fund (DODIX), they have long pursued the strategy of overweighting corporates relative to their BCAG index. As an owner of the fund, I liked this strategy and it has really driven their out performance relative their intermediate bond fund peers.

For the most recent period, the weighting of Corporates went to 44.5% of assets versus 19.8% of the BCAG benchmark. Bank of America's bonds are now the largest corporate issuer in the portfolio, at 2.6% of fund assets. Ally Financial weighs in at 2.4%, and Citigroup at 2.1% of assets. Both Bank of America and Citigroup are stocks that may look like values to the risk-loving investor.

Web commentators have suggested that deposits continue to stream into Bank of America, and bulls suggest that there is money to be made in the stock. It's extremely difficult to project what normalized earnings will be in 2-3 years. Without a reliable estimate, how can one project a reasonable target price?

Since the near-term discussion will be dominated by asset sales, additions to reserves, delinquencies, charge-offs and regulatory hurdles, it's impossible to make a fundamental, valuation driven case for the equity. The bonds clearly have been strong performers, and are senior in the capital structure. It seems as if Mr. Buffett's choice to be higher up the capital structure, i.e. above common equity, but with an equity kicker is another, lower risk way to play Bank of America.