Investors who invested in warrants of Bank of America (BAC, Financial) were rewarded recently: The price has soared 20.5% from low to high in less than a month, to trade for $4.58 on Friday. News that Citigroup (C, Financial) would lay off 11,000 employees, or roughly 4% of its workforce, pushed that bank’s stock up 6 percent, and affected other banks as well. Bank of America, up 91% year to date, rose about 8% since the layoff news was announced on Wednesday.
The layoffs signal to investors that Citigroup’s new CEO, Michael Corbat, who replaced Vikram Pandit in October, is willing to trim expenses and increase efficiency, which could mean higher profits. Citi’s revenue has declined for the last three quarters, and net income has yet to meet pre-crisis levels. Meanwhile, its stock has been essentially flat for the past two years.
Other banks’ stock rose in tandem on belief that those banks may be willing to make similar cost-cutting moves. Fox Business Network’s Charlie Gasparino reported that other banks are in fact planning year-end layoffs.
There are two types of Bank of America Warrants. The first, Class A Warrants, were issued in January 2009 as part of the U.S. Treasury bailout, expire on Jan. 19, 2019, and give holders the right to buy shares at a $13.30 strike price. The Class B Warrants expire on Oct. 29, 2018, and have a strike price of $30.79.
Several gurus have been holding Bank of America warrants as a safer way to invest in the banks. Bruce Berkowitz, founder of the Fairholme Fund (FAIRX, Financial), owns 9,886,128 BAC warrants, after increasing the holding 1.05% in the third quarter. The recovery of the financial sector overall has helped Berkowitz’s fund, composed 80.8% of financials, to rebound 30% year to date.
Another Guru holder is Francis Chou. He has 4,341,462 Bank of America warrants, a 4.4% weighting in his portfolio. Chou discussed his investment in warrants in his 2010 semiannual letter, calling it “one of the more interesting ways to invest in the better capitalized banks.” He bought stock warrants when they were issued to the U.S. Treasury by banks that received TARP funds. When the banks paid back the TARP funds, the Treasury then either sold the stock warrants back to the banks or publicly auctioned them.
Chou explained five reasons the stock warrants were unique:
1) They are long dated, with most expiring in 2018 or 2019. This time frame of eight- plus years
allows banks to grow their intrinsic value to a high enough level to have an appreciable impact on the strike price of the stock warrant.
2) The strike price is adjusted downward for any quarterly dividend that exceeds a set price.
Normally, you don't see that in a stock warrant. This is a truly stringent condition. In this case we should give the government credit for extracting a pound of flesh. An example: for Bank of America, class 'A' warrants, the strike price is adjusted downward for any quarterly dividend paid
exceeding one cent a share.
3) Many of the banks have excess capital on their balance sheet. When the economy settles down,
we expect the banks to use this excess capital either for buybacks or a one-time special dividend
that may reduce the strike price on the stock warrants if this provision applies.
4) The concerns over financial reform and its ultimate impact on the earning power of the banks
may be somewhat exaggerated. We believe the banks will most likely be able to pass the majority
of the costs to customers. For an economy to flourish we need sound financial institutions that
can generate reasonable profits.
5) Investing in financial institutions requires a leap of faith. Mind you, this leap of faith is no
greater than those we make on any company's future prospects, its position in the industry and
how well it will do in a future economy. Looking forward, as each year goes by, the quality of
earnings of the banks should be higher, the books should be cleaner, the risks will be lower and
management will be far more risk averse. Too bad we had to go through so much turmoil to get there.”
Chou also holds warrants of several other financial institutions, including Wells Fargo (WFC, Financial) and JPMorgan (JPM, Financial).
Similarly, Warren Buffett owns warrants to purchase 700 million shares of Bank of America at an exercise price of $7.14 per share, that he may exercise at any time in the next 10 years. Unlike Chou, Buffett did not purchase his through government auction, but received them when he bought $5 billion of Bank of America’s 6% Cumulative Perpetual Preferred Stock through Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) on Aug. 25, 2011. With a stock price of $10.64 on Friday, Buffett could exercise the warrants today, or wait to see if the price goes higher in the next nine years.
See more of these investors’ holdings in their portfolios. Bruce Berkowitz’s is here, Francis Chou’s is here and Warren Buffett’s is here.
The layoffs signal to investors that Citigroup’s new CEO, Michael Corbat, who replaced Vikram Pandit in October, is willing to trim expenses and increase efficiency, which could mean higher profits. Citi’s revenue has declined for the last three quarters, and net income has yet to meet pre-crisis levels. Meanwhile, its stock has been essentially flat for the past two years.
Other banks’ stock rose in tandem on belief that those banks may be willing to make similar cost-cutting moves. Fox Business Network’s Charlie Gasparino reported that other banks are in fact planning year-end layoffs.
There are two types of Bank of America Warrants. The first, Class A Warrants, were issued in January 2009 as part of the U.S. Treasury bailout, expire on Jan. 19, 2019, and give holders the right to buy shares at a $13.30 strike price. The Class B Warrants expire on Oct. 29, 2018, and have a strike price of $30.79.
Several gurus have been holding Bank of America warrants as a safer way to invest in the banks. Bruce Berkowitz, founder of the Fairholme Fund (FAIRX, Financial), owns 9,886,128 BAC warrants, after increasing the holding 1.05% in the third quarter. The recovery of the financial sector overall has helped Berkowitz’s fund, composed 80.8% of financials, to rebound 30% year to date.
Another Guru holder is Francis Chou. He has 4,341,462 Bank of America warrants, a 4.4% weighting in his portfolio. Chou discussed his investment in warrants in his 2010 semiannual letter, calling it “one of the more interesting ways to invest in the better capitalized banks.” He bought stock warrants when they were issued to the U.S. Treasury by banks that received TARP funds. When the banks paid back the TARP funds, the Treasury then either sold the stock warrants back to the banks or publicly auctioned them.
Chou explained five reasons the stock warrants were unique:
1) They are long dated, with most expiring in 2018 or 2019. This time frame of eight- plus years
allows banks to grow their intrinsic value to a high enough level to have an appreciable impact on the strike price of the stock warrant.
2) The strike price is adjusted downward for any quarterly dividend that exceeds a set price.
Normally, you don't see that in a stock warrant. This is a truly stringent condition. In this case we should give the government credit for extracting a pound of flesh. An example: for Bank of America, class 'A' warrants, the strike price is adjusted downward for any quarterly dividend paid
exceeding one cent a share.
3) Many of the banks have excess capital on their balance sheet. When the economy settles down,
we expect the banks to use this excess capital either for buybacks or a one-time special dividend
that may reduce the strike price on the stock warrants if this provision applies.
4) The concerns over financial reform and its ultimate impact on the earning power of the banks
may be somewhat exaggerated. We believe the banks will most likely be able to pass the majority
of the costs to customers. For an economy to flourish we need sound financial institutions that
can generate reasonable profits.
5) Investing in financial institutions requires a leap of faith. Mind you, this leap of faith is no
greater than those we make on any company's future prospects, its position in the industry and
how well it will do in a future economy. Looking forward, as each year goes by, the quality of
earnings of the banks should be higher, the books should be cleaner, the risks will be lower and
management will be far more risk averse. Too bad we had to go through so much turmoil to get there.”
Chou also holds warrants of several other financial institutions, including Wells Fargo (WFC, Financial) and JPMorgan (JPM, Financial).
Similarly, Warren Buffett owns warrants to purchase 700 million shares of Bank of America at an exercise price of $7.14 per share, that he may exercise at any time in the next 10 years. Unlike Chou, Buffett did not purchase his through government auction, but received them when he bought $5 billion of Bank of America’s 6% Cumulative Perpetual Preferred Stock through Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) on Aug. 25, 2011. With a stock price of $10.64 on Friday, Buffett could exercise the warrants today, or wait to see if the price goes higher in the next nine years.
See more of these investors’ holdings in their portfolios. Bruce Berkowitz’s is here, Francis Chou’s is here and Warren Buffett’s is here.
