Bank Of America: Second Guessing My Purchase

| About: Bank of (BAC)

You know you have a bad reputation when your earnings raises eyebrows due to perceived (let’s just say) “questionable” accounting practices. This perception is even more troubling if you are a bank; particularly one that has had some unfortunate realities of being linked to one of the worst recessions our country has ever seen. If that is not enough, add the fact that its acquisition of then mortgage lender Countrywide 3 years ago has resulted in record foreclosures and loan defaults Americans has ever seen.

The irony here is that I am talking about Bank of America (BAC); irony by name only as it has now become one of the most hated names and brands in America – I didn’t think surpassing Goldman Sachs (GS) and British Petroleum (BP) in that infamous category was possible, but remarkably here we are.

I am a big student of the Warren Buffett ways of thinking and investing. I look for value whenever possible and I seek to be greedy when others are fearful and I tend to be fearful when others are greedy. So to learn that Mr. Buffett had made a sizable investment in Bank of America certainly caused me to give more than a casual glance at the struggling bank. What did Buffett see that was not obvious to the market other than a depressed share price?

Seeking Alpha contributor Farah Lalani described the news this way:

Buffett’s announcement restored investor confidence in Bank of America and put a rest to the takeover rumors. After Buffett’s announcement, shares of Bank of America soared during Thursday’s trading day and closed up 9.44% at 7.65.

According to the deal's terms, Berkshire will get 50,000 preferred shares that carry a dividend of 6% a year and are redeemable at a 5% premium. The deal also warrants the purchase of 700 million BAC shares at $7.14 each over the next 10 years. If the warrants were fully exercised, Berkshire would own about 6.5% of the bank, which would make it the bank's biggest shareholder. The aggregate purchase price of the preferred stock and warrants totals $5 billion in cash, which is obviously a sweet deal for Buffett.

I don’t think there have been many poor investments by Mr. Buffett. Obviously his stake in Bank of America affords him many advantages that neither you or I would have by purchasing just the common shares, but it is a large investment nonetheless with ample risk. Perhaps what he saw was a stock with many favorable reasons to buy and I have to agree, which was precisely the reason I took a “decent” position myself. But I would not be honest if I didn’t admit that a part of me is now second guessing that decision.

Upon the release of its Q3 earnings results BofA reported net income of $6.2B or $0.56 diluted EPS; figures that beat analyst estimates by a significant margin. I also realized that even the most ardent bears had buy ratings on the stock even though (admittedly) it sported less than stellar returns on equity; it was hard not to consider that a turnaround was underway, especially with now institutional support of Berkshire Hathaway (BRK.A).

Then it made a mess

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently.”

The quote above also comes from Mr. Buffett, so applying it here on the heels of his new stake in BofA which has now become a public disaster makes sense. When one talks about being a hated brand, typically it is always the result of poor decision making and/or lack of consideration of those from whom you need support – in business these are called customers.

On Tuesday, Bank of America decided to abort its plans to charge customer $5 per month for using their debit cards for transactions. According to an Wall Street Journal article, its decision to scrap the $5 usage charge came only after U.S. Senator, Richard Durbin called on Oct. 3 for customers to "vote with your feet." The fee also made the bank the butt of jokes, with Jay Leno of NBC's "Tonight Show" likening Bank of America on Monday to a greedy trick-or-treater.


I plan to hold onto my stake for at least 12 months, but in the process, my second-guessing will continue as I see the likes of Wells Fargo (WFC), Citigroup (C) and JP Morgan (JPM) likely surpassing BofA in operating revenue and interest margin.

As an investor, I’m glad that it has decided against the $5 debit card fee, but I can’t help but question the decision making capability of the bank, particularly as it is trying to regain the trust of its customers and restore its brand to its once prominent standing. I have taken a chance with my stake in BofA but I’m questioning my due diligence and realizing (just maybe) mirroring Mr. Buffett should not have qualified as such.

Disclosure: I am long BAC.