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Ian Campbell

Ian Campbell

Through his www.BusinessTransitionSimplified.com website and his Business Transition & Valuation Review newsletter Ian R. Campbell shares his perspectives on business transition, business valuation and world…

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On Bernanke and Buffet

Bernanke From Jackson Hole!

This morning at 10:00 a.m. ET, Federal Reserve Chairman made his 'much anticipated speech' from Jackson Hole, Wyoming. You can read his speech ('The Near- and Longer-Term Prospects for the U.S. Economy' - reading time 10 minutes) and think about what he said. In my view, if you participate in the financial markets that will be 10 minutes very well spent. Reading and thinking about today's speech is a far better thing to do in these 'rude economic and financial market times' than reading my comments, or comments of other writers and 'experts' - not all of which may be written by persons who are unbiased and write from non-vested interest positions - that summarize and draw conclusions and inferences from it.

That said, having read Mr. Bernanke's speech carefully, my comments are:

  • Six printed pages in length, most of what he says to me is simply a litany of factual statements on the current state of the U.S. economy and how it got to where it is today;

  • Mr. Bernanke again said that the Federal Reserve currently thinks U.S. prospective economic conditions are likely to warrant 'exceptionally low federal funds rates through at least mid-2013. Again, as I read his words, he doesn't guarantee such low federal funds rates through that period - although many of the articles and commentaries I (and presumably you) have read would have one believe Mr. Bernanke did give such guarantees earlier this month. Those writers may well see his comments today as a reinforcement of this. I wrote about this same thing in my August 10 e-mail under the heading 'Federal Reserve Promise' - reading time 1 minute;

  • Mr. Bernanke made only three comments toward the end of his speech that I think are worth discussing - see following.

Let me begin by saying that I am sure Mr. Bernanke has a high intellect, that I am certain he has a knowledgeable and experienced grasp of Washington and its politics, and that he is far from as naïve as the following three 'motherhood' statements he made in his speech would- but for my qualifiers as to his intellect and 'Washington smarts' - imply for me. He made these three 'Bernanke statements' after saying "most of the economic policies that support robust economic growth in the long run are outside the province of the central bank". Those three statements are:

  • "without significant policy changes, the finances of the federal government will inevitably spiral out of control, risking severe economic and financial damage";

  • "fiscal policymakers can also promote stronger economic performance through the design of tax policies and spending programs"; and,

  • "perhaps most challenging, the country would be well served by a better process for making fiscal decisions. The negotiations that took place over the summer disrupted financial markets and probably the economy as well, and similar events in the future could, over time, seriously jeopardize the willingness of investors around the world to hold U.S. financial assets or to make direct investments in job-creating U.S. businesses".

In his speech he stated his belief that (my words): 'America is America' and in the end everything will recover nicely and life in America will go on and progress as it always has to the ongoing benefit of the American people.

I strongly suggest you read Mr. Bernanke's speech for yourself, and reach you own conclusions.

At 11:15 a.m. ET today the price of physical gold had recovered to U.S.$1,780, and the Dow and S&P 500 were down 23 and 5 points respectively. I say 'go figure', it seems to me that so far even the trading algorithms haven't figured it out - but they are programmed to read markets, not speeches (smile).

Warren Buffett - Standing In A Good Place!

Yesterday it was announced that Warren Buffet's Berkshire Hathaway Inc. bought a U.S.$5 billion 'Preferred Share and Warrant Package' from Bank of America's treasury. The terms of those Preferred Shares are set out in 'Buffett's BoA stakes net $1.4B on first day' - reading time 3 minutes. Those terms are reported as Berkshire having purchased:

  • 50,000 perpetual preferred shares with a liquidation value of U.S.$100,000 each that pay a 6% dividend, and that are redeemable by Bank of America at any time at a 5% premium; and,
  • a 10 year warrant to buy 700 million Bank of America common shares at U.S.7.14 per share, in circumstances where Bank of America common shares closed yesterday at U.S.$6.99, up U.S.$0.66 (10%) following the news of the Berkshire transaction.

My comments on this are as follows:

  • Warren Buffett didn't get to be Warren Buffett by being stupid, and for sure he has a lot of smart people working with him at Berkshire. I suspect there are other, more detailed terms, that protect the face (or capital) value of the Preferred Shares Berkshire acquired yesterday. Hence I disregard as irrelevant both in the 'profit on the transaction' alluded to in the article's title, and in the split in the 'value' of the amount Berkshire paid between those Preferred Shares and the accompanying warrants the article suggests;

  • I suspect the only risk Berkshire has incurred by purchasing those Preferred shares would arise if Bank of America was forced into liquidation, where the liquidation proceeds available to equity holders was less than U.S.$5 billion. In other words, I suspect that Berkshire stands ahead of all other Bank of America equity holders in the event it is liquidated. Given the U.S. Federal Government's predilection to date to stand behind major U.S. Financial Institutions, it seems to me Berkshire can reasonably assume that it has an undeclared U.S. Federal Government covenant backing the liquidation value of its Preferred Shares. Just imagine the consequences of a Financial Institution named 'Bank of America' going into Chapter 11 or defaulting. It seems to me the name of the institution alone protects Berkshire;

  • likewise, it seems to me there is little likelihood Berkshire will not collect on Bank of America's 6% dividend promise. Moreover, there may be retraction provisions in the 'fine print' (i.e. provisions enabling Berkshire to demand that Bank of America redeem Berkshire's Preferred Shares) if the dividend obligations are not met;

  • the 5% premium on redemption may result in a near term $250 million 'windfall' to Berkshire (as did a similar premium on a similar Preferred Share deal Berkshire did with Goldman two years ago) if Bank of America does further refinancings. Again, the 'fine print' may provide for a Berkshire retraction of its Preferred Shares in the event of further new financing; and,

  • while not unprecedented in Berkshire's dealings (reference both the Goldman deal and a similar deal done with GE - both in 2008) the warrant term is longer than normal. I don't know of a precedent for a 10 year warrant exercise period. As I understand it, both the 2008 Goldman and the GE deals carried 5 year warrant terms; and,

  • from 20,000 feet, to me that Berkshire was able to negotiate a 10 year warrant term speaks volumes about Bank of America's negotiating position, which I think had to be very weak.

Also from 20,000 feet I wonder this morning whether the fact that Berkshire was able to complete this transaction on terms that have been announced and the terms I am guessing at speaks to a possible view by Mr. Buffett and Berkshire on the current state of the U.S. economy and U.S. banking industry generally. To insist on a 10 year warrant term over a 5 year warrant term may be an indicator that Mr. Buffett and Berkshire now see a longer term time horizon for meaningful U.S. economic recovery to take hold than they did in 2008, when Berkshire was prepared to accept warrants with a 5 year term in the Goldman deal.

I say 'good for Warren Buffett and Berkshire' in entering into a transaction that I suspect is virtually risk-free to Berkshire shareholders. As an aside, to the best of my knowledge 'Warren' did not invent the concept of 'warrants' as a 'financial kicker' in financing deals (smile).


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