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The Bank of Buffett

With the annual Omaha pilgrimage underway, Berkshire Hathaway fires a $10 billion shot across the bow.

As the faithful gather in Omaha this weekend for Berkshire Hathaway Inc.’s annual shareholder rumpus, two key questions will be top of mind. 

How much See’s peanut brittle will CEO Warren Buffett, 88, pack away? And what’s behind Tuesday’s announcement that Berkshire will bankroll Occidental Petroleum’s bid for Anadarko Petroleum with a $10 billion preferred stock and warrant investment?

The answer to the first is anyone’s guess. As to the second, look to the mountain of cash — nearly $112 billion at last count — on Berkshire’s balance sheet. Buffett is engaged in almost Sisyphean efforts to put that money to work profitably.

The financing lets Occidental top a rival offer from Chevron. It’s is evidence that Buffett expects to garner better returns as a lender given today’s frothy equity markets than as a stock picker. It also follows an extended dry patch for the master allocator.

“The Bank of Berkshire remains open,” wrote Greggory Warren, sector strategist for Morningstar, the Chicago financial publisher, in a research note. “We are encouraged to see Berkshire finally putting capital to work.”

The financing deal is certainly a humdinger — and proof of Buffett’s ability to leverage Berkshire’s reputation for advantageous terms. The preferred stock, redeemable after 10 years, will yield 8 percent at a time when comparable Treasury bonds throw off 2.54 percent. The warrant, exercisable until one year after the preferred is redeemed, is for the purchase of 80 million Occidental shares at $62.50 each. They closed Thursday at $57.35.

“You can’t get that kind of yield in a preferred security with an 11-year warrant,” said Mark Curnin, co-founder of White River Capital, a hedge fund specializing in financial stocks. “That warrant is likely to be worth well in excess of $1 billion.”

“The deal offers an extraordinary risk-adjusted return, particularly given prevailing interest rates,” Curnin added.

The big question is whether Berkshire can make a go of it as a full-throttle lender, as opposed to a common stock investor. “Why not pretend to be a bank?” asked Meyer Shields, an analyst at Keefe, Bruyette & Woods. “I think it’s a great way to look at it.”

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Berkshire did not respond to an email seeking comment. Occidental did not return a phone call.

Berkshire has danced this number before. In September 2008, amid the carnage of the financial crisis, the firm bought $5 billion in preferred stock yielding 10 percent from Goldman Sachs Group, together with warrants to purchase $5 billion of common stock. Little more than a week later, it struck a similar deal with General Electric for $3 billion of preferred and warrants. And in 2011, Berkshire paid $5 billion for Bank of America preferred stock yielding 6 percent plus warrants. Today, the Omaha powerhouse is Bank of America’s largest shareholder. 

Buffett made billions from these transactions. “It proved absolutely successful during the financial crisis,” said Shields.

Berkshire’s positions in banks and other lenders recently dominated its roster of top public holdings. In addition to Bank of America and Goldman, as of December 31 these included American Express, Bank of New York Mellon, JPMorgan Chase, U.S. Bancorp., and Wells Fargo.

Lenders’ post-financial crisis stock performance has badly lagged that of the overall market. They represent compelling value in an era of rising technology stock prices and private equity exuberance. White River Capital’s Curnin said that despite stubbornly low rates, it’s likely Buffett views lending as a pretty good business, especially given banks’ bolstered capital bases and formidable returns on equity.

Still, if Buffett seeks to ramp up such deals, he will need to attract a greater volume and variety of borrowers than those after the imprimatur of a sterling creditor like Berkshire. “The farther you go out into conventional lending, the less value that imprimatur brings,” said Thomas Russo of investment firm Gardner Russo & Gardner. 

Of course, waiting for the next financial crisis for Berkshire to shine isn’t much of a strategy.

Buffett’s high profile deal with Occidental “says to people around the world that Berkshire has incredible resources,” according to Curnin. “He’s done that repeatedly.”

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