After the financial crisis of 2008, many investors are returning to bank stocks as the companies show strong signs of life again. Investors confident in the recovery and growth of America's most powerful financial institutions may be interested in a long-term leveraged investment in these banks: warrants.
Make TARP work for you
The Troubled Asset Relief Program (TARP) stepped in during the dark days of the financial crisis to provide assistance to the troubled banking system. Among the things, the government got as parts of the bailout were 10-year warrants on shares of some of the nation's largest banks.
However, as the government moved to liquidate its holding in the financial sector, it sold these warrants into the private market, where they trade today.
Buffett's favorite bank
Warren Buffett's Berkshire Hathaway recently increased its holdings of Wells Fargo to almost $20 billion. With a strong presence in the rebounding mortgage business and an acquisition of Wachovia that dramatically increased Wells Fargo's footprint, Wells Fargo has a lot of things going for it.
Investors bullish on the bank's prospects can gain leverage of approximately 3 to 1 by purchasing Wells Fargo warrants . These long-term warrants expire on Oct. 28, 2018 and have an exercise price $34.01 that has since been adjusted into the $33 range because of the bank's dividend payments.
With shares of Wells Fargo trading around $41, the warrants are well in the money and offer a way to leverage Wells Fargo stock for over five years without taking on excessive risk of being wiped out if shares fail to rise.
Another Buffett bank buy
While Berkshire has accumulated a giant stake in Wells Fargo, Buffett also got a good deal on Bank of America . Berkshire bought $5 billion of B of A preferred stock yielding 6% and got 10-year warrants to buy 700 million B of A shares. While the average investor is not able to extract the same deal as Buffett, there are long-term warrants available on B of A originating from the TARP program.
B of A actually has two classes of warrants. The Class A warrants expire Jan. 16, 2019 and have a strike price of $13.30, and the Class B warrants expire Oct. 28, 2018 and have a strike price of $30.79. With shares of B of A around $14, the Class A warrants are in the money and can provide a little over two times leverage. But the Class B warrants are a riskier play for investors very bullish on Bank of America. By purchasing these far out of the money warrants, Class B warrant investors can get around 18 times leverage on B of A shares.
Like the Wells Fargo warrants, these Bank of America warrants have their strike prices reduced for dividend payments of a certain size. The Class A warrants begin to adjust down for dividends in excess of $0.01 per quarter but the Class B warrants require a quarterly dividend of $0.32. With the B of A dividend currently only $0.01 per quarter, there have been no strike price adjustments yet. However, if B of A raises its dividend before 2019, as is quite likely given the bank's plans of returning capital to shareholders, then the Class A warrants will begin to adjust downward. And if the dividend really takes off, the Class B warrants may see a benefit as well.
After a major financial crisis, investors have a way to benefit from the banks' recoveries by investing in the long term warrants originally given to the government as part of the bailout. These warrants offer investors long term leverage of 2 to 18 times depending on their risk level. For investors bullish on Bank of America and Wells Fargo, taking a look at these warrants may be a worthwhile investment.
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The article 2 of Buffett's Favorite Banks Offer You Long-Term Leverage originally appeared on Fool.com.
Alexander MacLennan has no position in any stocks mentioned. The Motley Fool recommends Bank of America, Berkshire Hathaway, and Wells Fargo. The Motley Fool owns shares of Bank of America, Berkshire Hathaway, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.