Buffett's $5 Billion Lifeline Could Become B of A's Capital Noose

Warren Buffett's $5 billion investment in Bank of America Corp. looks likely to shore up investor confidence in the struggling bank in the short-term. In coming years, however, the deal looks likely to do wonders for the bottom line of Buffett's Berkshire Hathaway at the expense of Bank of America's long-term prospects.

The largest U.S. bank is still struggling with the high but still unknown cost of resolving the mortgage liabilities it assumed with its acquisition of Countrywide Financial and the need to boost its capital ratios prior to implementation of higher Basel III standards.

Under the term of B of A's deal with Buffett, it will pay Berkshire $300 million a year in preferred dividends and grant it $5 billion in warrants. Such terms do nothing to address the possibility that Bank of America will need to raise capital long-term. In fact, the deal looks likely to make it slightly more difficult or costly for B of A to raise that capital.

Buffett's infusion also marks the latest in a series of increasingly desperate moves at Bank of America to reassure investors and regulators about its capital adequacy and mortgage issues. Earlier this month, embattled CEO Brian Moynihan submitted to public questioning from more than 6,000 people during a 90-minute conference call.

Now Moynihan has agreed to pay the Oracle of Omaha a 6% annual dividend on the preferred shares, for what Reuters blogger Felix Salmon calls "the magical Buffett fairy dust." Sure enough, Bank of America shares were up more than 12% by midday Thursday.

Buffett's deal for $5 billion worth of preferred shares and warrants is similar to the deal he got at Goldman Sachs in 2008, which helped shore up confidence in the banking system during the height of the financial crisis.

B of A's move did nothing to address the concerns that have driven its stock to well under half of its book value, argues UBS analyst William Tanona in a note to clients issued earlier today. The value of the Buffett announcement, therefore, is predicated on the assumption that investors will grow more comfortable with the bank's position over time.

"[We] believe concerns around B of A had hit a point where they were driven more by emotion than logic, and this should temper those emotions, at least for now," Tanona wrote.

It remains to be seen whether the Buffett fairy dust will have lasting powers over Bank of America and a raft of problems that extend far beyond its stock price. In the end, Buffett's magic may help only Buffett.