Goldman Sachs (NYSE: GS) was on the ropes two years ago and looking for a savior. While their stock price was plummeting the firm sought to restore confidence and stability by gaining an investment from a big name. The biggest name in fact, Warren Buffett.
In light of the long term relationship, and solid value investment, Buffet made the deal and loaned the firm $5 Billion from his Berkshire Hathaway in the form of preferred stock. Buffett made some great deals for his firm during the crisis with many strong investments, this one in particular carried an annual dividend of 10%, or $500 million. When Goldman was facing SEC fraud accusations a few months ago, Buffett made a point of defending the firm, as has long been seen as a strong advocate.
A lot has changed in two years. Credit conditions have improved, and confidence in Goldman’s ability to stay in business has returned. So, the 10% dividend is a high price for Goldman to continue to pay for money that it could borrow today through more conventional channels. In order for Goldman to pay back its loan, it would actually need permission from the Federal Reserve, but it is not clear if Goldman has made a formal request for a go-ahead from the Fed. The firm is now flush with cash, and look at repaying it’s costly debts. People familiar with the matter add that executives are “looking closely at whether to use a small chunk of the firm’s $173 billion in excess liquidity to unwind the investment.”
The details of the 2008 detail does have a call provision, giving Goldman the option of paying back the loan for $5.5 billion, depriving Berkshire of any future annual dividend payments. Buffett recently joked that he tries not to answer the phone if he thinks Goldman is on the other end of the line, though we know the esteemed Mr. Buffett doesn’t joke about money. He made a smart investment with a great yield for his investors and in the process helped rescue a legendary institution. Berkshire holds a large amount of warrants and could pocket roughly $2 billion in paper profits, by paying only $5 billion for stock currently worth just under $7 billion at the market price. Buffett has indicated that he doesn’t plan to exercise those warrants until just before they expire in 2013, and could well hold onto them even if Goldman buys back the preferred shares it sold to Berkshire.
