New York: Goldman Sachs Group will buy back $5 billion (Dh18.36 billion) of preferred stock from Warren Buffett, ending a costly deal that helped shore up confidence in the bank at the height of the financial crisis.

The buyback has been expected for some time, given the relatively unfavourable terms for the investment bank, which paid Buffett's Berkshire Hathaway Inc $500 million a year in dividends.

The firm is paying a 10 per cent premium to buy back the shares. It will take a $1.6 billion hit to first-quarter earnings, including the premium. Repurchase terms were agreed in September 2008, when the deal was struck.

The transaction is expected to reduce reported earnings per share for the first quarter by about $2.80, plus another 4 cents for accelerated dividends. Certain financial details were outlined earlier in the firm's 10-K report.

"Berkshire Hathaway's 2008 investment in Goldman Sachs was a major vote of confidence in our firm and we are very appreciative of it," Goldman said in a statement.

Decision vindicated

The trade signalled Buffett's belief that Goldman would survive the financial crisis and the firm had to pay handsomely for Buffett's seal of approval.

Credit Suisse analyst Howard Chen says the repurchase stands to lift Goldman's earnings on an ongoing basis by 4 per cent per year and boost return on equity by 80 basis points.

"It was a great nod of confidence for the franchise during a more challenging time, but it is an expensive form of regulatory capital," says Chen.

Buffett lamented the likely redemption of the shares in his annual letter to shareholders last month.

"Goldman Sachs has the right to call our preferred on 30 days notice, but has been held back by the Federal Reserve [bless it!], which unfortunately will likely give Goldman the green light before long," he wrote in the letter.

Berkshire will continue to hold a warrant to purchase nearly 43.5 million shares of Goldman stock, which it bought at the same time as the preferred shares.

Fed approval

Goldman said it received approval for the buyback from the Federal Reserve, which also cleared Goldman's plans to potentially buy back stock and raise its common stock dividend this year. The Federal Reserve also approved dividend actions at other major banks that passed the latest round of stress tests, loosening the reins on the banking industry 2-1/2 years after the government bailed out the financial system.

Chen says a dividend rise is "not totally off the table," but he views it as a low priority for Goldman, which has historically favored stock repurchases over dividend raises.

The Buffett transaction also grants Berkshire warrants to purchase 43.5 million common shares at $115 per share through 2013.

Goldman shares rose 2.7 per cent to close at $159.96 on the New York Stock Exchange. Berkshire's class A shares advanced 0.5 per cent to $124,700, and its class B shares rose 0.9 per cent to $83.48.

The preferred shares carried an annual dividend of 10 per cent, meaning that buying back the securities will save the investment bank about $500 million a year.

Buffett also invested $3 billion in General Electric preferred stock with similar terms in 2008. GE Chief Executive Jeffrey Immelt has said he would like to retire the stock as soon as possible, perhaps some time this year.

Retiring the Buffett stock now will also allow top Goldman executives to sell more stock more quickly, if they choose to.