2014: Why did Berkshire change its Bank of America cumulative preferred shares to noncumulative preferred?
AUDIENCE MEMBER: My name is Ben Ottenhoff and I’m from Washington, D.C.
I was wondering if you could talk — I’ve read recently that the Bank of America investment, you changed it so they can now treat it as tier one capital.
WARREN BUFFETT: Right.
AUDIENCE MEMBER: Can you explain a little bit why you did that and what benefit, if any, there is to Berkshire’s shareholders?
And also, does it give you any pause that they can’t calculate their tier one capital requirements properly?
WARREN BUFFETT: The — it came about some — really, a good many months ago, that Brian Moynihan called me and asked me whether we would be willing to change our preferred stock, five billion of it, from a cumulative preferred, to a noncumulative preferred.
Now, a non-cumulative preferred has certain defects, obviously, compared to a cumulative preferred. As, for example, the shareholder — the preferred shareholders — of Freddie Mac and Fannie Mae are finding out.
Noncumulative preferreds — Ben Graham wrote about them in the 1934 edition of “Security Analysis” — they’re a terribly weak form of security.
But, partly because they are that weak form of security, they count different in capital with banks.
So Brian asked me to do that and then he said, “If you will do that” — and this requires approval by their shareholders and everything — but he said, “If you’ll do that, we would be willing to make your preferred noncallable for five years.”
Now, in a world of five-basis money — five-basis-point money — you know, practically nothing — no returns — I was very willing to make that trade-off.
It was — they felt it was good for them and I felt it was good for Berkshire.
So, I get five years at Berkshire of non-call of a 6 percent preferred, which I can always use as payment for the warrants we have.
So, I don’t have a problem of being locked into it forever, into a noncumulative committed preferred, and the BofA gets the benefit of using it in their calculation of capital.
That was all done before this recent — I mean, a long time ago — before the recent, you know, week ago or so when they had the miscalculation involving some structured notes of Merrill Lynch.
That error they made does not bother me. I mean, it — you know, we work on our figures, you know, we’ve got that 20,000 page-plus tax return. We have 10-Ks, 10-Qs, going in and out. You do the best you can.
But I — that error did not affect their GAAP reported numbers or anything of the sort. And they wished they hadn’t made it. And they’ll pay a penalty, in the sense of their capital plan, because they did make it.
But it doesn’t change my feeling about the Bank of America or its management one iota.
And I do think that this — they were going to pay the dividend anyway. You know, I mean, the probabilities that going to non-cumulative hurts us are very, very low. And the probability that making it noncallable for five years is a real plus to us.
So, it was an exchange I was happy to make. And I think that it was good for us and good for them.
Charlie?
CHARLIE MUNGER: Well, I agree with you.
WARREN BUFFETT: OK. (Laughter)