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Why Did Warren Buffett Change Berkshire's Bank of America Investment?

http://www.fool.com/investing/general/2014/02/26/why-did-warren-buffett-change-berkshires-bank-of-a.aspx

Alex Dumortier, CFA
February 26, 2014

U.S. stocks are little changed on Wednesday morning, with the benchmark S&P 500 and the narrower Dow Jones Industrial Average (DJINDICES: ^DJI) up 0.11% and 0.15%, respectively, at 10:15 a.m. EST. As the earnings season draws to an end, it's interesting to note that, according to Barclays Capital, "relative performance following misses was lower than prior quarters and [earnings] beats were rewarded less." I think that the Financial Times is right to suggest that "it's a sign that, as the S&P 500 again sits at a new summit, there remains some wariness over how sustainable it might be without a rebound in US growth and the faster earnings and revenue growth it should bring." And speaking of companies "making their numbers," Berkshire Hathaway (NYSE: BRK-B) (NYSE: BRK-A) has agreed to modify the terms of its Bank of America (NYSE: BAC) preferred shares so that they are counted as "tier one capital," thereby improving the bank's capital ratios.

It's worth looking at the gist of the modifications -- when Warren Buffett last year modified the terms of Berkshire Hathaway's Goldman Sachs warrants, the nature and implications of the changes were widely misunderstood in the financial media.

Here's the background: In August 2011, Berkshire Hathaway invested $5 billion in Bank of America in the form of preferred shares paying a 6% dividend. The investment conformed to a formula that has been tried and tested by Berkshire, whereby Buffett effectively loans out his good name and credibility to a troubled institution. In this case, Bank of America was struggling to rid itself of concerns regarding the size of its exposure to mortgage losses. Berkshire Hathaway made similar investments at the height of the credit crisis to shore up confidence at Goldman Sachs and General Electric.

Unfortunately for Bank of America, it found that, although the investment