Buffett’s Berkshire Swings to Profit on Derivative Holdings

Buffett’s Berkshire Swings to Profit on Derivative Holdings


Aug. 8 (Bloomberg) -- Billionaire investor Warren Buffett’s bet on derivatives tied to world equity markets helped Berkshire Hathaway Inc. return to profitability in the second quarter.

Net income rose 14 percent to $3.3 billion, or $2,123 a share, from $2.88 billion, or $1,859, in the same period a year earlier, the Omaha, Nebraska-based company said yesterday in a regulatory filing. The results halted six straight quarters of declining profit at Berkshire that included a first-quarter loss of $1.53 billion.

Berkshire benefited as stock markets on three continents rebounded, while preferred shares and debt in Goldman Sachs Group Inc. and General Electric Co. increased investment income. Buffett, the firm’s chairman and chief executive officer, has said Berkshire’s energy business is thriving amid the recession, while jewelry, home-building and airplane units suffered.

“It’s shocking how much the derivatives really make a difference,” said Michael Yoshikami, chief investment strategist at Walnut Creek, California-based YCMNet Advisors, which owns Berkshire shares. “If you take those out of the overall result, it doesn’t change the fact that some of the economically sensitive names are still hurting.”

Derivatives added $2.36 billion to earnings, compared with $689 million a year earlier. The firm valued the stock portfolio at its insurance units at $45.8 billion, a 22 percent increase from March 31.

Goldman Sachs

Buffett scaled back on the purchase of common stocks in the past year in favor of preferred shares in Goldman Sachs and GE, municipal bonds, and debt in firms including luxury jeweler Tiffany & Co. and motorcycle maker Harley-Davidson Inc. The shift boosted investment income 9 percent to $1.87 billion at its insurance and finance operations.

Berkshire’s own shares passed $100,000 for the first time since January this week, recovering from a six-year low in March. The stock gained $1,150, or 1.1 percent, to $108,100 in New York Stock Exchange composite trading yesterday before results were released.

Berkshire is the largest shareholder in American Express Co., whose stock rose 71 percent in the quarter, Wells Fargo & Co., which increased 70 percent, and Burlington Northern Santa Fe Corp., which advanced 22 percent.

Climbing stock prices helped increase book value to $118.8 billion, an 11 percent increase since March 31. Buffett typically highlights book value, the measure of assets minus liabilities, in the first sentence of his annual letter to shareholders. The figure includes $4.3 billion for non- controlling interests.

David Sokol

Buffett, 78, has been shuffling managers at businesses pressured by the recession, this week appointing David Sokol, chairman of Berkshire’s MidAmerican Energy Holdings Co., to run NetJets Inc. on a temporary basis after the head of the plane- rental unit stepped down. The assignment stoked speculation that Sokol may one day succeed Buffett as CEO.

The NetJets unit, which leases planes to corporate customers and individuals, posted a $253 million pretax loss, including asset writedowns and “other downsizing costs of $192 million” in the quarter.

“NetJets owns more planes than is required for its present level of operations and further downsizing will be required unless demand rebounds,” the filing said.

The stock-market rally helped derivative bets called equity-index puts that had weighed on results over the prior year. Buffett sold some of the derivatives when the Standard & Poor’s 500 Index and other markets were approaching peaks in 2006 and 2007, with the promise to pay buyers in 2019 or later if the indexes are lower than when the contracts were arranged.

New Terms

Berkshire said it renegotiated terms on six of the contracts, shortening their duration by 3.5 to 9.5 years, and reduced the strike price -- the level at which Berkshire would pay out -- by 29 percent to 39 percent. No funds changed hands between Berkshire and counterparties as a result, the firm said.

Buffett repeated an earlier statement to shareholders about the effect of the derivatives on quarterly results. The bets, Berkshire said in a statement yesterday, “will produce extreme volatility in our periodic reported earnings.” Ultimately, Buffett told shareholders in May, he expects Berkshire to make money on the bets.

Berkshire also sold credit-default swaps on individual companies, and contracts that require the firm to pay when credit losses occur at borrowers included in high-yield-bond indexes. The company paid about $825 million in the second quarter and $350 million in July, bringing the total for the year to $1.85 billion. Berkshire collected $3.4 billion in premiums on the contracts through the end of 2008.

Job Cuts

Profit from selling policies at car insurer Geico fell 63 percent to $111 million before taxes on an increase in claims. The unit added about 166,000 policyholders in the quarter, as growth slowed from the first quarter when the company gained 430,000 customers.

Revenue was also pressured at smaller Berkshire businesses that sell jewelry and furniture, and make products used in home building. Berkshire last year cut jobs at units including Clayton Homes Inc., which builds manufactured housing, and brickmaker Acme Building Brands.

Each of the manufacturing subsidiaries has “taken actions to reduce costs, slow production and reduce or delay capital spending until the economy improves,” Berkshire said yesterday.

bloomberg