Bloomberg News

Berkshire Profit Falls 9 Percent on Buffett’s Derivatives

August 03, 2012

Berkshire Hathaway Earnings

Warren Buffett, chairman of Berkshire Hathaway Inc., left, speaks to David Rubenstein, co-founder and managing director of the Carlyle Group, during the Economic Club of Washington dinner event in Washington. Photographer: Andrew Harrer/Bloomberg

Warren Buffett’s Berkshire Hathaway Inc. said profit slipped 9 percent in the second quarter as derivative bets declined in value.

Net income slid to $3.11 billion, or $1,882 a share, from $3.42 billion, or $2,072, a year earlier, the Omaha, Nebraska- based company said today in a statement. Operating earnings, which exclude some investment results, were $2,252 a share, beating the $1,777 average estimate (2FA:US) of 3 analysts surveyed by Bloomberg.

Buffett, 81, uses derivatives to speculate on long-term gains in stocks and the creditworthiness of corporate and municipal borrowers. The contracts that are tied to equity indexes in the U.S., Europe and Japan aren’t scheduled to mature until 2018 or later. Berkshire’s liabilities rise when the benchmarks fall, as they did in the second quarter.

“It was a long-term bet on those markets,” Doug Pawlowski, an analyst at Fitch Ratings, said in an interview before results were announced. “Given the accounting treatment, he’s essentially stopped making that particular bet.”

Buffett wrote in a February letter to shareholders that new rules around collateral have made the wagers less attractive. The derivatives book will probably shrink under the company’s next leaders, he said at the annual meeting in May.

Equity Puts

The loss from equity index puts widened to $1.17 billion in the three months ended June 30 from $271 million a year earlier. The gain from credit-default contracts, in which Buffett bets on the ability of borrowers to repay debt, was $171 million, compared with a gain of $142 million a year earlier.

Book value, a measure of assets minus liabilities, rose in the quarter to $177.4 billion from $176 billion at the end of March. The cash hoard climbed to $40.7 billion from $37.8 billion three months earlier.

Berkshire’s Class A (A:US) shares rose 1.7 percent to $128,479 at 4:15 p.m. in New York today. They have advanced 12 percent this year, compared with the 11 percent gain for the Standard & Poor’s 500 Index. Results were released after the close of regular trading.

Buffett’s biggest takeover, railroad Burlington Northern Santa Fe, was completed in 2010 in a $26.5 billion transaction. The business contributed $802 million to earnings, compared with $690 million a year earlier. Utility unit MidAmerican Energy Holdings Co. added $253 million to Berkshire’s profit compared with $215 million in last year’s second quarter.

Insurance Underwriting

The insurance division posted an underwriting profit of $619 million, compared with a loss of $7 million a year earlier. Buffett has used so-called float, or the insurance premiums Berkshire holds before paying claims, to amass the largest equity stakes in companies including Coca-Cola Co. and International Business Machines Corp.

Buffett, who oversees Berkshire’s more than 70 operating units selling products from insurance to underwear, has said his roles will be divided once he’s no longer running the firm. He has suggested that his son Howard, a company director since 1993, could be non-executive chairman. In February, the billionaire wrote to shareholders that the board has picked the next chief executive officer and has two back-up candidates. None of the individuals has been identified.

Investments will be overseen by Ted Weschler and Todd Combs, former hedge-fund managers hired in the past two years. They will oversee about $4 billion each, compared with $2.75 billion at the beginning of 2012, Buffett told Betty Liu in a July 13 interview on Bloomberg Television. Combs and Weschler have expanded equity holdings, taking stakes in companies including General Motors Co. (GM:US) and MasterCard Inc.

Wells Fargo

Buffett has been positioning his firm for a rebound in housing by adding to holdings (2FA:US) of Wells Fargo & Co., the largest U.S. home lender, purchasing residential real-estate brokers and bidding on the mortgage assets of bankrupt Residential Capital LLC. He said last month that housing is starting to rebound, while the rest of the U.S. economy is slowing.

“For the last two years, I’ve seen everything except housing moving forward in the economy,” Buffett said last month. “In the last few months, the rest of the economy actually has flattened out. Housing is picking up.”

To contact the reporter on this story: Noah Buhayar in New York at nbuhayar@bloomberg.net.

To contact the editor responsible for this story: Dan Kraut at dkraut2@bloomberg.net


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