twacowfca

The spikey price action today of the common suggests lots of shorting and short covering. We took some profits on some of the more liquid preferreds and continue to hold most of the others. :)

+1. Tweeted same sentiments yesterday. It is a great time to trade up the capital structure or engage in outright capital structure arbitrage. Incidentally, the same common/preferred disparity existed in 2009-2010, but it was even more glaring - the common traded not just at a higher market cap, but if memory serves me correctly, a higher nominal price as well. So save some dry powder for the trade, once fast money gets into something they can blow prices from merely irrational to insane. I was offered a borrow of 5.5%. But I'm afraid of a squeeze, and I don't have enough experience doing risk management for short-selling in situations like these in order to enter the trade with confidence. (Tips?) Unfortunately, there are no options. You're right. The arbitrage is virtually a sure thing in the long run, but the long run could be very long indeed. One reason the common is so pricey relative to the preferred is an extreme liquidity premium. Another reason is a little short squeeze. The squeeze may not extreme because the cost to borrow is "only" 5%. The pricing differential was indeed extreme in 2009 2010 because the preferred was completely off the radar. It took us quite a few weeks to accumulate a meaningful position in the preferred that was mostly owned by small banks that had been allowed by their regulator to own it because it was the only high yield security deemed to be "safe". We were the first to point out the differential between the common and the preferred, on this board. Then the idea got picked up on VIC , SA and other sites. Since then the differential has been smaller.

The problem is that screens that identify extreme values pick up a lot of turkeys or frauds that may not be evident at first glance. MF as a screen worked to some degree until the slew of Chinese frauds destroyed the results. What will work using the screen is waiting for the fat pitch: a company you know has honest management and a good business with problems that are over discounted. In other words : sound investing. :)

I feel Congress's hands are tied. Fannie and freddie are the mortgage market as we speak. Private business is negligible. If you say no more fannie or freddie, private mortgage lenders would demand a much higher rate and will kill housing market. I see very little risk of Congress killing Fannie or freddie for the near term (1-3yrs). But given that all profits are to be paid as dividends to govt held preferreds., essentially the public preferred+common gets nothing. it needs to be treated as a call option on a future action by congress to retain profits. That's right. There is always the possibility that the preferred and common could be wiped out because governmental decisions may be arbitrary. That's why the public preferred is selling for pennies on the dollar. This is not something one should put a big chunk of life savings into, Interestingly, for those who like arbitrage, the recent run up in prices has taken the market value of the F&F common way ahead of the market cap of the F&F preferreds. Yet the stated value of the preferreds is a lot more than the common should be worth in all but a pipe dream. What is the cost to borrow the F&F common?

We generally buy the best bargains measured by discount to stated value. These are not always the most traded. We will buy the most liquid if they are not too pricey. It's more of a trading opportunity with a call on possible future value because a reorganization that wipes out the public preferred seems unlikely. That's not the way we look at these. The margin of safety lies in the assumption that the UST won't wipe out their own investment in their F&F preferreds by a bankruptcy or similar reorganization. Therefore, it would be unfair to wipe out the rest of the capital structure and unnecessary because the UST's preferred is senior to the rest of the equity claims. Eventually, F&F should be able to earn their way out of the hole in the sense of returning more to the UST than the UST put into them. ( this is more or less the way our government spins accounting to prove they haven 't lost money on organizations they bailed out.) If that 's the case, then something good may happen to the holders of the public preferred. And possibly something less for the common.

We generally buy the best bargains measured by discount to stated value. These are not always the most traded. We will buy the most liquid if they are not too pricey. It's more of a trading opportunity with a call on possible future value because a reorganization that wipes out the public preferred seems unlikely. Congress guaranteed the survival of the GSEs at the end of 2011 when they raised guarantee fees for ten years to pay for a six-month extension of the paroll tax cut. Today, the GSEs are gushing cash as the housing market recovers and no doubt the politicians will find a way to tap this honey pot to repay taxpayers and fill DC coffers. When word that the White House was considering the sale of the Gov't preferred to the private market, Senators reacted by proposing a bi-partisan bill that would require congressional approval prior to any sale. Everyone wants a piece of this action. The often overlooked asset on the books of the GSEs is the DTAs which have up to now been written down to zero. But that too may change soon as FNMA is looking to reclaim their DTA to the tune of $62mm which would be 70% of the net amount owed to the US Govt. I expect FMCC to follow soon with a similar request. http://online.wsj.com/article/SB10001424127887323639604578368443773821834.html There is political risk here, but with the private preferreds trading at 9-12 cents on the dollar it is a very convex risk/return profile. That's an excellent summary, Wayne. Also today, Freddy has sued 15 big banks over LIBOR manipulation, asking triple damages be awarded under the Sherman Antitrust Act. Actual damages are estimated to be about $3B. :)

We generally buy the best bargains measured by discount to stated value. These are not always the most traded. We will buy the most liquid if they are not too pricey. It's more of a trading opportunity with a call on possible future value because a reorganization that wipes out the public preferred seems unlikely.

We got back in to the preferreds a few weeks ago because it became evident that F&F would post awesome earnings, despite the fact that there is no resolution to the ultimate standing of the holders of the public preferred.

This is a great topic and I remember when I read this story originally. Perhaps it is obvious to others, but do other posters see why / how this is relevant to business and investing? I have my opinion. I haven't previously seen the transitive dice discussion subsequently connected to why this might be interesting to the history's greatest investor. I think it is fascinating and learned something about how to think about investing when I first read the story. It is particularly interesting w/r/t investing in the case of Buffett but, in my opinion, it is also interesting in the case of Gates and Microsoft. Anyone with comments? It has to do with information asymmetry and the possibility of scienter. Simply, avoiding playing when the deck might be stacked against you or at least waiting until the informational advantage no longer resides with others. In other words, waiting at bat for the three two count with the bases loaded in a game when you know the pitcher will then be forced to throw the perfect pitch. If the pitch isn't perfect you can still win because the rules are skewed in your favor: no called strikes. Interestingly, the probabilities in the Monte Hall game or the earlier The Lady or the Tiger game are very different if the person in charge of opening the door has optionality and evil intent.

giofranchi “As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes You are in good company, Giovanni. Those lines by Lord Tennyson were among Ben Graham's favorites. :)

BNSF pays out a bunch to Berkshire proper as well which reduces equity at the subs. One of the points that I am making here is that these businesses earned 9.78% on beginning of the year equity. That seems very low. But it also makes me think about how high the ROE the other businesses had. Now let's try to estimate the returns on capital/equity going forward. Let's deduct the 20,056 in goodwill to come up with a tangible equity number: 51,725. The return on tangible equity is 13.57%. That's helpful information. Is it possible to infer Mid American's return on tangible equity separate from BNSF?

Does it? Isn't the story always the same in the insurance industry: "we just HAD to write more business!" There's better underwriting discipline in the P&C industry now with low interest rates than a few years ago. If underwriting discipline slips in the market, it's very likely that they will not renew these deals.

Thanks. That's good information. I overlooked the fact that they were paying a commission to Marsh on their quota share of their marine book and other business. The economics as you described it makes sense as NICO keeps its expense ratio down while foregoing the opportunistic mode of jumping in and out of specific markets as they exploit big changes in rates. One downside is that some of these quota shares are uncapped, thus increasing BRK's risk from "black swans". However, most of the policies written today have caps on coverage. Thus the risk from taking a quota share of another insurer's uncapped policy is small. Plus, these quota shares that BRK is taking are set up as collateralized side cars. Thus, BRK's maximal risk on the Aon deal would be $2.5B. That's not likely to happen without a true black swan. This should on average hugely expand their opportunities to continue to generate low or no cost float for many years and perhaps decades into the future. :)

A few years ago, Ajit stated that BRK had forgone billions of dollars of profitable business placed through brokers because they were unwilling to pay commissions. Now, Aon, one of the largest brokers has announced that Berkshire Hathaway will take a 7.5% quota share of all the business that Aon places that includes participation by Lloyd's of London. Berkshire will pay a commission on that business to the broker(s). This is a big big change that, when extended to other brokers, could go a long way to keep float increasing in the future. :)

I agree. Our business is a microcosm of the US service and light manufacturing industries. We knew how bad things were becoming in August, 2008 before others spotted the drastic change in perceptions. True deflation was massive in late '08 and '09, considering things that are muted when they show up indirectly in the CPI. The cost of housing went down dramatically for buyers not renters with price declines and low interest rates. Our part of the US did not experience a bubble in housing prices, but housing prices crashed so much that anyone with halfway decent credit could buy an almost new house for much less than replacement cost even with construction costs down by 30%. I know two people whose income was formerly too low to qualify for a loan who bought nice houses with principal and interest payments that were half what they would have been four years earlier. Those bargains are no longer available. We all know what happened to security prices ex UST's and commodity prices in 2008 and 2009. Our labor costs have flatlined with small increases in unit costs cancelled by attrition in the workforce. Raw material and transportation costs have been flat for the last couple of years , but no longer declining. Health insurance costs are on the rise and there are hints of future increases in other things. We will have our first substantial increase in employment costs in quite some time this spring. People are no longer cutting expenditures or saving drastically. I don't expect a downturn until there is a substantial increase in interest rates. Near that time, the stock market would be expected to lead the economy down. Is my prediction better than many others? Probably so because I am merely extending the observed trend, the only thing that works . . . . Until It Stops Working! :)

Yes, thank you, packer for your insightful comments.

They appear to be over hedged unless things have changed because their hedge was a total return swap. That is the equivalent of shorting the market at the time they put on the hedge of 100% of their equity portfolio. Without adjustment, their losses on the hedge go up exponentially as the market rises. Their portfolio has lagged the market. Therefore, they appear to be over hedged. This would explain the magnitude of the recent loss on their hedge. This is not necessarily a bad thing if the market tanks as Prem has hinted that he expects it to do probably before the middle of the year.

BRK, obviously with the free put. However, with BRK trading about 11% above the "strike price", I wouldn't lever up a lot unless that gap narrowed.

Jeez...you guys are harsh. I think the author recognizes this. It is a hypothetical...framed with "If you had to". FCBN Please tell us about First Citizens Bancorporation.

From a publisher: +1 :)

It was a pleasant surprise to see BRK's good underwriting results EOY, especially after the hit from Sandy, plus BRK's float growing, despite WEB 's caution at last year's AGM. Ajit Jain reportedly placed up to $2B in quota share or similar premiums for cat coverage in the Far East last year. 2012 was a low loss year for Aus/NZ and Asian cats, and a lot of those premiums evidently fell to the bottom line. Ajit is reportedly on the prowl now in Japan apparently to preempt the big April renewals of the big Japanese insurers, to the consternation of other international reinsurers.

It would be interesting to hear your ideas about the two or three companies that look good in Greece. Would you care to share them?

Have you seen the presentation Broyhill Asset Management published about Coca-Cola Hellenic? I thought it was interesting. :) giofranchi “As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes No. That looks interesting. Do you have a link? Thanks.

What are sound companies in Greece that will be relatively unaffected by recession in Greece or Greece's possible exit from the Euro?

BRK's float under the conditions Warren listed is better than free money if it grows over the years as it should. The growth of invested free money is reduced by income taxes or deferred tax liability. The growth of float doesn't have this drag. Imagine that you had a perpetual source of funds that is a liability that increased in principal amount by 10% each year. You also are able to invest those funds in stocks that increase in value by about the same amount each year. Then, you'll never have to pay taxes on those capital gains because the increasing liability for the increasing float matches the increasing value of your portfolio. Therefore your portfolio will grow at a much higher rate than if you had to pay taxes on its growth in value. The growth in that value over decades will be many times more than the value of the free money if you earned 10% per annum on it and had to pay taxes on the capital gains. :)