StubbleJumper

Really? FFH's stock price is flat today. Maybe you should add a salad or fries to your sandwich......

That the SEC is not doing its job is no news to FFH shareholders. Heavens, they issued a subpoena to FFH over 3.5 years ago and still have not issued a verdict about FFH's behaviour. On another issue, FFH has had to spend a pile of money on suing the shortsellers because that was the only remedy available given that the SEC didn't do its job....maybe they'll recoup some of that money through a settlement or maybe not. The SEC is an embarrassment. SJ

Wow! I wonder why Prem thinks this is a good idea? I wonder whether he is just stubbornly refusing to admit defeat? $180m is another $10/share. Surely there must be better opportunities out there for a large block of money like that?

That strikes me as a little counterintuitive. Looking at their Net Written:Statutory Surplus ratio, I'd say they could increase their premiums by about 50% (ie, roughly $1b) without adding any new capital. Very interesting move. Looking forward to see whether Prem has an ace up his sleeve!

Not sure that I'd characterize the SwissRe CDS as a "bet." That particular CDS is one of a select group that directly hedges reinsurance recoverable exposure. If Prem wins his bet on that CDS, FFH may lose a bit on the reinsurance recoverable. On the other hand, it would be nice if capital exited the reinsurance industry! SJ

It's not a question of borrowing new money at 8% and lending it out at 10% for a 2% margin. All the excess capital at the FFH holding level reflects retained earnings, not some 8% debt that they issued in 2005. Obviously if FFH were in a position to retire some of its bonds, that would be an excellent choice, and it would support their broader de-leveraging initiative. However, beyond making some marginal debt repurchases through the market, there is really a significant constraint in that AFAIK, there is no call feature on their debt. If you cannot retire your own debt, what are the other alternatives? Common re-purchases can be a good idea at the right price (and currently we have the right price!), but who knows whether the share price will be reasonable in October 2010? Investing excess capital can be a good idea if you can get a good return on your investment (and WFC-L currently looks to be a good return!). Or, if you have some preferred shares somewhere in your corporate structure, you could consider looking for a mechanism to retire them and save the annual dividend -- fortunately, the preferreds actually have a call feature which enables a bulk re-purchase. Right now, the $100m in ORH-A costs ORH about $8.125m per year in dividends. FFH's effective share of this cost is about $5.7m, since they are majority owner...and don't forget, this is after-tax money, so on a pre-tax basis it's more like $11m for ORH of which FFH's share would be perhaps $7.8m. FFH could lend ORH $100m for free to fund a preferred repurchase, and FFH would effectively get a pre-tax return of about 7.8%....risk-free.....the return would actually be marginally better if they actually charged ORH a bit of interest on the $100m! You are right that I offered a series of false choices about some of the potential alternate investments that could be made instead of using holdco money to fund preferred repurchases. The point of that was simply to show some of the places where large blocks of money have been invested over the past year, and describe some of the terms that FFH was able to negotiate. Compared to some of the risky investments made over the past year (ie, JNJ, H&R, Abitibi, USG), debt or preferred repurchases should be a no-brainer. Going forward, Prem's phone may be ringing a fair bit over the coming year, and there may be better opportunities in which to sink $100m (but it won't be WFC-L because, in total, there is only about $100m of WFC-L). But compared to last year's opportunities, the risk-free preferred repurchase looks pretty good... Anyway, thinking back to five years ago, this debate about what to do with surplus capital is a rather discussion. Back then, we were worried about holding company liquidity and whether FFH could find cash anywhere! SJ

Well, if it were your money, would you invest it in Megablox at 8%, Abitibi Bowater at 8%, H&R at 11.5% or ORH at somewhere between 8-10%? I know where I'd put my money! For FFH, assuming that there is any need for capital in the sub in 2010 (and seeing the current ORH common price, I'm guessing that ORH is blasting piles of cash out the door on repurchases), a loan to ORH might be a reasonable way to use excess capital at the holding co level. But overall, I would agree that FFH should be considering holdco debt repurchases too, to the extent this is possible. That's the nice thing about the ORH preferreds is that they have the option to call them in 2010. So many good choices available! SJ

WRT the preferred buybacks, I'm not too sure that open market purchases will be that relevant in Q1 or Q2 2009 as the ORH common shares have been trading at $35-38. At those prices, I expect that we will see ORH actively gobbing up as many common shares as they can -- just as they've done over the past 18 months or so. This really reflects the "FFH creeping takeover" hypothesis that we've kicked around. However, at some point common sense will return to the market and the common shares will at least rise to somewhere near book value (this finally occurred in about Q4 last year) and maybe there'll be some leftover cash for the preferreds. In any case by the time 2010 rolls around and the preferreds can be called at $25, it will be a compelling proposition. At that time there will be a number of options available to ORH: 1) Do nothing, continue to pay 8.125% after tax for Series A, or about 11-12 percent before tax. 2) Use ORH's excess cash/regulatory capital to call the series, thus improving annual cash available to common holders. 3) Borrow money on the open market at 8, 9, or 10% before tax to repay the preferreds. 4) Borrow money from FFH at 8, 9, or 10% before tax to repurchase the preferreds. Any of #2-4 would be beneficial to ORH common shareholders. Obviously, #4 would be beneficial to both ORH and FFH shareholders! SJ

WRT the ORH preferreds, I would expect that both the A and B series will be bought back in about 2 years, implying that inflation may not even be a consideration. The A series is relatively expensive capital, as 8.125% after tax would be 11 or 12 percent before tax. Prem and his team are investing geniuses, but it strikes me as a no-brainer to buy back your own preferreds and debt at 11 or 12 percent before dishing out money to Abitibi, Megablox, or even H&R at similar rates of return. The B series is not quite so clear as it is currently cheaper for ORH than the A series, but when LIBOR stabilizes at around 4% or so, there may be a compelling case to re-purchase it too. Even 7% after tax is relatively expensive on a before tax basis. SJ

WEB should take a page out of Prem's book, and simply ask Fitch to stop rating Berkshire. There is no substitute for integrity, and it sometimes appears to be lacking at Fitch. Maybe next we'll see an article from some two-bit analyst proclaiming that BRK is truly $80b under-reserved? History doesn't repeat, but it does rhyme! SJ

Holy smokes! Those guys sure don't mess around when they take a position! By my reckoning, an investment of $100m in WFC preferreds should yield out about $17-20m/year in dividends, or roughly $1/share for each FFH shareholder. OEC, good call on the WFC preferred recommendation !!!

This is an interesting perspective, and gives insight into why you might be a bit uncomfortable with the puts. I would offer a few comments: 1) BRK is not and has never been an index replacement. If people are thinking about it that way, it is a serious mistake. I personally take concentrated positions in my portfolio, but I am completely comfortable with the idea that I could be wiped out (but ouch, that would be bad!). Even with my tendency to take concentrated positions, it would be a really rare circumstance where I would ever consider "going all in" with 100% in a single security (I would never even go with 100% in a single currency). If people go 100% into BRK and get wiped out that is THEIR FAULT, not WEB's fault for taking the put option position. 2) In recent weeks, on this board we have been kicking around the "total wipe out risk" for BRK that has arisen from taking this position. You have correctly pointed out that if the S&P500 is at 100 or 200 in 2023, BRK will have a big liability....which might contribute to financial distress for the company. However, let's probe this idea a little more. What would the US economy look like if the S&P500 were to fall from 1400 in 2007 down to 100 or 200 in 2023? Under what circumstances would this occur? The depression to end all depressions? If returns to capital including inflation were that low for such a long period of time, what would be the associated impact on the GDP per capita and unemployment? I would propose that under these economic circumstances most companies, including BRK would be toast, puts or no puts. On the other hand, we have kicked around more modest declines in the S&P500, and found them to be manageable, particularly in the context of the potential compounding of the original option premium. 3) If you could not have thought of an event that would sink the ship prior to WEB taking the put position, I would respectfully suggest that you have not been thinking creatively enough! WEB himself noted that a dirty bomb could have wiped out BRK before they excluded terror from their insurance contracts (ie, pre-2001). Going forward, on an extremely improbable basis, I could see wipe-out potential from a) a ridiculous increase in litigation for some product that would make asbestos pale in comparison (ex, high fructose corn syrup is discovered to cause XYZ disease), b) a ridiculous biblical series of uncorrelated mega-cats (ie, a super west coast earthquake, 3 or 4 large east coast cities taking a direct hit from a hurricane, plus some other big cats all in the same year), c) political instability in the US (ie, the "Wing-nut Party" wins an election and legislates that all treasury bonds are written down by 50%), d) we experience the mother of all pandemics and nearly knocks us back into the stone age, e) fraud or mismanagement in BRK (Warren's successor comes from AIG or Enron). Overall, I think you are excessively concerned about the risks associated with these puts. As Scott Sagan said, "...things that have never happened before happen all the time." Fortunately, the really extreme stuff is very, very rare. SJ

Sure, you can get all the observable characteristics of the MBS. What about the characteristics that are unobservable to the typical buyer? Delinquency rates and foreclosures tell you about problems that have occurred in the past, which is good information....but when you plunk a cusip into a Bloomberg machine, does it tell you how many of the mortgages were liar loans, ninja loans, inflated property appraisals, etc? There was a big pile of crap mortgages issued over the past few years and you might be able to discern some of the losers from the winners though credit scores or the other observable characteristics....but isn't it a little like trying to pick fly-shit out of pepper? Or attempting to sort raisins and turds? Akerlof would argue that asset prices are bid down in those circumstances...we'll know in a few years!

I wonder whether the MBS market is really a variant of Akerlof's "Market for Lemons." There is no way for a buyer to reasonably assess the quality of the underlying mortgages, so a prudent buyer must assume that the MBS is comprised of the worst crap out there. Bids are probably pushed down in consequence. However, we know that the MBS are not all comprised of the worst crap out there. There will likely be some that come out quite nicely. It is entirely possible that this lack of transparency will result in undervaluation of MBS (we won't likely know for a few more years). Perhaps that's where Prem's coming from? SJ

Agreed Viking. BRK is in the business of selling risk reduction. The most amusing example of BRK shorting a lottery ticket was when BRK insured a contest by Pepsi Cola a few years back where some lucky Pepsi drinker could have won $1b. This was exactly a process of shorting a lottery ticket! However, the advantage in that particular circumstance is that the probabilities of winning (losing?) the contest were readily calculable, so defining an appropriate price should have been easy. The current situation with the put options is not quite the same simple process of evaluating the precise probability of loss and the precise magnitude of loss. For this reason, people seem to have gotten their knickers in a knot! However, as we have discussed at length on this forum, in a historical sense the probability of these things finishing in the money is low...from a logical economic sense, the probability of these things finishing in the money is low, the magnitude of any cash settlement is likely to be low, and the original proceeds are likely to have grown significantly. All the noise that we hear is from people who are uncomfortable with the uncertainty....did WEB charge enough? Frankly, I'm comfortable with this investment, but I must confess that I enjoyed the Pepsi contest more.... SJ

Don't forget the $1.5B is the amount they have before they pay for NB. Good point. I guess they can "only" re-purchase a couple million shares before going below Prem's $500m threshold for holding company cash. ;) :P SJ

I've perused the AR. A very complete document, as always. I really feel better about the company when I look at the accident year loss triangles and see the performance of the past 5 or 6 years at C&F! I am completely baffled about why this company was trading at US$220 over the past week. The $1.5B in holding company cash is a wonderful wild card. It is entirely conceivable that a portion of this could be used to repurchase a couple million shares at current prices, with no meaningful effect on holdco strength. A gift from Mr. Market? SJ

I've heard #1, 2, 4, 5 and 6. The President is sort of doing something like #7 by promising to increase taxes for the rich. So does that mean we're most of the way to capitulation? ??? ???

Why was it a bad decision to remove the hedges? If you think the market was fairly valued during Q4, why would you have left the hedges in place? Now, if you believe that the market was still overvalued last fall, then retaining the hedges would have made perfect sense. From my perspective, I am very comfortable with valuations in recent months when the S&P500 is 700-800. I am very enthused about the idea of the S&P hitting 500 during 2009, but I'm not sure that'll actually happen. IMO, we should evaluate the decision based on its underlying thought process rather than by its short-term outcome. SJ

This is amazing! FFH is trading below US$220 this morning. If we believe that the $8 dividend is now the norm, the dividend yield is a shade higher than 3.6%. FFH now qualifies as a "dividend stock!!" Who would have imagined!? I had not imagined that we would once again get a chance to buy at such an attractive discount to book value. SJ

Traction? From the SEC? Seems unlikely. That's the same organization that issued a subpoena to FFH in like 2003 and still has not made any declaration of their guilt or innocence.... The SEC is an embarrassment. SJ

Quick question for you, how does the suspension of a dividend change intrinsic value? Jack, I would suggest that suspending the dividend doesn't really change the intrinsic value of an enterprise unless 1) it permits highly profitable incremental investments that could not otherwise be made due to capital constraints, or 2) the suspension avoids the need to issue additional shares at a price below intrinsic value per share. However, that doesn't meant that the market price won't tank following a dividend suspension. Norwegian widows seem to have a strange love for their dividends and may take strange actions when they are chopped! A third possibility has been brought up, which is that chopping the dividend may result in a plummeting share price...which in turn may result in a loss of confidence in the bank which may have an impact on its operations and thus intrinsic value. However, I'm not quite sure that I buy that argument. You and I (and everyone on this board!) pay attention to stock prices, but does "John Q. Account-holder" pay any attention at all to the price of his bank's shares? This certainly has not been my experience -- I have friends and family who are decidedly unsophisticated consumers of financial products and barely understand the extent to which they are being hosed by their bank....and they certainly don't watch its stock price! Do the ratings agencies care if the dividend is chopped? I would say they would usually view it as a necessary move and a positive step! SJ

Jack, Your response is not inappropriate, but if I've read it correctly, it is a little sarcastic. This is an area where we collectively need to be a little bit careful as Sanj has created this area for us to have thoughtful, courteous discussions about markets and investing. Sarcasm can be a very effective communication technique, but it can also be perceived as belittling. That being said, there are many arguments for and against a purchase of WFC. It doesn't strike me that the fact that BAC or JPM cut their dividends would have any impact on WFC's intrinsic value. Perhaps it could be argued that WFC may follow suit, which could cause the share price to temporarily tumble...but a more fulsome explanation from kawikaho would clarify why he doesn't want to touch WFC...and then we could thrash out that discussion based on its merits. SJ

Wow! FFH closed at US$257 today! By my reckoning, the market is valuing it at about 85% of book, once you take into account the concealed value of ICICI Lombard. After the past couple of years, this is truly astounding. What does Prem have to do to get some respect? ??? ??? ??? ??? ??? SJ

The price of WFC-L has been ridiculous! I bought yet more this morning at $325. This is unbelievable. There are only about 4 basic outcomes that can be reasonably anticipated from Wells Fargo over the next 5 years: 1) WFC is as strong as they suggested in their Q4 report 2) WFC runs into some trouble, and maybe cuts the common dividend, but maintains the preferred dividend 3) WFC's loan losses get silly and they chop the preferred dividend for a couple of years out of the next 5. 4) The bottom drops out of our financial system and Wells goes under. For somebody with a long-term (ie 10 years) holding horizon, the cards are stacked drastically in favour of ridiculous returns from the L-series: In case #1, if they earn big bucks as they have suggested, we could see WFC-L approaching par in 5 years. Based on today's prices, this would be a dividend of 20% plus a capital gain of 200% over five years!!!! That's like an annual return of about 40%!!!!! In case #2, if they maintain the dividend, I can't imagine the price of WFC-L going any lower than it is today....but it might not go higher. So you get a dividend of 20% per year and 0% capital gain. An annual return of 20%????? Heavens! In case #3 if the dividend gets chopped for 2 years out of 5, assuming that they fix their operations and WFC-L won't drop much more, but it probably wouldn't go up either. In that case, you're looking at an average dividend of about 10% over the five years! Case #4 is the unlikely armageddon scenario, where you get whacked with a permanent loss of capital. But even then, you'll probably get at least a year of dividends before disaster strikes. So, that might be -80% over 5 years, or about -18% per year. So, weight out the scenarios: Probability Return Case 1: 50% 40% Case 2: 30% 20% Case 3: 15% 10% Case 4: 5% -18% Composite average: 26.6% per year for the next five years! I'm pretty comfortable withe the four states of nature. IF you don't like my subjective probabilities put in your own....but unless you figure there's a high probability of WFC going under, it's a drastic no-brainer at $325 per share!!!! SJ