Buffett loses $1.6bn on derivatives

Buffett loses $1.6bn on derivatives

By Francesco Guerrera and Justin Baer in New York

Published: May 2 2008 23:13 | Last updated: May 2 2008 23:53

Warren Buffett’s Berkshire Hathaway was hit by a $1.6bn first-quarter non-cash loss on derivatives contracts – an asset class he once described as “financial weapons of mass destruction.

The surprise investment loss, announced on the eve of Berkshire’s annual meeting in Mr Buffett’s native Omaha, caused a 64 per cent plunge in first quarter profits to $940m, from $2.6bn in the same period last year.

In a statement, Mr Buffett blamed the fall in profits on accounting rules that force companies to mark down unrealised gains or losses on derivatives.

Quoting an excerpt from Berkshire’s annual report, Mr Buffett said he and his long-term associate Charlie Munger were not “bothered by these swings even though they could easily amount to $1bn or more in a quarter and we hope you won’t be either”.

The investment losses at Berkshire, an insurance-to-sweets conglomerate, were concentrated in two areas. The company recorded a $1.2bn unrealised loss on put contracts on the S&P 500 index and three other indexes.

Under these contracts, Berkshire will have to pay investors between 2019 and 2028 if indexes are below a pre-determined level. The recent decline in world stock markets forced it to take an accounting loss on the contracts.

Berkshire also took a $490m hit on credit default swaps that protect investors against the default of high-yield bonds. The derivatives losses were mitigated by other gains, leaving Berkshire with an investment loss of $991m in the quarter.

The results are likely to be discussed by the 27,000 investors expected to attend this weekend’s at the Omaha meeting. However, much of the questioning will focus on how Mr Buffett plans to spend Berkshire’s $40bn cash pile.

On tour

Warren Buffett is turning his attention to Europe, a continent he has hitherto avoided, writes Richard Milne in Frankfurt. He will start a four-country tour on May 19 in Frankfurt before going on to Lausanne, Madrid and Milan. His goal is to examine the hidden secret of European capitalism: the family-owned companies that dominate the economies of regions such as northern Italy and Germany. People involved in his trip say he will meet some of the biggest such companies in each country, all of which are market leaders in their field.The impetus for the tour comes from his recent acquisition of Iscar, an Israeli manufacturing company that was his first major purchase abroad. Flush with cash, Mr Buffett could find many companies in Europe that meet his criteria of being understandable businesses in long-term industries. He will also take part in several events focusing on family businesses with the IMD business school. Family-owned companies across Europe are renowned for their long-term outlook and often have a much stronger export focus than their US rivals. But many have succession problems – and that is where Mr Buffett and his cash may well come in handy.

At last year’s meeting Mr Buffett struggled to hide his frustration about how a pliant debt market had helped to lift asset prices. The thousands of devoted shareholders making the pilgrimage to Omaha for this year’s “Woodstock for Capitalists” will probably hear Mr Buffett reflect on a much more volatile – and for him, opportunistic – 12 months.

After several quiet years, Mr Buffett has in recent months capitalised on the markets’ turbulence to buy companies, invest in undervalued shares and launch his own bond insurer.

This week he agreed to help Mars finance its $23bn takeover of rival Wrigley, the company whose chewing gum Mr Buffett peddled door to door as a schoolboy.

Along the way, Mr Buffett overtook Bill Gates, his friend and bridge partner, as the world’s richest person, with an estimated fortune of $62bn, according to Forbes magazine. Shares in Berkshire Hathaway increased by more than 20 per cent in the year ending February 11, Forbes’ cut-off date for its 2008 Rich List.

However, the past year has dealt Mr Buffett’s some setbacks into the bargain.

Joseph Brandon, once considered a leading candidate to replace Mr Buffett at the helm of Berkshire Hathaway, stepped down last month as head of its reinsurance division, General Re.

Mr Buffett had praised Mr Brandon’s stewardship of General Re since his appointment as chief executive in 2001. The departure followed the convictions of four former colleagues for fraud. Mr Brandon has not been charged. He was identified as a non-indicted alleged co-conspirator in the trial.

Berkshire came under scrutiny this week when shareholders learnt that it was being examined as part of Connecticut’s broad investigation into conflicts of interest in the credit rating industry.

Richard Blumenthal, Connecticut attorney-general, said Berkshire’s ownership of 19.5 per cent of Moody’s, which last week gave a top-notch rating to Berkshire’s newly formed bond insurance business, “certainly creates an appearance of a conflict of interest”. But he said the examination of the relationship was only “a slice” of the investigation.