Berkshire Hathaway profits up as Buffett's market bets book billions

Berkshire Hathaway (BRK.A, BRK.B), the conglomerate built by legendary investor Warren Buffett, reported its earnings after market close on Friday. Operating earnings of $1.78 billion were down 21.6 percent from the comparable quarter in 2008, although reported GAAP earnings per share were aided by a reversal in the mark-to-market effect of derivatives contracts written on major stock indices. On the quarter, derivatives gains of more than $1.5 billion helped push GAAP net income to $3.3 billion, although Buffett has publicly stated that he overlooks such fluctuations in assessing results.

With Berkshire's diversified ownership of firms in numerous industries, the company is often assessed in three parts: insurance (including GEICO and Gen Re), investments, and other operations. The non-insurance business saw operating earnings nearly cut in half, and insurance underwriting results suffered as well, falling 77 percent from last year. The downbeat insurance earnings were offset by a jump in investment income, as Berkshire's sizable float benefited from the rally in global risk assets.

Even though Berkshire's bottom line was helped by the rally, many could argue that Berkshire's finest time was during the financial crisis, as its exceptional balance sheet opened up numerous investment opportunities for Buffett to pounce on. His preferred stock and warrant deals with General Electric (GE) and Goldman Sachs (GS), derided as the financial turmoil persisted, have since booked billions of dollars in paper gains. Berkshire also provided financing to Dow Chemical (DOW), building products manufacturer USG (USG), and chewing gum giant Wrigley.

The strained markets have hurt in one way, however. Berkshire lost its coveted triple-AAA rating, as ratings agencies Standard & Poor's and Moody's (MCO) reassessed their approach to judging risk. Last month, it was revealed that Buffett reduced his majority stake in Moody's, a long-time holding, as questions swirl about the future oligopoly those firms have on the debt rating market.

Potential regulatory reform of the ratings agencies is not the only change that could impact Berkshire. In addition to the well-known put options Berkshire wrote on major indices, there are credit default swaps (CDS) the company sold on a number of bonds from government and high-yield (or "junk") borrowers. The potential liability associated with those contracts has narrowed by $2.3 billion since the start of 2009, the net effect of which is similar to a rising stock market off-setting paper losses on Berkshire's puts -- a paper gain that boosts earnings. It's something worth remembering the next time Buffett's quote about derivatives being "financial weapons of mass destruction" is taken out of context.

James Cullen edits and writes at He owns stock in and the debt of Primus Guaranty (PRS, PRD), a credit default swap seller. He is the Vice-President of the Boston College Investment Club, which owns GS, GE, and USG, but has no personal position in those stocks.

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