Berkshire net off 64 percent on derivatives, insurance

OMAHA, Nebraska Fri May 2, 2008 7:35pm EDT

Warren Buffett listens to a question during testimony at a Senate Finance Committee on Capitol Hill in Washington, November 14, 2007. REUTERS/Jason Reed

Warren Buffett listens to a question during testimony at a Senate Finance Committee on Capitol Hill in Washington, November 14, 2007.

Credit: Reuters/Jason Reed

OMAHA, Nebraska (Reuters) - Warren Buffett's Berkshire Hathaway Inc (BRKa.N)(BRKb.N) said on Friday that first- quarter profit tumbled 64 percent, hurt by losses tied to derivatives contracts and a steep slide in insurance premiums.

Net income for the Omaha, Nebraska-based insurance and investment company fell to $940 million, or $607 per Class A share, from $2.6 billion, or $1,682, a year earlier.

Operating profit fell 13 percent to $1.93 billion, or $1,247 per share, from $2.21 billion, or $1,434. On that basis, analysts on average expected profit of $1,477 per share, according to Reuters Estimates. Revenue tumbled 24 percent to $25.18 billion.

Results suffered from $991 million of after-tax losses tied mainly to contracts designed to make money if junk bond stay out of default and stock indexes rise. Buffett had warned in his annual letter to shareholders in February that derivatives could make quarterly results volatile.

Meanwhile, insurance underwriting profit fell 70 percent to $181 million, and earned premiums sank 54 percent to $6.21 billion. Berkshire had been able to boost insurance premiums following Hurricane Katrina in 2005, but Buffett said prices and profit margins have since fallen.

"When people see these derivatives numbers, they may be concerned, but Buffett gets his cash up front, so I'm not concerned about balance sheet integrity," said Thomas Russo, a partner at Gardner, Russo & Gardner in Lancaster, Pennsylvania, which invests more than $3 billion. "I'm not surprised at the insurance decline. Berkshire has a culture in which it will stop writing business it doesn't want."

In Friday trading, Berkshire's Class A shares fell $300 to $133,600, while its Class B shares fell $12 to $4,448.

BUFFETT HAD WARNED OF DECLINE

Berkshire said it had a $1.2 billion pre-tax unrealized loss on put options it wrote on the Standard & Poor's 500 .SPX and three foreign stock indexes. It also reported a $490 million pre-tax unrealized loss on contracts that require payouts if some high-yield bonds default between now and 2013.

In February, Buffett revealed that Berkshire ended 2007 with $40 billion of exposure to 94 derivatives contracts. Accounting rules require the company to regularly report unrealized gains and losses in earnings, Berkshire said.

The exposure may at first seem odd given that, in his shareholder letter in 2003, Buffett called derivatives "financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."

But in his letter this year, Buffett said Berkshire had already been paid for its derivatives contracts, giving it cash to invest, and that there is no counterparty risk." He also said shareholders should be prepared for gains and losses that could "easily" top $1 billion in a given quarter.

Pre-tax underwriting gains at auto insurer Geico Corp fell 37 percent to $186 million, as the average claim size increased and average premium per policy fell. They rose 40 percent to $42 million at General Re Corp. Several factors caused gains at Berkshire Hathaway Reinsurance Group to tumble 95 percent to $29 million, including increased competition.

The quarter was the first since Buffett created a bond insurer, Berkshire Hathaway Assurance Corp, to compete with rivals that struggled with guarantees of subprime mortgages. The unit generated about $400 million of business.

HOUSING SLUMP WEIGHS

In other businesses, net income from utilities and energy rose 8 percent to $316 million, while income from manufacturing and retailing businesses rose 9 percent to $487 million.

The latter, however, was partially attributable to acquisitions and results from an Israeli unit, Iscar Metalworking Cos. Berkshire said results weakened in businesses tied to the U.S. housing slump, including building products, carpeting, home furnishings and real estate brokerage.

"Construction and housing will be part of Berkshire's story throughout 2008," Russo said.

Buffett has transformed Berkshire since 1965 into a $207 billion conglomerate by acquiring out-of-favor companies with strong earnings and management, and investing in stocks.

It also invests in stocks such as American Express Co (AXP.N), Coca-Cola Co (KO.N), Procter & Gamble Co (PG.N) and Wells Fargo & Co (WFC.N). It ended the quarter with about $72.56 billion of stocks and $38.64 billion of bonds.

The company's book value fell to $119.37 billion from $120.73 billion at year end. Berkshire's cash stake fell to $35.57 billion from $44.33 billion.

During the quarter, Berkshire completed its $4.5 billion purchase of a 60 percent stake in Marmon Holdings Inc, whose products are used in energy and construction. Then on April 28, Buffett committed $6.5 billion as part of Mars Inc's purchase of chewing gum maker Wm Wrigley Jr Co WWY.N.

(Editing by Andre Grenon)