Warren Buffet's Interview

Interview of Warren Buffett @ CNBC (copied from CNN)

Warren Buffett said Monday the U.S. economy had "fallen off a cliff" but would eventually recover, although a rebound could kindle inflation worse than that experienced in the late 1970s.
Speaking on CNBC television, the 78-year-old billionaire said the country is experiencing a "close to the worst-case" scenario of falling business activity and rising unemployment, causing consumer confidence and spending to tumble.

Buffett called on Democratic and Republican policymakers to set aside partisan differences and unite under the leadership of President Barack Obama to wage an "economic war" that will fix the economy and restore confidence in banking.

He urged policymakers and regulators to communicate their efforts better to the public, though he stopped short of major, specific policy recommendations.

"People are confused and scared," he said. "People can't be worried about banks, and a lot of them are."

Buffett spoke nine days after his insurance and investment company Berkshire Hathaway Inc (BRKB) said quarterly profit fell 96%, largely from losses on derivatives contracts. Berkshire's book value per share fell 9.6% in 2008, the worst year since Buffett took over in 1965.

Recovery could trigger inflation

Buffett said Americans, including himself, did not predict the severity of home price declines, which led to problems with securitizations and other debt whose value depended on home prices continuing to rise, or at least not plummet.

"It was like some kids saying the emperor has no clothes, and then after he says that, he says now that the emperor doesn't have any underwear either," Buffett said. "We want to err on the side next time of not allowing big institutions to get as unchecked on leverage as we have allowed them to do."

Consumers too should reduce their reliance on debt such as credit cards, he said. "I can't make money borrowing money at 18 or 20%," said Buffett. "I'd go broke."

Buffett said the economy was mere hours away from collapse last September when credit markets seized up, Lehman Brothers Holdings Inc went bankrupt and insurer American International Group Inc (AIG, Fortune 500) got its first bailout.

While praising efforts by Federal Reserve Chairman Ben Bernanke and others to stimulate the economy, he said the economy "can't turn around on a dime" and that their efforts could trigger higher inflation once demand rebounds.

"We are certainly doing things that could lead to a lot of inflation," he said. "In economics there is no free lunch."

The stock of Omaha, Neb.-based Berkshire has fallen by half since September. Growth in some units such as auto insurer Geico Corp has been offset by weakness elsewhere, including jewelry retailers that Buffett said have "gotten killed."

Buffett said Berkshire will write less catastrophe insurance this year after investing roughly one-third of its cash in high-yielding securities issued by General Electric Co (GE, Fortune 500) , Goldman Sachs Group Inc (GS, Fortune 500) and other companies.

In morning trading, Berkshire Class A shares were down $795, or 1.1%, at $72,400. Their 52-week high is $147,000, set last Sept. 19, Reuters data show.

'Get back to banking'

Buffett called on banks to "get back to banking" and said an overwhelmingly number would "earn their way out" of the recession, even if stockholders don't go along for the ride.

Saying that "a bank that's going to go broke should be allowed to go broke," Buffett nevertheless added that the "paralysis of confidence" in the sector is "silly" because of safeguards such as deposit insurance.He said Wells Fargo & Co (WFC, Fortune 500) and U.S. Bancorp (USB, Fortune 500), two large Berkshire holdings, should appear "better than ever" three years from now, while the ailing Citigroup Inc, which Berkshire does not own, would probably keep shrinking.

Bank of America Corp (BAC, Fortune 500) Chief Executive Kenneth Lewis, in a Wall Street Journal opinion piece Monday, agreed that the vast majority of banks will survive. Berkshire has reported a small stake in Bank of America stock.

Buffett said he still expects Berkshire's derivatives contracts, whose value depends on where four stock indexes trade a decade and more from now, to be profitable.

Over 10 years, he said, "you will do considerably better owning a group of equities" than U.S. Treasurys.

Buffett also defended his imperfectly timed October opinion piece for The New York Times, where he said he was moving non-Berkshire holdings in his personal account to stocks.

"I stand by the article," he said. "I just wish I had written it a few months later."

Wells Fargo dividend cut

Mar 06, 09 Wells Fargo announce that it will cut dividend from 34 cents to 5 cents. It is the last "giant" to cut dividends. As I mentioned yesterday, I think cutting dividends is a right decision to regain investors' confidence, keep its capital and balance sheet strength (tangible capital ratio will improve by 40 bps).
It will also clear one of the big uncertainty issue for the company as well as the bank sector.

Here's from the CEO's press release:

“This was a very difficult decision but it’s absolutely right for our Company and our shareholders because it will further strengthen our ability to grow market share and to continue our long track record of profitable growth,” said President and CEO John Stumpf. “We will return to a more normalized dividend level as soon as practical. We have among the most loyal shareholders in America – individuals and institutions alike – and we’ve always recognized the value of dividends. Operating results for the first two months of the year are strong. Our ability to grow market share in this environment and to benefit from new business opportunities remains second to none. Our merger with Wachovia is on track and we remain as optimistic as ever about its potential benefits for all our stakeholders.”

Econ data: 09 week 10

Unemployment rate looks bad, and for sure it will continue to climb, but technically, based on the previous 10 times stock market crash history, stock market reach the bottom 9 months ahead unemployment rate reach its peak. If unemployment will reach its peak between 9% to 10% in 2010, then one should likely expect stock market will touch the ground somewhere between now and 2Q09.

Who knows about the future? None!! But who holds the future? Once again we realized that HE is GOD and there is only one GOD - Jesus Christ, who we can put our trust on in anytime , anywhere.

That why Warren Buffett describe today's economy in 2008 Berkshire Hathaway's annual letter to shareholders:

"For God we trust, all others pay cash."

Economic Data:

• US Feb unemployment rate up to 8.1% (worse than expect, 7.9%) prior 7.6%
• US Feb Non-farm job pos cut 651k (same, cut 650k), prior cut 655k. YTD has already lost 1.3M jobs;
• US initial jobless claim down to 639k, (better, 650k), prior 670k;
• US Jan personal income up 0.4% (better, -0.2%), prior -0.2%;
• US Jan pending home sales down 7.7% (worse, down 3.5%), prior up 4.8%. It may due to potential buyers/sellers all pending their trade on Obama's economy plan which published & finalized on the end of Feb;
• US Feb ISM index flat at 35.8 (better, 33.8), prior 35.6;
• US Feb Auto & Truck sales still do not look good at 2.9M & 3.5M, prior 2.9M & 4.0M;

News: dividends

Recently, Investors raise concerns on financial institutions and worry about their expected net income (or capital requirement) will not be sufficient to settle its dividend payout.

• Feb 25, 09 JP Morgan (JPM) is the 1st "giant" to cut its dividends from 38 cents to 5 cents, that will save JPM $5B per year;
• Feb 27, 09 General Electric (GE) cut its dividends from 34 cents to 10 cents, which will save $9B per year;
• Mar 04, 09 US Bancorp (USB) cut dividends by 88% to 5 cents and will save $2.6B;

In my opinion, I think dividend cut in such tough economic environment is understandable and it will also strengthen the company's capital and balance sheet and will reduce the risk of being downgrade. Unless, dividend cut is driven by an expectation of a huge potential loss.
The only "giant" that still did not announce a dividend cut is Wells Fargo (WFC). Stock price keep being pushed down these 2 weeks.

Operationally, I think WFC will make a profit in 1q09 and 2009 that is enough to settle its dividend payment. But if dividend cut can clear the uncertainty & risk that investors putting towards WFC. It is still a smart move to do so.

None of the companies I've mentioned above show any needs of capital injections. At least, not yet.

Berkshire Hathaway 2008 results

Berkshire Hathaway's has $37.1B equity put option contracts in sell position. The company loss $6.8B in 2008 because of this contact. One may concern if the equity market keep dropping, what will be the impact to BRK?

Here is what Buffett said in 2008 annual report:

• We have added modestly to the “equity put” portfolio I described in last year’s report. Some of our contracts come due in 15 years, others in 20. We must make a payment to our counterparty at maturity if the reference index to which the put is tied is then below what it was at the inception of the contract. Neither party can elect to settle early; it’s only the price on the final day that counts.
• To illustrate, we might sell a $1 billion 15-year put contract on the S&P 500 when that index is at, say, 1300. If the index is at 1170 – down 10% – on the day of maturity, we would pay $100 million. If it is above 1300, we owe nothing. For us to lose $1 billion, the index would have to go to zero. In the meantime, the sale of the put would have delivered us a premium – perhaps $100 million to $150 million – that we would be free to invest as we wish.
• Our put contracts total $37.1 billion (at current exchange rates) and are spread among four major indices: the S&P 500 in the U.S., the FTSE 100 in the U.K., the Euro Stoxx 50 in Europe, and the Nikkei 225 in Japan. Our first contract comes due on September 9, 2019 and our last on January 24, 2028. We have received premiums of $4.9 billion, money we have invested. We, meanwhile, have paid nothing, since all expiration dates are far in the future. Nonetheless, we have used Black- Scholes valuation methods to record a yearend liability of $10 billion, an amount that will change on every reporting date. The two financial items – this estimated loss of $10 billion minus the $4.9 billion in premiums we have received – means that we have so far reported a mark-to-market loss of $5.1 billion from these contracts.

I did a worse case scenario based on the following assumption:

• Assume 10% return per year on $4.9B (given that BRK had entered into bond / preferred shares contract with a return of 10-15% per year during 2008 & early 2009)

BRK will loss $$ only if S&P 500 (or the world wide equity market) did not bound back above 461 points in 10-15 years time.
Which is 69% dropped from 1,576 (historical peak) and 35% dropped from 712 (today).

Will this happen? May be. But what is the possibility of this happen?
I think it is unlikely!!

If S&P 500 rise above 1,100 @ 2019, BRK will earn a pre tax income between $11B to 21B on this contract.

	10%	max $37B			worse case
	Interest inc	G/L	Total gain		S&P 500
peak					1,576
2007	245		245		1,069
2008	515	(6,800)	(6,286)		903
2009	566	(14,894)	(14,328)		625
2010	623	9,543	10,165		719
2011	685	2,495	3,180		791
2012	753	2,196	2,949		854
2013	829	1,482	2,311		897
2014	911	(1,556)	(645)		852
2015	1,003	(2,957)	(1,954)		767
2016	1,103	(3,991)	(2,888)		652
2017	1,213	(2,714)	(1,501)		573
2018	1,334	(1,990)	(656)		516
2019	1,468	(896)	572		490
2020	1,615	(851)	764		466
2021	1,776	(162)	1,615		461
2022	1,954	-	1,954		461
2023	2,149		2,149		461
2024	2,364		2,364		461
Tol	21,105	(21,095)	10		461

HSBC 2008 results

HSBC is the one of the largest bank and financial insitution conducts business throughout the world with more than 10,000 offices in over 80 countries.2008 results1. Total net revenue up 1% vs 2007

• Good: Net interest income up 13% due to increase in net interest margin on significant interest rate cut;
• Bad: Net fee income down 9% and net trading income down 33% due to equity market down;

2. Reported EPS down 72% vs 2007 to US$0.47;

• Bad: Loan impairment charges & provision up 45% to $25B or 2.3% of its loan portfolio;
• Fair: Goodwill write off $10.6B, write off the goodwill on HFC totally;
• Fair: Excluded goodwill impairment, EPS should be around $1.17, down by 25% vs 2007;

3. Ratio

• Good: Tier 1 capital fall from 9.8% in 3q08 to 8.3% in 4q08, still strong given that no capital injection from government;
• Bad: Return on equity down from 15.9% in 07 to 4.7% in 08;
• Fair: Price / Book Value at 0.7644 (MV $28.25 BV $36.96 as of 03/02/09);
• Fair: Price / Earning at 12.04;
• Good: Cost efficiency ratio keep at 47.2%, lower than peers

4. Balance Sheet

• Bad: Total equity down 27%, huge loss happen in it's AFS assets;
• Fair: Total assets up 7%, exclude derivative contracts, total assets down 6%;
• Bad: Total deposit down 1.6%;
• Fair: Total liabilities (exclude derivative) down 4.7%;
• Bad: Cash flow from operating down significantly by 67%

Risk

• Issue shares at 50% discount to raise $17.7B capital, it will significantly dilute the existed shareholders' earning;
• Growth will slow down on emerging markets;
• Further loan impairment in 2009 if economy get worse and unemployment rate continue to rise

Comments

HOLD (in short term), until the share issuance has been finished and settled;BUY (in long term), fair value HK$115.32.

Berkshire Hathaway 2008 results

Berkshire Hathaway is a holding company that owns more than 70 business mainly in insurance, energy. It also has a $49B equity portfolio which owns large equity stakes in Coca-Cola, Wells Fargo, Proctor & Gamble and America Express etc.

2008 results:1. Total Reveune down 9.7% vs 2007

• Exclude $6.8B derivitve losses in 2008, reveune down only 3.1%;
• Exclude $6.8B derivitve losses in 2008 and the $7.1B special insurance deal in 2007, reveune up 2.9%;
• Strong 10.6% reveune growth in Utilities/Energy segment, continue future growth is expected;

2. Reported EPS $107 (class B) down 62% vs 2007 or adjusted EPS $228

• Exclude $6.8B derivitve losses in 2008, EPS down 20%;
• Insurance underwriting still manage to make a profit of $2.8B, about 5% of invested capital;
• Expenses management looks good;
• EPS down mainly due to change on investment from gain $5.4B in 07 (gain to sell all Petro China) to loss $0.6B in 08;

3. Ratio

• price / earning ratio as of Feb 27, 09 is 23.96, quite high compare to peers;
• price / earning ratio based on adjusted EPS is 11.25, looks reasonable;
• price / book as of Feb 27, 09 is 1.09, lower than company's historical average of about 1.8

4. Balance Sheet

• Book value fall 9.6%, better than my expectation and better than S&P's 37%
• Cash balance dropped from $44.3B in 07 $25.5B in 08;
• 2008 Net purchased in equity $3.3B, bonds $2.3B and special deals $14.5B
• Cash flow from opeartion remain strong at $11.2B or down 10.4%

Risk:

• Aging / retirement concerns for BRK's management team;
• Credit rating may fall derivative value / its equity holding continue to fall;
• Cost of capital may rise derivative value / its equity holding continue to fall;
• The conglomerate's nature makes it difficult and unclear to estimate the company's performance

5. Forecast 09

• Based on 2009 equity market performance so far, it will suffer another $6.2B hit on deriveritive and may be another $10B in its equity portfolio, which translate into 13.2% down in book value;
• Special deal should help to generate addition $1.7-$2.0B investment income per year start from 2009

Comments:
BUY, Fair Value $4,640 (not yet adjusted)