Berkshire profit falls as Buffett’s derivatives slump

Warren Buffett’s Berkshire Hathaway Inc. said second-quarter profit fell 40 percent as derivative bets on stock indexes by the billionaire chairman slid amid the retreat of global stocks.

Net income declined to $1.97 billion, or $1,195 a share, from $3.3 billion, or $2,123, in the same period a year earlier, the Omaha, Nebraska-based company said today in a statement. Operating earnings, which exclude some investment results, were $1,866 per Class A share, beating the $1,456 average estimate of four analysts surveyed by Bloomberg.

Buffett, whose career of stock picking helped him amass the world’s third-largest personal fortune, has accumulated losses for Berkshire on equity derivatives since the 2008 financial crisis. The contracts lose value when equity indexes decline.

“On the derivatives, we had a problem there in the second quarter,” Bill Bergman, an analyst with Morningstar Inc., said in an interview. “That’s clearly reflected in the bottom line.”

The Standard & Poor’s 500 Index fell 12 percent in the three months ended June 30, the first quarterly decline in more than a year. Berkshire slipped 1.5 percent on the New York Stock Exchange over the same period. The Class A shares declined $785 to $120,600 in regular New York Stock Exchange trading today, and have risen about 22 percent this year.

The equity derivative bets produced a loss of $1.8 billion in the period, compared with a gain of $1.96 billion in the same quarter a year ago. Credit-default swaps, in which Buffett bet on the solvency of borrowers, lost $320 million, compared with a gain of $391 million in last year’s second quarter.

Buffett, 79, bought railroad Burlington Northern Santa Fe Corp. for $27 billion in February to add freight hauling to a portfolio of businesses that spans insurance, energy and luxury travel. Buffett, Berkshire’s chief executive officer, told shareholders in May that the economy was improving and his company started hiring again after cutting about 20,000 jobs last year.

Burlington Northern contributed $603 million in net earnings in the second quarter. Insurance underwriting profit climbed to $462 million from $66 million a year earlier.

“Growth throughout the economy appears to be still positive but it seems to be slowing down a little bit,” said David Kass, a professor at the University of Maryland’s Robert H. Smith School of Business. “Even though it is a gradual recovery it will be reflected in the revenues and profits” of Burlington Northern and other Berkshire holdings.

Book value, a measure of assets minus liabilities, fell in the three months ended June 30 to $142.8 billion from $147.2 billion on March 31 as stock market declines weighed on capital. Berkshire said its stock portfolio was valued at $54.6 billion, a 10 percent decrease from the end of March.

Buffett spent $2.56 billion on fixed-maturity securities and $1.64 billion on equities in the quarter. He sold about $2 billion of fixed-income holdings and $427 million of stocks.

Berkshire’s collateral posting requirement surged to $173 million at the end of June from $28 million on March 31. The company said in the filing that it was probably spared more stringent collateral rules in the congressional overhaul of financial regulations.

The reform act “is not expected to have a material impact on our consolidated financial results or financial condition,” Berkshire said.

The top five investments in Berkshire’s U.S. stock portfolio fell in the quarter. Buffett uses the premium from insurance units like General Reinsurance and National Indemnity to buy equities. Coca-Cola Co., Berkshire’s top holding, declined 8.9 percent in the period, while Wells Fargo & Co. dropped 18 percent and American Express Co. slipped 3.8 percent.

Net investment income, which includes stock dividends and the interest payments in investments in Goldman Sachs Group Inc. and General Electric Co., fell about 9 percent to $1.09 billion at Berkshire’s insurance operations.

Berkshire got $4.9 billion in derivatives premiums from companies seeking protection against long-term equity market declines, Buffett said in his letter to shareholders last year. Under the agreements, Berkshire must pay out if, on specific dates starting in 2018, the four indexes are below the point where they were when he made the agreements, according to the 2009 annual report. Buffett can use the money in the interim to make investments.

Berkshire’s insurers include car coverage specialist Geico Corp. The gain at Geico was $329 million, compared with $111 million in the year-earlier period.

Berkshire has been scaling back coverage of hurricanes and the most unusual and risky policies as the commercial property insurance market contracts. Instead, Buffett has used Berkshire capital over the last two years to make acquisitions and extend financing to firms that were weakened by the financial crisis.

Buffett cut jobs and reshuffled managers at Berkshire’s operating companies last year as retail and industrial demand suffered in the recession. He replaced the CEOs of NetJets and jeweler Helzberg Diamond Shops Inc.

NetJets, the luxury flight provider, posted first-half pretax earnings of $114 million, compared with a loss of $349 million in the year-earlier period. David Sokol, the chairman of Berkshire’s energy business, fired pilots and wrote down the value of aircraft after Buffett installed him as NetJets CEO a year ago.

Earnings from Berkshire’s energy and utilities unit, which includes MidAmerican Energy Holdings Co. and PacifiCorp, decreased 7.9 percent to $233 million.

Profit from the manufacturing, service and retailing businesses more than doubled to $671 million. First-half revenue doubled at recreational-vehicle maker Forest River and jumped 40 percent at toolmaker Iscar Metalworking Cos.

“These operations rebounded in 2010 from very slow economic activity in the first six months of 2009,” Berkshire said in the filing. “Our manufacturing businesses benefited in 2010 from higher customer demand and the effects of cost management efforts over the past two years.”