Charlie Munger’s annual letter to shareholders of Wesco Financial Corporation was published on March 27. Wesco Financial is a publicly traded company that is 80 percent owned by Berkshire Hathaway. Charlie Munger is Berkshire Hathaway’s longtime Vice Chairman and also serves as Chairman and President of Wesco Financial.
Compared to Warren Buffett’s letters to shareholders of Berkshire Hathaway, Charlie Munger’s letters to Wesco shareholders tend to be much more brief but nonetheless provide important insights from one of the most successful value investors of the last half century. In this post, I will take a brief look at some of Munger’s comments that shed some light on the overall economy. This post is not intended to serve as a comprehensive review of Wesco Financial’s results for 2008, although certain Wesco subsidiaries are mentioned.
Kansas Bankers Exits Deposit Guarantee Bond Business
Kansas Bankers Surety Company is a subsidiary of Wesco Financial engaged in providing various types of insurance coverage to the banking industry. Kansas Bankers’ main customers are small and midsized community banks. Products offered include “crime insurance, check kiting fraud indemnification, Internet banking catastrophe theft insurance, Internet banking privacy liability insurance, directors and officers liability, bank employment practices, and bank insurance agents professional errors and omissions indemnity.”
Munger notes that recent events in the banking industry have called into question the long term profitability of Kansas Bankers’ line of deposit guarantee bonds. These bonds are intended to insure customer bank deposits above Federal insurance limits. Kansas Bankers suffered an after tax loss of $4.7 million in the second half of 2008 on this line of business and ceased to write such bonds. Starting in September 2008, Kansas Bankers began to exit this business as quickly as possible. Substantial reductions in exposure have already been made.
What is notable about Kansas Bankers’ departure from this business is that this line of insurance accounted for half of written premiums in 2008 and all of the business conducted in 16 of the 39 states in which it does business. One can conclude that Wesco management does not believe that prevailing premium rates will be sufficient to cover anticipated losses from this line of business. Wesco is willing to give up a business that accounts for half of Kansas Bankers’ premium volume in an attempt to maintain underwriting discipline and avoid underwriting losses in future years. This level of underwriting discipline is uncommon, to say the least. One might also reasonably infer that Munger considers the banking crisis to be far from played out based on this move.
CORT Experiences Headwinds
CORT Business Services is the leader in rentals of office furniture and is very much exposed to the business cycle. Wesco purchased the business in early 2000 during the tail end of the dot com bubble when CORT was rapidly growing due to high levels of business formation and expansion. CORT suffered a period of “protracted slowdown” in the aftermath of the dot com meltdown and the impact of the September 11, 2001 terrorist attacks. More recently, CORT has been experiencing “increasingly difficult recessionary conditions, perhaps the beginning of the worst economic recession in decades” to quote Munger’s words. Despite the difficulties of the past several years, Munger is confident that CORT is well positioned to benefit from an economic turnaround that is “certain to occur in due course.”
Munger reports that Precision Steel has experienced significant reductions in volume due to recessionary-caused weakness among Precision’s customer base. Q4 2008 was particularly weak with volumes down 34% from the prior year. Munger does not anticipate a quick reversal even when the economy recovers. There is also wording in this section that indicates a belief that the recession is “intensifying” and “deepening” rather than being close to a conclusion.
“The Worst Economic Disaster since the Great Depression”
It appears that Munger believes that the worst is yet to come for the United States economy: “The worldwide economy is currently suffering the effects of a deepening recession, perhaps the worst economic disaster since the Great Depression.” Obviously, a much stronger statement is hardly possible and Munger is warning that a quick recovery in 2009 is very unlikely.
While I believe that much of the value in following Buffett and Munger involves the intellectual underpinnings of value investing in general and methods for identifying well run and promising businesses, it is always useful to listen to their words on the macro economy as well. It will be interesting to listen to Buffett and Munger speak about the economy during the Berkshire Hathaway and Wesco Financial shareholder meetings in early May. Munger in particular is known for his very direct and candid answers to shareholder questions and he is sure to be asked about a wide variety of subjects at the meetings.