Wesco Financial reported results for the first quarter last week in a press release and filed the 10Q report with the SEC yesterday. Wesco Financial is a publicly traded 80% owned subsidiary of Berkshire Hathaway.
Wesco reported net income per share of $2.80 for the quarter compared with $2.91 per share in the first quarter of 2008. Results were impacted by weakness in the CORT furniture rental business and Precision Steel’s industrial business, which was partially offset by improved underwriting results at Wesco’s insurance businesses. Wesco’s balance sheet continues to show significant liquidity and little use of debt. Shareholder’s equity per share decreased to $297.44 at March 31, 2009 from $333.96 a year earlier mainly due to declines in the fair value of Wesco’s investment portfolio. Let’s briefly examine the results from Wesco’s three reporting segments.
Insurance
Wesco’s insurance segment includes Wesco-Financial Insurance Company and Kansas Bankers Surety Company. Written insurance premiums for the quarter increased by $43.8 million, or 53.9%, over the results for the first quarter of 2008. The bulk of this improvement was related to Wesco’s participation in the reinsurance transaction between Berkshire Hathaway and Swiss Re. Wesco entered into a quota share agreement with another Berkshire subsidiary to assume 1/10th of the 20% quota share reinsurance agreement with Swiss Re which commenced on January 1, 2008. Earned premiums attributed to the Swiss Re contract were $66.5 million for the first quarter of 2009 compared to $13.9 million for the first quarter of 2008.
Written primary insurance premiums for the first quarter of 2009 decreased by $3.1 million from the first quarter of 2008 representing a 52.6% decline. This was mainly due to a decision by Kansas Bankers Surety Company to exit its line of bank deposit guarantee bonds. I wrote about this decision in early April in coverage of Charlie Munger’s annual letter to shareholders. Munger included an explanation for this decision in his letter. My view is that the move shows considerable underwriting discipline given that bank deposit guarantee bonds accounted for a large portion of Kansas Bankers overall business.
The insurance segment posted after tax underwriting profits of $5.05 million for the first quarter of 2009 compared to underwriting profits of $1.711 million in the first quarter of 2008. Investment income increased to $16.2 million from $15.3 million in the first quarter of 2008. One factor that contributed to the improvement is Wesco’s investment of $205 million in shares of newly issued 10% preferred stock of Goldman Sachs. Apparently, a portion of the Goldman Sachs deal initiated by Warren Buffett in the early 4th quarter of 2008 was allocated to Wesco’s insurance subsidiary.
Furniture Rental
CORT Business Services is the only nationwide player in the “rent to rent” furniture industry. The business is sensitive to overall economic growth and business formation. Segment net loss was $956,000 for the first quarter of 2009 compared to net income of $3.5 million for the first quarter of 2008. While revenues increased compared to the first quarter of 2008, operating expenses increased more rapidly as a percentage of revenue primarily due to an increase in depreciation expenses on rental furniture that was acquired as part of the Aaron Rents acquisition in November 2008. In addition to the depreciation charge, CORT took a $3.5 million amortization charge related to the value assigned to rental contracts acquired from Aaron Rents. Management is taking steps to reduce operating costs going forward.
Industrial Segment
Precision Steel Warehouse and its subsidiaries had a net loss of $388,000 compared to net income of $296,000 in the first quarter of 2008. Revenues declined by $5.7 million, or 36.2% from the first quarter of 2008. The industrial segment has been impacted by the deepening recession as well as competitive pressures. Sales in terms of pounds of material fell by 45.4% compared to volume in the corresponding 2008 period. Wesco notes that the industrial segment operates on low gross margins and has significant fixed costs. Despite efforts to reduce expenses, the segment suffered losses during the quarter. I believe it is likely that this segment will continue to face headwinds until economic growth returns.
Investment Performance
Wesco held $1.44 billion in investments on March 31, 2009 compared to $1.87 billion a year earlier. The decrease in book value per share is primarily related to the decline in the value of Wesco’s investment portfolio. Investments declined from a position of net unrealized appreciation of $154.7 million at year end 2008 to a position of net unrealized depreciation of $122.3 million at March 31, 2009. While this decline did not hit Wesco’s income statement, the unrealized loss results in a decline in shareholder’s equity on the balance sheet. One should note that it is likely that Wesco’s investment portfolio has recovered significantly since the end of the first quarter due to the broad stock market rally of the past six weeks.