Berkshire Hathaway 2002 Annual Meeting Audience Question # 35

Warren gives an update on the Finova deal

Warren Buffett:

Now, you had another question, George?

Audience Member:

Yes, just briefly, if you could give us an update on the economics of the Finova deal?

Warren Buffett:

Well, the Finova deal is about like… well, it is like when we wrote the annual report.

And actually, Finova’s annual report deals with this, too. I think most of you know the terms of it.

We guaranteed what was originally going to be a $6 billion loan that enabled creditors to be paid a large percentage of their claim in the Finova bankruptcy. And we only took down 5.6 billion of the 6 billion because there had been payments made faster at Finova.

Finova was a failed finance company, a very big one, and we were in partnership with Leucadia in this operation. And they have management responsibility, and they’re doing a fine job.

That loan of 5.6 billion, on which, in effect, we make roughly a 2 percent override on 90 percent of the loan. So, if it had been 6 billion, we would have had a carry of 108 million a year, although it was going to come down.

Now the loan is down to 3.2 billion, I believe. There was a bulk sale of some franchise receivables for about 500 million to GE Credit here not so long ago.

So the exposure’s down to 3.2 billion, but of course the 2 percent override is down to 2 percent on 3.2 billion.

We feel… well, after September 11th, many of the assets at Finova were aircraft. And they were not the latest of aircraft, and they were not to the greatest of lessees in many cases.

So there was a big hit to the aircraft portfolio, and there was… there were other receivables relating to resort properties and that sort of thing, which were also hit by anything that impacted travel and that sort of thing.

So the portfolio was worth less… appreciably less… on September 12th than it was on September 10th. And that will not, in my view… our 3.2 billion, as far as I’m concerned, we’ve guaranteed it, but I think that is very close to 100 percent OK.

And then there’s a group of bonds underneath it which are the residual bonds, you might say, of the ones that existed in the bankruptcy, because 70 percent got paid off and 30 percent didn’t. And we own that means of that residual… we own 13 percent or so.

Those bonds are going to be worth a lot less than we thought they were going to be worth the summer of last year.

We bought our position at 67 cents on the dollar, and we’ve already… we got 70 cents on the dollar, plus these bonds, plus we get the override on the Berkadia loan.

So we got all our money back, and then some, on the bonds that we bought, and we get the override on the Berkadia, so we will, in all likelihood, almost certainly, I would say… although, who knows? I mean, I didn’t know about September 11th… but we will almost… we’re very, very likely… to make a significant amount of money on the whole transaction, but not as much money as we thought we were going to make last summer.

And we feel very pleased with the way Leucadia’s handling things, but there is not as much value in that portfolio today because of the events of September 11th.


Charlie Munger:

Yeah, it’s an interesting example of Ben Graham’s margin of safety principle. A whole lot has gone wrong that we didn’t predict, and yet we’re coming out fine.

Warren Buffett:

Yeah, we should make some hundreds of millions in aggregate over time on it, but a lot went wrong. But we, as Charlie said, we had a margin of safety when we bought into it, and we felt we had a margin of safety, and it turns out we needed it.

Audience Member:

Thank you.

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