Notes on Wesco Financial (Charlie Munger) Letters to Shareholders (1987-2009)
1985 Letter Notes
Munger writes extensively in this letter about the dangers inherent in the Savings & Loans industry that were years ahead of the early 90's S&L crisis. He makes his stance clear: it was highly irresponsible to insure these institutions and their depositors as the managers grew at all costs by offering sky-high interest rates on deposits just to attract more funds and used the deposits to fund ever growing loan portfolios with riskier and riskier credit quality. As interest rates were increasing rapidly in the early 80's, he wisely chose to sit on the sidelines as many S&L's granted high interest accounts just to expand depository funds available for lending. The section detailing his opinions on the excesses of mortgage lending in the S&L industry reads like a prelude to the 2007-2009 real estate crisis. The root causes were somewhat the same - excess leverage.
Wesco Reinsurance division was started with $45M in equity from Wesco Financial under the direction of Warren Buffett at Berkshire Hathaway, who owned 80% of Wesco at the time. Wesco Reinsurance immediately reinsured 2% of Berkshire Hathaway's subsidiary Fireman's funds premiums from 1985-1989, effectively giving them 2% of the company's book of business. It is interesting to note that Buffett used Munger's company, which he owned 80% of, to reinsure the Fireman's fund's book of business. It generated over $60M in premiums during 1986, available for investment purposes for Wesco. Seems to me that this was a move to get Munger's resources into the insurance industry.
Another little nugget that continues to show up in the reinsurance business letters I've read is that this business serves a highly commoditized product - namely, peace and security in the form of money paid out for an specific (bad) event occurring. So, what form of competitive advantage can be gained in the industry? Munger and Buffett often write in their letters about how the financial strength of Wesco and Berkshire Hathaway is their biggest advantage. In the reinsurance industry, returns can be wonderful for years due to very long-tail risks (low probability, high cost events). However, when the proverbial lightning strikes and many reinsurers become insolvent due to catastrophic events, the remaining players' not only pick up the pieces of competitor's books of business but their financial brands improve in the eyes of their clients and customers.
Finally, as I noted in Week 10 reading, savings and loan institutions as well as steel warehousing and metal work businesses are not particularly high return on capital businesses and typically are not associated with economic moats. Charlie made this clear in his 1985 letter that while he was looking for such high return businesses at reasonable prices to purchase outright, that they were hard to come by. And thus his quote at the end of the letter (emphasis mine):
"Wesco is trying more to profit from always remembering the obvious than from grasping the esoteric (including much modern "strategic planning" and "portfolio theory"). Such an approach, while it has worked fairly well on average in the past and will probably work fairly well over the long-term future, is bound to encounter periods of dullness and disadvantage as it limits action. Moreover, this approach is being applied to no great base position