Whitney Tilson VIF 2008.

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Whitney Tilson, Managing Partner, T2 Partners.

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Whitney Tilson VIF 2008.

  1. 1. Why We Are Still in the Early Innings of theBursting of the Housing and Credit Bubbles – And How to Profit From It T2 Partners LLC Value Investing Forum Mexico City May 28, 2008 T2 Partners Management L.P. is a Registered Investment Advisor 145 E. 57th Street ˚ 10th Floor New York, NY 10022 (212) 386-7160 Info@T2PartnersLLC.com ˚ www.T2PartnersLLC.com A link to this presentation is at www.valueinvestingcongress.com. We would like to thank Amherst Securities Group L.P. (www.asglp.com) for generously providing much of the data in this presentation.This document is not a solicitation to invest in any investment product, nor is it intended to provide investment advice. It is intended for informationpurposes only and should be used by sophisticated investors who are knowledgeable of the risks involved. All data and comments herein are believed tobe correct, but there are no guarantees and readers should do their own work. Please refer to the relevant Confidential Private Placement Memorandum forfull details on investment products and strategies of T2 Partners LLC.
  2. 2. From 2000-2006, the Borrowing Power of a Typical Home Purchaser More Than Tripled – And Has Now Tumbled 39% $400,000 1/1/95 1/1/00 1/1/04 1/1/05 1/1/06 1/1/07 6/1/07 1/1/08 1. 2. Pre-Tax Income Debt-to-Income Ratio $ 30,000 $ 33,693 $ 36,966 $ 38,064 $ 39,581 $ 40,403 $ 40,403 $ 41,963 33% 33% 40% 45% 55% 55% 60% 35% -39.4% 3. Non-Agency Mortgage Rate 10.50% 9.50% 7.50% 6.25% 6.00% 6.50% 6.75% 6.75% 4. Mortgage Type Full Am. Full Am. Full Am. Int Only Int Only Int Only Int Only Int Only 5. Borrowing Power $ 90,190 $ 110,191 $176,227 $274,060 $ 362,824 $341,873 $359,139 $ 217,585 $300,000 Equity Required 15% 15% 10% 0% 0% 0% 0% Cash Required $ 15,916 $ 19,445 $ 19,581 $ - $ - $ - $ - Leverage 3.0 3.3 4.8 7.2 9.2 8.5 8.9 5.2 $200,000 $100,000 $- 1/95 1/96 1/97 1/98 1/99 1/00 1/01 1/02 1/03 1/04 1/05 1/06 1/07 1/08 Pre-Tax Income Borrowing Power Factors contributing to the ability to borrow more and more were: 1. Slowly rising income 2. Lenders being willing to allow much higher Debt-to-Income Ratios 3. Falling interest rates 4. Interest-only mortgages (vs. full amortizing) 5. No money downT2 Partners LLC Source: Amherst Securities Group, L.P. -2-
  3. 3. There Was a Dramatic Decline in Mortgage Lending Standards from 2001 through 2006 (aka “Liar’s Loans”)T2 Partners LLC -3-
  4. 4. The Decline in Lending Standards Led to a Surge in Subprime Mortgage Origination 13.6% of all mortgages originated during the year $B 0.9% of all mortgages originated during the yearT2 Partners LLC -4-
  5. 5. The Surge in Borrowing Power and Decline in Lending Standards Led to Home Prices Soaring Far Above Trend Line A 34% decline to return to trend line Sources: OFHEO, Bureau of Economic Analysis.T2 Partners LLC -5-
  6. 6. Lenders Cared Little Who They Lent To Because They Assumed Perpetually Rising Home Prices When home price appreciation slows, loss severity skyrockets when mortgages default. What will loss severities look like when home prices are declining 10% annually?! No-one knows because there is no precedent for this. The assumption of perpetually high HPA led lenders to give virtually anyone a loan because even if they defaulted, the home could simply be resold with little or no loss. Source: LoanPerformance; OFHEO; Deutsche Bank; “Whos Holding the Bag?”, Pershing Square presentation, 5/23/07.T2 Partners LLC -6-
  7. 7. Home Prices Are in an Unprecedented Freefall Home prices fell an average of 12.7% in February in 20 major metropolitan areas Over the six months through February, home prices fell at an annual rate of more than 25% in Las Vegas, Phoenix, Los Angeles, San Francisco, San Diego and Miami. Source: WSJ, 4/30/08.T2 Partners LLC -7-
  8. 8. Almost No Subprime, Alt-A and Jumbo Mortgages Are Being Issued Non-Agency Mortgage Issuance Source: Deutsche Bank, Merrill LynchT2 Partners LLC -8-
  9. 9. Things Are Terrible – And There’s No Sign of a Bottom • 8.8 million homeowners had mortgage balances equal to or greater than the value of their homes as of the end of March according to Moody’s Economy.com – 30% of subprime loans written in 2005 and 2006 are already underwater • In Q4 07, 5.82% of all mortgages were delinquent (30 days past due), the highest level in 23 years, and 0.83% were in foreclosure, an all-time high • In February 2008, 25.8% of all subprime mortgages were delinquent, up from 9.9% a year prior. 8.1% of Alt-A mortgages were delinquent, up from 1.7%. And 3.2% of prime mortgages were delinquent, up from 2.6%. – At JP Morgan Chase, 3.5% of the bank’s prime mortgages were 30 days or more delinquent in Q1, up 40% since December and more than 200% YOY – At Wachovia, 1.15% of “traditional mortgages” were delinquent in Q1, more than double the number in Q4 • Nearly three million homeowners were behind on their mortgages at the end of 2007 and 1-2 million are at risk of foreclosure in 2008 • Foreclosures in April rose 65% YOY – About 2% of U.S. households were in some stage of foreclosure during April • Americans’ percentage of equity in their homes has fallen below 50 percent for the first time on record since 1945T2 Partners LLC -9-
  10. 10. Sales of Existing Homes Are Falling, Leading to a Surge in Inventories The proportion of Americans planning to buy a house is at a 33-year low Source: National Association of Realtors.T2 Partners LLC -10-
  11. 11. In Bubble Markets, Sales and Prices Are Way Down, While the Number of Homes Sold in Foreclosure Has Skyrocketed Case Study: Resale House Sales in San Diego 1,600 1,400 1,200 -34%ResaleHomes 1,000Sold Normal 800 1,417 -54% 657 Foreclosure 600 400 200 +328% 338 79 (5% of total) (34% of total) 0 January 07 January 08 The median resale home price fell 16.4% from 1/07 to 1/08 Note: Excludes condos and new construction. Source: San Diego Union-Tribune article, 2/13/08.T2 Partners LLC -11-
  12. 12. About $440 Billion of Adjustable Mortgages Are Scheduled to Reset This Year We are Loans with teaser rates were never supposed to here reset. Reinforced by many years of experience, both lenders and borrowers assumed that home prices would keep rising and easy credit would keep flowing, allowing borrowers to refinance before the reset. Now that home prices are falling and the mortgage market has frozen up, very few borrowers can refinance, which, as shown later in this presentation, is leading to a surge in defaults – in many cases, even before the interest rate resets! Actual reset & IO simultaneous Sources: LoanPerformance, Deutsche Bank; slide from Pershing Square presentation, How to Save the Bond Insurers, 11/28/07.T2 Partners LLC -12-
  13. 13. Subprime Resets Have Driven the Current Crisis. Option ARM Resets Will Likely Drive the Next Leg Down Monthly Mortgage Rate Resets Option ARM resets surge in 2010-11 Source: Credit Suisse.T2 Partners LLC -13-
  14. 14. What Is an Option ARM? From Washington Mutual’s 2007 10K (emphasis added): “The Option ARM home loan product is an adjustable-rate mortgage loan that provides the borrower with the option each month to make a fully-amortizing, interest-only, or minimum payment. As described in greater detail below, the minimum payment is typically insufficient to cover interest accrued in the prior month and any unpaid interest is deferred and added to the principal balance of the loan. The minimum payment on an Option ARM loan is based on the interest rate charged during the introductory period. This introductory rate has usually been significantly below the fully- indexed rate. The fully-indexed rate is calculated using an index rate plus a margin. Once the introductory period ends, the contractual interest rate charged on the loan increases to the fully- indexed rate and adjusts monthly to reflect movements in the index. If the borrower continues to make the minimum monthly payment after the introductory period ends, the payment may not be sufficient to cover interest accrued in the previous month. In this case, the loan will "negatively amortize" as unpaid interest is deferred and added to the principal balance of the loan. The minimum payment on an Option ARM loan is adjusted on each anniversary date of the loan but each increase or decrease is limited to a maximum of 7.5% of the minimum payment amount on such date until a "recasting event" occurs. A recasting event occurs every 60 months or sooner upon reaching a negative amortization cap. When a recasting event occurs, a new minimum monthly payment is calculated without regard to any limits on the increase or decrease in amount that would otherwise apply under the annual 7.5% payment cap. This new minimum monthly payment is calculated to be sufficient to fully repay the principal balance of the loan, including any theretofore deferred interest, over the remainder of the loan term using the fully-indexed rate then in effect. A recasting event occurs immediately whenever the unpaid principal balance reaches the negative amortization cap, which is expressed as a percent of the original loan balance. Prior to 2006, the negative amortization cap was 125% of the original loan balance... For all Option ARM loans originated in 2006, the negative amortization cap was 110% of the original loan balance. For Option ARM loans originated in 2007, the negative amortization cap was raised to 115%... In the first month that follows a recasting event, the minimum payment will equal the fully- amortizing payment.T2 Partners LLC -14-
  15. 15. Options ARMs Were Most Common in Housing Bubble States That Are Suffering the Greatest Home Price Declines California 18% Other 44% Nevada 12% Florida 9% Hawaii Arizona 9% 8% Note: Based on 2006 originations; Source: First American CoreLogic, as reported in Defaults Rising Rapidly For Pick-a-Pay Option Mortgages, WSJ, 4/30/08.T2 Partners LLC -15-
  16. 16. Background on Option ARMs and Their Rising Delinquencies • “Borrowers who make the minimum payment on a regular basis can see their loan balance grow and their monthly payment more than double when they begin making payments of principal and full interest. This typically happens after five years, but can occur earlier if the amount owed reaches a predetermined level -- typically 110% to 125% of the original loan balance.” • “’My sense is that many option ARM borrowers are in a worse position than subprime borrowers,’ says Kevin Stein, associate director of the California Reinvestment Coaliton, which combats predatory lending. ‘They wind up owing more and the resets are more significant.’" • “In Q1, Countrywide Financial Corp. said that 9.4% of the option ARMs in its bank portfolio were at least 90 days past due, up from 5.7% at the end of December and 1% a year earlier.” • “Washington Mutual Inc. reported earlier this month that option ARMs account for 50% of prime loans in its bank portfolio, but 70% of prime nonperforming loans.” • “At Wachovia Corp., non-performing assets in the companys option ARM portfolio, which was acquired with the companys purchase of Golden West Financial Corp., climbed to $4.6 billion in the first quarter from $924 million a year earlier.” Source: Defaults Rising Rapidly For Pick-a-Pay Option Mortgages, WSJ, 4/30/08.T2 Partners LLC -16-
  17. 17. Comments from a Federal Senior Bank Examiner “The next problem is with the Option ARM product. Approximately 80-90% are paying the minimum credit card payment and most loans are negatively amortizing. Here the payment shock is two-fold – rate and principal – and the increase in payments can be astronomical: 200% or higher, not the 10 to 100% that subprime has experienced. Also, the dollars exposed in Alt-A are nearly 50% higher than subprime (Alt-A average balance is $299k versus $181k for subprime). Also, 73% were underwritten with Low or No Doc. The option arm books of many lenders are already showing significant deterioration and they have not even recast yet. This is the next tsunami to hit the housing market. This will hit much higher price points $600k and above as this was the affordability product used by higher income/higher FICO score households to buy that dream home.”T2 Partners LLC -17-
  18. 18. The Timing Indicates That We Are Still in the Early Stages of the Bursting of the Great Mortgage Bubble • Mortgage lending standards became progressively worse starting in 2000, but really went off a cliff beginning in early 2005 • The worst loans are those with two-year teaser rates. As the subsequent pages show, they are defaulting at unprecedented rates, especially once the interest rates reset • Such loans made in Q1 2005 started to default in high numbers in Q1 2007, which not surprisingly was the beginning of the current crises • The crisis has continued to worsen as even lower quality loans made over the remainder of 2005 reset over the course of 2007, triggering more and more defaults • It takes an average of 15 months from the date of the first missed payment by a homeowner to a liquidation (generally a sale via auction) of the home • Thus, the Q1 2005 loans that defaulted in Q1 2007 are leading to foreclosures and auctions in early 2008 • Given that lending standards got much worse in late 2005, through 2006 and into the first half of 2007, there are sobering implications for expected defaults, foreclosures and auctions in 2008 and 2009, which promise to drive home prices down dramatically In summary, today we are only seeing the tip of the iceberg: an enormous wave of defaults, foreclosures and auctions is just beginning to hit the United States. We believe it will get so bad that large-scale federal government intervention is likely.T2 Partners LLC -18-
  19. 19. Hundreds of Billions of Dollars of Mortgages Were Securitized, Many On Terms With No Historical Precedent Securitized First Liens – Origination Volume These are the worst loans: $828 billion worth Green: Loans with historical precedent Yellow: Loans with limited historical precedent Red: Loans with no historical precedent Source: Amherst Securities Group, L.P.T2 Partners LLC -19-
  20. 20. Origination Volume of Fixed Rate, Full Doc Securitized Mortgage Loans, January 2005 In the best category of loans (full doc, fixed rate), in January 2005, just before mortgage lending standards collapsed, nearly all securitized mortgages were green, meaning they had FICO and LTV characteristics with historical precedent. Note: Subprime mortgages are generally those with FICO scores below 660; Alt-A is from 660 to 720-740.T2 Partners LLC -20-
  21. 21. Origination Volume of Fixed Rate, Full Doc Securitized Mortgage Loans, June 2005 Mortgage lending standards began to worsen by June 2005.T2 Partners LLC -21-
  22. 22. Origination Volume of Fixed Rate, Full Doc Securitized Mortgage Loans, January 2006 By January 2006, mortgage lending standards had deteriorated substantially, even more the best loans, with large percentages yellow and red, meaning they had FICO and LTV characteristics with little or no historical precedent.T2 Partners LLC -22-
  23. 23. Origination Volume of Fixed Rate, Full Doc Securitized Mortgage Loans, June 2006 By June 2006, mortgage lending standards had collapsed, even for the best loans, with large percentages yellow and red, meaning they had FICO and LTV characteristics with little or no historical precedent.T2 Partners LLC -23-
  24. 24. Origination Volume of 2/28, Low Doc Securitized Mortgage Loans, January 2005 For the worst category of loans (low/no doc with two-year teaser rates), mortgage lending standards were abysmal as early as January 2005 – and got worse from there.T2 Partners LLC -24-
  25. 25. Origination Volume of 2/28, Low Doc Securitized Mortgage Loans, June 2005T2 Partners LLC -25-
  26. 26. Origination Volume of 2/28, Low Doc Securitized Mortgage Loans, January 2006T2 Partners LLC -26-
  27. 27. Origination Volume of 2/28, Low Doc Securitized Mortgage Loans, June 2006 A very high percentage of these loans will never be repaid.T2 Partners LLC -27-
  28. 28. Monthly Default Rate for Fixed Rate Securitized Mortgage Loans (Green) 10% 9% Defaults are defined as loans that are 90 days or more 12/2004 delinquent. MDR measures the percentage of loans that 8% become 90 days or more delinquent during the month, as a 03/2005 percentage of non-delinquent loans at the beginning of the 06/2005 7% month. 09/2005 This chart shows the performance of the very best (fixed 6% rate, green) mortgages. Note that late 2004 and early 2005 12/2005 vintage loans have MDRs of approximately 30 basis points, MDR 5% 03/2006 which translates into a 3% cumulative default rate over three years, whereas more recent vintage loans are quickly spiking 06/2006 4% up to a 1% MDR, which translates into an 11.4% cumulative 09/2006 default rate in one year. 3% 12/2006 03/2007 2% 9/06 12/05 1% 12/04 0% 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 Source: Amherst Securities Group, L.P. Age (months)T2 Partners LLC -28-
  29. 29. Monthly Default Rate for Fixed Rate Securitized Mortgage Loans (Yellow) 10% 9% In this chart, late 2004 and early 2005 vintage loans have 12/2004 MDRs of approximately 50 basis points, which translates into 8% a 5.8% cumulative default rate in one year, whereas more 03/2005 recent vintage loans are quickly spiking up to a 2.5% MDR, 06/2005 7% which translates into an 26.2% cumulative default rate in one year. 09/2005 6% 12/2005 MDR 5% 03/2006 06/2006 4% 09/2006 3% 12/2006 03/2007 2% 1% 0% 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 Source: Amherst Securities Group, L.P. Age (months)T2 Partners LLC -29-
  30. 30. Monthly Default Rate for Fixed Rate Securitized Mortgage Loans (Red) 10% 9% In this chart, late 2004 and early 2005 vintage loans have MDRs of approximately 1%, which translates into a 11.4% 12/2004 8% cumulative default rate in one year, whereas more recent 03/2005 vintage loans are quickly spiking up to a 4.5% MDR, which translates into an 42% cumulative default rate in one year. 06/2005 7% 09/2005 6% 12/2005 MDR 5% 03/2006 06/2006 4% 09/2006 3% 12/2006 03/2007 2% 1% 0% 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 Age (months) Source: Amherst Securities Group, L.P.T2 Partners LLC -30-
  31. 31. Monthly Default Rate for 2-28 Securitized Mortgage Loans (Green) 10% 2-28 loans are those with two-year teaser 9% interest rates that then reset to much higher rates, which triggers a surge in defaults. 12/2004 8% In this chart, note the surge in MDR shortly 03/2005 after the two-year reset, as well as the 06/2005 7% rapidly rising MDR even before the reset in more recent vintage loans – compare 9/05 9/05 09/2005 6% and 9/06 loans, for example. 12/2005 A 5.0% MDR translates into a 46.0% MDR 5% 03/2006 cumulative default rate in one year. 06/2006 4% 9/06 09/2006 3% 12/2006 03/2007 2% 1% 0% 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 Source: Amherst Securities Group, L.P. Age (months)T2 Partners LLC -31-
  32. 32. Monthly Default Rate for 2-28 Securitized Mortgage Loans (Yellow) 10% 9% 12/2004 8% 03/2005 06/2005 7% 09/2005 9/06 loans are defaulting at 5% 6% per month even before the reset 12/2005 MDR 5% 03/2006 06/2006 4% 09/2006 3% 12/2006 03/2007 2% 1% 0% 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 Source: Amherst Securities Group, L.P. Age (months)T2 Partners LLC -32-
  33. 33. Monthly Default Rate for 2-28 Securitized Mortgage Loans (Red) 10% 9% For recent vintage 2-28 red loans, MDRs are jumping to 5% long before the reset and 12/2004 8% then spiking to 8% immediately thereafter. 03/2005 06/2005 7% 09/2005 6% 12/2005 MDR 5% 03/2006 06/2006 4% 09/2006 3% 12/2006 03/2007 2% 1% 0% 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 Source: Amherst Securities Group, L.P. Age (months)T2 Partners LLC -33-
  34. 34. Current MDR and CPR Trends Will Quickly Lead to Unprecedented Default Levels Three-Year Cumulative Defaults (1 yr): 2004 green, Late 2005 and thereafter, Historical levels fixed Green, 2/28 Late 2005 and thereafter, Late 2005 and thereafter, Green, fixed Red, 2/28 Note: Cumulative defaults represent the amount of loans in default as a percentage of the original balance at WALA 36 when keeping MDR and CPR constant for that time period. Source: Amherst Securities Group, L.P.T2 Partners LLC -34-
  35. 35. The IMF Estimates That Total Credit Losses Will Be Nearly $1 Trillion – And Only One Quarter of This Has Been Realized To Date The IMF’s estimate seems reasonable to us, except the estimate of prime losses, which appears to be roughly $30 billion. We think WaMu alone could have $ billion losses of $30 billion in its prime portfolio (from Option ARMs and HELOCs/CES). Source: IMF, BloombergT2 Partners LLC -35-
  36. 36. Where Did the Securitized Mortgages End Up? A Primer on ABSs and CDOs
  37. 37. Where Did All of These Toxic Loans End Up? They Were Securitized, First Into Asset-Backed Securities (ABS) Quick Review: What is a Securitization? Source: Deutsche Bank Securitization Research; “How to Save the Bond Insurers”, Pershing Square presentation, 11/28/07.T2 Partners LLC -37-
  38. 38. The Issuance of ABSs Backed By Subprime and Second-Lien Mortgages Surged in 2004, 2005 and 2006 Source: Thompson Financial, Deutsche Bank; “Whos Holding the Bag?”, Pershing Square presentation, 5/23/07.T2 Partners LLC -38-
  39. 39. Tranches from Asset-Backed Securities Were Pooled into Collateralized Debt Obligations (CDOs) Loss rates of, say, 20%, in the underlying RMBS’s can lead to catastrophic losses for a CDO This is an example of a “Mezzanine CDO.” A “High-Grade CDO” would select collateral primarily from the A and AA tranches mixed with ~25% senior tranches from other, often mezzanine, CDOs Note: Asset-based securities backed by home mortgages are called Residential Mortgage-Backed Securities (RMBS), those backed by commercial real estate loans are called Commercial Mortgage-Backed Securities (CMBS), etc. Source: Citigroup, All Clogged Up: What’s Ailing the Financial System, 2/13/08.T2 Partners LLC -39-
  40. 40. The CDO Market Has Disappeared Source: “How Mizuho Loved and Lost in CDOs”, WSJ, 5/14/08T2 Partners LLC -40-
  41. 41. How to Profit From the Continuing Mortgage and Credit Crises Long Positions Short Positions 1. Berkshire Hathaway 1. Washington Mutual 2. Fairfax Financial (In alphabetical order) As of May 12, 2008, funds managed by T2 Partners LLC are long Berkshire Hathaway and Fairfax Financial and short Washington Mutual. Positions may change at any time. This document is not a solicitation to invest in any investment product, nor is it intended to provide investment advice. It is intended for information purposes only and should be used by sophisticated investors who are knowledgeable of the risks involved. All data and comments herein are believed to be correct, but there are no guarantees and readers should do their own work.T2 Partners LLC -41-
  42. 42. Berkshire Hathaway
  43. 43. The Berkshire Hathaway Empire Today 6 Largest Stakes in Public Companies*T2 Partners LLC * As of 12/31/07
  44. 44. The Basics • Stock price (5/27/08): $127,910 – $4,295 for B shares • Shares outstanding: 1.55 million • Market cap: $198 billion • Total assets (Q1 ‘08): $281 billion • Total equity: $119 billion • Book value per share: $77,014T2 Partners LLC -44-
  45. 45. Recent Performance of Key Business Units (By Year) 2004 2005 2006 2007 Insurance Group: Premiums Earned GEICO 970 1,221 1,314 1,113 General Re 3 -334 523 555 Berkshire Reinsurance Group 417 -1,069 1,658 1,427 Berkshire H. Primary Group 161 235 340 279 Investment Income 2,824 3,480 4,316 4,758 Total Insurance Oper. Inc. 4,375 3,533 8,151 8,132 Non-Insurance Businesses: Finance and Financial products 584 822 1,157 1,006 McLane Company 228 217 229 232 Shaw Industries 466 485 594 436 MidAmerican/Utilities/Energy 237 523 1,476 1,774 Other businesses 1,787 1,921 2,703 3,279 Total Non-Insur. Oper. Inc. 3,302 3,968 6,159 6,727 Total Operating Income 7,677 7,501 14,310 14,859T2 Partners LLC -45-
  46. 46. The Earnings of Berkshire’s Operating Businesses Have Grown at a Very High Rate – And Growth is Accelerating Per-Share Per-Share Year Investments CAGR Pre-Tax Earnings CAGR 1965 $4 $4 1979 $577 42.8% $18 11.1% 1993 $13,961 25.6% $212 19.1% 2007 $90,343 14.3% $4,093 23.5% Berkshire is becoming less of an investment company and more of an operating business Note: CAGR: 1965-1979, 1979-1993, 1993-2007. EPS is pretax and net of minority interests.T2 Partners LLC -46-
  47. 47. Berkshire Is One of the Fastest Growing Large Companies in the World % Growth Company Name Market Cap Rate* Exxon Mobil $474,516 35 * 5-year General Electric $387,876 4 Microsoft $315,559 10 compound annual AT&T $237,739 17 growth rate of Procter & Gamble $218,699 15 Google $207,248 100 + EBIT (earnings Bank of America $195,133 - before interest Johnson & Johnson $186,472 10 and taxes) Chevron $184,244 46 Wal-Mart $174,527 11 through Q3 07 Cisco Systems $174,315 22 Citigroup $164,876 - Pfizer $155,924 5 Altria Group $153,151 1 Intel $147,052 13 AIG $144,718 17 Apple $144,257 147 JPMorgan Chase $143,173 - Coca-Cola $140,577 6 IBM $138,146 7 ConocoPhillips $132,059 64 Hewlett-Packard $124,752 33 Verizon $123,619 -1 Merck $121,670 -8 Pepsico $118,281 8 Median 12 Source: Capital IQT2 Partners LLC -47-
  48. 48. Valuing Berkshire “Over the years weve…attempt[ed] to increase our marketable investments in wonderful businesses, while simultaneously trying to buy similar businesses in their entirety.” – 1995 Annual Letter “In our last two annual reports, we furnished you a table that Charlie and I believe is central to estimating Berkshires intrinsic value. In the updated version of that table, which follows, we trace our two key components of value. The first column lists our per- share ownership of investments (including cash and equivalents) and the second column shows our per-share earnings from Berkshires operating businesses before taxes and purchase-accounting adjustments, but after all interest and corporate expenses. The second column excludes all dividends, interest and capital gains that we realized from the investments presented in the first column.” – 1997 Annual Letter “In effect, the columns show what Berkshire would look like were it split into two parts, with one entity holding our investments and the other operating all of our businesses and bearing all corporate costs.” – 1997 Annual LetterT2 Partners LLC -48-
  49. 49. Buffett’s Comments on Berkshire’s Valuation Lead to an Implied Multiplier of Approximately 12 Pre-tax EPS Excluding All Year-End Investments Income From Stock Intrinsic Implied Year Per Share Investments Price Value Multiplier 1996 $28,500 $421 $34,100 $34,100 13 1997 $38,043 $718 $46,000 $46,000 11 1998 $47,647 $474 $70,000 $54,000 13 1999 $47,339 -$458 $56,100 $60,000 • 1996 Annual Letter: “Todays price/value relationship is both much different from what it was a year ago and, as Charlie and I see it, more appropriate.” • 1997 Annual Letter: “Berkshires intrinsic value grew at nearly the same pace as book value” (book +34.1%) • 1998 Annual Letter: “Though Berkshires intrinsic value grew very substantially in 1998, the gain fell well short of the 48.3% recorded for book value.” (Assume a 15-20% increase in intrinsic value.) • 1999 Annual Letter: “A repurchase of, say, 2% of a companys shares at a 25% discount from per-share intrinsic value...We will not repurchase shares unless we believe Berkshire stock is selling well below intrinsic value, conservatively calculated...Recently, when the A shares fell below $45,000, we considered making repurchases.”T2 Partners LLC -49-
  50. 50. Applying the 12 Multiple: 2001 – 2007 Pre-tax EPS Excluding All Intrinsic Subsequent Investments Income From Value Year StockYear End Per Share Investments* Per Share Price Range 2001 $47,460 -$1,289 $64,000 $59,600-$78,500 2002 $52,507 $1,479 $70,000 $60,600-$84,700 2003 $62,273 $2,912 $97,000 $81,000-$95,700 2004 $66,967 $3,003 $103,000 $78,800-$92,000 2005 $74,129 $3,600 $117,300 85,700-$114,200 2006 $80,636 $5,200-$5,400** 143,000-144,400 107,200-151,650 2007 $90,343 $5,500-$5,700 *** 156,300-158,700 ? * Unlike the table on page 4 of the 2007 Annual Report, we include earnings from Berkshire’s insurance businesses. ** Actual result was $6,492, but we reduce this to assume the 2nd-worst year ever for super-cat losses. *** Actual result was $6,270 but we reduce the pre-tax, pre-investment-income margins of the insurance businesses by 400 basis points (from 14% to 10%) to reflect Buffett’s guidance in the Annual Report.T2 Partners LLC -50-
  51. 51. We Believe Berkshire Is Approximately 20% Undervalued Intrinsic value based on YE 2007 estimate: $157,000 Intrinsic Value* * Investments per share plus 12x pre-tax earnings per share (excluding all income from investments) for the prior year.T2 Partners LLC -51-
  52. 52. Buffett Is Putting Berkshire’s Cash to Work Rapidly 12 10 8 6 4 2 0 (2) 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1 08 (4) (6) Acquisitions Net Stock Purchases • He’s doing a good job – but the cash is coming in so fast! – A high-class problem • Markets have a way of presenting big opportunities on short notice – Junk bonds in 2002; cheap blue-chip stocks in 2005-07 – Buffett has reduced average maturity of bond portfolio so he can act quicklyT2 Partners LLC -52-
  53. 53. 12-Month Investment Return • Current intrinsic value: $157,000/share • Plus 10% growth of intrinsic value of the business • Plus cash build over next 12 months: $6,000/share • Equals intrinsic value in one year of $178,700 • 40% premium to today’s priceT2 Partners LLC -53-
  54. 54. Risks • No catalysts – Intrinsic value continues to grow nicely • Buffett’s health – In good health; turned 77 last Aug. 30th – Strong board and succession plan in place – Little Buffett premium in stock today • Major super-cats • Can’t find place to invest cash – This can change quickly – There are worse things than sitting on a lot of cash – Buffett has said Berkshire will distribute cash if he doesn’t think he can allocate itT2 Partners LLC -54-
  55. 55. Conclusion • Cheap stock: 80-cent dollar, giving no value to immense optionality • Extremely safe: huge cash and other assets provide downside protectionT2 Partners LLC -55-
  56. 56. Fairfax Financial
  57. 57. Fairfax and Its Primary Subsidiaries Had a Great 2007 and Growth and Underwriting Trends Have Been Strong for Many YearsT2 Partners LLC Source: -57- Fairfax presentation, year end 2007
  58. 58. Fairfax’s Financial Strength Has Improved Dramatically Q1 08 $1,155 Q1 08 911 1,121 2,032 1,132 900 6,401 12.3% 24.1% Source: Fairfax presentation, year end 2007; Q1 08 earnings releaseT2 Partners LLC -58-
  59. 59. Hamblin Watsa’s Investment Performance Has Been SpectacularT2 Partners LLC -59-
  60. 60. Fairfax’s CDS Portfolio Has Paid Off In a Big Way – And We Think There’s A Lot More Upside As the Credit Crunch Worsens Fairfax has harvested $1.125 billion in cash from its CDS portfolio in the last three quarters ($885M in Q1 alone) and, as of 4/25/08, has $17.5 billion notional amount of credit default swaps, valued at $685MT2 Partners LLC -60-
  61. 61. Fairfax Is Trading At a Low Multiple of Book Value, Even If the Entire CDS Portfolio is Excluded • Price (5/6/08): $282.75 • Market cap (5/6/08): $5.1 billion • Tangible book value (3/31/08): $4.76 billion • P/B: 1.07 • Tangible book value, subtracting $304.6 million loss on CDSs from 4/1/08 – 4/25/08 (with no tax adjustment): $4.46 billion • P/B (adjusted): 1.14 • Tangible book value, subtracting entire CDS portfolio of $990.9 million on 3/31/08 (with no tax adjustment): $3.77 billion • P/B (adjusted): 1.35 Summary: We think Fairfax’s core business is worth 1.5x book value, so at today’s price, the stock does not fully reflect this value, plus we’re getting a free call option on Fairfax’s CDS portfolio.T2 Partners LLC -61-
  62. 62. Washington Mutual
  63. 63. WaMu Over the Past Year Closed 5/27/08: $9.50T2 Partners LLC -63-
  64. 64. WaMu’s Loan Portfolio Mix Biggest areas of concern: $134.3 billon, Single-Family Residential1 55% of total exposure. $52.7 We think WaMu’s losses in these three 22% areas could exceed $30 billion. 23% Option ARMs $55.8 Source: WaMu Q1 08 Credit Risk Management presentationT2 Partners LLC -64-
  65. 65. Net Charge Offs Are Rising Rapidly in WaMu’s Option ARM Portfolio 1 Estimated loan-to-value calculation based on OFHEO December 2007 data (released February 2008).T2 Partners LLC Source: WaMu Q1 08 Credit Risk Management presentation -65-
  66. 66. 82% of WaMu’s Option ARM Portfolio Experienced a Net Increase in Negative Amortization During 2007 100% No Increase: $10.7 billion 75% 50% Increase: $48.2 billion 25% 0% Source: WaMu 2007 10K, page 57.T2 Partners LLC -66-
  67. 67. Option ARM Portfolio Resets Spell Future Trouble Source: WaMu Q1 08 Credit Risk Management presentationT2 Partners LLC -67-
  68. 68. 62% of WaMu’s Option ARM Portfolio Is in California and Florida Other 29% California 49% NY/NJ 9% Florida 13% Source: WaMu 2007 10K, page 58.T2 Partners LLC -68-
  69. 69. 71% of WaMu’s Option ARM Portfolio Was Originated in the Peak Bubble Years of 2005-2007 2007 25% Pre-2005 29% 2006 23% 2005 23% Source: WaMu 2007 10K, page 57.T2 Partners LLC -69-
  70. 70. Net Charge Offs Are Rising Rapidly in WaMu’s Home Equity Loan/HELOC Portfolio 1 74% of WaMu’s exposure is 2nd liens 1 Excludes home equity loans in the Subprime Mortgage Channel. 2 Estimated loan-to-value calculation based on OFHEO December 2007 data (released February 2008).T2 Partners LLC Source: WaMu Q1 08 Credit Risk Management presentation -70-
  71. 71. WaMu Has More Exposure to Home Equity Loans Than Any Other Large Bank With the Exception of Countrywide Source: U.S. Home Equity Woes: Banks Grapple With Higher Losses, Fitch, 3/14/08T2 Partners LLC -71-
  72. 72. 72% of WaMu’s Home Equity Loan and HELOC Portfolio Was Originated in the Peak Bubble Years of 2005-2007 2007 Pre-2005 27% 28% 2006 2005 24% 21% Source: WaMu 2007 10K, page 54.T2 Partners LLC -72-
  73. 73. Net Charge Offs Are Rising Rapidly in WaMu’s Subprime Portfolio 1 1 Comprised of mortgage loans purchased from recognized subprime lenders and mortgage loans originated under the Long Beach Mortgage name and held for investment. 2 Estimated loan-to-value ratio based on OFHEO December 2007 data (released February 2008). 3 Estimated combined loan-to-value ratio based on OFHEO December 2007 data (released February 2008).T2 Partners LLC Source: WaMu Q1 08 Credit Risk Management presentation -73-
  74. 74. 75% of WaMu’s Subprime Portfolio Was Originated in the Peak Bubble Years of 2005-2007 2007 11% Pre-2005 25% 2006 40% 2005 24% Source: WaMu 2007 10K, page 59.T2 Partners LLC -74-
  75. 75. Subprime Mortgage Channel Resets Are Almost Over Source: WaMu Q1 08 Credit Risk Management presentationT2 Partners LLC -75-
  76. 76. Loan Volumes of Fixed-Rate Loans Have Risen, While ARM and HEL/HELOC Loan Volumes Have Tumbled $15,000 Fixed-rate Loans $12,000 Option ARMs $9,000 Medium- term ARMs HEL& $6,000 HELOC $3,000 $0 Q1 07 Q2 07 Q3 07 Q4 07 Q1 08T2 Partners LLC Source: WaMu Q1 08 earnings release -76-
  77. 77. WaMu’s Total Nonperforming AssetsT2 Partners LLC Source: WaMu Q1 08 Credit Risk Management presentation -77-
  78. 78. WaMu’s Allowance for Loan LossesT2 Partners LLC Source: WaMu Q1 08 Credit Risk Management presentation -78-
  79. 79. We Think Even WaMu’s Aggressive Estimate for Cumulative Remaining Losses in Its Home Loan Portfolio Will Prove to Be Too LowT2 Partners LLC -79-
  80. 80. Summary of Why We Are Short WaMu • WaMu has lost $3.59/share in the last two quarters (-$2.19 in Q4 07 and -$1.40 in Q1 08) • With the recent investment by TPG, tangible book value per share is a bit under $13 • We think the company will lose $4-5/share in 2008 • This would reduce book value to $8-9/share • With huge losses in the immediate past and Option ARM losses looming due to large resets in 2009-2012, we question whether the stock would even trade at book valueT2 Partners LLC -80-

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