Savings & Loan Crisis

Kingswell asked Lynch about the folly of forecasting macro events, and his answer was that the consistent failure of macro forecasts — across decades, across forecasters, across regimes — is itself the strongest evidence that the activity does not pay. Lynch's Magellan record was built without a single correct macro call: he owned stocks through the 1979 oil shock, the 1981-82 recession, the 1987 crash, and the savings-and-loan crisis. In each case the macro forecasters were divided, and in each case the right action was to own businesses whose operating economics survived the macro event. Lynch's framing was that the macro economy has too many variables for any forecaster to model, and that the forecasts that turn out correct are usually correct for the wrong reasons. The forecasters who predicted the 1987 crash did so on the basis of a U.S. trade-deficit argument that turned out to be unrelated to the actual cause (portfolio-insurance mechanics). Being right for the wrong reason is no better than being wrong, because the rightness cannot be repeated. Lynch's Magellan compounding came from refusing to bet on macro forecasts and concentrating on the micro — the businesses whose cash flows he could underwrite from primary research. The article also touched on Lynch's view of 'Future Man' — his phrase for the contemporary habit of treating technological change as a foregone conclusion. Lynch's argument was that technology adoption curves are uncertain, that the beneficiaries of any given technology shift are usually not the companies the headlines mention, and that the investor who buys 'the future' at a hundred times earnings is paying for a forecast that has historically been wrong more often than right. He preferred to find the established businesses that the future, when it arrived, would benefit — and to buy them at prices that did not require the future to arrive on schedule.

What’s interesting about those outcomes is that it was only five or six transactions that carried all the freight. We focused on doing a few things over a long period of time and having them work out well. Those little nothing companies? They were all doomed savings and loan associations, and savings and loans [were] pretty well gone, and yet they worked out fairly well. There again, just a few decisions over a long period of time.the

But he has no magic wand with which to compensate for competitive losses among his best customers or from the weak economic conditions. He is redoubling his efforts to pare costs, which must be his response to conditions faced. Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco’s former involvement with Mutual Savings, Wesco’s long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of appreciated real estate assets consisting mainly of the nine-story commercial office building in downtown Pasadena, where Wesco is headquartered. Adjacent to that building is a multi-story luxury condominium building which MS Property Company has recently built and is in process of marketing. For more information, if you want a very-high-end condominium, simply phone Chris Greco (626-585-6700). MS Property Company’s results of operations, immaterial versus Wesco’s present size, are included in the breakdown of earnings on page 1 within “other operating earnings.” Other Operating Earnings (Loss) Other operating earnings (loss), net of interest paid and general corporate expenses, amounted to ($6.9 million) in 2009 and ($0.4 million) in 2008. The 2009 figure includes a $6.2 million after-tax writedown of the book carrying value of a condominium building that was completed in the worst condominium market in decades.

We do not consider Precision Steel’s recent after-tax operating earnings of approx- imately $1 million annually to be a satisfactory investment outcome, particularly when compared with its after-tax operating earnings which averaged $2.3 million for the years 1998 through 2000. And, because of the intensifying recession, more difficulty for Pre- cision Steel will surely lie ahead. Terry Piper, who became Precision Steel’s President and Chief Executive Officer in 1999, has done an outstanding job in leading Precision Steel through very difficult years. But he has no magic wand with which to compensate for competitive losses among his best customers or from the deepening recession. He is undertaking the difficult task of paring costs to an endurable level. Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco’s former involvement with Mutual Savings, Wesco’s long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of appreciated real estate assets consisting mainly of the nine-story commercial office building in downtown Pasadena, where Wesco is headquartered. Adjacent to that building is a parcel of land on which our construction of a multi-story luxury condominium building is almost complete. We are also seeking city approval of our plans to build another multi-story luxury condominium building, at a later date, on a vacant parcel of land in the next block.

$0.9 million for 2003, we do not consider present operating results to be a satisfactory investment outcome. Recent earnings of Precision Steel compare unfavorably with oper- ating earnings which averaged $2.3 million, after taxes, for the years 1998 through 2000. Because the steel warehouse business may revert to even more difficult conditions, more decline for Precision Steel may lie ahead. Terry Piper, who became Precision Steel’s President and Chief Executive Officer in 1999, has done an outstanding job in leading Precision Steel through very difficult years. But he has no magic wand with which to compensate for competitive losses among his best customers. Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco’s former involvement with Mutual Savings, Wesco’s long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of appreciated real estate assets consisting mainly of the nine-story commercial office building in downtown Pasadena, where Wesco is headquartered. Adjacent to that building is a parcel of land on which our construction of a multi-story luxury condominium building is nearing com- pletion. We are also seeking city approval of our plans to build another multi-story luxury condominium building, at a later date, on a vacant parcel of land in the next block.

Terry Piper, who became Precision Steel's President and Chief Executive OÇcer in 1999, has done an outstanding job in leading Precision Steel through very diÇcult years. But he has no magic wand with which to compensate for competitive losses among his best customers. Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of appreciated real estate assets consisting mainly of the nine-story commercial oÇce building in downtown Pasadena, where Wesco is headquartered. Adjacent to that building is a parcel of land on which we are building a multi-story luxury condominium building. We are also seeking city approval of our plans to build another multi-story luxury condominium building on a vacant parcel of land in the next block. For more information, if you want a very-high-end condominium, simply phone Bob Sahm (626-585-6700). MS Property Company's results of operations, immaterial versus Wesco's present size, are included in the breakdown of earnings on page 1 within ""other operating earnings.'' Other Operating Earnings Other operating earnings, net of interest paid and general corporate expenses, amounted to $.2 million in 2006, versus $5.2 million in 2005. Had it not been for favorable income tax adjustments of $4.

Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of appreciated real estate assets consisting mainly of the nine-story commercial oÇce building in downtown Pasadena, where Wesco is headquartered. Adjacent to that building is a parcel of land on which we have begun to build a multi-story luxury condominium building. We are also seeking city approval of our plans to build another multi-story luxury condominium building on a vacant parcel of land in the next block. We have recently begun to take reservations. Simply phone Bob Sahm (626-585- 6700) for more information. MS Property Company's results of operations, immaterial versus Wesco's present size, are included in the breakdown of earnings on page 1 within ""other operating earnings.''

Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of appreciated real estate assets with a net book value of about $8.6 million, consisting mainly of the nine-story commercial oÇce building in downtown Pasadena, where Wesco is headquartered. MS Property Company's results of opera- tions, immaterial versus Wesco's present size, are included in the breakdown of earnings on page 1 within ""other operating earnings.''

Terry Piper, who became Precision Steel's President and Chief Executive OÇcer late in 1999, has done an excellent job in leading Precision Steel through diÇcult years. Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of appreciated real estate assets with a net book value of about $6.4 million, consisting mainly of the nine-story commercial oÇce building in downtown Pasadena, where Wesco is headquartered. MS Property Company's results of opera- tions, immaterial versus Wesco's present size, are included in the breakdown of earnings on page 1 within ""other operating earnings.'' Other Operating Earnings Other operating earnings, net of interest paid and general corporate expenses, amounted to $.4 million in 2003 and $.6 million in 2002. Sources were (1) rents ($3.2 million gross in 2003) from Wesco's Pasadena oÇce property (leased almost entirely to outsiders, including Citibank as the ground Öoor tenant), and (2) interest and dividends from cash equivalents and marketable securities held outside the insurance subsidiaries, less (3) general corporate expenses plus minor expenses involving tag-end real estate.

Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of real estate assets with a net book value of about $5.8 million, consisting mainly of the nine-story commercial oÇce building in downtown Pasadena, where Wesco is headquartered. MS Property Company's results of operations, immaterial versus Wesco's present size, are included in the breakdown of earnings on page 1 within ""other operating earnings.'' Other Operating Earnings Other operating earnings, net of interest paid and general corporate expenses, amounted to $.6 million in both 2002 and 2001. Sources were (1) rents ($3.3 mil- lion gross in 2002) from Wesco's Pasadena oÇce property (leased almost entirely to outsiders, including Citibank as the ground Öoor tenant), and (2) interest and dividends from cash equivalents and marketable securities held outside the insur- ance subsidiaries, less (3) general corporate expenses plus minor expenses involving tag-end real estate. Corporate Governance Two of our long-standing directors, Jim Gamble and Dave Robinson, are not standing for reelection. At practically no pay, they have been wise and honorable protectors of Wesco shareholders for many decades going back to a time before Berkshire Hathaway had any interest in Wesco.

07 Precision Steel businesses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 388 .05 1,281 .18 Goodwill amortization (3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (6,814) (.96) (5,867) (.82) Other(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 632 .09 167 .02 52,536 7.38 70,087 9.84 Realized net securities gains ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì 852,383 119.72 Wesco consolidated net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $52,536 $7.38 $922,470 $129.56 (1) All Ñgures are net of income taxes. (2) Per-share data are based on 7,119,807 shares outstanding. Wesco has had no dilutive capital stock equivalents. (3) In accordance with a new pronouncement of the Financial Accounting Standards Board, Wesco will no longer be required to amortize goodwill beginning in 2002. The requirement for such amortization has been replaced by a standard that requires an annual assessment to determine whether the value of goodwill has been impaired, at which time the intangible would be written down or written oÅ, as appropriate. (4) After deduction of interest and other corporate expenses, and costs and expenses associated with foreclosed real estate previously charged against Wesco's former Mutual Savings and Loan Association subsidiary. Income was from ownership of the Wesco headquarters oÇce building, primarily leased to outside tenants, and interest and dividend income from cash equivalents and marketable securities owned outside the insurance subsidiaries.

Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of real estate assets with a net book value of about $5.8 million, consisting mainly of the nine-story commercial oÇce building in downtown Pasadena, where Wesco is headquartered. MS Property Company's results of operations, immaterial versus Wesco's present size, are included in the breakdown of earnings on page 1 within ""other operating earnings.'' Other Operating Earnings Other operating earnings, net of interest paid and general corporate expenses, amounted to $.6 million in 2001 and $.2 million in 2000. Sources were (1) rents ($3.2 million gross in 2001) from Wesco's Pasadena oÇce property (leased almost entirely to outsiders, including California Federal Bank as the ground Öoor tenant), and (2) interest and dividends from cash equivalents and marketable securities held outside the insurance subsidiaries, less (3) general corporate expenses plus minor expenses involving tag-end real estate. Realized Net Securities Gains The main tag end from Wesco's savings and loan days was an investment in Freddie Mac common stock, purchased by Mutual Savings for $72 million at a time when Freddie Mac shares could be lawfully owned only by a savings and loan association.

07 Ì Ì Precision Steel businesses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,281 .18 2,532 .35 Goodwill amortizationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (5,867) (.82) (782) (.11) Other(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 167 .02 730 .11 70,087 9.84 46,872 6.58 Realized net securities gains ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 852,383 119.72 7,271 1.02 Wesco consolidated net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $922,470 $129.56 $54,143 $7.60 (1) All Ñgures are net of income taxes. (2) Per-share data is based on 7,119,807 shares outstanding. Wesco has had no dilutive capital stock equivalents. (3) After deduction of interest and other corporate expenses, and costs and expenses associated with foreclosed real estate previously charged against Wesco's former Mutual Savings and Loan Association subsidiary. Income was from ownership of the Wesco headquarters oÇce building, primarily leased to outside tenants, and interest and dividend income from cash equivalents and marketable securities owned outside the insurance subsidiaries. The 1999 Ñgure also includes net gains on sales of foreclosed real estate and a beneÑt from the reduction of loss reserves provided in prior years against possible losses on sales of loans and foreclosed real estate. This supplementary breakdown of earnings diÅers somewhat from that used in audited Ñnancial statements which follow standard accounting convention. The supplementary breakdown is furnished because it is considered useful to shareholders.

Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of real estate assets with a net book value of about $6.5 million. MS Property Company's results of operations, immaterial versus Wesco's present size, are included in the breakdown of earnings on page 1 within ""other operating earnings.'' Other Operating Earnings Other operating earnings, net of interest paid and general corporate expenses, amounted to $.2 million in 2000 and $.7 million in 1999. Sources were (1) rents ($3 million gross in 2000) from Wesco's Pasadena oÇce property (leased almost entirely to outsiders, including California Federal Bank as the ground Öoor tenant), and (2) interest and dividends from cash equivalents and marketable securities held outside the insurance subsidiaries, less (3) general corporate expenses plus minor expenses involving tag-end real estate.time

when Freddie Mac shares could be lawfully owned only by a savings and loan association. Those shares, carried on Wesco's balance sheet at yearend 1999 at a market value of $1.4 billion, were sold in 2000, giving rise to the principal portion of the $852.4 million of after-tax securities gains realized by Wesco in 2000, versus $7.3 million, after taxes, realized in 1999. Although the realized gains materially impacted Wesco's reported earnings for each year, they had a very minor impact on Wesco's shareholders' equity. Inasmuch as the greater portion of each year's realized gains had previously been reÖected in the unrealized gain component of Wesco's shareholders' equity, those amounts were merely switched from unrealized gains to retained earnings, another component of shareholders' equity. Consolidated Balance Sheet and Related Discussion As indicated in the accompanying Ñnancial statements, Wesco's net worth, as accountants compute it under their conventions, increased to $1.98 billion ($278 per Wesco share) at yearend 2000 from $1.90 billion ($266 per Wesco share) at yearend 1999. The foregoing $278-per-share book value approximates liquidation value assum- ing that all Wesco's non-security assets would liquidate, after taxes, at book value. Probably, this assumption is too conservative.

28 Realized net securities gainsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,271 1.02 33,609 4.72 Gain on sales of foreclosed properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 968 .14 572 .08 Wesco consolidated net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $54,143 $7.60 $71,803 $10.08 (1) All Ñgures are net of income taxes. (2) Per-share data is based on 7,119,807 shares outstanding. Wesco has had no dilutive capital stock equivalents. (3) After deduction of interest and other corporate expenses, and costs and expenses associated with foreclosed real estate previously charged against Wesco's former Mutual Savings and Loan Association subsidiary. Income was from ownership of the Wesco headquarters oÇce building, primarily leased to outside tenants, interest and dividend income from cash equivalents and marketable securities owned outside the insurance subsidiaries, and, in 1999, the reduction of loss reserves provided in prior years against possible losses on sales of loans and foreclosed real estate. This supplementary breakdown of earnings diÅers somewhat from that used in audited Ñnancial statements which follow standard accounting convention. The supplementary breakdown is furnished because it is considered useful to shareholders. Wesco-Financial Insurance Company (""Wes-FIC'') Wes-FIC's normal net income for 1999 was $43,610,000, versus $34,654,000 for 1998.by

Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of assets and liabilities with a net book value of about $15 million. MS Property Company's results of operations, immaterial versus Wesco's present size, are in- cluded in the foregoing breakdown of earnings within ""all other 'normal' net operating income (loss).'' Of course, the main tag end from Wesco's savings and loan days is an investment in Freddie Mac common stock, purchased by Mutual Savings for $72 mil- lion at a time when Freddie Mac shares could be lawfully owned only by a savings and loan association. The 28,800,000 shares owned by Wes-FIC at yearend 1999 had a market value of $1.4 billion. All Other ""Normal'' Net Operating Income or Loss All other ""normal'' net operating income or loss, net of interest paid and general corporate expenses, amounted to after-tax losses of $238,000 in 1999 and $186,000 in 1998. Sources were (1) rents ($2,862,000 gross in 1999) from Wesco's Pasadena oÇce property (leased almost entirely to outsiders, including California Federal Bank as the ground Öoor tenant), and (2) interest and dividends from cash equivalents and marketable securities held outside the insurance subsidiaries, less (3) costs and expenses of liquidating tag-end foreclosed real estate.

38 Realized net securities gains ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 33,609 4.72 62,697 8.80 Gain on sales of foreclosed properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 572 .08 850 .12 Wesco consolidated net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $71,803 $10.08 $101,809 $14.30 (1) All Ñgures are net of income taxes. (2) Per-share data is based on 7,119,807 shares outstanding. Wesco has had no dilutive capital stock equivalents. (3) After deduction of interest and other corporate expenses, and costs and expenses associated with foreclosed real estate previously charged against Wesco's former Mutual Savings and Loan Association subsidiary. Income was from ownership of the Wesco headquarters oÇce building, primarily leased to outside tenants, interest and dividend income from cash equivalents and marketable securities owned outside the insurance subsidiaries, and, in 1997, the reduction of loss reserves provided in prior years against possible losses on sales of foreclosed real estate. This supplementary breakdown of earnings diÅers somewhat from that used in audited Ñnancial statements which follow standard accounting convention. The supplementary breakdown is furnished because it is considered useful to shareholders.

Wesco-Financial Insurance Company (""Wes-FIC'') Wes-FIC's normal net income for 1998 was $34,654,000, versus $33,507,000 for 1997. The Ñgures include $4,987,000 in 1998 and $6,044,000 in 1997 contributed by The Kansas Bankers Surety Company (""KBS''), owned by Wes-FIC since 1996. KBS is discussed in the section, ""The Kansas Bankers Surety Company,'' below. At the end of 1998 Wes-FIC retained about $24 million in invested assets, oÅset by claims reserves, from its former reinsurance arrangement with Fireman's Fund Group. This arrangement was terminated August 31, 1989. However, it will take a long time before all claims are settled, and, meanwhile, Wes-FIC is being helped over many years by proceeds from investing ""Öoat.'' We previously informed shareholders that Wes-FIC had entered into the busi- ness of super-cat reinsurance through retrocessions from the Insurance Group of Berkshire Hathaway, Wesco's ultimate parent. Wes-FIC's entry into the super-cat reinsurance business early in 1994 followed the large augmentation of its claims- paying capacity caused by its merger with Mutual Savings, the former savings and loan subsidiary of Wesco. In 1994, in recognition of Wes-FIC's sound Ñnancial condition, Standard and Poor's Corporation assigned to Wes-FIC the highest possible claims-paying-ability rating: AAA. The super-cat reinsurance business, in which Wes-FIC is engaged, continues to be a very logical business for Wes-FIC.

Precision Steel The businesses of Wesco's Precision Steel subsidiary, headquartered in the outskirts of Chicago at Franklin Park, Illinois, contributed $3,154,000 to normal net operating income in 1998, compared with $3,622,000 in 1997. The decrease in proÑt occurred as revenues decreased 2%, despite a 5% increase in pounds of product sold, and was attributable mainly to expenditures necessitated to upgrade computers and computer systems to ensure that Precision Steel's order-taking and other data processing systems continue to function accurately beyond December 31, 1999. Under the skilled leadership of David Hillstrom, Precision Steel's businesses in 1998 continued to provide an excellent return on resources employed. Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of assets and liabilities with a net book value of about $13 million. MS Property Company's results of operations, immaterial versus Wesco's present size, are in- cluded in the foregoing breakdown of earnings within ""all other 'normal' net operating income (loss).''loan

Daily Journal Corporation's late-1990s filings are notable for what they do and do not show. The company had, under Munger's chairmanship, avoided the speculative derivatives exposure that had destroyed several of its peers in the savings-and-loan and publishing-adjacent industries during the savings-and-loan crisis. The 10-K filings disclose a conservatively-financed publisher with a real moat - the appellate-decisions monopoly - and no exposure to the structured products that had ruined other ostensibly conservative companies in the same region. Munger's role at DJCO throughout the 1990s was, in effect, the same role he played at Berkshire: the disciplined refuser. He had refused to let Daily Journal take on the leverage that the cheap-money years of the mid-1990s had tempted other small public companies to take on. He had refused to chase the incremental yield that derivatives contracts appeared to offer. He had insisted that the company finance itself conservatively, hold its franchise honestly, and let the cash earnings of the legal publishing monopoly compound rather than leveraging them up in the name of growth. The retrospective lesson, visible in the 1997 10-K, was that avoidance was the operating decision. The companies that failed in the savings-and-loan crisis had not failed because they were stupid; they had failed because they had taken on exposure they did not need to take on, in pursuit of returns they did not need to pursue. Daily Journal, under Munger, had refused the exposure and survived the crisis with its franchise intact and its balance sheet clean. The same discipline would, two decades later, allow Daily Journal to pivot into court-automation software with the financial strength to absorb the long, slow, expensive slog of building that business. The avoidance had bought the optionality.

32 Realized net securities gains (losses)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 62,697 8.80 (115) (.02) Gain on sales of foreclosed properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 850 .12 14 Ì Wesco consolidated net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $101,809 $14.30 $30,619 $4.30 (1) All Ñgures are net of income taxes. (2) Per-share data is based on 7,119,807 shares outstanding. Wesco has had no dilutive capital stock equivalents. (3) After deduction of interest and other corporate expenses, and costs and expenses associated with delinquent loans and foreclosed real estate previously charged against Wesco's former Mutual Savings and Loan Association subsidiary. Income was from ownership of the Wesco headquarters oÇce building, primarily leased to outside tenants, interest and dividend income from cash equivalents and marketable securities owned outside the insurance subsidiaries, and, in 1997, the reduction of loss reserves provided in prior years against possible losses on sales of foreclosed real estate. This supplementary breakdown of earnings diÅers somewhat from that used in audited Ñnancial statements which follow standard accounting convention. The supplementary breakdown is furnished because it is considered useful to shareholders. Wesco-Financial Insurance Company (""Wes-FIC'') Wes-FIC's normal net income for 1997 was $33,507,000, versus $27,249,000 for 1996.by

The Kansas Bankers Surety Company (""KBS'') following its purchase by Wes-FIC early in the third quarter of 1996. The purchase of KBS is discussed in the section, ""The Kansas Bankers Surety Company,'' below. At the end of 1997 Wes-FIC retained about $27.5 million in invested assets, oÅset by claims reserves, from its former reinsurance arrangement with Fireman's Fund Group. This arrangement was terminated August 31, 1989. However, it will take a long time before all claims are settled, and, meanwhile, Wes-FIC is being helped over many years by proceeds from investing ""Öoat.'' We previously informed shareholders that Wes-FIC had entered into the busi- ness of super-cat reinsurance through retrocessions from the Insurance Group of Berkshire Hathaway, Wesco's ultimate parent. Wes-FIC's entry into the super-cat reinsurance business early in 1994 followed the large augmentation of its claims- paying capacity caused by its merger with Mutual Savings, the former savings and loan subsidiary of Wesco. In 1994, in recognition of Wes-FIC's sound Ñnancial condition, Standard and Poor's Corporation assigned to Wes-FIC the highest possible claims-paying-ability rating: AAA. The super-cat reinsurance business, in which Wes-FIC is engaged, continues to be a very logical business for Wes-FIC. Wes-FIC has a large net worth in relation to annual premiums being earned.

Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of assets and liabilities with a net book value of about $13 million. In 1997, MS Property Company shrunk by approximately half after sales of several foreclosed properties and contribution of $12,750,000 in cash to Wesco. MS Property Company's results of operations, immaterial versus Wesco's present size, are included in the foregoing breakdown of earnings within ""all other 'normal' net operating income.'' Of course, the main tag end from Wesco's savings and loan days is 28,800,000 shares of Federal Home Loan Mortgage Corporation (""Freddie Mac''), purchased by Mutual Savings for $72 million at a time when Freddie Mac shares could be lawfully owned only by a savings and loan association. This holding, with a market value of $1.2 billion at yearend 1997, now reposes in Wes-FIC. All Other ""Normal'' Net Operating Income All other ""normal'' net operating income, net of interest paid and general corporate expenses, increased to $1,133,000 in 1997 from $438,000 in 1996.of

Lynch dedicated a chapter of Beating the Street to the savings-and-loan crisis, framing it as the classic case where the panic of the crowd obscures the underlying value. Thrifts that had survived the interest-rate mismatch of the early 1980s were being marked down to fractions of book value because the market could not distinguish between the insolvent and the merely illiquid. Lynch's method was to read the balance sheets himself, look for institutions whose loan books were concentrated in sectors that had not deteriorated, and back the managements that had refused to chase yield into junk bonds or speculative real estate. The operational edge was the same scuttlebutt method he applied elsewhere: visit the branches, count the deposit accounts, look at the construction loans on the books. A thrift whose loan book was concentrated in local commercial real estate that the local press was reporting as healthy was worth more than its book value; a thrift whose book was concentrated in energy loans in Houston in 1983 was worth less. The market's inability to make these distinctions created the gap. Lynch's positions in financials during this period were not macro calls on interest rates but bottom-up inspections of individual balance sheets. The deeper lesson Lynch drew was about the asymmetric structure of financials investing. A bank or thrift with a clean book and a deposit franchise has a floor under its value — the deposit franchise alone is worth a multiple of book if the institution can be acquired. The downside is capped by the deposit base and the upside is uncapped if loan losses turn out to be lower than the market has priced. The asymmetry is what makes financials attractive at the bottom of a credit cycle: the most an investor can lose is one times their money, while the upside, in a successful turnaround or acquisition, can be a multiple.

Blue Chip Stamps and Wesco are public companies with reporting requirements of their own. On pages 40 to 53 of this report we have reproduced the narrative reports of the principal executives of both companies, in which they describe 1980 operations. We recommend a careful reading, and suggest that you particularly note the superb job done by Louie Vincenti and Charlie Munger in repositioning Mutual Savings and Loan. A copy of the full annual report of either company will be mailed to any Berkshire shareholder upon request to Mr. Robert H. Bird for Blue Chip Stamps, 5801 South Eastern Avenue, Los Angeles, California 90040, or to Mrs. Bette Deckard for Wesco Financial Corporation, 315 East Colorado Boulevard, Pasadena, California 91109.

Last year we said that we expected operating earnings in dollars to improve but return on equity to decrease. This turned out to be correct. Our forecast for 1980 is the same. If we are wrong, it will be on the downside. In other words, we are virtually certain that our operating earnings expressed as a percentage of the new equity base of approximately $236 million, valuing securities at cost, will decline from the 18.6% attained in 1979. There is also a fair chance that operating earnings in aggregate dollars will fall short of 1979; the outcome depends partly upon the date of disposition of the bank, partly upon the degree of slippage in insurance underwriting profitability, and partly upon the severity of earnings problems in the savings and loan industry.