On page nine of Berkshire Hathaway’s (BRK.A, Financial) (BRK.B, Financial) first-quarter earnings report, there is an interesting note about one of the company’s subsidiaries:
“Additional information concerning these investments follows. We own a 50% interest in Berkadia, with Jefferies Financial Group Inc. (“Jefferies”) owning the other 50% interest. Berkadia provides capital solutions, investment sales advisory and mortgage servicing for multifamily and commercial real estate.”
This note formed part of the commentary on the accounts for equity method investments. The group’s Berkadia subsidiary is accounted for using the equity method due to the size of the holding, but it is one of those investments in Berkshire’s stable that rarely gets talked about.
A hidden asset bought on favorable terms
The company dates back to 2009. The entity is one of Warren Buffett (Trades, Portfolio)’s financial crisis-era investments that he made when the market was on the edge of collapse.
In December 2009, Berkshire and Leucadia National Corp. formed a new entity named Berkadia Commercial Mortgage in order to acquire Capmark Financial Group’s North American loan origination and servicing business.
This is another example of how the conglomerate was able to use its huge financial resources to design a favorable outcome for one of its acquisitions. The initial cost to partners was $217.2 million, to which Berkshire added an additional $1 billion in a five-year secured credit facility.
Berkadia’s main business involves servicing commercial mortgage loans, which involves collecting payments from individual borrowers and ensuring that components of the payment (principal, interest, insurance and taxes) are paid to the correct recipient in a timely manner.
This is not a particularly unique business. There are plenty of other companies on the market providing the same service. However, it does require a stable backer and access to financing. This is where Berkshire has been able to lean on its advantages as a responsible funder of businesses that is in it for the long term.
As Berkshire’s first-quarter 2022 report goes on to note:
“A source of funding for Berkadia’s operations is through commercial paper, which was $1.47 billion at March 31, 2022 and is limited to $1.5 billion. Berkadia’s commercial paper is supported by a surety policy issued by a Berkshire insurance subsidiary. Jefferies is obligated to indemnify us for one-half of any losses incurred under the policy.”
Leucadia’s annual reports provide much more information on the joint venture. The structure of the deal is, as we would expect, tilted in Berkshire’s favor. The entity began with a loan from the conglomerate via a secured credit facility worth as much as $1 billion. Berkshire earned interest on this loan as well as holding a 50% equity stake in the company. It now looks as if the company is benefiting from the insurance policy supporting the commercial paper in the market. This essentially provides the group a relatively predictable and stable income stream attached to a company it knows well and is managed by a partner that has a significant financial stake in the joint venture.
While this is far from being a significant revenue generator for the group, I think it shows just how Buffett has been able to structure deals in his favor over the years.
The amount of capital committed to the joint venture is relatively insignificant compared to the size of the overall group. Still, it does generate a stable and recurring income stream, both from the insurance policy and from the 50% equity interest. The deal has always been structured in a way Berkshire cannot lose. It either earned income from the insurance policy or from the credit facility initially and then there is potential for additional profits on top.
It is these no-loss deals that have helped Berkshire Hathaway become the giant it is today.
