Becoming Berkshire: 1969 - Illinois National Bank

Issue 14 - Part 2| Buffett Buys a Bank

Oct 06, 2024

Charles T. Munger, Warren Buffett's One-of-a-Kind No. 2, Dies at 99 - The New York Times

By 1969, Buffett and Munger started to doubt Hochschild-Kohn's economics and were looking for a way to sell the business.

Gottesman, Munger, and Buffett acquired Hochschild-Kohn, a venerable department store headquartered in downtown Baltimore, for $12 million in 1966.

"Retail is a very tough business," says Charlie Munger. "Practically every great chain-store operation that has been around long enough eventually gets in trouble and is hard to fix." Their experience had given them a deemed wariness of trouble- one that would only grow, not lessen, over time.
They wanted businesses that would marmalade them with money, businesses that had some sort of sustainable competitive advantage and could outwit the natural cycle of capital creation and destruction as long as possible.1

The company was sold to Supermarkets General for around $12 million. As Buffett wound down the partnership, he appeared to be attempting to simplify his life. Charlie Munger was managing his own partnership, headquartered in a utility closet at a regional stock exchange in California. The two would not officially become partners at Berkshire for some time, but they would occasionally exchange ideas and invest in the same business.

American actors Dennis Hopper and Peter Fonda ride through the Desert on motorcycles in a scene from the film 'Easy Rider', directed by Hopper, 1969.

Berkshire Hathaway 1969 Letter to Shareholders

“Four years ago, your management committed itself to the development of more substantial and more consistent earning power than appeared possible if capital continued to be invested exclusively in the textile industry. The funds for this program were temporarily utilized in marketable securities, pending the acquisition of operating businesses meeting our investment and management criteria ... We have been able to conclude two major purchases of operating businesses, and their successful operations enabled Berkshire Hathway to achieve an overall return of more than 10% on average stockholders equity last year in the fact of less than 5%retun from the portion of our capital employed in the textile business.” 2

Textiles

“We are presently in the midst of a textile recession of greater intensity than we have seen for some years.”3

The lack of demand and the closing of the Box Loom division resulted in a 12.1% revenue decline and a profit of $1.5 million.

Insurance Operations

“Jack Ringwalt and his outstanding management group turned in new records in just about every department during 1969".”4

And boy, they did not waste any time. Jack and his team created a surety department, entered California's workmen's comp market, and started planning a new "home state" insurance operation.

The insurance operation had a pre-tax underwriting loss of about ($153,000) and a combined ratio of 96.2%. You may ask yourself how a combined ratio under 100% resulted in an underwriting loss. Adam Mead, in The Complete Financial History of Berkshire Hathaway, does a wonderful job of pointing out that the numbers are calculated using more conservative Insurance Accounting Principles as opposed to Generally Accepted Accounting Principles ("GAAP"), which resulted in a loss.

Banking

“The most significant event of 1969 for Berkshire Hathaway was the acquisition of 97.7% of the stock of The Illinois National Bank and Trust Co. of Rockford, Illinois. This bank had been built by Eugene Abegg, without the addition of outside capital, from $250,000 of net worth and $400,000 of deposits in 1931 to $17 million of net worth and $100 million of deposits in 1969.”5

The bank produced record operating earnings of approx. $2 million in 1969.

Illinois National Bank

Around this time, Buffett and Munger sought a bank to purchase and found a candidate in Rockford, Illinois.

On April 3, 1969, Berskhire Hathaway, Inc. acquired 81,989 shares, out of a total of 100,000 shares outstanding, of the common stock of the Illinois National Bank and Trust Co. of Rockford, Illinois, at a cash price of $190.00 per share. They also have made a tender offer to acquire the remaining outstanding shares at the same cash price. 6

Buffett considered Rockford Bank one of the most well-run and profitable he had ever seen. It was managed by Eugene Abegg, who was 71 years old.

Abegg, who owned one-quarter of the shares, had been negotiating to sell the business to someone else before Buffett came along. The potential buyer had started criticizing the deal and wanted an audit. This affected Abegg, and he decided not to go ahead with the deal. Meanwhile, Buffett worked out what he was willing to pay, which turned out to be about $1 million less than the other buyers.
Abegg was so fed up with the other bidders that he pressured his fellow shareholders to accept Buffett's offer, threatening to resign if they did not.7

The crusty Abegg was just the type of fellow that Buffett liked.

In 1931, Eugene Abegg, a young man with only $250,000 of capital, formed a bank in Rockford, Illinois… It had $400,000 of deposits. Since then, no new capital had been added to the bank by its owners. Nevertheless, by 1969, Abegg had built, piece by piece, a bank with a net worth of $17m and $100m of deposits. 8

He carried thousands of dollars of cash in his pocket and cashed checks for people on the weekends. He carried a list of the number of unrented safe deposit boxes with him everywhere and would try to rent you a safe deposit box at a cocktail party. Mind you, this is the biggest bank in the second-largest city in Illinois at that time. He set every salary and paid every employee in cash, so the head of the trust department did not know how much his own secretaries made.9

1929 Ty.1 $20 National Currency Note - The Illinois National Bank & Trust of Rockford, Illinois.

The Illinois National Bank, which Buffett soon came to refer to by its colloquial name of Rockford Bank, had been chartered in the days before the U.S. Treasury assumed the exclusive right to coin money. Buffett was fascinated to discover that it still issued its own currency. The ten-dollar bills featured Abegg’s picture. Buffett, whose net worth was now more than $26 million, could have bought almost anything he wanted, but not this. Gene Abegg had done him one better. He and the United States Treasury had the privilege of issuing their own currency, but not the Buffett Partnership or Berkshire Hathaway. The idea of legal tender with your own picture on it captivated him. He began carrying a Rockford bill in his wallet.10

1902 $10 Ten-Dollars U.S. National Currency Large-Size Bank Note - Union National Bank of New ...

Financials

Berkshire paid $190 per share to acquire Illinois National, plus $2 per share to an investment bank for services rendered in the transaction.11

From what I could find in my research, the purchase price was approximately $15.6 million; however, it has been challenging to get an exact number. Jacob McDonough’s brilliant work in Capital Allocaiton shows that Berkshire paid just under Book Value for this well-capitalized bank.

With total Assets of $117.3 million, shareholder equity of $16.8 million, and a net profit of $1.7 million in 1968, the bank had an ROE of 10% and ROA of 1.4%.

The acquisition was part of Buffett’s strategic shift away from the faltering textile business that Berkshire was initially known for. It was evident that textiles was no longer a viable business. Buffett continued to allocate capital away from the division and into sectors with better long-term prospects, like financial services and insurance, which were cash-generating and had predictable earnings. Moreover, Buffett appears to have targeted businesses with float, as National Indemnity and Illinois National Bank were flush with cash.