February 16, 2010

Dear Partners,

Evaluating investment managers is like evaluating riders in the Tour de France: a single stage win does
not equal a contender, nor does 12 months performance signify investment ability. Nevertheless, Im
delighted to report Arlington Value Management (AVM) gained 58.5%, net of fees, for the year ended
December 31, 2009. This result compares favorably to the S&P 500s gain of 26.5% over the same
period. While these one year results, for both AVM and the S&P 500, are impressive, perspective and
context should be applied before drawing conclusions. Even with the S&Ps heady gain of 26.5%, the
medias steady motif of a lost decade depicts a more sobering picture. Similarly, AVMs 58% return
looks anomalous against the backdrop of our ten-year track record.

However, contrary to the indices the decade was not lost for AVM shareholders. In fact, we averaged
15.5% per annum, net of fees, outperforming the S&P 500 by over 16% annually, which would rank
AVM # 2 if included in Morningstars data base of over 3,000 domestic equity funds.

(AVM Ranger Fund LP 18-month return ended December 31, 2009: 120.3%, gross of
fees, vs. -8.8% for the S&P 500)

Despite my poor record of predictions I feel a cautionary forecast is warranted: we are certain to have
periods of underperformance in the future, though that shouldnt preclude us from achieving solid long-
term results. Furthermore, I believe striving for monthly, quarterly, or even yearly outperformance, or
alpha as they say on Wall Street, would hamper, and possibly derail, long-term returns.

Review and General Comments

During the first quarter of 2009 a renewed aura of panic spread across the market. The alarming chatter
from armchair orators and major media outlets - conjecture ranging from blue-chip bankruptcies to the
end of capitalism - caused investors to scurry for safety. The dire economic data and nervous
atmosphere induced frantic selling, causing stocks to drop precipitously (at the low, the S&P declined
55% from the 2007 peak). While the Treasury Department was busy stress-testing the banking system,
investors were subject to a stress-test of their own, albeit more cerebral in nature. This tense period
tested investors philosophies and principles. Quickly forgotten during times of distress, yet no less
important to remember, is that lower prices are an ally to long-term returns.

The fearful climate produced a slew of compelling values, leading us to diversify more than usual as we
snapped up numerous bargains among the sturdy companies we admire. The largest contributors

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positively impacting the portfolio were Odyssey Re, Philip Morris International, and White Mountains
Insurance. Stakes were also taken in a number of companies weve wanted to own for years that
subsequently performed well - Watsco, OReilly Automotive, and Diageo to name a few. What these
and most new holdings have in common, is dominant competitive positions, hardy business models, and
favorable long-term prospects. In addition to establishing new positions, we boosted our stakes in a
handful of obscure, small-cap companies that recorded lofty gains.

Fairfax Financial, navigated by an investment team second to none, continued to be the gift that keeps on
giving, harvesting another strong year in 2009. Fairfax has managed the asset side of their balance sheet
masterfully throughout the financial crisis. If youre happy with your year-end statement, thank the team
at Fairfax, not me.

Two of our holdings were acquired in 2009. The experience was bittersweet, as the immediate
gratification of profits was somewhat subdued based upon the low buy-out prices and reputations of the
buyers, both notorious for having sharp business intellects and frugal dispositions. Cavalier Homes, a
manufacturer and seller of modular and mobile homes, was purchased by a subsidiary of Berkshire
Hathaways Clayton Homes midway through 2009 at a modest premium to our cost basis. And Odyssey
Re, a reinsurance company majority owned by Fairfax, was acquired in full by Fairfax in late August.

The make up of the portfolio consists of cash and equity investments in an assortment of companies,
ranging in size from very small to mega-cap behemoths. We have no restrictive stipulations, such as
market-cap size, sector weightings, or other common industry handcuffs. We simply look for
compelling opportunities that inspire conviction, which is driven by clear understanding and a vacancy
of major risks. Our appetite is paltry for risky investments, almost regardless of potential reward.
Theoretically this stance is illogical as pot odds can dictate taking a flyer - where the potential payoff
compensates for the chance of loss - however these situations are difficult to handicap, and can entice
one to skew probabilities and payoffs.

The major mistakes of the year stemmed from allowing macro noise to creep into my psyche, causing
me to sell first-rate companies after modest gains, hoping to buy back in after a pullback. Such
behavior has the hallmark of a lose-lose situation and reminds me of NBA color man Hotrod Hundleys
comments after Utah Jazz center, Mark Eaton, made a long range jump shot: The good news is he
made it, the bad news is he might try it again!

Selling exceptional companies that are undervalued (hoping to buy back in later), after buying in at
generational low prices, is a foolish mistake and smacks of self delusion - equivalent to forfeiting lottery
winnings in order to let the payout grow larger for the next time your number is called! This is a mistake
we will not soon forget, as buying excellent businesses for long-term gains has advantages beyond the
obvious (lower tax rates and reduced frictional costs); it helps reduce unforced errors (a major barrier to
strong returns), as it allows one to think more and act less, allowing compound interest to work its magic
unfettered. Activity is the enemy of investment returns. - Warren Buffett

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If Ive learned anything over the past decade it is this: The art of stock picking is more about
synthesizing information across disciplines and making decisions than a strict devotion to finance. And
because sound decision making is heavily influenced by psychology, having a good grasp of the subject
is vital to investment success. The investors chief problem - even his worst enemy - is likely to be himself. -
Ben Graham

A recent book titled Think Twice (on the psychology of decision making) speaks to both the wisdom and
pitfalls of crowds. The author states,
The diversity theorem tells us that a diverse crowd will always predict more accurately
than the average person in the crowd. Not sometimes. Always. This suggests that
modesty is in order, but most people dont think of themselves as average - and certainly
not below average. Yet in reality, half of all people must be below average, and so you
should sort out when you are likely to be one of them.
This has distinct implications for investors, and suggests it may be wise to evoke humility before taking
frequent action, as its easy to find yourself at or below the average in a hyper-competitive field.

My partner Ben and I have left many meetings bewildered when a potential investor seemed unaware of
the wisdom-of-crowds phenomenon. Many times these gate-keepers of capital have expressed
admiration for our results. Yet for them to invest we would need to not only continue to find
undervalued stocks, wed need to find more of them; additionally, we would need to identify overvalued
stocks - and short them - as well as find ideas across the globe in both large and obscure markets. Such
comments are flattering, yet we see nothing but wild-eyed hubris attempting to outsmart more people,
more often, in more ways, and in more markets, as opposed to sticking with what produced top-tier
results in the first place. Rest assured, we have no interest in trading our principles for assets; we gain
more satisfaction from producing top results than from the size of our paychecks.

We think successful investing is less complicated, and for us, boils down to taking a few simple tenets
seriously: patience, discipline, long-term orientation, valuation, independent thinking, and an ethos of not
fooling ourselves. Such simple investment principles seem obvious and easy to apply, much like the
notion of eating healthy: everyone understands the benefits, yet few can resist indulging in the
abundance of high calorie eatery options. Implementation is easier said than done!

The salient skill for an investor to master is being able to sit still, without tiring of sitting still, while
recognizing the constant tug of an overconfident psyche.
Understanding the limits of ones understanding is the dawning of wisdom. - Socrates.

Looking Forward

There is no shortage of economic commentary these days and I feel ill equipped to be the arbiter of
macro economic prognostications. Most arguments Ive read fail to inspire conviction due to poor
synthesis or a tendency to over-simplify and unduly extrapolate, or both (granted, accurately predicting
such a complex system borders on impossible). Its convenient and easier to conceptualize todays

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problems as wreaking havoc tomorrow. However, the stark reality is that most problems - and solutions
- of the future are not recognized by the throng of economic seers today. Clearly the economy faces
near-term challenges and certainly there will be unintended consequences from dramatic policy actions,
but I believe its a mistake to ignore Americas 220+ year track record of resilience. Underneath ongoing
challenges is a vibrant ecosystem bubbling with creative talent and energy that is certain to produce
happy surprises in the future; my conviction is not diluted just because the precise form and nature are
not apparent today.

In years past I have highlighted unnerving market issues, and thought caution was the better part of
valor. But in part, this attitude is deep-rooted in the culture of Arlington; we think vigilance towards risk
is the plow-horse to harvesting solid investment returns.

Going forward I will stay focused on buying mispriced securities where success does not depend on
buoyant economic conditions. Crucial to adopting this favorable approach is maintaining a long-term
focus and making sure future partners share our long-term perspective. Like-minded business partners
understand that our mindset is one of buying entire businesses outright and retaining management;
therefore, forecasting GDP growth rates, interest rate levels, and other macro variables are not the salient
factors to get right in order for us to succeed.

Although we have learned much over the past decade, our underlying principles have not deviated since
AVMs inception. While some funds talk about adjusting strategies as a result of the financial crisis
(incorporating more macro views, paying closer attention to valuation, shorting, diversifying more, etc.)
we have maintained our hedgehog-like approach, being stubborn in our criteria and worrywarts toward
risk and folly. We are certain to make mistakes in the future, but the guiding principles wont change,
functioning as a stable beacon in times of distress. Without a clear focus and sound philosophy, price
fluctuations become the bugle that stampedes the cavalry.

Our first decade of operation is satisfying beyond appeasing our competitive spirit and meeting our
economic needs. Equally fulfilling is adding value to partners in exchange for your trust. We appreciate
you for being savvy, patient partners and for entrusting us with your capital.

I enjoy the investment process as much today as I did when I started AVM ten years ago, and dont
consider my job work at all. I feel fortunate and agree with president Reagan when he said, Hard work
never killed anyone, but why risk it. I look forward to reporting to you again next year. As always,
dont hesitate to call or email with questions or comments.

Sincerely,

Allan Mecham

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The information contained herein is a reflection of the opinions of Arlington Value Capital (Arlington) as of the date
of publication, and is subject to change without notice at any time subsequent to the date of issue. Arlington does not
represent that any opinion or projection will be realized. All the information provided is for informational purposes
only and should not be considered as investment advice or a recommendation to purchase or sell any specific
security. While it is believed that the information presented herein is reliable, no representation or warranty is made
concerning the accuracy of any data presented. This communication is confidential and may not be reproduced
without Arlingtons prior written consent.

Indices are provided as market indicators only. It should not be assumed that holdings, volatility or management
style of any Arlington investment vehicle will, or is intended to, resemble that of the mentioned indices. The
comparison of this performance data to a single market index or other index is imperfect because the former may
contain options and other derivative securities, may include margin trading and other leverage, and may not be as
diversified as the S&P 500 Index or other indices. Index returns supplied by various sources are believed to be
accurate and reliable.

Past performance is not indicative of future performance. Inherent in any investment is the possibility of loss.

This performance reporting is not an offer to sell or a solicitation of an offer to buy an interest in any Arlington
investment vehicle. Such an offer may only be made after you receive the investment vehicle's Confidential Offering
Memorandum and have had the opportunity to review its contents. This reporting does not include certain
information that should be considered relevant to an investment in Arlingtons investment vehicles, including, but not
limited to, significant risk factors and complex tax considerations. For more information, please refer to the
appropriate Memorandum and read it carefully before you invest.