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Berkshire Ratings Has Been Cut By Fitch!

Thursday, March 12, 2009

Hot from Bloomberg.

Buffett’s Berkshire Has AAA Debt Rating Cut by Fitch

  • By Erik Holm

    March 12 (Bloomberg) -- Billionaire Warren Buffett’s Berkshire Hathaway Inc. had its top-level AAA credit rating cut by Fitch Ratings,
    which cited concern about the potential for losses on the insurer’s equity and derivatives holdings.

    Buffett’s role as chief investment officer also puts the company at risk if he becomes unable to do the job, Fitch said in a statement. Fitch cut the so-called issuer default rating on Berkshire to AA+, and senior unsecured debt to AA. The insurance and reinsurance units kept their AAA status, with a negative outlook for all entities, Fitch said.

    “Fitch views this risk as unrelated to Mr. Buffett’s age, but rather Fitch’s belief that Berkshire’s record of outstanding long-term investment results and the company’s ability to identify and purchase attractive operating companies is intimately tied to Mr. Buffett,” Fitch said. Buffett is 78.

    Berkshire joins General Electric Co., which was downgraded by Standard & Poor’s today and lost its status as one of the remaining AAA companies in the U.S. Berkshire stock fell 35 percent in 12 months on concern that Buffett’s bets on derivatives -- instruments he has called “financial weapons of mass destruction” -- will crush profit at the firm.

    The downgrade isn’t surprising because the deteriorating economy is leading to increased uncertainty about all financial companies, said Michael Yoshikami, chief investment strategist at YCMNet Advisors.

    An Abundance of Caution

    “Triple-A in the end is probably going to be left for the Treasury when it’s all said and done,” said Yoshikami, whose Walnut Creek, California-based firm oversees $800 million and owns Berkshire Hathaway shares. “You’re seeing the rating agencies taking an abundance of caution at this point.”

    S&P and Moody’s Investors Service assign the top credit grade to Berkshire. Buffett’s assistant, Carrie Kizer, didn’t respond to a message left after normal business hours in Omaha.

    Berkshire has outperformed the S&P 500 Index in 38 of the 44 years Buffett has run the firm and handled its investments, according to the Omaha, Nebraska-based company’s 2008 annual report. The company is backing derivatives pegged to corporate junk bonds, municipal debt and the performance of stock indexes on three continents, with liability of more than $14 billion as of Dec. 31.

    Buffett said in an e-mail in November that collateral calls from the institutions on the opposite side of his derivative bets are “under any circumstances, very minor.” In a Bloomberg Television interview conducted last week, Buffett said he plans to sell more derivative contracts, which he personally negotiates. Some investors have said the derivatives may saddle the insurer with billions of dollars in losses.

    Making Money

    “Oh, we’ll continue,” Buffett said. “We do anything that I think I understand and where I think that the odds strongly favor making money, which doesn’t mean you make money every time.”

    The $37.1 billion in equity puts tied to four of the world’s stock markets -- the largest portion of the derivative contracts -- have “no collateral posting requirements with respect to changes in either the fair value or intrinsic value of the contracts and/or a downgrade of Berkshire’s credit rating,” said the company’s latest annual report, released this month.

    Buffett will “likely make money on at least the index put contracts,” said Jeff Matthews, author of “Pilgrimage to Warren Buffett’s Omaha” and founder of hedge fund Ram Partners LP. “Even if he didn’t, his balance sheet would in no way be as weak as GE’s.”

    Insurers depend on high credit ratings to keep down the cost of raising capital and reassure policy holders that their claims will be covered.

    “If Berkshire isn’t triple A, I’m not sure which company would be,”
    Buffett said in a Bloomberg interview at last year’s annual shareholders’ meeting.

    Matthews said investors may ignore the Fitch rating change because they give more weight to analysis by S&P or Moody’s. He added, “Buffett’s true believers won’t believe it.”

On CNBC: Fitch Cuts Berkshire's Rating on Investments, Buffett Role

Here is one early editorials questioning the justification of the downgrade. Fitch Downgrades Berkshire Hathaway, But Is It Justified?

For example on the derivatives exposure issue..

  • Derivatives Exposure Cited

    Fitch specifically cites Berkshire’s derivatives contracts as a factor in the downgrade. I believe
    that Berkshire’s derivatives exposure is widely misunderstood and poses no liquidity concern whatsoever due to the nature of the contracts. The vast majority of Berkshire’s derivatives carry no counterparty risk, cannot be exercised by counterparties for over a decade, and are being valued by a model that recognizes mark to market gains and losses but no cash flow consequences. Nevertheless, the Fitch analyst is concerned:

    With respect to BRK, Fitch views the company’s potential earnings and capital volatility derived from its large, unhedged market exposures as inconsistent with the stability required at the ‘AAA’ level. Such exposures include large, concentrated equity investments, as well as exposure to the equity and credit markets through various derivative contracts. Fitch views BRK’s investments in a wide variety of retail, service and manufacturing companies as mitigating this exposure somewhat, but Fitch does not view BRK’s degree of diversification as sufficient to offset these concerns at the ‘AAA’ level.

    While this initial statement seems to indicate significant concern and misunderstanding, it is interesting to note that later in the report, the analyst does outline the actual terms of the derivatives and the nature of the contracts:

    While the contracts’ recent mark-to-market losses are large, the agency believes that the ultimate economic effects, while uncertain, are likely to be significantly less than indicated by the marks. Favorably, the equity index put contracts were generally written with strike prices equal to the then current index value, had a weighted average maturity of 13.5 years at YE 2008, and are exercisable only at maturity. The CDS contracts appear to be well-managed with reasonable contract and per issuer limits. Additionally, few of the contracts have collateral positing requirements. At YE 2008 BRK had posted $550 million of collateral related to these contracts, a small amount for a company with BRK’s liquidity profile.

    It is difficult to reconcile the analyst’s concern about the derivatives noted early in the report with the later paragraph that indicates a clear understanding of the true nature of the derivatives risk.

That last passage by Ravi questioning Fitch's analyst issue on Berkshire's derivative is rather valid, yes?

Ravi then writes..

  • My overall impression from reading the Fitch report is that the logic supporting the downgrade is highly suspect. All of the ratings firms have taken a beating in terms of reputation given the very high profile cases where AAA ratings were kept on securities that clearly were impaired. The most famous recent example involved the senior tranches of mortgage backed securities that received AAA ratings and suffered impairments. The rating firms are struggling to stay relevant in this environment. While the ratings firms were blind to risk during the boom years, it seems that they are now equally irrational in terms of risk aversion. It will be interesting to see whether the other ratings firms follow Fitch and downgrade Berkshire in the coming days.

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