Will Berkshire Lose Its Triple-A?

by: Felix Salmon November 19, 2008 | about stocks: BRK.A / BRK.B    
Felix Salmon

Felix Salmon

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On the face of it, recent activity in Berkshire Hathaway (BRK.A) makes little sense. Credit default swaps on the triple-A company were trading at 388bp yesterday, and are somewhere over 450bp today, possibly having risen as far as 560bp this morning. As Bloomberg says,

For the swaps to pay off, Berkshire would have to exhaust its $33.4 billion cash hoard, and Buffett's decades-long record as the world's most successful investor would have to come to a cataclysmic end.

That isn't entirely true, of course: So long as the swaps widen out at all, traders can make money off them even absent an event of default. But given that the CDS is pricing in such a high probability of serious distress, it's entirely reasonable for Berkshire's stock to have fallen -- it's now below $90,000 a share, a level not seen since mid-2006.

Even so, Berkshire's market capitalization, at $139 billion, is still significantly higher than its book value, which was $118 billion as of June 30 and is surely significantly lower now, given the degree to which Buffett's investments in the likes of Goldman Sachs (GS) have eroded. In other words, the stock market is still pricing in growth and profits, even as the bond market is much more pessimistic.

All insurance companies have a certain amount of event risk. But for Berkshire Hathaway the event the company is most worried about isn't a hurricane or an earthquake -- it's a credit downgrade. Roger Ehrenberg asks the question on everybody's mind: "If the market continues to push against Berkshire's credit will a downgrade become a self-fulfilling prophecy?"

A downgrade could be very, very bad for Berkshire, depending on how its collateral agreements are worded. At some point, Berkshire's counterparties are going to be able to ask it to put up a lot of collateral against the derivatives contracts it has written -- not only the CDS contracts, mind, but quite possibly also the long-dated put options it's written on broad stock-market indices. Such collateral calls could be extremely harmful to Berkshire's business model -- and that's before taking into account the loss of business at its new monoline subsidiary.

On the other hand, I'm not comfortable with any company -- not even Berkshire Hathaway -- having a business model which requires a triple-A rating. Triple-A ratings should be the consequence of a company's profitability, not a cause of it. If Berkshire lost its triple-A and started playing on a level playing field with everybody else, that might be more sustainable, in the long term, than an attempt to shore up the triple-A at all costs. Certainly there's something very weird going on when CDSs are at 450bp and the credit is still triple-A: One or the other has to be wrong.

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This article has 23 comments:

  •  
    Nov 19 04:04 PM
    OMG! BRK-A is down to only $84,300. (calling broker ...)

    "I'll take ONE share."



    If GE drops much further it will be paying a 10% yield, provided they don't lower the dividend or go under. Very tempting, but too soon to bite yet.
    Reply | Link to Comment
  •  
    Nov 19 04:20 PM
    Warren! Warren!

    NO CUTS IN THE SOUP LINE!!!

    Don't lie on that Food Stamp application either.

    And when you're finished, go fix me an Omaha Burger. Sacred cows, always make the best burgers.
    Reply | Link to Comment
  •  
    Nov 19 04:25 PM
    why can we just get a federal income tax refund for 2008 that would do. People will spend some cash, some will use their credit cards, banks will charge a fee, and we all would get the money back from the gov in the spring of 2009.
    Reply | Link to Comment
  •  
    Nov 19 04:25 PM
    I'm with Smarty...want to split a share?LOL..
    Reply | Link to Comment
  •  
    Nov 19 04:29 PM
    ambushed:

    Even better idea.

    We package all of the money we owe to everyone and market it as an "investment" to be sold to suckers in Asia.

    Oh! We already did that... And what happened? Oh!
    Reply | Link to Comment
  •  
    Nov 19 04:31 PM
    "We package all of the money we owe to everyone and market it as an "investment" to be sold to suckers in Asia." - curbs in

    curbs: We can't have found ALL the suckers in Asia. Maybe we could trade that stuff for coconuts and bananas on some small island in Indonesia. At least we'd get something out of it.
    Reply | Link to Comment
  •  
    Nov 19 04:46 PM
    I find it amazing how much power we still allow the rating agencies to have over our market. I'm not saying the reason AIG fell was a credit downgrade but I think all will agree it was the "death blow."
    If you read this and the GE article poosted here and on minvanville you see that the largest risk to Berkshire and GE are a loss of their AAA rating.
    I'm not invested long or short in GE or Berkshire but how could we let S&P and Moody's (well I guess not Moody's in Berkshire's case since Buffett owns some Moody's) have so much power after the job they have done? Scary stuff to think about.........
    Reply | Link to Comment
  •  
    Nov 19 04:49 PM

    GE and Goldman Sachs would not say,
    That Warren's rescues had helped save their day,
    When his lottery ticket hit,
    moonbat used most of it,
    To buy a few shares of BRK-A
    Reply | Link to Comment
  •  
    Nov 19 05:07 PM
    Porbably idiot Doug Kass manipulating the stock through funny CDS transactions to cover his short position...

    That idiot Kass should be investigated...he also went on CNBC bashing the stock while being short...

    Really, how can BRK be more risky than a bank like citi that has been loosing billions upon billions...or Goldman, which is leveraged a huge amount, while BRK has very little debt, and contrary to what this article says, BRK does not need AAA as much as other companies (like GE, AIG, etc). It sure helps lower costs and not have to post collateral in some positions, but the company was NOT built on the credit rating (contrary to Fannie and Freddie, etc.).
    Reply | Link to Comment
  •  
    Nov 19 05:07 PM
    Sorry, no fan of Warrens. It is all well and good to profit off a rigged system one did not set up but having made his wealth and achieved some influence I would expect him to at least point out the dishonesty of it.

    My hero in that respect is Jim Rogers and eventually you.
    Reply | Link to Comment
  •  
    Nov 19 05:19 PM
    You made an error when you referred to BRK book value: "which was $118 billion as of June 30 and is surely significantly lower now, given the degree to which Buffett's investments in the likes of Goldman Sachs (GS) have eroded."

    Berkshire did not buy GS or GE common stock but instead bought preferred shares which are paying 10%. He also received a "lottery ticket" known as warrants. He has the option to exercise them over a certain period of time. If the stock price is not above the strike price, they are worthless. But if the stock price is above...then its all gravy.

    Buffett was getting less than 2% on $8 billion while he was waiting to do something with it. When he bought the preferred shares (GS+GE) he received 10%...end result: BRK will net an additional $640 million per year (2% - 10% = 8%) * $8 billion) REGARDLESS of where GS or GE trade.

    So once again, can you tell me how Buffett's investment in GS or GE "eroded BRK's book value?"
    Reply | Link to Comment
  •  
    Nov 19 06:02 PM
    Buffetts investment in GS and GE I thought were not BRK investments they were Buffetts personal investments so they dont have any impact on BRK.

    What I find most amusing is that by the time Obama gets ready to rob from the rich to give to the poor, there wont be many rich left. They are getting robbed by thier own greed as we read this.
    Reply | Link to Comment
  •  
    Nov 19 06:19 PM
    Good analysis of brk.a
    Reply | Link to Comment
  •  
    Nov 19 06:49 PM
    You're both wrong: GS/GE are Berkshire investments and they can erode the book value (we won't know officially until the next Q, of course). Preferred shares have to be marked-to-market and in this case we would have to calculate a market value by comparing the cashflow and risks to other similar products, such as other forms of GS/GE equity or debt. Given that prices have declined sharply for both and the warrants are now way out of the money, one could see justification for discounting BRK's book value. Furthermore, erosions in WFC/AXP/etc. will clearly and directly reduce book value.

    Not saying I think BRK is going down, just pointing out that all investments at a company like BRK should be marked to market and that the value of future cash flows from an investment should be based on credit risk/cost of capital for the company in which one invests.
    Reply | Link to Comment
  •  
    Nov 19 07:12 PM
    Has anyone thought about whether the CDS market is being manipulated by groups and countries that might wish to do American industry and the American people harm? It is hard to imagine a market this large being manipulated that way, but this simply makes no sense.

    In this environment, though, if you were looking for a way to exacerbate the doubt of the overall marketplace, and did not want to actually have to short stocks (which can cause you to lose a lot of money), wouldn't the CDS market be the perfect way to do it?

    Not to be too paranoid, but to be clear, I am talking potential economic terrorism here.
    Reply | Link to Comment
  •  
    Nov 19 07:32 PM
    More denial in the comment field.

    So far, the CDS market has been prescient about imminent collapses.

    From Berkshire, we will, of course, hear nothing but lies as we head nothing but lies from every single doomed financial firm. And of course everyone on Wall Street will believe the lies.

    What choice do they have? Blame themselves?

    And of course Warren Buffett cannot be wrong. It's not physically possible in the minds of most in the investing world.

    I don't know what the truth is but before people start blaming the ratings agencies for committing "financial terrorism", I would remind people of this: Berkshire OWNS an interest in a rating agency.

    So wouldn't it be just as logical that the ratings agencies had covered up for him?
    Reply | Link to Comment
  •  
    Nov 19 07:47 PM
    But this is not about blaming anyone. It's about looking at reality. Berkshire has had zero write downs due to non-performing loans. It has boatloads of cash. The first possible default it could have as a result of its very limited derivative positions is in -- get this 2019. The mark to market paper loss on these contracts is now, at most at $9 billion, which is a fraction of Berkshire's cash position, which grows at the rate of approximately $200 millon per week. This might go down a little as some companies slash dividends to hoard cash, and as Berkshire's operating companies keep a bit more rather than sending it in to Omaha.

    So, let's cut that in half for argument's sake. Cash position, even after recent investments, is still super strong, and growing at the rate of $100 million per week. So what am I missing here?

    The CDS market has been prescient you say -- well of course. Here's the analogy. If you look at the CDS spreads as a smoke alarm, it stands to reason that in the few instances where there is actually a raging fire, the alarm would go off. But the question is how many false alarms there are with that same smoke alarm. And what the results of a false alarm are.

    You would not want to rely on a canary in a coal mine if the canary was narcoleptic and kept falling over for no reason, causing everyone to run for the mine exits. Nor would you want someone drugging your canary.


    On Nov 19 07:32 PM dlaw wrote:

    > More denial in the comment field.
    >
    > So far, the CDS market has been prescient about imminent collapses.
    >
    >
    > From Berkshire, we will, of course, hear nothing but lies as we head
    > nothing but lies from every single doomed financial firm. And of
    > course everyone on Wall Street will believe the lies.
    >
    > What choice do they have? Blame themselves?
    >
    > And of course Warren Buffett cannot be wrong. It's not physically
    > possible in the minds of most in the investing world.
    >
    > I don't know what the truth is but before people start blaming the
    > ratings agencies for committing "financial terrorism", I would remind
    > people of this: Berkshire OWNS an interest in a rating agency. <br/>
    >
    > So wouldn't it be just as logical that the ratings agencies had covered
    > up for him?
    >
    Reply | Link to Comment
  •  
    Nov 19 09:13 PM
    BRK is in a very safe position. No one has perfect timing and maybe Buffet bought a little too soon.
    Reply | Link to Comment
  •  
    Nov 19 10:14 PM
    Few are excellent market timers, and those who time well find replicating that ability difficult indeed. The majority of WB's investments are for the very long term - so positions he might have taken recently do not easily convert to investing advice for folks pouring through articles, hoping to replicate even a portion of positive performance with a shorter time horizon in mind. At this point, an investment in BRK is still beating the S&P for the year, if not by much. I am long BRKB, am and considering purchasing more.
    Reply | Link to Comment
  •  
    Nov 19 10:14 PM
    WB doesn't have to be right or wrong really. Time and perserverance will make himm whole on bad buys. One only has to have the cash to hold on to until then and the will to see it through.
    Reply | Link to Comment
  •  
    Nov 19 10:30 PM
    Berkshire may very welllose the AAA ratingassome of the recent investment were logical and very selective ,the market paranoia continues to impact the stockmarket negatively and inflictsmonetary losses even on the investment choices made by Master Portfolio manager.
    Will GE lose AAA rating?it doe4s not matter ,the GE's stock has been unjustifiably decimated ,reflection of the market Armageddon. which is well divesrified .
    The real issue is why does any entity still writes the CDS's as the risk is demoralized investor without the ability to quantify the real risks (which are acceptable after the major market adjustment).
    The other issue is ,why do I get on my PC ,a pictorial pop-out of Mr.Salomon-I already know that he iswrong.
    Reply | Link to Comment
  •  
    Nov 19 11:48 PM
    So the BRK-A is one of the next sacrificial lamb online on the alter of capitalism.
    Reply | Link to Comment
  •  
    Nov 20 02:11 PM
    St. Warren loses 99.9% of his net worth and he still has $40 million. Oh, well.
    Reply | Link to Comment
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