When Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B), with its fortress balance sheet and superb earnings power, loses its triple-A rating, it's surely a sign that the swing in sentiment from exuberance to despondency is nearing completion. As Warren Buffett himself said during a Bloomberg interview at last year's Berkshire shareholder meeting: "If Berkshire isn't triple-A, I'm not sure which company would be."
Yesterday, Fitch Ratings cut Berkshire's issuer default rating by a single notch to AA+ (the insurance and reinsurance units keep their triple-A ratings). The downgrade came on the same day that Standard & Poor's downgraded another former triple-A issuer, General Electric (NYSE:GE). (The situations are anything but comparable, though. In GE's case, the action was long overdue.)
The $37 billion "fear factor"
Fitch cited two main factors in explaining the downgrade:
- The potential earnings and capital volatility due to Buffett's equity investments and his much-misunderstood $37 billion stock index derivatives trade.
- The "key man risk" linked to Buffett's contribution in terms of investing and deal-making on behalf of Berkshire.
Back in November, when the cost of Berkshire credit debt swaps spiked up, I wrote:
Given the misunderstanding of this options trade in the credit-default-swap market, which sets the price of insuring a company's debt, I now think the greatest economic risk of this [derivatives] trade is not inherent in the trade itself. Rather, it is that the credit-rating agencies, including Moody's and Standard & Poor's, will also misunderstand the risks of the trade and downgrade Berkshire, in a move that would increase its cost of funding.
Who's following whom?
That risk has now been partially realized, although any increase in funding costs is likely to be minimal, given that the downgrade isn't severe. Perhaps Fitch took its cue from the credit default swap (CDS) market (instead of the other way around), reasoning that if CDS traders equate the riskiness of Berkshire debt with that of junk bonds, there must be something to it. If that is the case, it is simply one party piling onto another's misunderstanding.
After Berkshire, who's next? I don't anticipate this, but it sure would be entertaining to watch the credit rating agencies lose all composure and downgrade the last four nonfinancial AAA's not already on a downgrade watch: Microsoft (NASDAQ:MSFT), ExxonMobil (NYSE:XOM), ADP (NASDAQ:ADP), and Johnson & Johnson (NYSE:JNJ).
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