When Berkshire Hathaway
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
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
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Alex Dumortier, CFA, has no beneficial interest in any of the companies mentioned in this article. Johnson & Johnson is a Motley Fool Income Investor selection. Berkshire Hathaway, Moody's, and Microsoft are Motley Fool Inside Value recommendations. Berkshire Hathaway and Moody's are Motley Fool Stock Advisor recommendations. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.
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