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Berkshire Hathaway Downgraded By S&P From AAA to AA+, As BRK Launches Massive $8 Billion Bond Offering

Tyler Durden's picture




 

S&P downgrade the firm just in time for Berkshire's attempt to place a whopping $8 billion in a four-part deal underwritten by JP Morgan (What, no Goldman)?

Overview

  • Berkshire Hathaway plans to purchase Burlington Northern Santa Fe for approximately $26 billion in cash and stock for the shares it does not already own. The transaction is pending shareholder approval.
  • We believe that the railroad acquisition will reduce what historically has been extremely strong capital adequacy and liquidity, and that investment risk with sizable concentrations remains very high.
  • The group's risk tolerances are, in our opinion, not clearly defined at the enterprise level and are a concern as the group's profile becomes more complex.
  • We are lowering our ratings on Berkshire and various affiliates.
  • We are removing the ratings from CreditWatch, where they were placed with negative implications on Nov. 4, 2009. The outlook is stable.

Rating Action

On Feb. 4, 2010, Standard & Poor's Ratings Services lowered its long-term counterparty credit rating on Berkshire Hathaway Inc. (BRK) to 'AA+' from 'AAA'. We also lowered our financial strength ratings on BRK's core insurance operations to 'AA+' from 'AAA'. At the same time, we removed the ratings from CreditWatch, where they were placed with negative implications on Nov. 4,
2009. The outlook is stable.

Rationale

We are taking these actions in anticipation of BRK's acquisition of Burlington Northern Santa Fe Corp. (BNSF), which we expect to close no later than Feb. 15. The transaction is BRK's largest acquisition to date. BRK already owned more than 22% of the stock of BNSF. BRK will finance the acquisition of the remaining shares for about $26 billion with a combination of 60% cash and 40% through the issuance of new BRK shares. The cash portion of about $16 billion will come from cash on hand and new debt issuance of approximately $8 billion. Standard & Poor's expects that a significant part of the internal cash will come from BRK's core insurance operations, as has been the case in other transactions.

The rating actions are based on our view that Berkshire's overall capital adequacy, as well as that of its insurance operations, has weakened to levels no longer consistent with a 'AAA' rating and is not expected to return to extremely strong levels in the near term. Furthermore, we expect that the consolidated liquidity position of BRK will be reduced from extremely strong historical levels as a result of the acquisition. As capital adequacy and liquidity levels have declined, investment risk remains very high in our view,
compounding the need for extremely strong capital and liquidity given potential investment volatility. A key concern is that BRK's risk tolerances appear to have increased, yet we believe they remain ill defined while the organization increases in complexity. Generally, we believe Berkshire has a high risk tolerance for capital volatility and investment risk. We do not believe that the company's overall risk management framework has evolved at the same pace as the organization's complexity and that enterprise risk management practices remain in silos within each investment.

Earnings remain very strong, and we expect them to increase following the acquisition of BNSF. It is our expectation that Berkshire likely will use these incremental earnings and cash flows to pay down the debt resulting from the acquisition rather than rebuild insurance company capitalization. We view BRK as having an extremely strong and well-diversified competitive position
across its business. Albeit weakened, we view the company's liquidity position and balance sheet as still very strong. However, we see meaningful exposure to adverse development of reserves held for long-term insurance liabilities, and uncertainty remains regarding management succession. The rating on the holding company is the same as the ratings on the
operating insurance companies and

reflects our opinion of the substantial diversity of assets, the large cash balance at the holding company, and the dividend capacity of the numerous noninsurance operations the holding company owns. BRK also has the ability to sell noncore operations in the event of an unforeseen liquidity need, though we would expect this to occur only under extreme circumstances.

BRK is a unique holding company that owns a large number of insurance and noninsurance subsidiaries. The core business of BRK is its extensive insurance operations, which include Berkshire Hathaway Insurance Group (BHIG), Berkshire Hathaway Reinsurance Group (BHRG), GEICO Insurance Group (GEICO), and General Re Group. Unlike many of its competitors, BRK's insurance and reinsurance operations have been able to maintain pricing power, manage through cycles, and create distribution and underwriting competitive advantages in a predominantly commodity business. These advantages are reflected in the group's exceptional underwriting results to date. The noninsurance subsidiaries are in a variety of sectors including utilities and energy, finance, manufacturing, retailing, and business services. The more prominent noninsurance affiliates (based on earnings contribution) are MidAmerican Energy Holdings Co. (BBB+/Stable/--; regulated utility subsidiaries are rated 'A-'), Clayton Homes Inc. (BBB/Stable/--), and Marmon Holdings Inc. Following the acquisition, BNSF will represent the second-largest noninsurance segment within Berkshire, after MidAmerican.

Even following the BNSF acquisition and related debt issuance, BRK's financial flexibility is extremely strong, in our opinion. Excluding the debt obligations of MidAmerican, which is rated on a stand-alone basis, and debt associated with the mortgage finance operations of Clayton Homes that is viewed as operating leverage, BRK's financial leverage as of Sept. 30, 2009,
was conservative at 5.3%. This increases to about 10% pro forma for the debt issued for the BNSF acquisition. Fixed-charge coverage declines to 21x on a pro forma basis from 34x in the first nine months of 2009.

Uncertainty surrounding management succession and management structure, corporate culture, and business strategy following an eventual transition of the company's leadership from current CEO Warren Buffett is an ongoing concern. This, in our view, is only partially mitigated by a board-approved succession plan and the experienced management teams in place at the operating companies, given Mr. Buffett's strong and positive influence on all aspects of operations at Berkshire.

Outlook

The outlook on the ratings is stable. We expect BRK's consolidated operating earnings to improve in 2010, in line with an overall gradual economic recovery in the U.S. BNSF also likely will contribute to earnings for Berkshire in 2010 and prospectively. Despite this increase in earnings, sizable declines in capital adequacy and liquidity are expected to result in a multiyear rebuilding period for the company to restore to historical levels. Furthermore, earnings remain potentially volatile because of the insurance operations' exposure to any sizable natural peril or man-made catastrophe. Our expectation is that any such event would result in lower earnings in a given year but not an overall loss that would reduce capital in 2010. We expect financial leverage and coverage metrics to improve from their current levels over the next three years as BRK repays the debt related to the BNSF acquisition. The ratings could come under more pressure if BRK further increases its investment risk tolerance or if its overall level of capital adequacy relative to its risks deteriorates further. We currently do not expect that we would raise the ratings in the intermediate term.

 

 

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Thu, 02/04/2010 - 13:45 | 217354 deadhead
deadhead's picture

ball in your court Moodys....that ought to generate a few phone calls....

Thu, 02/04/2010 - 14:59 | 217505 AR
AR's picture

Hey DH...hope you are well. W're starting to nibble (1st leg) on some gold down here in the low 60's. May still go lower, however, we think it a good possiblity that sentiment may shift a bit in the next month due to global events leaving the instrument as a possible emerging safe haven. Good luck our friend. Funny, only a month or so ago, folks wanted volatilty, well, they've got it. Unfortunately, few of the youngsters know how to trade it with appropriate risk parameters. Times like these makes us old timers alive again. Take care...

Thu, 02/04/2010 - 15:37 | 217594 deadhead
deadhead's picture

thanks AR....glad to see you back and look forward to more insights.....as you know, PNC up to a secondary to try to remove TARP baby status...just before the announcement yesterday, BAC/ML reiterated their buy, price target @ 62....

as to the old timers, they seem to have more respect for the bear....i think he is going to be vicious for several years......

Thu, 02/04/2010 - 15:44 | 217610 AR
AR's picture

Hey DH / We're short PNC from above 58. Also short many of the others. we're trading though, taking profits, minimizing risk and exposure with every opportunity. Notice, that with 70% of all market volume quants, HFT's, government, or institutional computer led, instruments are getting whipped abnormally. Thus, when we're rewarded with moves of 5, 10, 20% in a week or month -- we aggressively book our profits and reset our risk and positions. You understand this, most don't though. Volatility will expand greatly this year (in our opinion). We just posted a little response on Tyler's "Blue Mountain" piece about managing risk and exposure. Be well our friend...

 

Thu, 02/04/2010 - 16:14 | 217664 deadhead
deadhead's picture

thanks AR!  glad to hear about PNC....i've reached my limit of the capital committed to this market but was awfully tempted to grab some OTM puts on STI.  however, i stuck to my rules and it is prudent for me to do so.

a much older guy once told me "nobody ever lost money taking a profit"....

agree with volatility increase....i still think we will print the nov 08 low of 751 this year.  lower if geopolitical events hit the boiling point and tip over...

Thu, 02/04/2010 - 17:24 | 217821 AR
AR's picture

Finally, we're also starting to build shorts (1st leg) in the 30-year up here into the close above the 118.28+ area. We have some event and weekend risk coming up (maybe to 120.04-09), however, we're willing to add to this position. We're targeting 115.10-20 area on the downside. Good luck. Heck, you and me are pioneers at our age. We still have fun though, do we not...

Thu, 02/04/2010 - 18:20 | 217958 deadhead
deadhead's picture

i just typed a lengthy reply but somehow lost it!!

oh well...

 

having a ball in this market and it seems to me that volatility is pretty much a solid thing through 2010 and into 2011.....like you said on the other thread, be aggressive taking profits, and i have been since Oct 2008......i use stops pretty frequently as well but not always.....i don't trade bonds, but watch very closely and understand the bond market well......  my concern on shorting treasuries is that i think bernanke sold his soul to the politicians....it will be most interesting to watch the long end over the next year....good luck, please keep sharing your insights, it is appreciated and i am grateful for the education.

 

Thu, 02/04/2010 - 13:57 | 217367 TraderMark
TraderMark's picture

This just in from the Greek people

"We don't do austerity"

strikes lines up in both public and private sector unions

even the tax collectors are going on 48 hour strike

http://www.fundmymutualfund.com/2010/02/greeces-biggest-union-sets-strike-tax.html

heck even people in the finance ministry are striking - lol.

in a related note, the american sheeple look forward to next week's American Idol.  Oh yeh - they are sorta pissed about government but anything over and above venting on a message board is too much work.  Wait, the Super bowl is on this weekend... nevermind.

Thu, 02/04/2010 - 14:13 | 217409 John McCloy
John McCloy's picture

+1

I better make sure those bullets are hollow points. Davos 2011: "The Road to Civil Unrest"

Thu, 02/04/2010 - 14:19 | 217426 anynonmous
anynonmous's picture

+1

Thu, 02/04/2010 - 14:53 | 217493 moneymutt
moneymutt's picture

I get mad at American sheeple, then I see this type of thing from Greece and France, and it strikes me as bad form...am I a sheeple? I remember reading the book 1776 where they said the mercenaries from German, the Brit soldiers couldn't figure out American colonist were have a revolution when the saw the abundant lifestyle average Americans had compared to european peasants (I'm sure they weren;t factoring slave population).

 

Thu, 02/04/2010 - 19:03 | 218061 Anonymous
Anonymous's picture

Bear in mind that even in the South most of the wealth from slave agriculture was going to the gentry classes who were rich in Europe too. It's Native Americans who really suffered for the prosperity of ordinary American colonists. (Not that it was zero-sum, of course; the colonists accumulated more wealth than they stole.)

Thu, 02/04/2010 - 13:52 | 217368 order6102
order6102's picture

Buffet is the greatest scambag of our times. If you looking for somone who was able to arb system to full - he is the man. Secure cheap funding via insurance company and use it to buy cashflow rich companies using regulatory loopholes. 

Thu, 02/04/2010 - 15:09 | 217534 Anonymous
Anonymous's picture

Buffet is a weasle - BRK pays ZERO dividends, but he insists that everyrhing he buys must pay dividends. The only genuis he has is getting people to accept how he skims the dividends...

Thu, 02/04/2010 - 22:43 | 218371 Hephasteus
Hephasteus's picture

Too bad Geiko doesn't have a policy for getting a squirrel stuck up your ass.

Thu, 02/04/2010 - 13:57 | 217375 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

Why did Berk split stock?  So when the hype commences people will be able to buy their stock and hold on for the ride.  Facebook btw will be hilarious!  People will buy facebook and then facebook all day and think of it like a job.  No joke.  "Hey what did you do today?" "I bought more facebook stock and then I went on facebook for a few hours."  "Did you see it gained 5% today?"  "Yeah, I think I will get back on, do a little farming, and help it go up more!"  "Haha, me too!"  Seriously, watch for it.  Buffett will be a savior over the next year while 'Merica rides into the hyper inflation nation.  Then once everyone realizes stocks went up because the Doelarr went down, they will turn on him.  They will turn on BS Bernanke.  They will turn.  Too bad the 'Merican people will be homeless and hungry and probably on drugs. 

Thu, 02/04/2010 - 13:58 | 217376 suteibu
suteibu's picture

That just took the shine off of the Bershire-B stock split and being added to the S&P.

Thu, 02/04/2010 - 14:11 | 217403 John McCloy
John McCloy's picture

I had a feeling the split for the B shares was a desperate ploy to suck in some retail cash.

Thu, 02/04/2010 - 22:04 | 218334 Anonymous
Anonymous's picture

that's my thinking also.

Thu, 02/04/2010 - 14:12 | 217407 Anonymous
Anonymous's picture

It's interesting that all these years Buffet was able to increase value in BRK, yet value was a function of the lax lending standards and credit easing that we have seen worldwide. I don't particularly think he is that useful to our country, yet many in the financial community think he's a God.

What does Buffet make? Does he build roads? Schools? We need productive people to pull us out of this mess, not further stock market manipulations and balance sheet adjusters.

I see him as a very intelligent, white collar extortionist of the capitalitst system. I do not envy him, nor honor him, as I see his empire is starting to falter. And this is common with all successful men who enter the golden years and don't acknowledge when they should step down and move aside.

Thu, 02/04/2010 - 14:31 | 217445 Anonymous
Anonymous's picture

He's a welfare queen, he was all in favor of TARP to bailout Wells Fargo, American Express, Sun Trust and M&T Bank.

Thu, 02/04/2010 - 14:46 | 217477 Anonymous
Anonymous's picture

What's even scarier is his followers, i.e., shareholders.

Go visit a stock message board. They put him up on a pedestal. He can do no wrong. He is their god, their savior. They go to great lengths to show how Wall Street is undervaluing their stock by 30%, 50%, 100%, at any given time. And heaven forbid you should ever speak ill of the man, his performance, or his actions or words.

They drink gallons of the Kool-Aid by the day.

It's truly sickening and even disturbing.

Quite the cult.

Thu, 02/04/2010 - 15:06 | 217524 moneymutt
moneymutt's picture

I really see him as a symbol for his generation, I call them the luckiest generation evah...buy businesses and invest during biggest, longest bull run in history of country...if you are 70, 80 now, you didn't need to be smart, super talented to make a good life, just a HS education, show up to your manufacturing job everyday and you could single-handedly support family of four, nice house, retirement etc..Buffet just stayed in too long, outlived the bull market that did him so well, for so long.

People in 70s 80s made good middle class salaries, went to college on the cheap if they even bothered, bought houses cheap, sold them when they were high, got pensions, got a good deal from Soc Security/Medicare, have a baby boom wind at their backs, etc...its an end of era and Buffet represents it.

Thu, 02/04/2010 - 14:18 | 217422 anynonmous
anynonmous's picture

this should help

Berkshire Cuts 3,000 Jobs After Demand Falls for Carpet, Bricks

http://www.bloomberg.com/apps/news?pid=20601087&sid=amK7hwfclzGE&pos=4

 

(did Mr. Buffett offer odds on his "all in bet on America")

Thu, 02/04/2010 - 14:21 | 217433 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

Not sure Buffet knows what odds are.  He does know free ride however.

Thu, 02/04/2010 - 19:49 | 218124 Rainman
Rainman's picture

....and the best ride of all is insurance. Government mandated for vehicles, bank mandated for homes with a mortgage. Suck up the cash premiums and grind down the claims.

I suppose they'll be stuffing that slimy little gecko up our ass 6 times per hour soon , versus the usual 4. Got to make more cash to pay off the choo-choo.

Thu, 02/04/2010 - 21:45 | 218303 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

haha!

Thu, 02/04/2010 - 14:22 | 217435 Anonymous
Anonymous's picture

Maybe Buffett should have said the market will tank the day after BB is sworn in.

Thu, 02/04/2010 - 14:22 | 217439 Assetman
Assetman's picture

S&P assumes that Warren and his buddies have not kept up in managing the portfolio of risks at Bershire due to complexity.

I disagree.  Warren knows about those embedded risks very well.  He also knows that his losses will likely be socialized if those risks don't pan out in his favor.  

Thu, 02/04/2010 - 14:41 | 217466 Anonymous
Anonymous's picture

Buffet's holdings in GS, WFC and especially GE will get crushed when the great debt unwind happens. Maybe today is the day that markets finally began the the unwind?

Thu, 02/04/2010 - 14:47 | 217478 Anonymous
Anonymous's picture

Deleveraging of debt will be an ugly bitch!

Thu, 02/04/2010 - 14:57 | 217501 moneymutt
moneymutt's picture

Toyota having quality problems, Buffet going down....what is going on? Next thing you reveal is that house prices don't always go up....I liked 2005 so much better...

Thu, 02/04/2010 - 18:57 | 218044 Anonymous
Anonymous's picture

That's our problem at the moment, right? The dream of 2005 dies hard.

Thu, 02/04/2010 - 15:05 | 217519 Forbes
Forbes's picture

If BRK has been downgraded to AA, what does that suggest about the rating of GE?

(Or did I miss GE's downgrade?)

Thu, 02/04/2010 - 15:27 | 217572 Anonymous
Anonymous's picture

ouch that has to hurt. couldn't happen to a nicer guy than that old curmudgeon warren buffet, the most intelligent invester the world has ever seen....ha ha ha

Thu, 02/04/2010 - 15:31 | 217574 ATG
ATG's picture

Fitch and Moodys already lowered BRK and GE

credit ratings. The WEB weapons of mass

financial destruction naked put portfolio could

not only drop BRK earnings 96% again, and wipe

out the BRK public investment portfolio,

WEB overpaid for BNI, COP, Cadbury and Irish

banks by his own courageous admission.

The BRK/B 1500:1 split goes against long-held

WEB principles, as do moral hazard bailout

stims of once free economies.

Now S&P lowers the boom as WEB emulates

Geithner by extending duration for cash

"before iRates rise."

($TNX almost doubled last year so far.)

This market may take no prisoners from here

on out. Time will tell.

There are only 4 AAA credits left, with two

of them headed south.

We have had a sell on BRK/A below 116,910

BRK/B below 101.10...

http://www.jubileeprosperity.com/

Thu, 02/04/2010 - 16:43 | 217725 Anonymous
Anonymous's picture

Funny that S&P downgrades BRK after Buffett sleezily convinced them to add BRK to the S&P 500. BRK's holdings include 33 S&P constituents already. Why would they need to be added to the index?

Thu, 02/04/2010 - 18:41 | 218005 MarketTruth
MarketTruth's picture

BWAAAAHAHAHAHA!!! 

He bails out Goldman Sachs like a good little soldier and then dares to compete with the U.S. Gov to sell bonds? Hope this wolf in old man sheep's clothing realizes how it feels to get it without any lubricant like the rest of us.

Besides, Morgan is the retail arm of the Federal Reserve (and a member/owner of the fed), what did Buffett expect to happen to his ratings if he dared to sells bonds when the USA Gov needs to do the same at record levels?

Thu, 02/04/2010 - 21:46 | 218307 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

+ a million quadrillion.

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