Wednesday, April 8, 2009 0 comments ++[ CLICK TO COMMENT ]++

Moody's Cuts Berkshire Hathaway ratings

Saw the story first on Bloomberg... Moody's just cut the ratings of Berkshire Hathaway and all its related companies. Office press release states:

Moody's Investors Service has downgraded the insurance financial strength (IFS) rating of National Indemnity Company (National Indemnity) to Aa1 from Aaa and the long-term issuer rating of its ultimate parent, Berkshire Hathaway Inc. (Berkshire -- NYSE: BRKA), to Aa2 from Aaa. The rating agency has also downgraded the IFS ratings of Berkshire's other major insurance subsidiaries to Aa1 from Aaa (see list below). Berkshire's Prime-1 short-term issuer rating has been affirmed. The rating outlook for all of these entities is stable.

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"Today's rating actions reflect the impact on Berkshire's key businesses of the severe decline in equity markets over the past year as well as the protracted economic recession," said Bruce Ballentine, Moody's lead analyst for Berkshire. For National Indemnity, falling stock prices have reduced its investment portfolio value and, in turn, its capital cushion relative to ongoing insurance and investment exposures. For some of Berkshire's non-insurance businesses, the recession has caused a meaningful drop in earnings and cash flows, particularly for businesses tied to the US housing market, construction, retailing or consumer finance. "These extraordinary market pressures have reduced the excess cushion available from National Indemnity and the other affected operations to support potential funding needs of the parent company," said Mr. Ballentine.

Moody's rating on National Indemnity, Berkshire's flagship reinsurer, has historically reflected its superior capitalization, which has helped it to attract business and has served as an offset to its relatively high tolerance for underwriting and investment risk. With an investment portfolio marked by a high proportion of common stocks and large concentrations in individual names, National Indemnity's regulatory capital fell by 22% during 2008 (to $27.6 billion as of year-end) and by a significant additional amount through early March 2009. National Indemnity still has a robust capital base, in Moody's view, but it remains exposed to further equity market declines, yielding a credit profile more consistent with the Aa1 rating level.


Fitch cut Berkshire's ratings earlier but many investors and financial customers look at Moody's and Standard & Poor's. Given the Moody's move, Berkshire wouldn't be considered AAA-rated anymore. I don't follow Berkshire and some readers suggested that the impact of a ratings cut will be minimal but it remains to be seen.

The lower ratings should slightly increase the cost of capital for Berkshire Hathaway and its related entities, and weaken its competitive position slightly. For example, it wouldn't have much of an advantage in bond insurance anymore--not that it was much of a business for Berkshire. Customers would also view it less favourably in mega-catastrophe insurance business, where perception and likelihood of paying losses seems paramount.

Companies that lose AAA ratings rarely get it back within a few years. Since we are facing a massive global credit bust (possibly the biggest in history), I think rating agencies will be unlikely to raise the ratings of a company operating in any financial industry for a long time.

A big problem for insurance companies is that a chunk of their assets have vaporized. I can speak firsthand by observing what happened to my reinsurer, Montpelier Re (MRH), but it also applies to companies like Berkshire Hathaway. They are stuck in a vicious cycle of declining asset prices, which is what funds their underwriting and absorbs losses, and increasing insured losses. Many life insurers, including supposedly safe Canadian ones, are facing huge problems for various reasons. Fortunately for Berkshire, it is mostly in property & casulty, which isn't tied to the economy very much. The only positive thing in the insurance business, and in the banking industry too, is that spreads are very wide hence profits can be high. In banking, the spreads between their cost of their funds, which is close to zero, and what they loan it out at, is really high; in insurance, the insurance premium is really high, partly because many insurance companies have withdrawn from the market or are unable to write any more insurance. If a young Buffett was running Berkshire, it would be time to go long simply from a contrarian point of view...

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