In the last few weeks, Berkshire Hathaway (BRK-A) has been downgraded from its triple-A rating, with Moody’s being the most recent firm to strip Berkshire of its prized position. While it is never a good thing for a company to lose its triple-A status, I don’t think these moves will have an overly material effect on Berkshire, or the perception of its financial strength in the marketplace.
Over the last year, several companies, such as AIG, and securities, including a bevy of mortgage related investments, that had been rated very highly have been proven out over the past year to have not deserved their previously lofty status. As such, several firms that had bestowed these ratings, now appear to have egg on their face, and as a result, are reviewing their ratings on almost all other companies and securities. In my opinion, this type of review is generally a good idea, and something that should be done constantly, but I also think that current market circumstances are causing some of these firms to now be overly conservative.
And this, in a nutshell, is what I think has happened to Berkshire’s rating. By all appearances, Berkshire still seems—to me, at least—to be a bastion of financial strength. The conglomerate has more than $20 billion of cash on its balance sheet. In addition, it has tens of billions of both equity and fixed income securities that it could sell in the marketplace if it needed to raise capital. Several of its subsidiaries are still sending cash to Omaha for Chairman Warren Buffett to invest, though probably less than last year. And finally, the company has little debt, other than in its utilities and manufactured housing subsidiaries, whose debt does not appear to have recourse to the assets of the holding company.
While I think that all of the elements I just described help to illustrate the soundness of Berkshire’s financial health, there are some things to watch too. Berkshire’s bigger foray into the derivatives market—especially after warning about their risks for years--certainly adds some complexity to the conglomerate’s balance sheet. And even though I think the profit potential of these contracts is good, in an era where simple is now better, Berkshire’s derivative positions do add a couple shades of gray to its financial position. It is important to remember, though, that Berkshire has minimal collateral posting requirements on its derivatives in the event of any sort of downgrade. This is critical, because, if you’ll remember, collateral postings on derivative positions are what led to the downfall of AIG. The other things to watch are not new. Chief among these is succession planning, which has been acknowledged, and, in my opinion, addressed.
It seems that at some point, there will not be any--or maybe just a few--triple-A rated companies left. What that essentially means then, is that double-A will be, in effect, the new triple-A. And if this eventuates, the scale will have just slid down, and Berkshire—even with its recent downgrade—will still have some of the best ratings around.
You might also be interested to know that this article was recently mentioned in a Bloomberg article, which I’ve linked here, as well as an Associated Press article, which I’ve linked here.
Justin
The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business. This content is intended solely for the entertainment of the reader, and the author.
