Berkshire's Downgrade: Rating Agencies Become More Irrelevant

Did you ever hear the saying "when a pendulum swings too far one way, it then swings too far the other"?. This is a textbook example. As of last night Fitch has downgraded Berkshire Hathaway (BRK.A). Below is the action from Fitch (hat tip to Zero Hedge for finding it).

BUT, to find out what this is really all about one need only read one paragraph in the whole document (click image to enlarge).

As you read the document, the reasoning is... bizarre, for lack of a better word.

Berkshire was downgraded because:

1. There can be no AAA rated "holdings companies of financial oriented enterprises".

2. Warren Buffett is old (they actually take pain to say "this is not age related") Well, what else could it be? Berkshire's corporate structure has not changed in 44 years and in reality, Berkshire now has a succession plan in place that was not there 4 years ago, so the "risk" for anything other than age is less. But, Fitch says having arguably the single best capital allocator in history at the helm is "too risky". They would apparently prefer two mediocre ones?

Here is what it is NOT due to:

1- Equity Index Puts

2- Derivative Contracts

3- Equity investment losses in 2008

4- Operating businesses

5- Insurance results

In other words, some legitimate reasons one would think a downgrade might be warranted.

After years of lumping BBB- mortgages together and then telling people they are now AAA and selling them as such only to watch them behave like, well CCC loans, Fitch is now telling us no AAA will be given to companies with "financial oriented enterprises". Let's not forget, Fitch at one time told us AIG (AIG) was a AAA company. So, you know, we should take what they say "to the bank".

For those who do not know about AIG, they are this cute little company that almost brought down the entire U.S. financial system last year. Its bailout will eventually cost U.S. taxpayers well in excess of $100 billion. But, hey, they had a much younger guy running things over there, so AAA was entirely warranted.

It matters not that Berkshire maintains a .25 debt to equity. It matters not that the roughly $9 billion in notes downgraded Warren could write a check for tomorrow and pay off without any impairment in Berkshire operations. It also matters not that Berkshire's insurance operation generates $35 billion of float for Warren to invest for free...

Nope, we now have blanket rules at Fitch.

This decision flies in the face of all reason, logic and is not in the least based on operating results at Berkshire. It makes no sense...

Well, given what the ratings agencies have done for the last decade, I guess them making yet another decision that undermines the investing community's faith in anything they say does make perfect sense...

BRK Downgrade

Disclosure: None

Comments

[Stephen Yu:]

Amen! Sorry, folks at the rating agencies, I really am not trying to hurt anyone's feelings, but I wish they would swing from one side back to the center, rather than just to the other side. Being overly zealous now does not wash away the loose rating mistakes of the past. What we need is objective and sensible rating.

Mar 13 04:01 AM

[JPM4:]

I don't get your point. You are saying there are good reasons for a downgrade (equity puts, CDS contracts, etc), but that Fitch didn't focus on these. Well, how about this: "With respect to BRK, Fitch views the company's potential earnings and capital volatility derived from its large, unhedged market exposures as inconsistent with the stability required at the 'AAA' level. Such exposures include large, concentrated equity investments, as well as exposure to the equity and credit markets through various derivative contracts." Read the whole note and then get back to us. Fitch has balls to d/g Buffett but there is also logic there - how can a company be AAA rated when its tangible equity is 90% backed by....common equity?? MCO of course will never d/g its owner but S&P will be next....

Mar 13 06:13 AM

[CaptainJJack:]

It is pretty clear that Fitch does not want to rate any financial company AAA. They made up a rationale, and they really do not care if you believe them.

In a past life, I was responsible for "managing" the ratings for a company that had ratings from S and P, Moody's and Fitch. I believe there was merit to the rationale's used by Moodys and S and P.

With Fitch, the best way I can describe it is : tunnel vision. They would lock on to one metric, and if you looked good using that metric, you got a good rating, relative to the other two. If not, you got hammered.

The problem was that the metric would change, and it is was often bizarre.

In general, the ratings are valuable because the ratings agencies have every reason to give lower ratings than higher. If there is a default, they look less dumb, and if there isn't, few people even remember the ratings, let alone care.

During the MBS debacle, the ratings agencies clearly were out of their element, and while there was the obvious profit motive, I suspect there was something far more subtle going on:

When I met with them, the analysts were VERY sensitive about how they were viewed by us. They viewed themselves as being financial geniuses that were undervalued (and underpaid) relative to the people they were rating.

So, it was easy for us to play to their ego. We would show them some very sophisticated modeling, and give them "insight" as to how we used the models.

They would often show boredom, but we knew they were following as best they could, and we usually made the sale that we knew what we were doing. They would rarely challenge our conclusions and never challenge our analysis.

In giving us a rating, they often went back to basics; however, over time we established a lot of credibility, and overtime, they deferred to us on some key issues.

None of this was nefarious or underhanded, but I believe it was effective.

Now imagine how they felt sitting in a room with the main Wall Street Financial engineers, that were truly rocket scientists, evaluating models based on Stochastic Differential Equations and options pricing.

Given their own sense of self worth, they were goners.

Mar 13 08:32 AM

[Stephen Yu:]

Thanks. This is good information.


On Mar 13 08:32 AM CaptainJJack wrote:

> It is pretty clear that Fitch does not want to rate any financial
> company AAA. They made up a rationale, and they really do not care
> if you believe them.
>
> In a past life, I was responsible for "managing" the ratings for
> a company that had ratings from S and P, Moody's and Fitch. I believe
> there was merit to the rationale's used by Moodys and S and P.<br/>
>
> With Fitch, the best way I can describe it is : tunnel vision. They
> would lock on to one metric, and if you looked good using that metric,
> you got a good rating, relative to the other two. If not, you got
> hammered.
>
> The problem was that the metric would change, and it is was often
> bizarre.
>
> In general, the ratings are valuable because the ratings agencies
> have every reason to give lower ratings than higher. If there is
> a default, they look less dumb, and if there isn't, few people even
> remember the ratings, let alone care.
>
> During the MBS debacle, the ratings agencies clearly were out of
> their element, and while there was the obvious profit motive, I suspect
> there was something far more subtle going on:
>
> When I met with them, the analysts were VERY sensitive about how
> they were viewed by us. They viewed themselves as being financial
> geniuses that were undervalued (and underpaid) relative to the people
> they were rating.
>
> So, it was easy for us to play to their ego. We would show them some
> very sophisticated modeling, and give them "insight" as to how we
> used the models.
>
> They would often show boredom, but we knew they were following as
> best they could, and we usually made the sale that we knew what we
> were doing. They would rarely challenge our conclusions and never
> challenge our analysis.
>
> In giving us a rating, they often went back to basics; however, over
> time we established a lot of credibility, and overtime, they deferred
> to us on some key issues.
>
> None of this was nefarious or underhanded, but I believe it was effective.
>
>
> Now imagine how they felt sitting in a room with the main Wall Street
> Financial engineers, that were truly rocket scientists, evaluating
> models based on Stochastic Differential Equations and options pricing.
>
>
> Given their own sense of self worth, they were goners.

Mar 13 11:39 AM

[notsosmart:]

its really easy.just ignore the rating agencies.when i heard about GE last week i bought more.these businesses are phony like the ratings they gave out for years.just think for yourself.worked well for me.i got out @ 14,000dj. just starting to nibble now.

Mar 13 12:01 PM

[henarl:]

Why does anyone pay attention to the archaic rating agencies any longer? They have totally lost credibility and should themselves be heavily downgraded by the market.

Mar 13 01:25 PM

[Dave Shafer:]

Hmmm..... what Fitch is really telling us is that they are either too lazy or too incompetent to actually do any analysis, so they are just rating based industries recent past performance!

Mar 13 02:18 PM

[Vox Rationalis:]

Perhaps nothing should be AAA. Gee, what a novel concept for one of the companies that put AAA on so much mortgage-related debt that's now haunting us all.

One thing's pretty certain: Moody's will not be downgrading BRK.

Mar 14 11:45 AM

[Andy Singh:]

Berkshire and General Electric (GE) now have the same credit rating from Moody's when Berkshire has roughly 10 times GE's tangible book value. As Whitney said, the inconsistency "underscores why no sane investor should pay any attention to the credit rating agencies."

Apr 08 10:33 PM