S&P Affirms Berkshire Hathaway’s ‘AAA’ Ratings; Outlook Stable

May 7, 2008

Standard & Poor’s Ratings Services has affirmed its ‘AAA’ counterparty credit, ‘A-1+’ commercial paper, and ‘AAA’ senior unsecured debt ratings on Berkshire Hathaway Inc. (BRK). The outlook remains stable.

S&P noted that although Berkshire’s net income declined to $940 million in the first quarter of 2008 from $2.6 billion in the first quarter of 2007, “the decline was caused mainly by a derivative loss of $1.6 billion in the first quarter of 2008 versus a gain of $143 million in the first quarter of 2007. Specifically, credit default contracts had fair value losses of $490 million, while equity derivatives (all European puts) had losses near $1.2 billion. The equity derivatives expire in 2019 and later.”

S&P credit analyst Damien Magarelli explained: “As these are all European puts, with no cash payments required and no collateral established before the expiration date, and because this is not viewed as a cash loss, this accounting volatility of $1.2 billion in 2008 is not a concern for the rating in the next few years.

“However,” he continued, “the credit default contracts do create cash losses. The notional value of the credit default contracts was $8.5 billion in the first quarter of 2008, so while sizeable, the full-limit loss is contained within the $281 billion in total assets at the end of the first quarter of 2008 and $119 billion in shareholders’ equity of BRK.”
Historically, these investments have generated significant premiums in prior reporting periods and, potentially, investment earnings prospectively.

“Despite the first-quarter 2008 earnings volatility, we expect BRK’s earnings to be very strong in 2008,” Magarelli added. “But potentially well below the record $13.2 billion in 2007.”

S&P said it “expects BRK’s combined ratio to increase in 2008, but despite these trends, we expect BRK to maintain its underwriting discipline and underwriting profitability in 2008 in support of the rating.

“A negative outlook could result following a management change if the culture or risk profile of BRK were to change substantially.” S&P added that it doesn’t expect CEO Warren Buffett “to retire other than because of disability.”

Source: Standard & Poor’s – www.standardandpoors.com

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