Berkshire Hathaway 2009 Annual Meeting Audience Question # 32

Berkshire’s credit rating makes “very, very little difference” on it’s borrowing costs

Warren Buffett:


Carol Loomis:

Warren, Charlie… this question, I got a good many of these. This one comes from… who does it come from? Well, it comes from Mr. Kempton… Kempton Lam or Lam Kempton… one of the two… from Calgary, Canada.

And the question is, “How would you quantify the financial impact and damage of Berkshire losing its triple-A credit rating… which increased the cost of capital of Berkshire, which was surely a competitive advantage for the company?

“And Warren, what are you doing actively to try to restore Berkshire’s triple-A rating? Do you think that Berkshire will be able to regain it?”

Warren Buffett:

Well, it won’t regain it soon, because I don’t think rating agencies will turn around like that, even if they should. We have a triple-A from Standard & Poor’s, but it’s provisional. And they’re going to look at it in about… I think they said about 12 months.

Moody’s affirmed the rating early in January. Then we issued a bond at one point, where it was… well, that was right after the rating changed.

And actually, in terms of our credit default swaps, which is a metric you can use for credit acceptance… although, I’ll tell you, in a second, an interesting aspect of that… that spread came down, actually.

It makes very, very little difference in our borrowing costs. I mean, very little. And it never has, incidentally. I mean, double-As versus triple-As, the spread has always been very small.

And people would argue, in finance classes and all that, it wasn’t worth paying the price to have a triple-A because you didn’t save that much on debt. And it costs you, in terms of return on equity.

I never subscribed to that. And I very much liked having a triple-A from both Moody’s and Standard & Poor’s. I was disappointed when Moody’s downgraded us. We didn’t really think that was going to happen, but it did.

And… it doesn’t have any material effect on borrowing costs. It does cause us to lose some bragging rights around the world in terms of our insurance promise, although nobody ranks ahead of us, that’s for sure.

But, it will not change back in a hurry. I mean, people don’t make decisions in committees that they reverse very quickly. It’s just not human nature.

We’re still a triple-A in my mind. And actually, we’re a triple-A in Standard & Poor’s’ mind, till we hear something differently.

We certainly think, and we run it in a way, that there can be no stronger credit than Berkshire.

It’s difficult for a rating agency, if they have a checkbox system of ratios and such, to measure something like the attitude of management toward creditors.

But I will assure you that Berkshire has a management that regards meeting its obligations as sacred and a lot more important than increasing earnings per share or anything of the sort.

I mean, we have obligations to people in something like workers’ compensation that go 50 years out in the future. I mean, this is somebody that’s been injured severely and they get a check every month from Berkshire.

And you know, that’s a lot more important than whether we earn X, or X plus a tenth, or a couple of tenths, percent on equity. And we conduct ourselves, or we try to… certainly try to conduct ourselves… so that not only will people get those checks, but they’ll never have to even worry about getting those checks.

And that’s very difficult for a rating agency to quantify that attitude on the part of the management of Berkshire. But believe me, it exists.

And… I would say that the triple-A change at Moody’s is not going to be material in the future of Berkshire. But it still irritates me.


Charlie Munger:

Well, at least they showed a considerable independence.

Warren Buffett:

Who knows? That may have entered into it, too.

Charlie Munger:

Yeah. My attitude is quite philosophical. I think the next change at Moody’s will be in the opposite direction. And I think that will happen because we deserve a higher rating and they’re smart.

Warren Buffett:

When Charlie and I disagree, and we do disagree a lot. We never argue, but we disagree.

And Charlie, when he gets to the point where he really wants me to do something, like buy the BYD interest or something, he always says to me, “Well,” he says, “in the end, you’ll see it my way. Because you’re smart, and I’m right.”

I will… I can’t resist pointing out one item that is, maybe, a little technical to most of you. But there are some people here who will find it quite interesting. And it actually even enters into credit ratings to a great extent, the credit default swaps enter into it.

When we write a, let’s take an equity put option, and we get paid for writing a billion dollar put, somebody pays us $150 million, we get the $150 million of cash that day.

And we set up a liability for 150 million the first day, for the value or the… that we… our appraisal of what it’s going to cost us to meet that obligation. I mean, that’s the market price for it.

The other guy takes 150 million out of his cash and sets up a $150 million receivable that day.

Now, these receivables and payables change over time. But the first day, no profit, no loss, just cash changing hands. One guy sets up an asset, the other guy… we set up a liability.

Now, as the world has developed in the last couple of years, the value of that asset to the other fellow has increased in a mark-to-market basis.

And he reports that through earnings. So his asset goes up. Our liability goes up. And we report that through earnings as a loss.

But we’ve got the cash and he’s got an asset from us that comes due in 15 years or something like that.

And in the last couple of years, the… his auditors… his credit department… has said, “Gee, you’ve got a receivable from Berkshire that comes due in 15 years. And, they don’t have to post collateral. So you have to go out and buy a credit default swap to protect yourself against that receivable going bad.”

Now, that has two effects. A, he’s laying out money every year to buy something that doesn’t cost us anything but costs him real money. So the… and the more he shows us a profit, the more of the credit insurance he has to buy, so the more money it costs him every year.

And that has driven up the demand for credit default swaps at Berkshire, which made for some crazy prices. So at one point, our credit default swaps were costing that guy five percent a year.

So if he was showing, say, a $200 million asset, he was laying out $10 a year, and he was going to have to lay it out for 15 years, just because of these… this credit department’s requirements.

And it made it very unpleasant for the people on the other side of our transactions, even though they keep writing up the profits. It doesn’t cost us anything. But it does result in kind of a crazy market in the credit default swaps.

I realize that that has not been a burning issue with many of you. But it is an unusual… it’s something I didn’t anticipate.

And it explains why, to some extent, people may want to modify their contracts with us. And if they… with us… and if they want to modify them enough, we’ll answer the phone. But in the meantime, we’re sitting with the money.

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