from Standard and Poors
On New Criteria, Berkshire Hathaway Inc. Downgraded To 'AA', Core Ins. Subs Affirmed At 'AA+', Senior Debt Rated 'AA'
Overview
- Under our revised group methodology criteria, we are lowering our counterparty credit rating on BRK to 'AA' from 'AA+'. At the same time, we are affirming our 'AA+' counterparty credit and financial strength ratings on BRK's core operating insurance companies.
- The ratings reflect our view of the group's excellent business risk profile and very strong financial risk profile based on an extremely strong competitive position and very strong capital and earnings.
- The negative outlook reflects the U.S. sovereign ratings cap and our view that the group's capital adequacy per our capital adequacy model could deteriorate relative to its risk profile.
Rating Action
On May 16, 2013, Standard & Poor's Ratings Services lowered its counterparty credit rating on Berkshire Hathaway Inc. (NYSE:BRK; AA/Negative/A-1+) by one notch to 'AA' from 'AA+' and affirmed its 'AA+' insurance financial strength ratings on BRK's core subsidiaries following release of our revised Insurers Rating and Group Rating Methodology, released on May 7, 2013. The outlook on all ratings is negative. At the same time, we assigned our 'AA' senior debt rating to Berkshire Hathaway Finance Corp.'s (BHFC) $1.0 billion senior
unsecured notes. BHFC has issued the notes in two tranches: $500 million 1.3% senior unsecured notes due May 15, 2018, and $500 million 4.3% senior unsecured notes due May 15, 2043. The company used the proceeds of this issue to repay $1.0 billion of senior notes maturing on May 15, 2013.
Rationale
BRK fully guarantees BHFC's new note issuance. BHFC's borrowings are used to fund the finance operations of Vanderbilt Mortgage & Finance Inc., a wholly owned subsidiary of Clayton Homes Inc., a vertically integrated manufactured housing company. We treat these borrowings as operating leverage, so we exclude the debt, interest expense, and pretax operating income of these operations from our calculations of financial leverage and coverage for BRK.
The lower credit rating on BRK better reflects our view of BRK's dependence on its core insurance operations for most of its dividend income. Its non-insurance business segments generate a majority of BRK's operating income, but aside from the insurance subsidiaries only Burlington Northern Santa Fe LLC (BNSF) has provided a significant portion of the total dividends paid from the operating companies to the holding company. BRK's adjusted leverage and coverage metrics are more consistent with those of 'AA' rated issuers rated under our comparable corporate criteria.
BRK's adjusted debt-to-EBITDA ratio of 1.6x as of year-end 2012 was slightly less than the 'AA' U.S. corporate median (three-year average) of 1.2x, while its adjusted EBITDA fixed-charge coverage ratio for 2012 was about 23x, when evaluated against the 'AA' U.S. corporate median (three-year average) of 19.6x. As of year-end 2012, adjusted financial leverage was about 12%. The vast majority (close to 80%) of the insurance group's dividend capacity is from insurers domiciled in one state. Therefore, dividends are subject to the applicable statutory limitations on the amount of dividends an insurer is permitted to pay without receiving special approval from the state insurance commissioner, in this case the Nebraska Department of Insurance. Nevertheless, BRK continues to benefit from nonstandard notching and is the only interactively rated insurer that has an issuer credit rating less than two notches below the core insurance company ratings. This reflects our view of the diversity of businesses and the substantial amount of cash and investments at the holding company.
The ratings reflect our view of BRK's excellent business risk profile (BRP) and very strong financial risk profile, built on an extremely strong competitive position and very strong capital and earnings. These factors are offset to some extent by BRK's high tolerance for equity investments, which has resulted in volatility in the company's insurance subsidiaries' statutory capital, capital adequacy of the insurance operations being less than what we typically expect for the rating category, and adequate enterprise risk management. Management succession at BRK is also an offsetting factor. We assess a one-notch uplift to the BRP to reflect our view of the low-risk nature of its non-insurance operations, which comprise approximately 60% to 70% of total earnings. In addition, we apply a holistic adjustment because BRK, on a consolidated basis, continues to outperform its insurance and non-insurance peers with respect to operating and financial performance, such as underwriting and cash-flow generation. For first-quarter 2013, pretax operating income was $5.9 billion, up 36% from the same quarter in 2012, with most of the improvement stemming from the insurance segment of BRK. Shareholders' equity rose to $198.1 million from $187.6 million as of year-end 2012, mostly driven by $5 billion of net income in the quarter and the appreciation of unaffiliated equity securities.
Outlook
The outlook is negative for two reasons. One is the sovereign rating cap of 'AA+/Negative', which applies to the obligations of the U.S. government, government-related enterprises, and U.S. financial services firms. The second reason is that we could lower the rating if the capital adequacy according to our capital model of BRK's insurance operations relative to its risk profile deteriorates as a result of a material increase in investment risk exposure or the funding of a large acquisition by the insurance companies. The negative outlook reflects our sovereign rating cap and our view on the group's capital adequacy per our proprietary capital model. We also expect the group to maintain operating performance consistent with our base-case scenario, and at least a very strong competitive position.
