By Andrew Frye
Nov. 9 (Bloomberg) -- Berkshire Hathaway Inc. said “the credit crisis has abated,” bolstering the firm’s earnings potential after Chief Executive Officer Warren Buffett agreed to pay $26 billion and take on debt to fund his biggest takeover.
Improvements in the creditworthiness of U.S. companies helped triple third-quarter profit, announced by Berkshire in a Nov. 6 filing, and provide a cushion for Buffett as he buys railroad Burlington Northern Santa Fe Corp. Berkshire made the comment on credit markets in the same filing, saying that “interest rates for investment grade issuers relative to government obligations have declined.”
Refinancing costs for municipalities and the riskiest corporate borrowers plunged, reducing the chance Omaha, Nebraska-based Berkshire will have to pay out on protection it sold against defaults. After a second straight profit increase, Berkshire is risking its AAA credit grade by borrowing about $8 billion for the purchase of Fort Worth, Texas-based Burlington, a deal Buffett called an “all-in wager” on the U.S. economy.
“He’s clearly talking from the position of a guy that has his finger on the pulse of the world economy,” said Jeff Matthews, the author of “Pilgrimage to Warren Buffett’s Omaha” and founder of the hedge fund Ram Partners LP. “If he were still worried about credit markets he wouldn’t be doing this. It does say something for this guy to put that much money on a bet on the U.S. economy.”
The acquisition of Burlington, the biggest U.S. railroad, comes after 12 months in which declining sales at Berkshire’s retailing, manufacturing and jet-leasing units forced the firm to cut jobs and close plants. The takeover will bring $10 billion of assumed debt and add about 40,000 employees to a Berkshire workforce that already totals more than 200,000.
‘Money to Work’
“It’s time to take a little more risk,” said Gerald Martin, a finance professor at American University’s Kogod School of Business in Washington. “He’s now saying ‘OK, if it’s now abating, then it’s time to put money to work rather than keeping it for a rainy day.’”
Buffett, the second-richest American, positioned Berkshire to weather the contraction in the U.S. economy by stockpiling $44 billion in cash. Starting in 2008, when corporate borrowing costs surged, he drew on that hoard to finance Goldman Sachs Group Inc., General Electric Co., Swiss Reinsurance Co. and the Mars Inc. takeover of chewing-gum maker Wm. Wrigley Jr. Co.
Credit-Default Swaps
Third-quarter profit was fueled by payments from those investments and improved bond prices that allowed the firm to reverse losses on protection it sold against bad loans through credit-default swap contracts. Net income surged to $3.24 billion from $1.06 billion as the swaps had a $1.44 billion gain. Book value, the measure of assets minus liabilities, jumped 10 percent in three months to $126.1 billion.
Berkshire advanced $1,870, or 1.8 percent, to $104,270 at 9:39 a.m. in New York Stock Exchange composite trading, the biggest gain since September. The stock rose 12 percent in the three months ended Sept. 30, the best quarterly performance since 2007.
Demand for the lowest-rated securities drove junk bonds to their eighth straight monthly gain in October, the longest streak since June 2007, as data showed the U.S. economy may have emerged from recession last quarter. Benchmark municipal borrowing costs reached a 42-year low in October before rebounding.
The Lehman Brothers Holdings Inc. bankruptcy in September 2008 caused investors to curtail financing and helped produce three times as many global high-yield, high-risk corporate bond defaults this year as in the same period of 2008, Standard & Poor’s said last week.
‘Highly Leveraged’
“Non-investment grade issuers are typically highly leveraged and therefore dependent on having ongoing access to the capital markets,” Berkshire said in its third-quarter report. “The freezing of the credit markets in late 2008 and early 2009 was particularly detrimental to these issuers.”
Berkshire paid $1.9 billion on soured credit-default swap deals in the first nine months of the year and could be liable for a maximum of about $25.6 billion if all contracts require full payment, according to the company’s filing.
S&P and Fitch Ratings said last week they may cut Berkshire because of lower liquidity after the Burlington deal. Downgrades, “depending on the degree,” may force Berkshire to post as much as $1.1 billion of collateral with trading partners, the company said in the filing.
Insurance Operations
The sale of insurance from underwriting units, which typically account for the largest portion of Berkshire profit, will be curtailed to guard capital, the company said. Buffett buys stocks, bonds and companies with insurance premiums before paying claims. Profit from underwriting policies more than quadrupled to $363 million, after taxes, on lower storm costs.
“Management will continue to constrain the volume of business written in light of the pending Burlington Northern Santa Fe acquisition,” Berkshire said. “Restricted access to credit markets at affordable rates in the future could have a significant negative impact on operations.”
Berkshire’s energy business and the unit that sold the swaps are among those most vulnerable to an increase in borrowing costs, the company said in the filing.
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