Immelt Meets Buffett in Market Roiled by Credit Swaps (Update4)
March 6 (Bloomberg) --
Warren Buffett and
Jeffrey Immelt are among a handful of chief executive officers whose companies are rated AAA. Yet Buffett’s Berkshire Hathaway Inc. and Immelt’s General Electric Co. are being treated like junk in the market for credit-default swaps.
Contracts that protect investors against a default on bonds of Omaha, Nebraska-based Berkshire, which has $25.5 billion in cash, cost as much as those of KB Home, the homebuilder that lost money for seven consecutive quarters. Credit-default swaps on the finance arm of GE, which holds $45 billion of cash, are about as expensive as those for building materials-maker Louisiana-Pacific Corp., which posted nine straight quarterly losses.
Trading in credit derivatives is proving investors believe no borrower is immune from the seizure in credit markets that led to the U.S. government’s takeover of insurer
American International Group Inc. and the collapse of investment bank
Lehman Brothers Holdings Inc. Like those companies, Berkshire and GE relied on high credit ratings to generate profit and win new business.
“The market is tarring them with a similar brush in that these guys likely used their AAA ratings to achieve a very low funding on bets that you and I may have not otherwise have taken,” said
Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California.
Highest Ratings
Traders are increasing bets against GE because the Fairfield, Connecticut-based company’s
finance arm may need to post as much as $12 billion in collateral if long-term ratings are cut to the single-A level and short-term ratings fall below the top A1/P-1 category, CreditSights Inc. analyst
Richard Hofmann in London estimated in a research note this week. He based the analysis on a review of GE’s regulatory filings.
Berkshire and GE have the highest ratings from both Moody’s Investors Service and Standard & Poor’s. Berkshire said Feb. 28 that fourth-quarter net income fell 96 percent to $117 million from $2.95 billion in the same period a year earlier. GE just posted its third-highest
annual profit and is the biggest maker of jet engines and power turbines.
Moody’s judges the debt obligations of companies with its Aaa rating to “be of the highest quality, with minimal risk.” S&P says its AAA credit rating means an “obligor’s capacity to meet its financial commitment on the obligation is extremely strong.”
Reviewing Rating
Moody’s said Jan. 27 that it’s evaluating whether to lower GE’s rating, a review that typically takes about 90 days. GE cut its
dividend Feb. 27 for the first time since 1938 to save $9 billion a year. Bonds ranked below Baa3 by Moody’s or less than BBB- by S&P are considered high-yield, high-risk, or junk.
Credit-default swaps are used to hedge against losses or to speculate on a company’s ability to repay its debt. They pay the buyer face value if a borrower defaults in exchange for the underlying securities or the cash equivalent. Prices for the contracts rise when perceptions of credit quality decline.
Trading in the unregulated $27 trillion market has come under scrutiny by regulators and company executives, who blame bets made in the market for amplifying the credit crisis.
Richard Fuld, Lehman’s CEO, in Oct. 6 congressional testimony blamed his firm’s September collapse on “destabilizing factors” including the soaring price of default protection on the investment bank.
Regulators in the U.S. and Europe are pushing dealers to develop clearinghouses that would act as the buyer to every seller and seller to every buyer, reducing the risk of a counterparty defaulting on a transaction.
Upfront Payments
Sellers of credit-default swaps tied to the
debt of General Electric Capital Corp. for five years today demanded 14.5 percent upfront, in addition to 5 percent a year, according to broker Phoenix Partners Group. That means it costs $1.45 million initially and $500,000 annually to protect $10 million of obligations. The cost was $446,000 a year two weeks ago.
Swaps on Nashville-based
Louisiana-Pacific, rated BB by S&P, or 12 steps lower than GE Capital, trade at about 18 percent upfront, according to London-based CMA DataVision.
GE Chief Financial Officer
Keith Sherin said in an interview on the GE-owned CNBC television network yesterday that the surge in credit-default swaps on his company’s finance unit “is overdone” and worsened by below-average trading volume.
“We looked at the actual CDS trades on Monday and Tuesday,” he said. “It was a total of $35 million over the two- day period. Normally, it’s $100 million a day. Was that really market fundamentals or was it just some sort of disruption based on very narrow trades in a volatile time?”
Immelt’s Plan
Outstanding credit swaps on GE Capital increased $963.8 million the week ending Feb. 27, according to the Depository Trust & Clearing Corp., which runs a central registry for the market. There were a gross total $79.9 billion of swaps tied to the company, protecting a net $11.2 billion of the company’s debt from default, the third-highest in the market, the data show.
Immelt said he intends to shrink the finance arm to 30 percent of total earnings this year from about half in 2007. GE’s profit from continuing operations was $18.1 billion last year as finance made $8.6 billion. The company projected the unit will earn $5 billion this year.
GE has still lost about $266 billion in
market value in the 12 months through yesterday, while Berkshire has declined by $120.3 billion since peaking at $231.06 billion on Dec. 10, 2007.
GE rose 40 cents, or 6 percent, to $7.06 in New York Stock Exchange composite trading. The shares have dropped 56 percent this year. Berkshire rose $795 to $73,195. The stock has lost 24 percent in 2009.
Buffett’s Letter
Swaps on Berkshire have climbed 2.09 percentage points the past three weeks to 5 percent a year, CMA data show. Contracts on Los Angeles-based
KB Home trade at the same level.
Buffett said in his annual letter to shareholders Feb. 28 that companies such as his that haven’t taken government bailouts or don’t have access to state funding are effectively being penalized by markets. More than 500 banks, insurers and credit- card companies applied for capital from the Troubled Asset Relief Program and the government has distributed almost $300 billion.
“Funds are abundant for the government-guaranteed borrower but often scarce for others, no matter how creditworthy they may be,” he wrote. “Government is determining the ‘haves’ and ‘have-nots’.” Buffett didn’t immediately respond to a request for comment left with assistant
Carrie Kizer.
Selling Swaps
Berkshire in 2008 started writing credit-default swaps on individual companies, with contracts guaranteeing $4 billion of debt from 42 borrowers, Buffett said in the letter. The company is unlikely to expand the position because “most buyers of this protection now insist that the seller post collateral, and we will not enter into such an arrangement,” he said.
Buffett has struck deals with firms that Berkshire hasn’t identified to protect them against declines in four equity indexes and guarantees on indexes of non-investment grade debtors that require the company to pay out when there’s a default.
The firms that bought the derivatives from Berkshire may now be buying credit swaps on the company to ensure they get paid,
Jeff Matthews, author of “Pilgrimage to Warren Buffett’s Omaha” and founder of hedge fund Ram Partners LP, said earlier this week.
Because an average of just 1,550 Berkshire shares are traded on public exchanges, it’s difficult to borrow the stock to bet against the company through short
sales. So, speculators may be buying credit-default swaps to hedge against equity losses, said Backshall of Credit Derivatives Research.
‘Choking Everyone’
Until the plunge in the housing market is stemmed and asset prices stabilize, finance companies such as GE Capital will continue to be penalized, said
Gregory Habeeb, who manages $7.5 billion of fixed-income assets at Calvert Asset Management Co. in Bethesda, Maryland.
“They need some improvement in fundamentals that we’re just not getting,” Habeeb said. Housing “continues to create the drop in asset values that’s choking everyone,” he said.
The surge in GE’s credit-default swaps may also be related to collateralized debt obligations that bet on companies’ creditworthiness. The CDOs often held credit-default swaps tied to GE because they paid higher premiums relative to the company’s ratings, boosting returns, said Backshall. Now, the dealers who sold the CDOs must hedge their exposure by buying protection, pushing prices of the contracts higher.
Among the so-called synthetic CDOs ranked by Fitch Ratings, GE Capital is the company most often bet on, according to data compiled by the firm.
A lot of traders “are in a position of where it’s sort of hedge or lose your job,” Backshall said. When GE credit swaps soared to as high as 20 percent upfront yesterday, “that was likely driven just by a desk deciding to desperately hedge,” he said, “rather than a real belief” that the company had a high risk of defaulting.
To contact the reporter on this story:
Shannon D. Harrington in New York at
[email protected]
in sostanza dice:
un problema con FDC che acquista SOLO 
