CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Berkshire Hathaway Inc.'s (NYSE:BRK) Issuer Default Rating (IDR) at 'AA-' and senior unsecured debt at 'A+'. The Rating Outlook is Stable. In addition, Fitch has affirmed the 'AA+' Insurer Financial Strength (IFS) ratings on BRK's key insurance subsidiaries. The Rating Outlook is Stable. A complete list of ratings and rating actions follows at the end of this release.
KEY RATING DRIVERS
Fitch's ratings on BRK continue to be supported by diverse sources of earnings with a history of solid profitability. Financial flexibility and liquidity are key rating attributes and Fitch maintains a favorable view of BRK's access to capital markets and large holdings of cash and equivalents. BRK's insurance operations continue to be a key area of earnings and expertise within BRK and are typified by extremely strong capitalization and large market position, size and scale.
Balanced against these strengths is earnings volatility risk given BRK's material exposures to equity markets, insured natural catastrophes and asbestos and environmental retroactive reinsurance. BRK's acquisition strategy brings additional risks including potential earnings volatility and increased financial leverage.
BRK reported net income of $9.2 billion for the first six months of 2015 or a 7.6% annualized return on equity, down from $11.1 billion and 9.8% in the comparable period of 2014. Unrealized gains on fixed income securities are excluded from return on equity calculations. The decline can be explained by reductions in insurance operations and gains from derivatives, which overcame a sizeable increase in earnings from Burlington Northern and Santa Fe (BNSF).
BRK's insurance group reported $3.1 billion in earnings before tax in the first half of 2015, down from $3.8 billion in the comparable period in 2014. The insurance operations accounted for one-quarter of BRK's $12.3 billion in pre-tax earnings allocated to operating segments, which was the largest contributor along with BNSF through the first six months of 2015. Worsening frequency and severity loss trends in BRK's personal auto line, GEICO, were primarily responsible for deteriorating profitability in BRK's insurance segment.
BNSF railroad operation continues to make significant contributions to earnings. BNSF reported a pre-tax gain of $3.2 billion for the first six months of 2015, up from $2.6 billion in the comparable period in 2014. Fitch expects BNSF's profitability for the remainder of 2015 to be squeezed by lower freight volumes attributable to a softening demand for energy related products and increased spending on plant and equipment.
BRK's GAAP basis earnings will continue to be exposed to accounting earnings volatility given the large notional values and long duration of BRK's outstanding derivative contracts. Additionally, Fitch believes that BRK's earnings will be exposed to potential volatility from the company's reinsurance businesses and its exposure to catastrophe-related losses as well as the company's large equity investment portfolio.
BRK maintains excellent financial flexibility as seen in its cash and equivalents balance and access to capital markets. Cash and equivalents amounted to nearly $67 billion as of June 30, 2015, most of which resides at the insurance operations. At June 30, 2015, BRK's subsidiaries in aggregate had approximately $8.9 billion in available capacity under lines of credit and commercial paper with $5.3 billion related to BHE and its subsidiaries.
Cash and equivalents will decline materially with the acquisition of Precision Castparts Corp. (PCP) and additional purchases of Phillips 66 common stock. PCP is a worldwide manufacturer of complex metal components and products, serving aerospace, power and general industrial markets. Berkshire will finance the transaction with approximately $23 billion in cash and issue approximately $10 billion in debt. The deal is expected to close in the first quarter of 2016.
BRK's consolidated financial leverage ratio (FLR) was 25.3% as of June 30, 2015 and will approach 30% with the financing of the PCP acquisition. The consolidated FLR includes $57 billion of debt attributable to BRK's Railroad, Utilities and Energy business. Fitch expects these major non-insurance businesses will service their own debt.
An alternate calculation of BRK's financial leverage ratio, using holding company debt and debt issued by the finance operations and guaranteed by BRK, was 17.1% at June 30, 2015. The agency views BRK's ability to fund finance operations at a low cost as an important competitive advantage for the finance operations and also notes that much of the finance company debt is guaranteed by BRK.
Consolidated interest coverage for the first six months of 2015 was 7.5x excluding realized investment gains and derivative gains, which is below Fitch's expectations of 12x for companies at BRK's rating level. An alternate calculation of interest coverage, excluding railroad, utilities and energy, was 14.3x during the first six months of 2015 and is consistent with the current rating category.
Following the acquisition of PCP, BRK is approaching Fitch's tolerances on financial leverage and interest coverage. Consequently, another material acquisition similarly or more aggressively financed than the PCP acquisition would place downward pressure on BRK's ratings.
Key rating triggers that could lead to a future downgrade include:
--Deterioration in the credit quality of key insurance subsidiaries (National Indemnity, GenRe, and GEICO) that is no longer consistent with the current 'AA+' rating. Measures of credit quality include Fitch's judgment of capitalization, a total financing and commitments ratio greater than 1.5x, net leverage (excluding affiliated investments) over 3.5x or a sharp and persistent reduction in underwriting profits.
--A consolidated run-rate debt-to-total capital ratio that exceeds 30% or a run-rate debt-to-total capital ratio from the holding company, insurance and finance operations (including debt issued or guaranteed by the holding company) that exceeds 25%.
--Material increases in leveraged equity market exposure such as its equity index put derivative portfolio.
--Acquisitions or other actions that reduce outstanding cash below $10 billion or approximately 5x consolidated interest expense.
Key rating triggers that could lead to an upgrade include:
--A commitment to lower debt-to-tangible capital ratios attributed to the holding company, insurance and finance operations. Fitch believes that this would likely require the scaling back of the finance operations.
Fitch has affirmed the following ratings:
Berkshire Hathaway, Inc.
--Issuer Default Rating (IDR) at 'AA-'.
--$300 million 0.8% senior notes due February 2016 at 'A+';
--$750 million 2.20% senior notes due August 2016 at 'A+';
--$1.1 billion 1.9% senior notes due January 2017 at 'A+';
--$800 million 1.55% senior notes due February 2018 at 'A+';
--$750 million 2.1% senior notes due August 2019 'A+';
--$500 million 3.75% senior notes due August 2021 at 'A+';
--$600 million 3.40% senior notes due January 2022 at 'A+'
--EUR750 million 0.75% senior notes due March 2023 at 'A+';
--$500 million 3.0% senior notes due February 2023 at 'A+';
--EUR1.25 billion 1.125% senior notes due March 2027 at 'A+';
--EUR1 billion 1.625% senior notes due March 2035 at 'A+';
--$1 billion 4.5% senior notes due February 2043 at 'A+'.
Berkshire Hathaway Finance Corporation (BHFC)
--$500 million 2.45% senior notes due December 2015 'A+';
--$1 billion 0.95% senior notes due August 2016 'A+';
--$400 million floating rate senior notes due January 2017 'A+';
--$650 million floating rate senior notes due January 2017 'A+';
--$1,350 million 1.6% senior notes due May 2017 'A+';
--$400 million floating rate senior notes due August 2017 'A+';
--$600 million floating rate senior notes due January 2018 'A+';
--$1.25 billion 5.4% notes due May 2018 'A+';
--$500 million 2.0% senior notes due August 2018 'A+'
--$500 million 1.3% senior notes due May 2018 'A+';
--$550 million 2.9% senior notes due October 2020 'A+';
--$750 million 4.25% senior notes due January 2021 'A+';
--$775 million 3.0% senior notes due May 2022 'A+';
--$750 million 5.750% senior notes due January 2040 'A+';
--$725 million 4.4% senior notes due May 2042 at 'A+';
--$500 million 4.3% senior notes due May 2043 'A+'.
--$150 million 7.4% senior notes due July 15, 2023 'A+'.
General Re Corporation
--$500 million commercial paper program 'F1+';
--Short-term IDR 'F1+'.
Fitch affirmed the following insurance subsidiaries that carry an 'AA+' Insurer Financial Strength:
--Government Employees Insurance Company;
--General Reinsurance Corporation;
--General Star Indemnity Company;
--General Star National Insurance Company;
--Genesis Insurance Company;
--National Indemnity Company;
--Columbia Insurance Company;
--National Fire and Marine Insurance Company;
--National Liability and Fire Insurance Company;
--National Indemnity Company of the South;
--National Indemnity Company of Mid-America;
--Wesco Financial Insurance Company.
Although BRK's General Reinsurance Corp. subsidiary participated directly in the rating process, BRK did not participate other than through the medium of its public disclosure.
Additional information is available at www.fitchratings.com
Insurance Rating Methodology (pub. 16 Sep 2015)
Dodd-Frank Rating Information Disclosure Form