News came out recently that Berkshire Hathaway and Warren Buffett just canceled $8.25 billion worth of credit default swaps tied to municipal bonds. The experts in this area say that you should not take this as a warning for various reasons.
Stephen Winterstein commented on this exact topic during a webcast interview that he gave with InvestmentNews last Tuesday. He is the managing director at Wilmington Trust Corp. He said “I don’t think Berkshire Hathaway or Warren Buffett was trying to send us a flare to beware the municipal market.”
The CEO of Bernardi securities, Ronald Bernardi, also commented that he didn’t feel like this was a warning at all by Buffett, but most likely an opportunity that Warren Buffett just couldn’t pass up.
Ronald said “We view it as a trade. Mr. Buffett is a very smart man and was astute enough to underwrite insurance against municipal defaults back in 2008 – and he’s had to pay out very little. I suspect he’s made a lot of money on that trade. I don’t necessarily conclude he sold because he’s concerned about massive defaults in the muni market.”
During the second quarter earnings report of Berkshire Hathaway, they revealed that they actually canceled the credit default swaps, which is a way to have insurance just in case those municipal bonds happen to default, and they did this five years ahead of their schedule. This is information that we learned in a report from The Wall Street Journal.
These particular credit default swaps were initiated by Warren Buffett in the year 2008, back when the issuers of muni bond insurance were struggling.
According to Mr. Winterstein, the biggest change to the muni landscape recently is the vanishing act of municipal bond insurers.
“It used to be humongous; everything was AAA rated. Now it is much more fractured. That makes credit quality the focus,” which Mr. Winterstein mentioned just days before the financial crisis took place.
The biggest shift, according to Mr. Winterstein, is that some AAA rated bonds are now only single A rated. And others have actually dropped as far as triple-B.
He also said that “Credit research is paramount today. An overwhelming amount of municipalities are going to pay their interest and principal back, but there are some land mines out there.”