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Buffett Reduces Municipal Credit Bets

Written By Brian Hicks

Posted August 23, 2012

Led by Buffett, Berkshire Hathaway (NYSE: BRK.A) will be slashing its $16 billion municipal credit bets by half.

The company will terminate $8.25 billion comprised of credit default swap protection which it has thus far sold on municipal debt. The move is likely due to a rising anticipation among leading investors about the sharp increase in domestic municipal bankruptcies.

Just last month, Buffett discussed how three Californian city-declared bankruptcies appeared to be making the usually-frowned-upon Chapter 9 bankruptcies a lot more attractive to regional governments under financial pressure.

Berkshire Hathaway’s involvement in this area comes from its sales of protection against such state/town/city defaults by means of credit default swaps. The company basically reimburses counterparties for debt loss if a municipality declares bankruptcy.

In this case, Berkshire has gone ahead and cut out $8.25 billion of its credit default swaps portfolio (in agreement with a counterparty). The portfolio implicates over 500 debt issuers across states and municipalities.

According to Citigroup analysts, the contracts may have been ones struck with Lehman Brothers, which had bought $8.25 billion in CDS (protecting 14 states) from BH Finance LLC, a Berkshire subsidiary, in 2007. After that, of course, Lehman crashed spectacularly in 2008.

Over the first half of this year, Berkshire has systematically reduced its vulnerability to credit default swaps backed by high-yield corporate debt. As of the end of 2011, Berkshire held $4.57 billion; now, it is down to $3.26 billion, and it has accepted no new CDS positions whatsoever through 2011 and 2012.