In a surprising development, Swiss Re has reached an agreement with Berkshire Hathaway to repurchase the CHF 3 billion convertible preferred security which represented a large injection of cash into Swiss Re at a time when the company was at risk of a ratings downgrade.  We discussed the terms of the investment shortly after the deal was finalized in March 2009.

It is not surprising that Swiss Re is repaying Berkshire since Swiss Re management announced its intention to do so earlier this year.  However, repayment was not expected until March 2011 due to a requirement to pay 140 percent of face value for redemption prior to that time.  The repurchase price dropped to 120 percent of face value after March 2011.  However, Berkshire has apparently agreed to waive the additional charge for early redemption and will receive 120 percent of face value.

The Swiss Re convertible preferred security carried a stiff interest rate of 12 percent and one can see why Swiss Re management was eager to eliminate this financing now that the company’s financial condition is on more solid ground.  It is less obvious why Berkshire Hathaway would agree to an early repayment while waiving the additional 20 percent premium that the deal called for in the event of repayment prior to March 2011.

At this point, no statement from Berkshire has surfaced regarding the transaction, but we can potentially see a reason for Berkshire agreeing to ease the terms of repayment.  It is possible that Warren Buffett has a better use for the funds which would justify giving up the 12 percent interest accruing on the security.  It is not likely that these funds are simply going to be redeployed into publicly traded securities since few if any would offer more attractive returns, but perhaps a major acquisition is on the horizon that could absorb the funds.

Berkshire will receive 120 percent of face value for the investment which amounts to an additional CHF 600 million.  It is also important to note that the Swiss Franc has appreciated substantially against the U.S. dollar since March 2009.  On the date of the transaction, March 23, 2009, one Swiss Franc was worth US 88.6 cents.  Today, one Swiss Franc is worth $1.035.  This 16.9 percent appreciation in the Swiss Franc will further increase Berkshire’s return on the investment when converted back to U.S. dollars.  The impact of the repayment will positively impact Berkshire’s Q4 2010 results, although we can safely eliminate the timing of the gain as a factor influencing Mr. Buffett’s decision to ease the repayment terms.

Update, 11/4/2010 12:00 pm

Based on Swiss Re’s investor presentation, the terms of the deal are even more favorable to Berkshire than the early news reports indicated.  Swiss Re will pay Berkshire interest on the security for Q4 2010 and Q1 2011 in addition to the 20 percent premium.  This renders the speculation above regarding Mr. Buffett’s motivation for accepting early payment irrelevant.  Obviously, Berkshire was happy to accept a full pre-payment of interest through Q1 2011 in addition to the 20 percent premium.

Disclosure:  The author owns shares of Berkshire Hathaway.

Swiss Re Repays Berkshire’s Investment After Buffett Eases Early Payment Terms
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6 thoughts on “Swiss Re Repays Berkshire’s Investment After Buffett Eases Early Payment Terms

  • November 5, 2010 at 2:40 pm
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    As you say, timing is unlikely to influence Buffett, but timing may be the reason that it makes any sense to Swiss to pre-pay 4 months’ worth of interest. THEY get to book the transaction in Q4, and they may have some reason for preferring this, like a big countervailing gain. As often happens, Buffett is happy to see lumpy returns and take advantage of OTHERS’ compulsion to get the timing right.

    • November 5, 2010 at 2:42 pm
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      I agree. In today’s Financial Times, Swiss Re management explicitly says that they did this to help their stock price. This is the type of odd thinking that has helped Warren Buffett pick up a few billion here and there for years since Berkshire does not care at all about the impact of rational business decisions on quarterly financials.

  • November 5, 2010 at 4:57 pm
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    Hi Ravi, are you certain Berkshire undertook the currency risk? This is icing on the cake, do you have a link reference to those details.

    • November 5, 2010 at 5:00 pm
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      I can’t say for sure. Berkshire could have hedged the risk but that would be uncharacteristic of Buffett, particularly since he’s been saying that the US Dollar may be on a long term decline for some time and has expressed concerns about inflation/quantitative easing, etc… I can’t recall where Berkshire has said one way or another whether the currency exposure from the Swiss Re investment was hedged or not.

      • November 5, 2010 at 5:02 pm
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        OK, Thanks Ravi, and thanks for the quick response.

  • November 5, 2010 at 6:52 pm
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    According to Berkshire’s Q3 10-Q, just released tonight, Swiss Re will pay 180 million CHF on 11/25/2010 and 3.7 billion CHF on 1/10/2011 – so the company isn’t getting everything immediately there is some delay.

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