Macroeconomics, Insurance to Dictate Berkshire Hathaway's 2H17

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Part 8
Macroeconomics, Insurance to Dictate Berkshire Hathaway's 2H17 PART 8 OF 11

How the Fed’s Rate Hikes in 2018 Could Impact Berkshire Hathaway

Monetary policy

Corporations in the United States have leveraged over the past few years thanks to a zero interest rate policy after the 2007 financial crisis. However, since the Fed has raised rates since December 2015 and brought the interest rate to 1.25%, the cost of funds has increased for debt offerings. Companies with higher leverage could see marginally lower profitability compared to equity-backed companies. The Fed has suggested at least three rate hikes in 2018, which is in line with its policy in 2017. It also plans to reduce the size of its balance sheet. That could result in some liquidity drain as well as higher rates for all categories of borrowers.

How the Fed&#8217;s Rate Hikes in 2018 Could Impact Berkshire Hathaway

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Berkshire Hathaway (BRK.B) raises funds in the form of premiums from its insurance business. However, its subsidiaries have raised capital through debt offerings. The company on a whole is slightly less prone to a higher cost of capital due to its ability to generate strong operating cash flows. That scenario could benefit insurance players and commercial banks (XLF) such as Bank of America (BAC), American International Group (AIG), and Prudential (PRU), which have parked funds in debt offerings as well as lending activities to command higher yields and margins.

Equity investments

Berkshire’s funds are invested in equities of private as well as listed companies across the sectors by its managers Warren Buffett and Charlie Munger. Berkshire’s subsidiaries might see a lowering of debt from the capital structure if and when interest rates rise at a faster pace. BNSF, manufacturing, and energy are among the major sectors with utilized leverage for expanding the business.

In 2Q17, Berkshire’s interest, dividends, and investment income from its insurance division fell to $1.3 billion from $1.4 billion in the prior year, reflecting lower investment income, partially offset by higher interest income. For finance and financial products, investment income stood at $364.0 million compared to $411.0 million in 2Q16.


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