Fairfax 2021

[Phoenix01]

Thanks for that info.  Much appreciated

[bearprowler6]

Boat Rocker Media Inc. expects to debut on the Toronto Stock Exchange next week after reducing the share price for its initial public offering.

 

The amended IPO will raise $170-million, down from the initially proposed $175-million and will debut at $9 per share, less than the $12-$14 range offered in the initial prospectus.

 

Boat Rocker will sell more of the company than originally planned, and at a lower valuation. There will be approximately 32.6 million common shares outstanding in the amended IPO, compared with 26.7 million in the initial prospectus.

 

Boat Rocker IPO details have been finalized. Fairfax will own 45% of BR after the IPO and had to subscribe for $30 million of the IPO to get it done.

 

https://www.newswire.ca/news-releases/boat-rocker-media-files-final-prospectus-and-announces-pricing-of-initial-public-offering-898386001.html

[Viking]

Insurance companies have started reporting Q1 results. I like listening to WR Berkley to get a general sense of what is going on in the insurance business.

The hard market is well into year 2 and will soon enter year three with no signs of slowing down yet (getting rate on rate increases and will soon be getting rate on rate on rate). Pricing in many lines is VERY good with focus shifting in those lines from rate to exposure. Economic growth (economy opening up) will drive further top line growth. 

Bottom line: well run insurance companies are making lots of money with the business they are writing today; top line growth is also very strong. This should be very good for earnings not just this year but also many years into the future. 
——————————-

Notes from WR Berkley Q1 call:

- premium growth was a little over 11%; workers comp only area down and it may bottom late ‘21 or early ‘22

- re-insurance (+18%) now growing faster than insurance (+10%)

- continue to see above average cat losses in the quarter

- see ‘fair amount of runway’ for growth not just the next few quarters but the next few years

- economic growth (as economy opens up) will result in growing top line

- see opportunity to push rate higher (13%)

- some lines rate is now good; will shift focus to grow exposure

- are now getting rate on rate increases in excess of loss cost trend; soon this will be rate on rate on rate (3 years of this happening); ‘encouraging’ for margins

- renewal retention is 80% (customers are taking rate)

- watchout: covid may be masking loss cost trend severity / frequency

- investments: focus is on total return with emphasis on alternatives; fixed income has 2.4 year avg duration and is rated AA- and is well positioned for rising rate environment

- rates are so attractive in some lines (several hundered basis points in excess of adequacy) no longer trying for more rate; shifting focus to exposure

- balance sheet / capital front: last 18 months refinanced a large chunk of debt (took out higher cost maturities); pushed out average maturity; lowered cost of capital 100 basis points; reduced interest expense +$20 million per year beginning in 2022.

Edited April 22, 2021 by Viking

[OracleofCarolina]

slides are up for the 2021 annual meeting

 

https://s1.q4cdn.com/579586326/files/doc_presentations/2021/Fairfax_Financial_AGM_April_2021.pdf

 

[sdev]

No audio or transcript of the AGM?

[Viking]

It looks to me like higher inflation in the coming months is now being confirmed by the data. As a result bond yields are once again moving higher. 

There are three key buckets to understanding Fairfax and its ability to grow BV:

1.) insurance: we are in the middle of a hard market

2.) equity holdings: have been on fire the past 6 months

3.) bond portfolio: this is the bucket that has been the biggest question mark the past 6 months. Fairfax is positioned very conservatively (with very low duration). They have positioned their portfolio to benefit from higher interest rates, which we are now starting to see.

The question is now how fast will interest rates move higher and how high will they go?

Higher rates will also impact the insurance and equity buckets. Higher rates will hit earnings and book value of insurance companies (as they take losses on their bond portfolio) and this likely will extend the hard market. I think the key for equity markets is the speed with which rates move higher: if rates (10 year US treasury) move quickly to 2% then equity markets could sell off aggressively. 

So my take is higher rates will benefit Fairfax in two buckets (insurance and bonds) and be a headwind for their stock portfolio.

Edited May 12, 2021 by Viking

[Xerxes]

I think the tailwind from substantial deployment of that dry powder in the bond portfolio will totally crush and net out any headwinds on its equity portfolio. Until then the stock doesnt deserve a premium to book.

I complained in the other thread, about him being perma-bear for so long (2010-16), the positive effect of that is him having that substantial dry powder available and un-deployed.

[Viking]

If the move to higher 10 year treasury yields is somewhat orderly i agree with you. But if the move in yields is a spike i think the stock market will sell off aggressively and this will hit Fairfax in the short run.

The other risk is if inflation moves much higher than the Fed expects. This will also likely hit equities hard. 

Bottom line, inflation looks like it will cause volatility to hit financial markets in the coming months. As we learned last year, Fairfax has been very opportunistic in volatile markets. Their recent selling of 1/2 of their corporate bond portfolio at yields under 1% is looking very well timed.

Edited May 12, 2021 by Viking

[TwoCitiesCapital]

When do you guys think they'll deploy cash? They weren't buying bonds in 2018 when the 10-year hit 3.25% - will it be different this time around? Or are we waiting for a 4-5% treasury yield for the team to actually start buying duration? 

[Viking]

Good question. I have no idea  If we see volatility i do think they will be opportunistic. Like they were with buying corporates in March/April of last year. And my guess is we could see some serious volatility if the economy and inflation run hotter than expected (decent chance of this happening).

[petec]

The key thing will be how steep the curve gets, more than the absolute rate. No point buying 10y if you’re not paid to take the risk vs 2y. 

[TwoCitiesCapital]

8 minutes ago, petec said:

The key thing will be how steep the curve gets, more than the absolute rate. No point buying 10y if you’re not paid to take the risk vs 2y. 

I mean - I generally agree, but there are certainly instances where that may not be the case. The curve was inverted in 2019, but buying long-term bonds was the play the worked - not short-term. So I think it matters on what your outlook for rates are as well as not just the steepness of the curve. 

[Xerxes]

I did find it interesting that they did not react more forcefully in 2018. If the framework that they have is that in 2016, the economy flipped and therefore higher rates were coming, one would have expected that in 2018 they would have bought the dip in the bond market (i.e. locking in some parts). That they didn't, could mean that they expected the rate to go even higher than it did. In late Dec 2018, when the stock market took a plunge, it took some dovishness from the Fed in mid-Dec 2018, to calm the beast. So maybe that dovishness ended that rate increase cycle then.

Fast forward into this new economic cycle, if there are far reaching consequence from pedal to the metal Fed policy (i.e. inflation being more perm than transitory), than that would be another opportunity. It just seem to me they are "waiting" for substantially higher rates before locking. If there is an opportunity in the next 8 months, i hope they wont miss it.

March 2020 was interesting. They deployed about 7% of their $40 billion portfolio as spreads opened (corporate bonds i believe) up, and rode the collapsing spread from 4-5% to 1-2% approx. Amazing but one would ask, why not more than 7% allocation. Was it because it was too fast ? if the downturn was more prolonged, than that new reality would have different than the one we went through, therefore, it is likely that a larger 15% allocation as spreads opened up would not have snapped back that fast. 

Therefore, 

current reality: 7% allocation in March-April 2020 as spreads opened up => made your money in 6 months

Alternate reality: +15% allocation in March-April 2020 as spreads opened up => still licking your wounds

 

Edited May 13, 2021 by Xerxes

[StubbleJumper]

1 hour ago, Xerxes said:

I

March 2020 was interesting. They deployed about 7% of their $40 billion portfolio as spreads opened (corporate bonds i believe) up, and rode the collapsing spread from 4-5% to 1-2% approx. Amazing but one would ask, why not more than 7% allocation. Was it because it was too fast ? if the downturn was more prolonged, than that new reality would have different than the one we went through, therefore, it is likely that a larger 15% allocation as spreads opened up would not have snapped back that fast. 

 

 

No, I'd say the issue was credit risk.  Prem puffed his chest out a bit and proclaimed that FFH obtained an attractive interest rate by lending to Disney, among others, but let's not join him in his narrative and pretend that it was risk-free.  It's all fine and good to dedicate a certain portion of the portfolio to equities, corporate bonds and other risky assets.  But the move last spring was a considerable corporate debt purchase that was added to FFH's existing corporate bond holdings, and then enhanced by a slug of commercial paper that they bought using proceeds form the revolver.  When you take all three together, you suddenly have a fair exposure to debt instruments that carry greater credit risk.  If you are maintaining a portfolio in which to hold your insurance reserves, you need a very, very large slug of (almost) risk-free sovereign debt and you need to carefully manage your exposure to risky assets (even AAA corporate debt carries risk).

During the financial crisis, FFH was able to take advantage of a better opportunity when they loaded up on munies which were insured by Berkshire Hathaway.  Municipal debt is already a reasonably low risk, and when you add a BRK guarantee, it is *almost* as good as sovereign debt (but not quite).  You can get silly about your position-sizing on something like that, but you shouldn't do it with garden variety corporate debt.

 

SJ

[Xerxes]

It was not risk-free (and could have gone the other way (i.e. prolonged downturn)), but still lower on the risk ladder than adding to equity, but either way as shareholder aren't you paying the management team their annual salary to take risk to take advantage of market dislocation ? 

[StubbleJumper]

12 minutes ago, Xerxes said:

It was not risk-free (and could have gone the other way (i.e. prolonged downturn)), but still lower on the risk ladder than adding to equity, but either way as shareholder aren't you paying the management team their annual salary to take risk to take advantage of market dislocation ? 

Yes, we are paying them to maximize shareholder wealth.  But part of that is running the actual business, not just investing.  The insurance business requires that the reserves be available for policy holder indemnities.  You can invest in any old risky assets if your premiums:surplus ratio is very low.  But, once you get your underwriting gets into gear the premiums:surplus ratio rises, you need to manage the risk of the securities that make up your insurance reserves.  Otherwise, wouldn't the optimal strategy always be to invest 100% in equities because over the medium and long-term,  the return will blow the snot out of debt instruments?

So, if you review Note 5 from the 2020 Q1 report, FFH had $28B of cash, short term investments and bonds.  Of that, $12B was corporates.  With the lessons learned during the ABCP freeze-up and the other joys of the financial crisis, how high would you want to see that go?  As an insurer, you still need to write cheques to the policy holders, irrespective of what is happening in the world.

 

SJ

[Cigarbutt]

^About the bond investing bucket for FFH. It's an important part because the bond portfolio could very well match shareholders' equity and more. As SJ describes, the bond portfolio can be seen from many angles (source of earnings, pool of funds to pay claims, and a potential for positive returns in a contrarian way).

Investing in FFH in the early 2000s meant expectations of superior returns on the bond portfolio going forward.

As reported in 2004 (first time reported in this form):

Bonds 12.0% 9.8% 9.8% Merrill Lynch Corporate Index 8.0% 7.9% 7.9% for 5, 10 and 15 year periods.

As reported in 2016 (last reported in this form in 2017 and 2016 matches with a shift in personal opinion vs expected future excess returns on bond portfolio; 2017 reported numbers similar (slightly lower overall) vs 2016):

Taxable bonds 6.0% 9.6% 10.3% Merrill Lynch U.S. corporate (1-10 year) bond index 3.8% 4.9% 5.1% for 5, 10 and 15 year periods.

The bond results don't include the CDS returns. So, investment results from bonds (period 2001 to 2016) had been significant contributors to the bottom line.

This hasn't been much discussed but the bond performance since 2016 (year when expectations about inflation changed, at least as reported) has been less impressive, see 10-yr Treasury constant rate graph for reference (what happened since 2016, where we are now after the Covid-19 episode etc).

i submit the opinion that the present bond environment is, by far, most challenging (ever?). Also, during 2020, the Fed (and Treasury) put in place backstops (for corporate bonds and munis) that were relatively symbolic but that crystallized the notion (similar for GSEs and the implicit support concept) that such backstops and more will happen again anytime stress appears in the credit markets and what happens if there is a Lehman moment or a bond equivalent? At this point, FFH is positioned with low duration and liquidity but they don't have residual protection against a deflationary environment. What happens next in the bond markets is anybody's guess but reading again parts of the earlier annual reports helps to remember how FFH used to be able to find relatively cheap ways to benefit if real risk shows its ugly head.

10-year.pdf yields-overview.pdf

[petec]

6 hours ago, Cigarbutt said:

i submit the opinion that the present bond environment is, by far, most challenging (ever?).

Totally agree, and I don't expect the bond portfolio to contribute much in the next few years. But that applies to all insurers and the industry as a whole needs to earn a return. So lower bond earnings drive underwriting discipline and contributes to the hard market. I think of it as two sides of the same coin. 

Also, FFH do have deflation protection - they have the swaps. It's not perfect, and won't pay out under a mild deflation, but they do have good protection against more extreme outcomes in both directions (inflation and rising rates, deflation and falling rates).

[Cigarbutt]

^Not much protection left, if any IMO.

-A big chunk of the CPI-linked derivative notional value will go with the European run-off.

-Overall, they've had a tendency to let contracts mature.

-The residual duration was at 2.7 years at 2020 yr-end.

-The contracts are far out of the money and a 5 to 10% deflation would be required to make the trade profitable upon maturation.

-Even if potentially of value as a trading vehicle, the short period to maturation lessens the potential convexity to a significant degree.

Anyways all the above points may be irrelevant. When those contracts were initiated, some people put in opposition the deflation thesis with an opposing view (championed by Mr. Buffett for example) that deficit spending could counteract deflationary forces and recent events suggest that this possibility remains alive and well.

---) Back to FFH and investing.

[Xerxes]

17 hours ago, StubbleJumper said:

Yes, we are paying them to maximize shareholder wealth.  But part of that is running the actual business, not just investing.  The insurance business requires that the reserves be available for policy holder indemnities.  You can invest in any old risky assets if your premiums:surplus ratio is very low.  But, once you get your underwriting gets into gear the premiums:surplus ratio rises, you need to manage the risk of the securities that make up your insurance reserves.  Otherwise, wouldn't the optimal strategy always be to invest 100% in equities because over the medium and long-term,  the return will blow the snot out of debt instruments?

So, if you review Note 5 from the 2020 Q1 report, FFH had $28B of cash, short term investments and bonds.  Of that, $12B was corporates.  With the lessons learned during the ABCP freeze-up and the other joys of the financial crisis, how high would you want to see that go?  As an insurer, you still need to write cheques to the policy holders, irrespective of what is happening in the world.

 

SJ

I admit that I am not familiar with the 08-09 event with FFH getting a hold of Berkshire-backed municipal bonds and even less familiar with what is a "optimal" surplus ratio. But given some of the missteps they have done in the past few years, I think going in March 2020 on the risk curve with a 7% allocation wasn't totally a bad move.

[Xerxes]

13F Q1

An increase on Atlas ? maybe exercising some warrants

FAIRFAX FINANCIAL HOLDINGS LTD/ CAN Top 13F Holdings (whalewisdom.com)

Fairfax Financial Holdings Ltd Can Top Holdings 13F Filings (holdingschannel.com)

I find it interesting that you can neither see Exxon nor Bank of America in the list, yet those two name make it to the conference call and letter to the shareholder. Is that some sort of Marketing on some insignificant position.

 

[Pedro]

I get the sense the two lieutants - have short duration trades that pay well and prem brags about.  Could explain XOM and BAC not making the list

[petec]

Or they used TRS’s?

[Xerxes]

Boasting about catching Exxon when it dividend yield expanded to 10% on the 2020 shareholder meeting, strongly implies buying Exxon direct.

"After the March/April crash in the stock market, we could not resist buying Exxon shares at a dividend yield of 10.5%, Canadian banks at an average yield of 6.1% and some other companies like Royal Dutch Shell, Alphabet, FedEx and Helmerich & Payne at very attractive prices. We sold approximately half of them in 2020 for a profit of $212 million or an average gain of 40% on our investment."

I looked all the past 5 quarters' 13F; On Q1 2020 it shows FFH buying 155,800 shares of Chevron; but no Exxon. They still hold all of the 155,800 of Chevron. But no sign of Exxon anywhere unless it is being held elsewhere where 13F disclosures doesn't cover. But then again, it is not like it is an international equity. 

Would it be too farfetched to think that Prem thinks his team bought Exxon, whereas his team actually bought Chevron, and two sides within FFH haven't reconcile yet. Just weird.

FAIRFAX FINANCIAL HOLDINGS LTD/ CAN Top 13F Holdings (whalewisdom.com)

[petec]

Possible, but more likely it’s a TRS. Remember they offer the total return, so dividends count. Prem is a somewhat vague communicator in my view, but usually doesn’t get things outright wrong, and I suspect they’d have had to issue a clarifying statement if he’d done that. Plus specifying the yield to a decimal point suggests knowledge of the stockS