Viking

I think there are times, outliers, when things a so nutty paying attention to the macro makes some sense (very rare). I also think trying to get too cute with the macro and trying to predict too much is nearly impossible. A key learning for me since the crash is to get back to simple value investing (which Sanj outlined earlier with his 4 points) and too stop trying to predict things too much (so I do not read D Rosenberg or J Hussman as much these days). As the market rises higher and positions become fully valued (and sold) it becomes more difficult to find value and cash (as a percent of the portfolio) will rise; you don't need to predict the macro so much as manage your holdings appropriately. I know, easily said but hard to do...

As boardmembers have come to appreciate, FFH tends to be a very volatile stock (although not as much as when they were listed on NYSE) as they tend to zig when the market zags... Furtunately, they have enough disclosure (i.e. 60 page quarterly reports) for most investors to get a general feel for how their underlying business is performing from Q to Q. My preferred investment approach with FFH (and similar to a few other investors on this board I think) is take advantage of the volatility and think about buying when it trades at 0.9 x BV and when it is sitting on significant unrealized gains on investments (resulting in a nice pop in BV when it then reports Q results). Currently, shares are trading at around BV and they are likely sitting on losses in their investment portfolio (meaning mark to market BV is likely lower) given strength of equity markets in Q1. I would like to see the FFH stock price lower (0.9xBV) and stock markets correcting 10 to 15% before getting too excited about getting back in.

biaggio, I am hopeful that you are correct regarding reserving at FFH (overly conservative). However, if this was the case (overly conservative) I would expect this to also have been a past practice and I do not see large reserve releases (like other conservative insurers/reinsurers such as WRB, PRE, RNR etc). Or perhaps FFH is more conservative today than they were in past years? When I see the range in CR's being reported by different companies it does make me wonder who is swimming naked; I have a hard time believing it is FFH given their reported numbers. Interesting times!

Results look to be just about in line with what we discussed in January http://cornerofberkshireandfairfax.ca/forum/index.php?topic=3612.0 And I do want to thank benhacker for taking the time back then to post some thoughts on the hedges; it helped me better understand what FFH was doing and the loss potential given the rise in interest rates and the rise in the equity markets. Looking at 2011 we can estimate: 1.) Underwriting income = -$300 mill 2.) Int / Div Income = +$800 Operating Income = +$500 3.) Net Gains on Invest = ???? 4.) Interest Exp = -$200 5.) Corporate Overhead = -$100 6.) Runoff = -$50 Pre Tax Income (before Investments) = +$150 As usual for FFH, the key is investments. With bond yields rising AND equity markets rising, in the very near term things do not look good. To be fair to FFH they do not buy investments with a one or two quater time horizon so we can't say they are wrong. We can only say that reported book value will decline further in Q1 should current market trends continue.

Agreed. I also enjoyed reading his article on Greece www.vanityfair.com/business/features/2010/10/greeks-bearing-bonds-201010 Getting context certainly helps get a better understanding of what is going on in each country.

Here is the news clipping from WDC's earnings release yesterday: "BANGALORE, Jan 18 (Reuters) - World's No. 2 hard-drive maker Western Digital Corp (WDC.N) surprised investors with its quarterly results, indicating hard-drive sales remained robust, but warned excess inventory could hurt third-quarter sales. The company's shares, which have been among the worst performers on the S&P 500 index .SPX in 2010, rose 5 percent after the earnings beat expectations but pared most of the gains on the weak sales outlook. Western Digital expects third-quarter revenue of $2.20 billion to $2.25 billion compared with analysts' expectations of $2.27 billion. "Despite a reduction of about 2-3 million hard drives in the PC supply chain, there is still an inventory in excess of 6-8 million units in the PC manufacturers pipeline," Chief Operating Officer Timothy Leyden said in a conference call. The inventory warning indicates that Western Digital could see a return of the supply glut that hit its results in mid-2010.

I also have a number or insurance companies on my watch list (FFH, WRB, PRE, RE). Given the recent move in bond yields (especially muni yields) I expect BV to take a hit when they start to report Q4 results (some more than others). And with excess capital everywhere pricing trends still look ugly which mean underwriting results will suffer (especially if reserve releases slow even further). It appears we are in the midst of an ugly 'death by a thousand cuts' for many companies. When I add it all up I see too much risk to BV and valuations (what multiple Mr. Market is willing to pay) so I have chosen to stay on the sidelines. But I am watching things closely should we get one more big leg down...

I think many big pharma stocks qualify. My current favourite is Abbott Labs. Stock yields 3.6% (should announce a 10% increase soon taking yield to just under 4%). Top line should grow at low double digits the next few years. PE for 2011 should be under 12 (unfortuantely, as with most pharma, there is alot of noise - and one time items - in earnings). Stock was trading at current level in Dec 1998. Since then, their earnings, dividend and business have grown significantly. I hold ABT and view it almost like a bond holding (high dividend with great upside as business chugs along waiting for sentiment to change). I also hold a smaller amount of GILD as it is also cheap (PE = 10) and unloved. They do not pay a dividend; they are using pretty much all their earnings (significant) to re-purchase their stock which I like (versus paying huge premiums to buy competitors). I also hold a decent chunk of Teva. They a generic monster (with decent a branded business as well). While not as cheap as ABT or GILD their growth is higher (could be mid teen the next few years). Right now it appears Mr Market doesn't know how to value big pharma in aggregate and therefore is selling all companies in the sector (good or otherwise). I like the current risk/reward tradeoff.

Regarding Q4 earnings, here are some comments. Bottom line is I really am quite lost trying to understand all the hedges FFH has in place. Instead I am just going to assume mgmt knows what they are doing. There are going to be some very large puts and takes this quarter! ICO Sale 1.) $7.35-$3.70=$3.65x22.5 mill = $82 mill gain 2.) does this mean the remaining stake will no longer be captured under Investments at Equity (as FFH will own less than 20%). If so, and holding is valued at mark to market then they will also see a nice $7.74-$3.70=$4.04x22.5 mill = $91 million 'gain'. Equity Holdings: before market hedges gains est = $370 mill (note: I have updated my old excel sheet. In a previous thread it was mentioned that FFH has replaced their KFT, WFC & USB sales with derivatives so in the attached sheet I have not changed their overall position for these three securities. The Canadian holdings in the spreadsheet are quite old and I have not attempted to update quantities although I did add some prices). Municipal Bonds Yields: have spiked 1% in Q4 which will hurt valuations and BV. In Q3 interest rate moves were favourable and bond gains were $400 million. On the positive side, given that more than 1/2 of FFH municipal holdings are insured by BRK I wonder if their yields held up better??? Derivatives: does anyone have a perspective on all the derivative holdings and how they are going to net out? Abitibi: anyone have a perspective on what we might see?

Here is my very rough calculation of what FFH should earn going forward (annualized snapshot). Please correct me as you see fit. I am going to also throw out some stuff regarding Q4 to get the ball rolling in a second update. It looks to me that underwriting for the industry is only going to get worse in 2011. I am assuming FFH earns just under 8.5% on its investments of $22.5 bill (med term avg = 9%). My guess is FFH should be able to earn $50/year. With stock trading at about BV it looks to be a reasonable value. 1.) Underwriting income (YTD Q3 CR = 105) = -$200 mill 2.) Int / Div Income (Q4 $200x4) = +$800 Operating Income = +$600 3.) Net Gains on Invest (5% on $20 bill) = +$1,000 (incl change in realized gains/losses) 4.) Interest Exp (Q4 $50x4) = -$200 5.) Corporate Overhead = -$100 6.) Runoff = -$50 Pre Tax Income = 1250 6.) Inc Taxes (20%) = $250 Net Earnings = $1,000 = $50/share (about) Q3 BV = $401 BV Growth = $50 = 12.5% Note: tax rate is 31%; factor in tax exempt bonds and dividends results in actual rate closer to 20%

Great question. Sounds really simple. Simple answer is... lots. More realistic answer is it depends... probably the two biggest factors are what is your lifestyle (expenses) and how good are you at managing your investments (rate of return going forward). If you have reasonable expenses and above average financial savvy $1.5 million should do it. If you like expensive things and are a terrible investor then you likely do not want to quit your day job...

Very good summary of the bullish case. The comments at the end are also quite good. www.bankstocks.com/ArticleViewer.aspx?ArticleID=6224&ArticleTypeID=2

Bond yields moving up dramatically are going to result in a hit to year end book values for insurers (offset by gains in equities). Treasuries Dec 8 Sept 30 June 30 5 year 1.88 1.27 1.79 10 year 3.27 2.53 2.97 It looks to me that muni yields are also up about 75 basis points since Sept 30. There are so many puts and takes (particularly for insurers like FFH who also have hedges in place) that it will be very difficult to forecast Q4 results and YE book value. The good news from the rise in bond yields is insurers will be able to reinvest at higher rates which will help future earnings. Bottom line is the well run companies looks to me to be crazy cheap.

I believe FFH stated 15% increase per year in mark to market BV.

Here is a nice summary from WSJ: "Low Interest Rates Hurt Insurers' Bottom Line" online.wsj.com/article/SB10001424052748704405704575596932278239578.html With 10 year US Treasuries yielding 2.5% and 10 year corporates yielding 3.5% book values at insurance companies are high; the offset is operating income has been shrinking. When interest rates turn the opposite will happen with BV getting pressured (at first) but over time operating income will improve. It will be interesting to see what happens the next couple of years in this space. We have had two very slow years on the cat side of things so companies have been able to rebuild their balance sheets (and BV is high). Should we get above normal catastrophes (on a full year basis) things will really get interesting (only a matter of time).

Myth, I would argue that a compelling reason to buy now is because they are cheap. 1.) earnings are depressed. Underwriting profits are shrinking and bond yields are very low. 2.) they are out of favour and many well run companies are trading right around book value. The key point here, though, is the well run insurers are still VERY profitable (meaning you get paid to wait via dividends and growth in BV). When the hard market comes, earnings will improve and they will be back in favour. I have been very fortunate over the past few years of being able to time the market. I am in the process of trying to unlearn that (somewhat). When I find great opportunities (likely with a three to five year holding period) I am starting to establish a position (not too aggressive). Should a sell off happen then I will buy more. The risk I am finding in trying to get too cute with timing is great ideas can move up faster than you can pull the trigger and once you miss the initial move it is hard to get in (too tempting to wait for it to fall back) and as it keeps moving up you miss the initial 20% to 30% move. PRE is a great example (for me). I bought it in the spring and then sold it going into hurricane season (this was supposed to be a bad one) thinking I could buy it cheaper. And then got busy with life. Their business chugged along and the hurricane season was a non event. Stock was trading at $72; now it is trading at $82 and it is STILL dirt cheap. My learning is I got too cute (it is easy to identify the risks but not so easy to identify the positive catalysts). And, yes, I have reestablished a position.

I recently posted my thoughts on FFH Q3 results. Lots of things going on with insurers. I thought I would ask what board members were thinking right now. 1.) Does anyone like insurers at current price levels? 2.) If yes, is it a sector play? Re-insurers? Others? 3.) Or are there companies out there that people feel are dirt cheap? At current price levels, I like the re-insurer space and PRE (there are a bunch of cheap ones). And I also like WRB (as I have previously posted). My challenge with FFH is underwriting results will likely continue to be poor and I cannot estimate investment gains over the next 12 months (and I have been conditioned that positive moves in financial markets will not be reflected in the stock price in a timely way so I will likely have time to buy later should investments do well). So I will take a pass at current valuation.

I do find it fascinating to see how various companies are managing their business and capital during the current soft market. The re-insurers impress me the most as they remain disciplined on pricing (posting solid CR's) so when you fold in low interest and div income and decent investment gains you get decent overall results. and what are they doing with earnings? Buying back huge amounts of stock (given that most are trading at or below BV). FFH has been aggressive consolidators. Last year it was NB and ORH. This year it was Zenith. And they have made a bunch of smaller moves that I am having trouble following (shotgun approach versus rifle???); I am not sure how they can be sure they are getting best of class companies when they are making so many moves; perhaps they don't care given the small size (so I would ask who do it? Roll it all together and FFH has a bit of a conglomorate look to it... WR Berkley is growing organically (a while ago pulled in some teams from AIG I believe) and is using quaretly earnings to aggressively buy back shares (closer to re-insurers than FFH). It is easier to understand what the re-insurers and WRB are doing than FFH. But you have to love FFH track record the past 3 years.

I finally had a chance to gert through the quarterly report (needed a couple of drinks so if I make no sense I appologize). Here are my key takeaways: 1.) at 57 pages, not a light read (I noticed BRK's quarterly reports are also getting longer) 2.) ex ORH looks to me that FFH is writing at a CR of 110 (which is what WRB says 'industry' in US is currently writing at - but not reporting... perhaps they are on to something!) 3.) ORH had a phenominal Q3 4.) Goodwill and intangible assets = $943 million = $46/share 5.) net gains on investments = $68 million but the swings were wicked: bonds were up $422 million (looks to me that Zenith had lots of US treasuries); common stocks were down $388 million and equity derivatives lost $23 million. Not sure where the hedge fits in??? When I weave it all together and look out into the future I see a company: Underwriting (incl runoff) = -$200 Interest & Div = $600 Op Inc = $400 Int Exp = -$200 Corp = -$60 Total before investment gains = $160 million (= small potatoes) Until pricing improves (so CR improves) the company remains (perhaps similar to a few short years ago) a play of how you think they will do with their investments. If they continue to make shrewd investments then BV will grow.

Key Takeaway: "the supply of reinsurance capital continues to grow at a faster rate than insurers’ demand for capacity" = continued pressure on pricing come Jan 1, 2011 renewals. Drip, drip, drip... [ftp=ftp://http://www.aon.com/attachments/reinsurance/201009_ab_reinsurance_market_outlook_sept_2010.pdf]http://www.aon.com/attachments/reinsurance/201009_ab_reinsurance_market_outlook_sept_2010.pdf[/ftp]

Bottom line is the hedge funds felt that they could make money with FFH. - FFH had issues (two large aquisitions had reserving issues that FFH did not fully understand until after aquisition). - Stock had just started trading on NYSE. - Stock was thinly traded. - Confidence (banks, investors) was key to company remaining going concern. Having lived through the dark days, my takeaway is the hedge funds felt they could drive the share price lower through a short and distort campaign. Given the incredible volatility we saw in FFH shares my guess is they made money on the downside and also on the upside. What likely stopped FFH from going to zero was the strength of their management team and the relationships they had with the investment community that allowed them to get more capital despite the misinformation campaign being waged by the hedgies. In the dark days they were able to get money from Templeton, Markel and Southwestern. Times kind of felt like the wild West!

Why I love FFH: 1.) trust management (years ago I placed a very large bet back when the stock fell to $70 and it was based on this) 2.) investment returns (they are as bright as any group I know) Jury is out: 1.) how good they are at underwriting (need to see how they exit this soft market)

It looks that we have a partial answer as to what insurers will be doing with all the excess capital that is out there... share buybacks. Interesting to note that it is expected that re-insurer rates will be falling 2% to 5 % for January renewals. Swiss Re is targeting 12% ROE. When you look at low bond yields and falling pricing one has to wonder how long ROE's can stay at double digit levels. My guess is things may go sideways until reserve releases slow or natural catastrophes get back to more normal levels. [ftp=ftp://http://www.bloomberg.com/news/2010-09-13/swiss-re-to-spend-up-to-3-5-billion-on-buybacks-dividends.html]http://www.bloomberg.com/news/2010-09-13/swiss-re-to-spend-up-to-3-5-billion-on-buybacks-dividends.html[/ftp]

This is also something I am starting to think about for my kids (doing something at their school) although my oldest is only in grade 5. What about having 'the club' run some fundraising type activity, such as the school concession? Or they could run a fundraiser with the proceeds going to the school (and they need to research what kind of fundraiser, build a business plan and budget, manage people, execute, finish and then do a post mortem, including final financials). For older kids, I had a family friend run a Student Painter program one summer and he learned a ton (although he was third year university).

Just finished listening to the presentation and Q&A. For those interested in learning more about insurance, the future and WRB I highly recommend you listen to this. My key takeaways: Industry current year underwriting continues to be poor. As bond yields fall, interest and dividend income will continue to shrink. It looks to me that all that is saving the industry are reserve releases (likely being fueled by lower than expected inflation). Clearly not a sustainable situation. Perhaps all that is needed to drive in a hard market is a couple of large catastrophes. Regardless, once reserve releases are burnt through the day of reconing will arrive and select companies (WRB, BRK, FFH) will do very well. In the presentation Bill reviewed their minimal exposure to catastrophes so I will spend some time thinking about when I want to re-establish a position in the stock...