Viking

http://phx.corporate-ir.net/phoenix.zhtml?c=129394&p=irol-newsArticle&t=Regular&id=1314639& Highlights for the second quarter of 2009: - Shareholders’ equity of $3.14 billion as of June 30, 2009, an increase of $310.6 million, or 11.0%, compared to December 31, 2008, and a 15.7% increase compared to March 31, 2009; - Book value per common share(2) of $51.90 as of June 30, 2009, an increase of $6.53, or 14.4%, compared to December 31, 2008, and an increase of $8.10, or 18.5%, compared to March 31, 2009; - Total invested assets and cash of $8.1 billion as of June 30, 2009, an increase of $197.6 million, or 2.5%, compared to December 31, 2008; and - During the second quarter of 2009, 1.2 million shares of the Company’s common stock were repurchased and retired at an aggregate cost of $47.5 million; 532,000 shares of the Company’s common stock were repurchased and retired from July 1 through July 29, 2009 at an aggregate cost of $21.6 million.

I would think mergers would lead to firmer pricing and this would be a good thing for ORH. I also wonder what ORH will do with their excess capital should the reinsurance hard market not live up to expectations (and if they realize a sizable portion of the equity gains)... Perhaps this will be discussed during the Q2 conference call. http://www.royalgazette.com/siftology.royalgazette/Article/article.jsp?articleId=7d976b33003000d&sectionId=65

Here is an article discussing investment gains and insurers: http://finance.yahoo.com/news/US-insurers-to-get-2ndquarter-rb-2775308674.html?x=0&.v=1 I do find in amazing what Hamblin Watsa has accomplished the past 9 months: 1.) sold CDS (realizing gains) 2.) sold equite hedges (realizing gains) 3.) sold Treasuries (realizing gains) 4.) bought municipals (tax free & insured by BRK) 5.) bought stocks 6.) bought corporate bonds The best part is the investment community still does not understand the size of the gains coming (AGAIN). Analysts look only at operating earnings (underwriting and interest & dividend income) when building their earnings estimates. Regarding the US equities (reported via 13F), we just passed the $1 billion mark in gains today! March 31 $2.685 April 24 $3,142 $456 17% June 30 $3,484 $798 30% July 23 $3,724 $1,039 39% I look forward to not only seeing what changes Hamblin Watsa has made to their investment portfolio in Q2. I also look forward to seeing what rabbits they pull out of their hat... I remember an line from Jim Rogers about how to make money and he said "when you see a $20 bill lying on the ground you pick it up." Yes, FFH & ORH have traded higher in recent weeks (moving in tandem with the general market and other insurance stocks). I think I see (once again... just like last year and the year before and...) a $20 bill lying on the ground....

jegenolf, no problem... that is why I share this stuff... for others to use and for all of us to debate.

ORH = 55% FFH = 12% Cash = 33% Regarding opportunities, I look forward to seeing what Hamblin Watsa has been doing in Q2 regarding asset allocation.

"But for some reason (and perhaps someone could share their opinion) the Fed and Treasury have been protecting bondholder's claims at all costs." John Hussman has been railing about this for some time... I read somewhere that we will not see hyperinflation because the bond market will not allow it. I also read that hyperinflation has not happened in an ecomony with a strong bond market (i.e. the article said Germany back in the 20's did not have an efficient mature market). I wonder if the bond market is not being treated with kid gloves because they really DO rule the roost.

I also took a quick look at Advent and wondered why FFH would spend their scarce resources here instead of other places. The two things that stood out to me were: 1.) they already own 66%; they can now run it as they see fit 2.) re-insurance operations: this is the part of the insurance business where pricing appears to be improving first

Should we see earnings per share in this range, growth in BV would be: $50 / $255 = 19.6%; $75 / $255 = 29.4%.

Mungerville, here is a little more detail: Regarding bonds, my 'read' is muni yields came down quite aggressively to mid April and then a little more in May (most of the gains were likely in Q4 and Q1). At the same time, Treasury yields were rising. Since May both Treasury and Muni yields have come back up and it looks to me that Muni yields are higher than they were April 24 (implying the bond gains at FFH are likely lower than $200 million). The wild card is I believe FFH communicated on their conference call that they had after March 31 purchased 1 billion in corporate bonds... if this is indeed the case then bond yields should be greater than $200 million in Q2 (I am unable to locate a transcript from the Q1 FFH conference call... can anyone help me out here???). Here is what US Treasuries have done in Q2... pretty ugly. I wonder how this will impact the investment results of insurers who exited risky assets in Q4 and Q1 and moved to the 'safety' of US treasuries. One has to be impressed with the decisions coming out of Hamblin Watsa! Date 1 mo 3 mo 6 mo 1 yr 2 yr 3 yr 5 yr 7 yr 10 yr 20 yr 30 yr 03/31/09 0.17 0.21 0.43 0.57 0.81 1.15 1.67 2.28 2.71 3.61 3.56 04/24/09 0.07 0.10 0.31 0.50 0.99 1.38 1.96 2.56 3.03 3.99 3.89 06/30/09 0.17 0.19 0.35 0.56 1.11 1.64 2.54 3.19 3.53 4.30 4.32 Another really important point is all of this stuff I am communicating is really just an educated guess. I expect that FFH has continued to make changes to the investment portfolio's and these I am not able to see... Perhaps they realized some gains early in the month? So please take all that I am communicating with a few grains of salt (I do!). Bottom line is we should see large investment gains from FFH and ORH in Q2... how great we will have to wait and see.

Crip, to state the obvious, I expect ORH investments to outperform FFH on a percent basis (not absolute). As well, I expect the outperformance to be a small amount. The reason I like ORH more right now is when I add all the 'small' amounts up (underwriting, income, investments gains, pricing power) I get a large enough number to like ORH a little more (given it is also trading at a lower P to BV ratio). this is not an exact science. FFH stated in their Q1 earnings release that as of April 24, investments had appreciated by $900 million; equities by $700 and debt by $200. C&F also communicated that investments had appreciated by $230 million; equities = $152 and debt = $78 million (p 34 of their 10Q). ORH simply said investments had appreciated a 'material' amount more than the Q1 loss in BV. Here is my logic: 1.) bonds: most of the gains in bonds were likely driven by US municipals (not Canadian gov't bonds which are held at NB). ORH holds a higher percent than FFH of what has appreciated in value; hence they should benefit much more on the bond side of the equation. 2.) equities: the largest gainer on the equity side has likely been Wells Fargo and we know that a disproportionate amount of the new position is held at ORH (7.6 of 16.5 million purchased in Q1 = 46%). So to summarize, I expect equities at ORH to perform in line with FFH as a whole and bonds to outperform = slight outperformance at ORH on investments. The US equities that FFH reports in its 13F were up 17% to April 24 and 30% to June 30. The reported gains at C&F to April 24 on equities was 15% ($152 million/$1.0 billion) which is very close to the 13F number. Using this logic, I think it is reasonable to assume that ORH will see a 30% lift in their equity portfolio in Q2 = 30% x $1.5 = $450 million. Add in $100 million for bonds (hard to know as yields have come up some since April 24) and we could see investment gains of $550 million. And yes, this is my optomistic scenario. Enclosed is my updated investment tracker of the stocks reported in the 13F (March 31, April 24 and June 30). FYI, as of today 13F portfolio is up just under 2% to June 30 close.

Below is the link to an article referencing information from MarketScout: "MarketScout insurance exchange reported that the U.S. property and casualty market remained soft, as rate declines for risk placements continued moderating at a slow but steady pace." Here is a quote I found interesting: Mr. Kerr advised that “smart insurers are retaining their capacity until sensible risk return ratios are available,” and “poor underwriting results are pending for some major insurers. Expect significant market movement in the next twelve months with clear winners and losers.” There is a perspective that pricing has not been hardening fast enough in the past 12 months as some insurers have been underpricing.... if this is the case, C&F will be in an ideal position as some insurers begin reporting reserve issues and rates harden. http://www.property-casualty.com/News/2009/7/Pages/PC-Market-Rates-Down-6-Reductions-Lessen.aspx

Regarding buying back ORH, I think FFH should first build up their cash reserves. Q2 will hopefully show this happening as C&F sent $100 million after Q1 close (as reported previously by Ben H I believe)and my guess is runoff can afford at least $100 million special dividend given all the realized gains from last year. We also know in Q2 very large gains in the equity portfolio will be reported (if any were realized we will see). Investment gains may be very large over the next 12 to 18 months. ORH also has the ability to buy back more shares. As earnings continue and if the hard reinsurance market is delayed utilizing surplus to buy back stock (below book) makes sense to me. FFH could find itself in another 12 months with much more cash on hand and fewer shares of ORH outstanding to purchase. The risk to FFH is BV for ORH will grow rapidly and perhaps more quickly than for FFH. If reinsurance pricing continues to firm more quickly than insurance pricing ORH's share price may also command more of a premium than FFH. Holding off may result in FFH paying materially more to bring ORH back in. What I find interesting is NB did nor repurchase any shares (of significance) in period preceding the FFH aquisition (6 or was it even 12 months) even though they were also trading very cheaply and they had the cash to do so. I do not expect FFH to buy back ORH. However, it would not surprise me if they did. Currently I hold much more of ORH that FFH because: 1.) cheaper on P/BV (ORH=0.93; FFH=0.96) 2.) I expect current underwriting at ORH to be more profitable in near term (reinsurance doing better than insurance) 3.) ORH portfolio yield is higher 4.) I expect near term investment portfolio gains at ORH to outperform FFH 5.) I expect pricing trend for reinsurance is better than insurance 6.) I expect ORH to report reserve redundancies higher than FFH Yes, ORH is much more exposed should a catastrophe occur. And the stock is quite illiquid and thinly traded which has resulted in the past in it staying undervalued for long periods of time. I like FFH; I just like ORH a little more right now (even given the higher risk).

I think this link will let you view the entire article without registering... www.ft.com/cms/s/0/5192dade-6d6a-11de-8b19-00144feabdc0,dwp_uuid=02e16f4a-46f9-11da-b8e5-00000e2511c8.html

Eric, I agree that FFH purchasing their own shares would also be a very good move. They had the same opportunity when they bought back NB... why pay 1.2xBV rather than purchase FFH back then?

Here is my updated analysis regarding ORH. I have also enclosed a thread from April where Smazz copied over some well thought out comments from Mungerville which you also may want to review: http://cornerofberkshireandfairfax.ca/forum/index.php?topic=459.0 Bottom line, I expect Q2 BV to be in the $49 range. With the stock trading at $39.80 July 10th the P/BV = 0.81 - the key risk that I see is the volatility in the stock holdings as we could easily see a 20 or 30% fall in the general markets. - the key opportunity is that we see reinsurance (and insurance) pricing continue to harden. - the wild card is that FFH announces it is buying the 30% of ORH it does not own. - another wild card is we get some costly catastrophies… yes, this would hurt short term. But as Mungerville has pointed out, this would hit FFH competitors much harder (as they are not as well capitalized) and a hard market would likely happen instantly and ORH would actually benefit over the medium term. Regarding Q2 BV: - Op Income = +$1.60 - Investment Gains = +$6.00 (extrapolated Apr 24 number provided by FFH) - Currency Adjustment = +$0.50 - Interest & Other Exp = -$0.25 - Total = $7.85 - Taxes = 33% = $2.60 - Earnings = $5.25 Q1 BV = $43.80 Q2 BV = $49.05 Please note, my numbers above are trying to estimate the change in BV at quarter end. I do not expect realized investment gains of $6.00, but rather expect that to be the approximate number of mark to market gains, some of which will flow through to net income and the majority to OCI. Regarding average earnings for the next 5 years: 1.) Underwriting: CR = 98 = $50 million 2.) Interest & Dividends = 4.54% x $7.5 billion = $340 million 3.) Operating Income = $390 million 4.) Net Gains on Investments = 4% x 7.5 billion = $300 million 5.) Interest Expense = $33 million 6.) Other Expense = $20 million 7.) Pre-tax Income = $637 million 8.) Tax Rate = 33% = $210 million 9.) Net Income after Taxes = $427 million = $7.09/share = 16.2% growth in BV 10.) Shares Outstanding = 60,243,000 11.) Book Value per Share (Mar 31) = $43.80 12.) Share Price (July 10) = $39.80 Regarding estimates, I am looking for a 5 year average and I am trying to be reasonably conservative: 1.) Underwriting = 98%. The market for reinsurance is beginning to harden and the insurance market is flat. My guess is the reinsurance and insurance markets will harden as we enter 2010. This should give ORH a 5 year average CR of 98. - Adverse Development: since 2001 ORH has had favourable = $868.4 million and unfavourable = $174.2 or net favourable development = $694.2 million. The issues regarding adverse development are really for accident years prior to 2001. Most importantly, since 2004 the cumulative development has been decreasing each year and was +$10.1 million in 2008. Bottom line, looks to me that the adverse development issues are largely behind us and one could reasonably expect for reserve redundancies on a cumulative go forward basis (perhaps $50 million this year if the trend of the past few years continues) which would reduce their CR to 96. See p. 22 of ORH annual for more details. - if analysts become more comfortable with underwriting at ORH we can expect to see ORH trade at a multiple to book greater than 1. 2.) Interest & Dividends: From the Q1 conference call 'In the first quarter of 2009, the tax equivalent yield on our portfolio was 4.54%.” - the major changes to the portfolio during Q1 were sales of remaining short term treasuries (yielding nothing) and the purchase of corporate bonds and stocks (primarily Wells Fargo and USB) which should result in small increase in Q2 portfolio yield. 3.) Net Gains on Investment: Since 1986, Hamblin Watsa Total Return on Avg Investments has been 9.8% (see p 142 of FFH Annual Report) and for the past 10 years I estimate it has been about 9%. Let’s assume the return going forward is 8.5%; the current portfolio yield is 4.5% so our assumption is for a Net Gain on Investments going forward of 4%. Other notes: FFH Asia: ORH also owns 26% of FFH position in ICICI Lombard. It is carried on the books at $67 million. I think their share is worth perhaps twice that meaning BV is understated by perhaps $0.50 to $1.00. See p. 123 of ORH AR. Balance Sheet: ORH has low amount of debt ($489 million) and no maturities are due before 2013. ORH Dividend Capacity: ORH has the ability to pull $544.8 million in dividends in 2009 from Odyssey America (sub) if they so chose. I believe they plan to leave the cash with the sub and to utilize to grow their business as the markets harden in the future. Bottom line, this value is not built into the above analysis (i.e. they could pull this money up and buy back another 10 million shares to grow shareholder value). See p. 83 of ORH AR. FFH Buyout: FFH has to be looking at how it can buy the 30% of ORH it does not currently own (they need at least US$1 billion). ORH is dirt cheap and poised to grow significantly; I am not sure how FFH can justify spending its money on anything else at present. Further, I think ORH can use the $545 in dividend capacity to help fund this (I think NB did this to help cover their purchase by FFH). Perhaps this will be the next rabbit we will see FFH pull out of the hat.

Al & Cardboard, my post was meant to more illustrate the increased volatility that we will see with FFH book value going forward given they now hold more risk assets (with hedges removed). Yes, today I estimate BV = $290 to $300 range, making P/BV = 0.84 ish

I still get shivers thinking about the 70's and Farrah Fawcett... my best friend's sister had the feathered hair look and was a knock out. Charlies Angels. 6 Million $ Man. That poster with the red swimsuit. Sad to hear that Farrah passed away. M Jackson is also a shocker, but for me does not bring back so many memories.

My read is Fairfax has a business model that has not been understood or appreciated since the late '90's. In all the reading that I have done recently (quite a lot) OPERATING EARNINGS is pretty much all that analysts pay attention to when they look at insurance/reinsurance stocks. The problem that FFH and ORH have is their combined ratio has not been great; I believe the problem is due to the legacy issues and the repeated addition to reserves from accident years pre 2002. Looking forward I believe underwriting at FFH/ORH will surprise to the upside (as the legacy issues are no longer a concern). Their portfolio yield is much improved given their shift into tax free US muncipals and tax advantaged dividend paying stocks. Bottom line, I expect their OPERATING INCOME to be much improved going forward. Ans of course, I also expect their investment gains to also be MUCH better than their peer group. Add it all up and I expect VERY LUMPY but large gais from FFH/ORH going forward. In another couple of years perhaps they will trade at a premium to their peer group. Of note, book value of FFH today is US$255. Shares todat closed at $248 = P/BV = 0.97. This is much higher than many insurers. Now if you add in expected increase in Q2 BV ($35??) and then the math becomes $248/290 = 0.86. And then add in hidden value of ICICI ($10???) and the math becomes $248/300 = 0.83. How cheap FFH is today depends on what you think happens to equity markets. Bottom line is most analysts cannot handle how FFH operates as they will sacrifice short term profits for long term gains. I do believe FFH will deliver 15% ROE over a couple of years, although the ride will be VERY wicked. ORH has been my favourite the past few months. Although this week I just re-established a small position in FFH.

I will be happy to see the paragraph that communicates this issue disappear from Q and annual reports. You never know what may happen with these sorts of things so I am happy to see it simply go away. Good riddance. I wonder if this issue impacted any institutional investors from buying FFH or ORH? Bottom line is the story continues to get better and better...

I also have started watching BRK again. Back when the b's were trading at US$2,300 the CAN$ was about $0.80 so the cost in Can$ = $2,875. Today with BRK trading arounf US$2,750 and the CAN$ at $0.87 the cost in Can$=$3,161. In Can$ terms, BRK is only 10% off its bear market low (20% off in US$ terms). Currency moves affect the Can$ traded shares of FFH is a big way. It is a US stock. Yes, it is traded on the TSE, but its moves are driven by NYSE thinking. With FFH going to CAN $400 last year, we can attribute 15% or $60 of this move to currency. More recently, FFH falling from CAN $320 to CAN $280, I estimate that about $30 of the move was currency driven. I am still trying to decide how to overlay currency into my investment decisions. Up until now it has not played a large roll.

Granitepost, I have a 7 year old boy and will let the board know if this becomes popular in rural BC.

Crip, I also was not aware that it was the largest outstanding. When you look at all the various activities FFH has taken the past 4 or 5 years (not just the investing but also what they did with extending their debt maturities when interest rates were low, for example) this team has done a number of amazing things. Makes me wonder what they will do in the coming year and years...

I must say that I do enjoy reading these sorts of things (given the situation and the press the company was receiving a few short years ago). - not sure if some where expecting an upgrade; given the current environment 'affirm' and 'stable' are not bad things - I especially like the fact that FFH appears to be getting more press/respect regarding their returns on invested assets. - interesting that the valuation of FFH (i.e. price to book value) has also come down over the years... www.businesswire.com/portal/site/cnnmoney/index.jsp?ndmViewId=news_view&newsId=20090622006076&newsLang=en&ndmConfigId=1000618&vnsId=33

I just recently finished Malcolm Gladwell's recent bestseller, Outliers (the story of success). I enjoyed it very much. At one point he talks about 10,000 hours (time needed to invest to beome really good at anything)... this perhaps helps explain to me what most people fail at managing their own money... I look at my past and I pass the 10,000 hour test (note, just because you spend 10,000 hours at something doesn't mean you will be good at it). It is more of a necessary but not sufficient thing... Anyone else read the book? Thoughts?

Here is the link to a June update from hedge fund, Eclectica Asset Management, that I had never heard of before. I must say their logic makes some sense to me. www.scribd.com/doc/16525584/Eclectica-Fund If we are in a 1 in 50 or 1 in 100 (and I think we are) I do not see how we have seen the worst of the downside yet. This does not mean that the averages will not be higher from current levels in 5 years. Look at past asset deflations (Great Depression in US or lost decades in Japan). These things were ugly, lasted for MANY years and took valuations of all assets much lower than anyone thought possible. I do not see how the worst can be behind us... SO MUCH PAIN IS LIKELY YET TO COME AS WE PAY OUR DUES FOR PAST EXCESSES. Prem also made a comment (AGM?) and asked if the government (20% of economy) could be expected to offset the issues n the non-government (80% of economy). His point, I think, was obviously, NO, this is not possible. I will be watching what FFH does with great interest. Their batting average is tops in the league right now!