Viking

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!

Barry Ritholtz at the Big Picture provides a link to and article by Andy Xie, who was with Morgan Stanley: english.caijing.com.cn/2009-06-09/110180019.html Andy's conclusion: "The world is setting up for a big crash, again. Since the last bubble burst, governments around the world have not been focusing on reforms. They are trying to pump a new bubble to solve existing problems. Before inflation appears, this strategy works. As inflation expectation rises, its effectiveness is threatened. When inflation appears in 2010, another crash will come. If you are a speculator and confident you can get out before it crashes, this is your market. If you think this market is for real, you are making a mistake and should get out as soon as possible. If you lost money during your last three market entries, stay away from this one – as far as you can." I think Fairfax 'gets it'. I think we will see them play the volatility game. I do not expect them to sell 100% of their positions as the market tops out. However, I will be surprised if they do not book some decent gains when they report Q2 results. Andy's perspective has a much higher probability of playing out than what Mr. Market is currently expecting. I put the percent of another crash happening at 30% (taking the S&P below 6,000). Notwithstanding what we are hearing from Buffett/Watsa, it may still be a little early for 'buy and hold'.

The more I read about John Templeton's investment style, the more I wonder if Prem's investment style is not closer to Templeton than Buffett: invest internationally (i.e. ICICI Lombard), not afraid to short or hedge (US stock hedges last year), buy at maximum point of pessimism (bought stocks in Nov last year and more stocks in March of this year). Templeton is also noy buy and hold... buy when others are pessimistic, sell when securities appreciate a few years later to fair value. Certainly interesting (and profitable) to watch moves being made by Hamblin Watsa...

Yes, I know that we should not be monitoring this thing day to day... however, it is relevant to review once in a while. I input the shares and prices provided by FFH in their most recent 13F into an excel spreadsheet (and also into a google finance portfolio) which is attached below. The total value of the equities at March 31 was $2,685 million. The total value of the equities at April 24 was $3,142 = +$456 = +17% - with Q1 earnings release, this was the date that FFH communicated total gains = $900 million or $30/share (after tax and minority interest). ORH simply stated gains to April 24 were 'substantial'. The total value of the equities at June 11 (12:30 PST) was $3,602 = +$917 = +34% - the gain in US equities has now doubled from April 24 All this says is at current stock prices, FFH (and ORH) are sitting on very large gains and book value is much higher from that reported March 31. Positive development.

I think they need to issue large amounts of debt. What they are able to buy back is only a small amount compared to the total. I am wondering if we are seeing 10 year Treasuries peaking here around 4%. If not, the resulting higher interest rates (for mortgages etc) will become a negative for the weak US economy. My guess is given the increasing supply of US debt (US deficits) and the apparent shrinking of demand (other countries diversifying out of Treasuries, investors shifting out of 'safe haven' Treasuries and into risk assets - stocks, corporate & international bonds) yields may surprise to the upside. I also wonder if FFH will shift back from municipals (realize massive gains ) to Treasuries... and wait for fear to return to markets (at which point demand for Treasuries will increase and yields will fall). I look forward to reading Vanhoisington's Q2 report. I think the Fed's perspective is Treasury yields would be higher if they had not engaged in quantitative easing to this point...

Ben, I would agree with you that normally stock prices and the economy are somewhat separate. The difference to me is debt deflations. The 1930's saw 90% drop in markets that took years and Japan saw similar results: catastrophic losses for equities that took years to play out. With $4 billion in stocks (of $18 billion total) and more in corporate bonds I am not sure that FFH has the ability to 'double down' from here should equities go even lower from their March lows. Sanj, since I have been following FFH I will say that they have demonstrated to be very opportunistic with their investments. Q2 will be fun to see what they have realized and what they have purchased! Cardboard, yes, I have done a bit of a deep dive on many of the reinsurers and how Hamblin Watsa manages investments is unique in the industry. If they can join the top 20% in underwriting FFH/ORH will do exceptionally well going forward! I also appreciated your comments regarding past portfolio weightings (like in the 90's) and will review in a little more detail to better understand what they are capable of doing in a stock market they view as fairly valued. Sharper, regarding the hedges and other reasons they are holding certain things, I agree that there is much going on beneath the surface. They are clearly playing chess and not checkers. They also have the feel of a hedge fund in how they manage investments. Partner, I am trying to get better at that looking out 5 to 10 years thing (and holding too). My 'brain cramp' is whether this is a great time to overweight and with FFH trading at current book (US$254) I am not sure that it is dirt cheap (given the near term investment gains could be transitory). Shah, if I was more comfortable that insurance pricing was firming (reinsurance pricing is firming) then that would then provide me with a higher level of confidence that future earnings would be solid and investment gains could be viewed as more of a wild card. Thanks for sharing what you are hearing regarding insuranace pricing!

I have been trying to understand the current FFH investment approach and I am having trouble reconciling Prem's apparent concerns regarding the economy/outlook and FFH shift into risk assets. Prem has repeatedy compared our current situation to that of Japan after their bubble burst in 1989/1990. Until Nov of last year they had about as conservative portfolio makeup as one could have (US Treasuries/stocks fully hedged & CDS). His most recent comments still talk to concerns regarding the economy which suggests he has not altered his view that we could be at the early stages of economic decline. I am not complaining about the investment moves since Nov; they have been good (US stock purchases) to brilliant (shift from US Treasuries to US tax free municipals & corporates) with the odd dog mixed in (CAN stock purchases - Brick, Canwest - & Abitibi bonds). When I look at the total portfolio today I see a VERY LARGE weighting to risk assets. As we saw in March when the markets sold off, FFH book value dropped (end of Q1) to US$254 from $278'ish. Yes, today it is likely in the US$300 range. However, it would not surprise me to see US stock averages tank again in October (to lower than March lows) as people come to understand what Prem is saying... the economy is not going to bounce back quickly and we could see 5 or 10 years of deflation. With the shift to risk assets in the investment portfolio and with all the hedges off FFH could quite easily see a $50 to $75 move in book value ($300-$75) back to US$225. At current prices, FFH is a solid buy. However, to go overweight with FFH, one has to feel strongly that the stock market averages lows are likely behind us; to be bullish on FFH current prospects I think one also has to be reasonably bullish on the outlook for risk assets. What do others think?

If you lived in Iceland and before their currency/economy imploded last year you invested 10% of your investable assets in GLD (or bought the metal outright) how would that investment be doing today? My guess is that investment would be outperforming bonds, stocks (local icelandic stuff). I do not plan on holding gold as a long term investment. I simply view it as a way to preserve my net worth in the short term as we work through some things the US and global economy have not seen before. Having said all that, I do not own gold today...

I have read similar comments regarding AIG from other insurance executives. AIG also appears to be losing many of its best people. I wonder if the many AIG businesses have begun the 'walk of death'... losing their good people, customers shift some business to competitors, business shrinks... more employees leave, customers pull the plug, business shrinks some more... "He attributed Travelers' lead, at least in part, to winning customers away from rivals, including AIG, which has struggled after massive derivatives losses led to a $180 billion federal bailout." "A flight to quality—there is no doubt there is one," said Mr. Fishman. He added that feedback from agents and brokers was that "many are concerned some companies won't have the capacity to service customers." www.businessinsurance.com/article/20090604/NEWS01/906049986

One thing that I am learnings is when valuing insurance companies is most analysts/large investors look for predictable earnings. That is why most analyst reports simply look at operating earnings (CR plus interest/dividend income). Investment gains and losses ARE NOT VALUED until after the fact (i.e. they are realized). FFH/ORH are anomalies in that they outperform their peers with investment gains but they still do not get any respect for this skill. I know FFH did in the 80's and 90's when it traded for crazy multiples. My guess is should FFH continue to outperform (over years, not quarters) Mr. Market will start to attach a higher multiple to its stock. I hope they continue to improve their underwriting versus their peers... this will be icing on the cake... The benefit is we continue to get great opportunities to buy stock at a good discount to book value.

I am definitely not a gold bug. However, I do buy into the 'store of value' argument. Buffett appears to be diversifying outside of US$ somewhat (buying multinatinals and companies such as Iscar). If gold was to sell off, I likely would re-establish a position (5% or 10%) in either GLD or a precious metals mutual fund (RBC?). Interest in gold continues to increase but I do not think we are at the mania/bubble phase quite yet.

Sorry, here is the promised Excel file!