StubbleJumper

Would you want to do that? Really, you just want your capital back with a return. Foreclosing on actual real estate and hoping you can eventually sell it to get your capital back doesn't sound so enticing. Sj

@netcash1It's interesting that Bradstreet et Al have chosen now as the time to reach for yield. When they picked up the $2b of Pacificorp debt at 10%, I raised my eyebrows, but it was a smallish bond investment at an attractive rate. If the next $2 billion have a similar risk-reward profile, it's pretty aggressive. If it works out, the results will be outstanding. But you don't get 10% without taking on a bit of credit risk. The easiest thing in the world to do for FFH would be to sit back and roll the US treasuries as they mature. It would lock in good profits for the next few years. But it requires some balls to reach for yield. Let's hope it works out! SJ

+1 The pandemic didn't put any (many?) insurers out of business, but it should be instructive for us. What didn't happen was an enormous hit from business interruption claims. Thankfully, the legal framework prevented that ridiculous cat claim. But what if it had not done so? What if there would have been a couple billion of BI indemnities at FFH? And what if Ffh's reinsurers had been hammered with enormous claims as a result? Go back in history almost four years. In spring 2020 credit markets seized up briefly, equity markets went into the shitter, and FFH reported significant M2M losses on its equity port, and moderate cat losses from covid. At that time, the company had already tapped its revolver for general corporate purposes before that virus even broke out and they were already subject to the covenants. Imo, FFH came uncomfortably close to violating those covenants in summer 2020. Had the cat claims been meaningfully worse or if the collectibility of ffh's reinsurance receivables had been called into question (ie reinsurers who can't pay or won't pay), Prem might have driven the company onto a wall. For me, it was masterfully managed by Prem given the cards he had available, but it was uncomfortable. The lesson is to not fuck around. Have plenty of capital and plenty of Holdco cash. Keep a revolver, but never put yourself in a position where you might be reliant on the kindness of bankers. SJ

@Crip1 We have seen one quarter of slower premium growth, which may be the beginning of a trend, or it may be simply an aberration. Personally, I hope it's the latter, but we know every hard market must eventually turn. You are correct that the subs can release more capital to the Holdco if growth does slow (we will see in the next couple of quarters). That being said, in the short-term, FFH has been running light on Holdco cash this year, which carries its own risk. In this most recent note flotation, they've shown they can borrow at 6% over 10 years and we know that the holdco can buy treasuries at ~5%, at least in the short-term, so what does it cost to float an extra $300m or $400m of debt? For me, it's basic risk management. SJ

No, my point is not to convey some sort of crisis, as the regulators have approved significant dividends from the insurance subs, so as you say, a short term cash need can be addressed at the stroke of a pen. But, as always, during a hard market, that stroke of a pen does not come without cost. SJ

I'm not Sanj, but I'll chip in a viewpoint anyway,. The Holdco requires cash for interest, the annual divvy, corporate overhead, and the pref divvies. Sometimes it will require cash for debt repayments, and sometimes for "re-purchasing" minority positions in the subs from outfits like OMERS. Add on a buffer, and that's the basic need. Then consider the strategic opportunity. Suppose the market goes to hell and FFH suddenly trades at 0.7x adjusted-BV. How much cash would be required to hammer the gas on that NCIB and repurchase 1 million shares? I'd say roughly $750m.... Add it up, and maybe $2b of short-term securities that can actually be easily liquidated might be about right (that derivative line in Note 5 might not count). SJ

I guess we will see when the AR is released in April, right? FFH does have US$280m coming due in August. It's possible that they might have taken care of this (or some other notes) early, or it's possible that they are just being cute and simply plan to repay that debt in August when it comes due. In the mean time, they get to use the cash for general corporate purposes and it buys another 8 months before they need to issue a larger than usual divvy or float some other debt. Fine in either case. They have been obviously running short on actual cash unless you hold the view that the derivative line in Note 5 is actually something that they could easily liquidate and use (meaning that the derivative was speculative rather than for risk management or other strategic objectives). Sometimes the Holdco sources - uses forecast exercise is instructive. While FFH does have a large revolver available, I dislike that option because they are subject to covenants and need to be renewed relatively soon (ie, they are usually 3 years or less between renewals). It is preferable to not be reliant on the kindness of bankers. In Spring/summer of 2020, Prem came surprisingly close to driving FFH into a wall because of those covenants. SJ

Good. I would have preferred to see $750m, but $400 makes a difference. They have been blatantly short of actual cash and short term marketable securities at the Holdco level, so this is long overdue. SJ

Actually, what he's saying in that particular quote is that the Watsa family will never sell its interest to an outside party. He's not saying that the Watsa family won't expand its interest, and possibly take it private some day. In fact, a couple of days after that interview was conducted, FFH's substantial issuer closed and the Watsa family interest in FFH effectively increased by about 4% because they didn't tender any of their shares... It's not anything that will happen any time soon. But, it's always a remote possibility, and given how minority shareholders have been treated in other FFH transactions, that possibility should not be dismissed lightly. SJ

I know you were talking about FFH and so was I! There is little likelihood that FFH will go private, but never say never. It would require a particular set of circumstances, and a lengthy period of buybacks would be a necessary precursor because the Watsa family's economic ownership is not currently all that high. With a lengthy period of buybacks and a pile of outside capital, it could be possible. Let's just say that if the Watsa family were in the situation of the Jackman family, my guess is that they'd have gone private five years ago... My only caution is not to assume that we'll never see an opportunistic take-private bid from the Watsa family because my take is their constraint is currently financial capacity more than desire. Buffett is clearly currently disposing of his BRK ownership, so there's no question of going private. SJ

I would encourage you to not hold this viewpoint very firmly. The history of FFH would suggest that investors are best advised to ensure that their interests are aligned with Prem's interests to the greatest extent possible. There have been numerous occasions when minority shareholders of subsidiaries have been unhappy with being bought out on terms that they viewed as unfavourable (in fact, just last week FFH announced it would buy back Farmers Edge. Are the minority holders happy? I haven't seen any feed back, but I don't doubt there would be some unhappiness). Prem's interests are broadly clear as the result of his having the overwhelming majority of his personal assets in FFH shares (and not directly in the subs where shareholders believed they were screwed). The advantage of being a minority shareholder of FFH is that it would require an absolute boatload of capital to buy us out. But, if Prem could find somebody who would provide US$20-25 billion on favourable terms, I don't doubt for a minute that he would buy out minority holders if it were advantageous to the Watsa family. What is more, Prem has advanced significant hints about large scale share repurchases and has even trotted out the Teledyne example. If he actually follows through, in 10 years a family buyout might become more realistic. In any case, it's not something to lose sleep over at the moment, but I would say that it's a mistake to assume that there will never be a take-private offer and that minority holders will never be screwed. If you see a smiling shark, accept him for what he is. SJ

Working from memory, FFH had something like US$115 billion of deflation derivatives. What was that supposed to cover? Take a look at the balance sheet, take a look at the income statement, and the notional amount of those derivatives far exceeded the sum of liabilities and the expenses. So what exactly were they trying to "hedge?" Clearly, if you had, say 15% deflation you could have an issue with your nominal indemnities growing in real value, so you might want to hedge a portion of that (rarely is your ideal hedge ratio even 100%). But, to date, I have never read a compelling explanation about why the notional value of those derivatives exceeded the exposure to the underlying. It's a little like owning 100 shares of a company and then "hedging" by buying 120 put options against those shares. Anyway, I have spilled much ink about this over the past 6 or 7 years to the point where people are undoubtedly tired of my belly-aching. But I take issue with the word "hedging" in this case because usually hedging implies a thoughtful, analytical approach to risk management. But, 6 and 7 years ago, FFH wasn't using derivatives to manage risk, but rather to speculate (I use speculate in the nicest possible sense, as any time you buy a security you are speculating). SJ

You are being kind to FFH management. For both the deflation derivatives and for the equity hedges, a key point of reflection is what should your hedge ratio be? So, usually, you look at your exposure to the underlying asset and you choose a hedge ratio between 0 and 100 percent depending on your desire to lay-off risk. But the deflation hedges and the equity hedges both exceeded 100% of FFH's exposure to the underlying. When you have a hedge ratio above 100%, you are no longer hedging, you are speculating. The fatal flaw with those two initiatives was not the concept, but rather the position size. At this point, FFH doesn't need to do anything fancy. There are significant earnings baked in for the next year or two. Some of the risky investments of the past are bearing fruit (ie, Eurobank). Run the insurance companies in a rational manner, let Bradstreet be his normal fabulous self, and try to exploit value in plain sight. They don't really need to swing for the fences at this stage. This is a really good point. The challenge of evaluating the macro bets is that the more recent ones were for much higher nominal dollars. But, Bradstreet has made several good calls about the evolution of the yield curve that have earned FFH a shit load of money. But, the shitload in the past was like $500m because the company was smaller. The credit default swaps was a bigger shitload because the company was larger. The deflation hedges and equity hedges were also large, in part because the company was larger yet again. And now the excellent management of the fixed income portfolio in 2020 to 2023 has been done for yet a larger company. So, the exercise is a little complicated because a good macro call in 2003 may have been for smaller nominal dollars, but it's had an enormous impact 20 years later. Somebody smarter than me might be able to quantify all of this and net out the losers from the winners, but a simpler approach is to acknowledge that the winners have likely been more important over the long term. SJ

That appeared in Prem's annual letter last spring. SJ

It's most likely a holdco cash issue (see note 5 of the Q3 financials). FFH holdco actually has very, very little cash and true short term investments available. They had about US$650m of cash and easily liquidated securities at the end of Q3, and $400m+ of "derivatives" which is probably some form of short-hand for the TRS. To buy back a meaningful number of shares, they would need to either make a much larger series of dividends from the insurance subs, float some new debt, or tap into the revolver. The dividends from the insurance subs have been limited for the past few years because they've been growing their book at an impressive clip. The growth in premiums reported in Q3 was low compared to the past couple of years, so that's a bit of an alarm that makes me question just how much longer the hard market will endure. If premium growth continues to be slow for the next few quarters, it will put FFH holdco in a good position to extract larger divvies from the insurance subs. If those divvies are very large, then you might see some buybacks during 2024. The $2B revolver could be used to buy back shares, but it's not something that I'd like to see. The revolver is there for emergencies and for seizing highly unusual opportunities. I wouldn't want to see the revolver routinely tapped. SJ