StubbleJumper

When Torstar was bought out a few months ago, I don't think any of us anticipated that it would shift into the online gambling industry: https://www.cbc.ca/news/business/torstar-casino-1.5931827 SJ

No, there's no capital loss on a bond you hold to maturity (since the change a few years back, there's now a bit of mark-to-market noise, but who cares about that anyway). The question boils down to whether it's a good idea to lock-in a 0.80% return by investing a portion of the bond port into 5-yr treasuries, or whether you bite the bullet and stay short and earn 0.05 or 0.10 for another six months or a year. If you hold the view that the economy is going to take off and that there will be a relatively rapid, parallel increase in the curve, you are probably better off to stay short for another year. If you hold the view that short term rates will remain in the toilet for another few years, but that the curve will steepen relatively rapidly, you are still better to stay short and wait to increase your duration. But, if you think that rates will muddle along around their current levels for a few years, then the shift of some money into 5-yr is a clear winner. In terms of dollars-and-cents, a large shift for FFH would be to pile perhaps $10 billion into 5-yr treasuries, which would provide the princely sum of $80m annually in interest....or you keep the $10 billion short and only get $5-10m in interest. It costs maybe $75m per year, pre-tax, to sit and wait for a favourable move in the curve. The opportunity cost is pretty small. SJ How much further do rates have to rise for buying the 10-year to be worse than holdings 0.1% paper? At 2% on the 10-year, rates have to rise 0.22% this year, 0.28% the next year, and 0.36% the year following for 0.1% to outperform over 3-years. (very rough math in my head using a 9ish year duration starting duration and not considering the benefit of rolldown over 3 years) Do we believe rates will be sustainably higher than 3% on the 10-year after just 3-years? For reference, please recall we were at 3.25% in 2018 with record employment, trillion dollar deficit/spending and tax cut stimulus, and 9 years removed from the last recession. Seems like 3+% would be a tall order today unless if you actually believe they've been successful in creating the inflation they've failed to over the last 10-years. So if we're not going be sustainably above 3% in the next 3 years, buying 10-year at 2% is a no brainer. And if buying at 2% is a no brainer, than beginning to accumulate at 1.5% probably isn't the worst thing you could do. I would hope they consider small incremental buys if duration from here on out Your rough math looks about right to me. But, I don't think that anyone was suggesting that FFH should commit to staying short for three years. The question is whether Bradstreet et al hold the view that there is likely to be a relatively rapid, favourable move in the curve (ie, a healthy parallel increase or a steeping over the next six months or year as economies reopen post-covid). If you believe that this is likely to be the case, you don't need an enormous increase in the 5-yr or 10-yr to make up for taking it on the chin for another 6 months or year. But, all of that depends on FFH's particular view of how the curve is likely to evolve (I'm inclined to trust Bradstreet when it comes to bonds). My guess is that they will make the small incremental buys like you suggest. I just don't expect to see a large increase in duration when the Q1 is published in May. But, I've been wrong before, and there's still another month left in Q1! SJ

No, there's no capital loss on a bond you hold to maturity (since the change a few years back, there's now a bit of mark-to-market noise, but who cares about that anyway). The question boils down to whether it's a good idea to lock-in a 0.80% return by investing a portion of the bond port into 5-yr treasuries, or whether you bite the bullet and stay short and earn 0.05 or 0.10 for another six months or a year. If you hold the view that the economy is going to take off and that there will be a relatively rapid, parallel increase in the curve, you are probably better off to stay short for another year. If you hold the view that short term rates will remain in the toilet for another few years, but that the curve will steepen relatively rapidly, you are still better to stay short and wait to increase your duration. But, if you think that rates will muddle along around their current levels for a few years, then the shift of some money into 5-yr is a clear winner. In terms of dollars-and-cents, a large shift for FFH would be to pile perhaps $10 billion into 5-yr treasuries, which would provide the princely sum of $80m annually in interest....or you keep the $10 billion short and only get $5-10m in interest. It costs maybe $75m per year, pre-tax, to sit and wait for a favourable move in the curve. The opportunity cost is pretty small. SJ

FFH has historically shown to be pretty adept at positioning themselves within the bond market. Accordingly, the volatility we're seeing now plays into their hands, IMHO, far moreso than it does the aggregate of the industry. This month the yield on the 5 year is up 39 bps compared to 45 bps on the 10 year, not enough to risk capital loss on a significant portion of their investment portfolio. -Crip Yes, that's the line that everyone needs to walk. Either stay short and earn nothing, or roll the dice on the 5-yr and earn like 0.80%. For an insurance company, it's currently a choice between bad and worse. Probably best to stay mostly short, but then again, Bradstreet has rolled sevens on how many occasions? Frankly, I'd trust his judgement. SJ

Are you thinking that they might be pushing up their duration within governments, or do you think they are looking for corporate spread? I would understand the idea of rolling a bit of capital into 5-yr treasuries, but yields are still so low that you wouldn't want to go too crazy. This might be a market where staying mostly short would work better (as painful as that is). SJ

As part of the IPO, the convertible debentures are converted into shares. SJ

So, it's good if FFH can IPO these outfits and book a gain. It pushes up their equity number and gives a bit of slack on the revolving credit facility covenants. It might even enable some of the insurance subs to increase their underwriting volume. It also gives a higher profile to those companies which might turn them into acquisition targets in the future (ie, it could facilitate an exit). However, while this will increase reported earnings, it looks like there will once again be a bit of a quality of earnings issue in 2021. If all four IPOs come to fruition during 2021, it will likely give the appearance of high earnings, but clearly this is not something which is repeatable every year, nor do the "earnings" from these exercises result in any cash that can be used by the holdco for debt repayment, dividends or share buybacks. While the gains are a credit to management and reflect good decisions made in the past, when thinking about the longer term valuation of FFH, it might become important during 2021 to use some sort of adjusted income number. It's a good outcome, but it will definitely muddy the accounting numbers for the next year or two. SJ

Yes, this is good. They definitely needed to get some cash into the holdco and stop relying on revolving credit to fund the company's operations. It is noteworthy that this is a relatively large debt issuance for FFH and the interest rate is considerably lower at 3.95%. I have expressed misgivings in the past about FFH failing to deleverage, and this does not really change the fact that they are more leveraged than I would like and their risk management has been disappointing at times. But, it's a positive step towards at least managing their maturities and reducing the routine reliance on that revolver. SJ

Yep, looks like you called this one right! It was up like US$5/sh on Friday (the day after the earnings release), and then another US$15/sh on the second trading day after earnings. It's funny, but predictable. SJ

Has anybody done the arithmetic to figure out what value this might place on FFH India's 48.5% ownership? SJ

Thanks for posting the presentation; i had not seen it before. The $100 in EPS is not a crazy number if you look at it as a rolling number from Q4 2020 (from when the presentation was made). Q4 came in at $36. We could easily see another $64 from Q1-Q3 2021 = $100 EPS. Agreed, although I think he meant ongoing. $20bn NPW, 90% CR, $500m in interest and dividends, and enough investment gains to offset holdco costs, and you're there. Unlikely, but not impossible, that they can sustain this for a couple of years. Yeah, you don't get a sustainable CR of 90, because the industry would be flooded with capital which would put pressure on prices. Even a longer term CR of 93 will be tough to maintain. In the particular case of a 90, we know that it would be a no-brainer to add capital to the subs because every dollar of new capital allows the FFH subs to write $1.5 to $2 of new business. So, at a 90 CR, the return on that incremental dollar of capital is 15+% in underwriting profits plus maybe 1% in bond returns. The prospect of that kind of return would cause a rapid inflow of capital into the industry. As I said, even a long-term 93 results in a very attractive place for new capital. At 94 or 95, maybe it wouldn't result in a tsunami of new money. EPS of US$100/sh in the short-term is definitely conceivable, but it would require some pretty large gains on the equity positions and some large gains on the equity accounted positions (eg, trigger a paper gain by selling 10% of the airport to your buddy). The arithmetic on the gains makes it a bit challenging to get $100/sh on a regular basis. The investment portfolio is $40B, so you'd need a weighted-average after-tax return of approximately 6% to generate US$2.4B in after-tax investment income, which, when added to the UW profit, could get you to $2.6B in net income, which would be $100/sh. With such a large portion of the portfolio held in bonds, we should not expect anywhere near a 6% weighted average after-tax return on a recurring basis from that portfolio. There are lots of good things going on right now for FFH, but the challenge for them will be to take advantage of the temporary craziness in the tech market while it lasts and exploit the underwriting cycle while they can. If they can do a good job of that for the next 0-24 months, they might earn us a hell of a lot of money for a couple of years and hopefully FFH comes out the other side on a more solid, sustainable financial footing. SJ

The CDS is becoming a more distant memory over time, but don't forget that the CDS was not the first successful macro call. FFH made a shitload off index puts in the early aughts, and on multiple occasions made a shitload off fixed income by correctly assessing the moves in the yield curve. But, the past is past, so what have they done for us lately? ::) SJ

Thanks for posting. Great summary. Hopefully the FE IPO is successful. Technology companies need $ to scale and the IPO should help in the near term. It looks like it will take a few years for FE to become profitable. Fairfax needs an exit strategy on these types of investments (the ones that do not play out as they expected at acquisition and this one clearly has not). There needs to be a limit of how much $ they commit. The big reason is Fairfax is, at its core, an insurance company. And if it wants to be valued at BV or (dare we hope) a premium to BV it needs to have earnings that are somewhat predictable. The non-insurance operations cannot keep driving $100 or $200 million write offs every year (as assets are written down). These write offs happen far too much. The good news is i think we can see a trend. In the past 12 months, APR was sold to Atlas. Fairfax Africa was merged into Helios. Farmers Edge IPO. And it appears Fairfax is not done. 2021 is certainly shaping up to be a busy year for Fairfax. Nice to see Fairfax motivated to act and take advantage of current market conditions. I am looking forward to the day when the non-insurance companies generate large and consistent free cash flows for Fairfax each and every quarter... when analysts are able to model that in their estimates we should see a nice increase in multiple to BV with target prices. PS: it is not surprising that Fairfax keeps saying that Digit is now profitable. Another headwind will become a tailwind as results are reported in the future. Of course, Digit looks like a home run. But still, it is nice to see more and more operations becoming profitable. Couldn’t disagree more. Prem has never managed the firm for consistent earnings and has repeatedly said he never will. If that means the stock trades below the multiple it could, good: more buybacks. What matters to me is how fast BVPS compounds over 5 and 10 year time periods, and that’s all. IMO, you need to go one more step. That BV needs to be converted at some point into cash flows available for use by shareholders. That requires either interest/dividends from the investment, or it requires a compelling, profitable exit-strategy. To date, that has been the shortcoming of the investment in BB shares (but the debs have been a bit better). Let us hope that this doesn't also end up being the shortcoming for Eurobank. SJ

It's always really tough at Q4 to figure out what happened during the quarter because the release is so scant. We will likely need to wait until the AR comes out to get a better handle on exactly what FFH held for investment during the quarter. The one item that stands out as a wildcard in my mind is #5, and in particular, the TRS that were disclosed during 2020. At one point last year, Two Cities walked us through the calculation of FFH's likely return from them, and they could have been a material contributor. But, did FFH still hold them during Q4, or was the position closed? I've never really liked the Q4 release, but I am making an exception this year with the underwriting results being so strong! SJ

We often say that FFH owns XX% of BB and YY% of ATCO, but what we really mean is that the ownership of those shares is scattered across the various insurance subs, including the run-off subs like Riverstone. As part of the Riverstone sale, either FFH wanted to retain those holdings, or the new buyers didn't want them, so FFH needs to figure out a way to transfer cash to Riverstone and extract the designated investments from Riverstone. This is of particular importance if some of those investments are not public (eg, Boat Rocker, etc). SJ

Refused to comment on BB, several questions on it. All shorts closed. Doesn't this seem like a completely unreasonable stance? I haven't heard the call but how can you refuse to comment on something so material to the company?? The worst was that Prem seemed to be playing dumb when one of the questioners asked how it was that Roger Lace and Wade Burton were able to dump their personal BB shares, but FFH was seemingly unable (or unwilling). To a large extent, that furnishes Wade Burton's opinion of the BB valuation. So, we know what Wade likely wanted to do with FFH's BB position, so who made the decision to stand pat? <==rhetorical question! SJ

Petec, I don't think you have the math quite right. There is going to be a consolidation of shares immediately prior to the IPO (see page 101 of the preliminary prospectus) While we don't yet know the exact ratio we can back into it from the PowerPoint presentation on Sedar. Using the midpoint of the offer range, the company suggests that the IPO shareholders will own 16% and Fairfax will own 65%. Based on $100 million being raised at $13.50 per share implies that the IPO shareholders will own 7.41 million shares. If the IPO shareholders own 16% this implies a total share count outstanding after the IPO of approximately 46.31 million shares outstanding (i.e. after the effects of the share consolidation immediately prior to the IPO). With 65% ownership post IPO, this suggests that Fairfax will own about 30.1 million shares. At $13.50 per share, it also implies that the market valuation will be about $625 million in total. Ay ay ay how did I/we miss that? I think your maths works out at about a 5:1 consolidation ratio, and if you search for "consolidation" in the prospectus the first hit gives an assumed ratio of 7:1. That changes the picture totally: at a 7:1 ratio Fairfax's cost is $2.4*7=$16.8, which is at the high end of the IPO range. It is quite likely Fairfax will not book a gain. There won't be a loss either, because the debs convert at the lower of ($2.40 * the consolidation ratio) and the IPO price, and the Osmington transaction has this feature too. It also means there are fewer warrants than we thought. Frankly strikes me as a mindlessly complex way to do an IPO. But the bottom line is that FFH won't be booking a profit. The main benefit is that FDGE will get $100m of funding that didn't come from Fairfax. Good catch, Patient Investor! We should all read the filings as thoroughly as you did! A valuation of CAD$625m is less bat-shit crazy (but it still is bat-shit crazy!). SJ

What was said? Rough version: Called in and told him he needed to step away, he wasn't paying attention anymore, and had lost his touch. Continued by saying that Prem didn't understand any of the companies he was investing in and wasn't doing any detailed analysis on microeconomics, his partners agreed but were Canadian so too nice to tell him, and the bankers were cowards not asking hard questions because Canada doesn't have enough good companies. I was surprised that the operator permitted the guy to make such a long and rambling speech. Prem gave the best (and only) answer he could. SJ

Is there a reason to assume that the TRS are held at the holdco and not scattered across the subs? Given that FFH is currently ahead on the swaps, it would be nice if that occurred at the holdco... SJ Hard to say. I'm not familiar enough in the regulatory side to know, but it would certainly be easier to open a single contract at the holdco for the entire amount then multiple contracts across all of the subsidiaries. Trading these things requires an ISDA (or at least used to) and probably easier to not have every single subsidiary having to have one That makes sense. The TRS are probably held at the holdco level. SJ

It's like the acceleration lag on a turbo charged car! SJ

Is there a reason to assume that the TRS are held at the holdco and not scattered across the subs? Given that FFH is currently ahead on the swaps, it would be nice if that occurred at the holdco... SJ

2 years after inception, starting in 2004 and going to the time Allied was acquired by FFH, they focused on primary property layers and low excess casualty layers and consistently (and in correlation to their exposure profile, industry practice and reinsurance pricing) retained 78 + or - 1% of their gross premiums. After the acquisition, there has been very significant growth in the primary casualty lines which have more uncertainty in relation to real exposure, loss development and timing of payments, requiring to cede a higher level of premiums, especially if reinsurance pricing is reasonable for those business lines. Retention has gone down accordingly: 2017:72%, 2018:70%, 2019:65% and 2020:64%. Also fast premium growth (even if capitalization has been relatively high at Allied and even in a hard market) is an added consideration for future uncertainty of cash flows. At least that's the way i see it and people actually writing contracts likely know better. That's an interesting trend in premium retention. What really struck me is that Allied was one of the few subs that had considerable dividend capacity and a reasonably low premiums-to-surplus, as at Dec 31, 2019 (no capital problems). It's a bit of a funny trend to see in a hard market for a well capitalized sub. Perhaps management foresees big things in 2021 or 2022. SJ

Not only were they able to do it, but they apparently didn't have to disclose the swap in the same way they have to disclose market purchases. Which makes me think that a TRS on Blackberry was also possible without disclosure. Time will tell. We can live in hope! SJ Very great quarter. Laughed when I saw the TRS on themselves. Have been speculating they would do that for the BB position - never imagined they would use it for repurchase purposes and as away around leverage ratios. Prem always surprises! A little disappointed with the Brit sale - it was established yesterday... If they needed cash, they could've gotten that from selling some of the BB shares. The sale of Brit suggests that they probably didn't sell/trim BB for that cash. We'll see what they say tomorrow, but I'm not optimistic that BB was hedged/sold anymore. Could you please walk us through the TRS situation? So, they entered into TRS equivalent to 1.4m shares at US$344. Today FFH closed at US$399. Would I be correct to understand that FFH is therefore ahead by about US$77m on that transaction? Yes, the leverage ratios are high and look like they are a constraint. The gains in Q4 and Q1 help immensely, as would a ridiculous Farmers Edge valuation, but holdco will need more cash during 2021, and now is not the time to take dividends from the insurance subs. IMO, they'll need to float some debt this year, and it might be time to have a conversation with the banker about amending the covenants on that revolver. SJ

Not only were they able to do it, but they apparently didn't have to disclose the swap in the same way they have to disclose market purchases. Which makes me think that a TRS on Blackberry was also possible without disclosure. Time will tell. We can live in hope! SJ

Am I the first to say that the insurance subs shot lights out? Holy smokes! Net Written growth is not just double-digits for most of those subs (Brit and Zenith excepted), but well into the double digits (WTF, Odyssey gross written up by like 25%!!!). The combined ratios were outstanding. Capital still looks a bit tight at Crum, despite the holdco pumping an enormous amount into the subs. Just as an observation completely separate from Q4 results, does anybody have a good explanation for why Allied cedes so much premium? The FFH total return swaps are very likely to work out fabulously during 2021. Is anyone else surprised that the regulators even allow companies to buy TRS in themselves? Not a criticism of FFH, but it's just that I don't ever recall seeing that technique disclosed by other companies. Not a word about "subsequent to quarter's end?" How is that possible? Best quarter that I can recall in quite some time. SJ