SharperDingaan

Re the UW; you might want to normalize the last 3-5 yrs of CR against a broader view. The income side has been artifically low for an extended period, as the assets were invested to maximize the compound vs cash (bond int/pref divs) return. Investment results have proven that this was the right strategy (CDS's, heavy cash weightings, etc.). But in reporting terms it moved some of CR return out to the day that the underlying investments were realized. Example: Holding a bond with a 3% coupon & a 20% YTM; will contribute only 3% cash to the CR today - but 20% on that future date when it matures. IE: YTM maximization does not translate into CR maximization. Going forward we should see mich higher income generation (convertibles at 10%+) which should push CR >100; & well > 100 if there is also a concurrent hard market. Consider that if your people/approach didn't change, how did you suddenly became good at UW when you were supposedly useless at it before ? Weren't you allready good at it, but it just wasn't showing ? IE: measurement bias. Depending on the normalization assumptions everyone will get different results. Normalized results certainly look like they are top quartile, & are consistent with what we'd expect from their approach. SD

In the spirit of the Martin letter: The authors probably didn't quite realize it, but they found some masterkeys. At any given time the majority of the years portfolio gain/loss will be attributable to whether you were long the day a statistical outlying event occurred. IE: over the long run if you're long the index, the normal curve tail risks will pretty much determine how you do. Example: If you were long insurance coys & unhedged the day Katrina hit, that event pretty much dominated what your return was that year Unfavourable consequences far outweigh favourable consequences, they did so in all 15 markets, & some markets are far more sensitive than others. IE: If the outlier is in the negative tail it has far more impact. Business & economic cycles generate serial correlation and that impacts the consequences of the tails. IE: When the cycles are in downturns the positive effects are lower & the negative higher - & the longer the cycle the greater the magnitude of those consequences. Example: If you were long the index today your losses are far higher than they would have been had we allready had a mild recession a year ago. Application ? You dont know when these outliers will occurr but as the downside is more severe, you should hedge the downside pretty much all the time. Rule #1? The more concentrated the portfolio the bigger the impact. IE: because you're concentrated the hit could easily miss - but if it does hit it will be devastating. Rule #2? If you bought the day the negative outlyer occurred, you were set for life. The once in a lifetime opportunity ? SD

Grantham's study made a few key assumptions: The company financial structure was relatively stable at the time he measured it, & it had products that would remain in demand throughout the depression. However the reality was that if the company hadn't yet had to sell assets/take writedowns, its earnings quality was artifically high & its forward earnings projection would (typically) be overstated. He also didn't recognize that if most of your product lines are somewhat 'non-essential', in a recession/depression there is less/no market for them - & this is most companies. If your coy was #1 or #2 in a cyclical industry (mining, drilling, commercial ppty, etc) & cyclical write-downs are common industry practice, your coy wouldn't qualify because earnings quality wasn't there. And if you did buy, you'd be buying closer to the peak or trough of what had already been a most often longer than average cycle. Measurement bias. 12 months ago the banks & car makers etc. would have been high on the list, & primarily because of their long history of prior earnings. And the riskier coys would have ranked highest because their earnings were being 'boosted'. Historic bias. Grantham's is a valid analytic, but overweight forward earnings 2-3 years out & those coys with the newer & more relevant product lines. Essentially - where will we make our money 5-10 yrs out ? vs where we make it today, & are we making enough today ? to finance the R&D on those future products. SD

Ex the chest thumping what's really being said. I hear reduce the carbon footprint by 2/3. Sequesture the CO2 in old fields (to boost pressure & production). Build pipelines (green infra-structure) to get the CO2 from the tarsands to those fields. Reduce/recycle the water consumption. IE: Scale up what's allready being done. New industry making old fields worth far more as carbon sinks, than they ever were when they were producing. And somehow this is a bad thing ?

Canadian cultural practice is typically a 25 yr amortizing recourse mortgage, that results in a mortgage free house at retirement (55-70). Consequently, a large part of the lenders mortgage portfolio has systemic monthly & cummulative equity growth to offset adverse price volatility. For the most part, the average equity is also well > 25% of the house value. All mortgages with < 25% DP are insured by CMHC/BOC. The insurance is essentially a put priced to favour a minimum 10-25% DP - & if execized, results in (1) the CHMC re-paying the lender 100% of the mortgage (2) seizing your house & selling it, & (3) prosecuting you for any shortfall. In really bad times CHMC can deliberatly hold the houses off the market (BOC essentially finances them) untill pricing improves. Customary lending practice is to automatically refinance mortgages @ 25% DP, through the use of a LOC & (often) mandatory CHMC insurance. Monthly payments decline significantly (better debt servicing) & any further decline becomes the governments problem. The last 3-4 years have changed practices a bit, but the safeguards are largely still intact. We will get falling house prices, but it is highly unlikely that you will see it to the same degree as in the US or UK. Even if a large chunk of the population is out of work. SD

Interesting related article "Black Swans and Market Timing: How Not to generate Alpha", Journal of Investing,Javier Estrada vol 17, no. 3 http://www.iijournals.com/JOI/default.asp?SM=ALL&DatePeriod=0&OB=D&Catalog=IIJ&Page=13&PID=107&SearchStr=Estrada&Image1.x=30&Image1.y=13 If you missed the best 100 trading days on the Dow over the last 107 years your wealth would be 99.7% lower; but if you missed the worst 100 trading days your wealth would be 43,396% higher. Similar results (lessor scale) for the most recent 17 year period, & in 15 other international markets. It would seem that no matter how 'cheap' it is, it is better to stay in cash untill you see clear & hard evidence that XYZ coy has turned around. You will give up some return, but are likely to end up roughly 435x [43396/99.7] better off. Magnitude may vary by time period/market. SD

Keep in mind what a recovery initially looks like - a very small (sub)sector starts demonstrating optimism in a sea of pessimism. Look at WEB, FFH, etc & the senior companies in the industries (insurance, etc) they are asociated with. Spreading optimism ? It should take a good 9-15 months for the major indices to start rising, if only because year-end hasn't hit yet & the zombie banks are still operating (bad news swamping the good). Change the metric ?

Consider what the next one quarter EMV might look after FFH reports. P(x1) of the price staying the same is fairly small, P(x2) of price rising is moderatly high (Q1 is where you make the $ for the year), & P(x3) of the price falling is moderately high (group think & great results temporarily boosted todays price). Multiply by the associated values (V1, V2, V3). But what if V1 is negative, & V3 is strongly negative ? The point is that existing price growth is unlikely to maintain the same clip, & that the probabilities also assume no major change to the 'baked in' current market assumptions. There are many other coys where the odds are more favourable, but the specific company risk is higher. FFH options, sale/repurchase, etc. should be high on your list. 'Baked in' assumptions could also be changing. Manulife has just publicly asked officialdom for insurance similar to WEBs coverage for mono-line insurers, & for the purposes of covering acquisitions (releases reserves). Should it occurr it's highly likely that it will be offerred to not just Manulife. Simple buy/hold may not be the most optimal any more

The mechanics run on beneficial ownership. Give your certificate of 100 shares to the broker; he will re-register it with the transfer agent in his name, & give you a paper statement showing you beneficially own 100 shares. If its a cash account the broker is required to deposit (101% to 105%) of the cash equivalent of the days closing market value with the regulator/BOC, & can use your shares however he wants. If the broker goes under you get reimbursed the cash value of your shares, the day before the broker crashed. As the broker is required to put up more than 100% (in Canada), he has incentive to push you towards other account. If its a non-cash account the broker still has to deposit with the regulator/BOC but can offset (100 +X%) of the margin loan he's made to you. X varies with the security. If the broker goes under the 'shortfall' is essentially the margin difference before & after the collapse, plus all unrecoverable margin balances net the sale of the underlying. The bigger the broker the greater the margin delta, the sleazier the broker the bigger the unrecoverable balance. The brokers deposits are typically made at a Sched-A bank, & flow up to the BOC that night. Different mechanics in the US, but same general idea. * Cash & margin accounts are backed by BOC deposits. How much you get depends on your account. * Headlines will cause disruption, but while it happens there is relatively little risk. * Recoverables are a 3 step process. Sell the underlying, int'l cooperation in funds tracking/recovery, tell your less savoury friends - Europe typically being a little more aggressive [Roberto Calvi, Banco Immobilari]

Stubble, they may well have some of this http://cxa.marketwatch.com/TSX/en/Market/article.aspx?guid=http%3a%2f%2fsystem.marketwatch.com%2fnewscloud%2fdocguid%2f%7b398A7C56-C545-4AAA-B1F7-75775D87B97F%7d&symb=PD.UN

Keep in mind that this is an off-shore bank. If Coy A, Sub A made a Euro$ deposit in the bank & Coy A, Sub B simply withdrew it (for use in the US) there would be no loan. But Coy A would be up the capital tax, less a substantial fee for services rendered. At $100M increments this isn't change. What's good for Coy A is also good for money laundry, drug lords, arms dealers, & various sundry. Friends in the right places, a small rake for the house on every transaction, & honest dealing incentive. There is more to this than published

Quick note on margin funding. In the US the fed is the backstop. Mechanically XYZ coy is seized, & the fed makes the legal entity an unsecured short-term loan to keep the accounts on side. Account holders are then given a letter, asked to verify their bonafides, & transfer their accounts elsewhere within X days. Once the days are up accounts that aren't transferred go to the fed for safekeeping, & the loan repaid. Any losses incurred are repaid from the industries 'insurance' account, recoveries, & writeoff. Minor differences in Canada. Suspicious accounts are not unusual, & there are often ties to money laundering/drug proceeds/home country tax evasion/slush funds, etc. Where proof of ownership is problematic, the funds are seized. Discussion between the former beneficaries & the fed, are by neccessity - somewhat delicate.

Good post. - This combo is attractive because it offers a positive spread, over a long period, at supposedly minimal risk; different spin, & different mechanics - but isn't this pretty much the same message that Alt-A mortgagees heard when they rushed to sign up ? - As pointed out this is a variable spread & for now its strongly positive. But look forward; doesn't the P(x1) of the spread widening seem pretty low, & the P(x2) of it narrowing, or even going negative P(x3)seem much bigger ? If we have inflation, wouldn't this spread also get very negative, very quickly ? - To unwind you need to sell the CD for at least what you paid it, & any realized loss will be multiplied by 4. But if you only unwound when the spread was negative, at that time wouldn't the YTM on the CD be higher than when you bought it ? - almost guanteeing a realized loss on this long term CD - To make money on the combo you really need (1) the spread to widen & (2) the CD YTM to fall, plus the sooner it occurrs the better. In effect you need the fed to run out of rabbits, & the stimulus package to fail. Who is more likely to win here ? the buyer of this combo, or the folks who sold you the CD & margin debt ? Lessons ? * Dont be afraid to ask * Look critically. Why is it good today, will it do better/worse going forward, what happens on exit * Who benefits. Is it mostly you, or the guy who sold it to you ? Next time you go past a soup kettle throw some change in. You just saved a fortune SD

If its just strategy as it relates to Portfolio Management, there are all kinds of text books. There are a series of well defined steps, & mechanical execution will get you to a reasonable solution relative to your defined paramaters. If its about application, look at the various academic papers on different topics. But do not expect someone to tell you how to apply the concept, or what to watch out for. These are essentially the value propositions that keep individuals in business. There are very real differences between how public vs private money is managed. Most of it is fiducial, temprement, the relative strengths/weaknesses of the individual vs the institutional Balance Sheet, & estate planning. Strategy & execution are largely the same, just executed from a different POV. As the majority of the more successfull individuals are current & former Portfolio Managers, Treasurers, CFO`s, etc. , much of the ìnvestment`skill set is similar. Most private money is individuals investing for a specific purpose (buy a house, pay for a wedding, go to school, etc.) The majority of the `return` is as practical education, vs actual $. Generally longer term views, as many of those individuals will go on to be those future PM`s, Treasurers, etc. WEB does the MBA students, this is `School of hard knocks`. Be a little more specific. SD

To do CWB successfully you need to take the long view. Loan provisioning will be a lot more volatile, & earnings erratic, but if the province doesn`t goose the industry out of downturns they loose a lot more than CWB does. The `blue eyed sheiks` are effectively implied guarantors. The real value will be the contacts developed out west. Canada is a small place & FFH will be pretty much obliged to make oil & gas investments as the portfolio expands. CWB will be a great place to develop the `circle of competency`.

Were Abitibi in CCA, debtholders would essentially need to do a debt to pref share swap to refinance the company. In practical terms only the better assets would be put into new coys & refinanced. The poorer assets would be discontinued. Pension shortfalls would be dealt with through some kind of pragmatic compromise arrangement. At 15.5%, we can reasonably assume that this new debt is secured against the better assets. Each new coy would likely be regional, have a very strong BS, & would probably include seperate subs in 2-3 LOB`s. Providing it was done quickly the coy`s would also be profitable, as all existing Abitibi contracts could now be met through fewer plants - generating higher thoughputs & minimizing fixed costs per ton. 1st stage rationalization. But to get a piece of these coys you would have to be an existing debt holder, & essentially agree to a `pre-pack`. Where Abitibi leads others will immediately follow, & subs in the industry`s various LOB`s will get traded (same as hockey). Fewer, bigger, & the most efficient plants in specialized sectors - owned by coy`s that become proxy`s for that segment. Pure, & profitable, plays that facilitate investment. 2nd stage rationalization. It looks like the long awaited industry rationalization has begun, & that FFH is essentially positioning itself. Hopefully, we`re more or less correct. SD

Apologies if we came off as a little aggressive. Shortly after KFS had their first 'hiccup' we bought in & did well. We made the gain because we got in at a very low price, & essentially got out at what was the best exit point in many years. Management was why we left. The reserving issues aren't new - ordinary errors/re-assessments occurr in normal course business, but extra-ordinary adjustments are just that; extra-ordinary. Sizeable extra-ordinary adjustments year-after-year is hard evidence that key actuarial & executive controls are weak, & that current income is being systematically overstated by under-reserving. Add in evidence of casino betting, & a senior departure, & it becomes fair assumption that there may well also be an ingrained cultural problem of boosting current earnings. You don't change culture by simply changing one exec. The press release suggest current quarter operational earnings in the $44M range. Given the reserving history, & the cultural assumption, the prudent question is why is the current CR not actually <100 ? - in a quarter when there were clearly a lot of internal strife. ie: shouldn't the current quarter's operational earnings really be negative? Granted extra-ordinary charges create noise, but the prudent action is to give benefit of the doubt only when there is evidence of reasonable credibility. Portions of the business aren't that bad, but there is a strong case that they would be far better served were they in another carrier. The business could be turned around, & there is evidence of an attempt - but doing it in a recession with credit markets seized & workforce morale probably near rock bottom, is no picnic. Hard markets will benefit other carriers as well, & at far less risk to the investor. That said, we wish the management well, & hope to see them turn it around. SD

80M in additional UW provisioning, despite reducing the book 43%. So it would otherwise have been well north of 140M [80/(1-.43)] ? & in what is supposed to be short tail less risky business ? 114M of investment losses ? They knew there were reserving issues requiring greater conservatism, but still chose not to hedge the equity portfolio - despite direct & overwhelming evidence of growing volatility ? We've fired one exec, now please believe us ?

Keep in mind that the convertible component is just an option; the principal stays in either fixed income or senior equity. If the common goes up, great. If the common continues to fall, you swap the debt for equity at a lower conversion rate. The `too early` issue is still there, but hedged. Of real time interest, may well be FFH & its debenture holding in SFK. One of the higher probability outcomes to managements recent comments is a debenture to snr equity conversion; an example of the hedge being used. Disclosure: We hold a long position in SFK common. While there recently seem to be more snr equity than convertible debt issues, its more likely attributable to issuers needing to improve BS ratios vs raise cash. ie: Not a reflection of WEBs macro view. SD

Almost never mentioned is that Graham (of Graham & Dodds) almost went bankrupt while applying the methodology. Arguably, untill the recovery actually began, he survived only because he had more money than he had places to put it. Downside volatility. Graham made his money, primarily because he was overweight the right stocks at the start of the recovery, & then held them pretty much through to the top of the cycle. The methodology got him there, but its not universal - it works only in up-cycles. Were today's hedging instruments available at the time, he might well have actually made more in the down-cycles. Almost all value investors have been experiencing extreme adverse downside volatility, & in most cases they made thier money in the up-cycles - classic Graham. A very few have modernized the methodology, largely by taking the opposit side of market hedges (ie: FFH-CDS's, WEB-S&P option puts). We may well eventually conclude that WEB & coy actually had too much capital, & that it effectively drove them into the market too early. They did not risk bankruptcy because they were able to efficiently hedge, something that Graham wasn't able to do. Its not always a bargain SD

Another option is direct investment in some of the stuff FFH owns. You still have some FFH weighting (via FFH's investment in the coy you've chosen) but end up with more chance of hitting a bigger 'X'-bagger. Different kinds of risk, generally higher volatility, & also the potential for discontinuity (FFH is not obliged to bail out the coy if/when it screws up).

Keep in mind that the law of large numbers has been systematically making the ratio less sensitive, and that the GNPs measurement has changed over time. The 75% cutoff may need to be lower. Over the next 6 months GNP is projected to decline. For the trend to continue, the decline in stock price would actually need to accelerate. The graph suggests a buy point at 50%, or less (35% over WWII). To get there the 'average' stock price needs to fall at least 62% [(50-130)/130] from the average 'peak'. Normal curve tails suggests there were will be some big winners & losers, & a way to quantify how many. Bear Sterns, Lehmans, etc. were losers, the equivalent offseting winners are still something of a mystery. A laymans look would suggest that except for a very few stocks, its still too early to buy. SD