SharperDingaan

What's your mention of problem re current securities laws about? If your direct common holding exceeds 'X'% of the total common outstanding, you're required to make a bid for the entire company. In practical terms if one of the existing investors simply bought the other out, they would exceed the threshold & have to make an offer for the entire company. However, if that investor had a convertible with a conversion price above todays price - they wouldn't have to make an offer, as theoretically the share price may never get to that conversion price. Hence the need for SFK itself to act as intermediary. The rule exists to stop creeping takeovers. While a takeover is not the intent here, there will however probably need to be a higher than average conversion premium because it converts to a control block. SD

We’ve reposted this solely for continuity purposes, re the transition from the old board. This is not a solicitation to purchase, & we would suggest that you do your own due diligence. We know that SFK is one of the better run companies, their BS is far stronger than most, & that they currently have an above average cash balance. The shareholder base is long-term orientated & includes master capital allocators, but there have been exits by some institutions. Management has repeatedly stressed the need to further strengthen the BS, cut distributions, shut down production, & initiated 250 person layoffs. Sometime in 2010 there is a long debt payment due, totalling $CAD 25-36M. We know that the current Canadian pulp industry has effectively collapsed; producers are aggressively cutting back production, & many are permanently closing. One of SFK’s significant shareholders has been aggressively trying to raise cash, and the global price of NBSK and RBK continues to fall dramatically. While extraordinary global credit restrictions are severely restricting demand, SFK’s underlying business model is repeatedly proving to be sound. For 2009, assume an average 7% CAD/USD appreciation (USD depreciation) and a 10% volume reduction. We think EBITDA would be around 32-40M, there will be significant losses, & those losses will tend to increase the debt/capitalization ratio just ahead of the 2010 debt repayment, making refinancing more costly/difficult. Were the convertible debt renegotiated into convertible prefs; the capital structure, & SFK’s IV, would materially improve for the better. We have implied that were the capital structure so improved, SFK would concurrently buy in some of its own stock. As current security laws are effectively prohibiting any kind of significant rebalancing, SFK effectively has to act as intermediary, & finance via some kind of conversion issue that can push the shares out again. In effect; put a control block in a conversion wrapper, pay a cash yield on it, & set the conversion price low enough that conversion could be reasonably assured. We have implied that a convertible debenture renegotiation would be mutually beneficial to all, & that sooner versus later is preferable. Friendly parties around the table make the process easier. At this point while a warrant/rights issue will raise cash, it will not solve the shareholders rebalancing issue. A very telling measure as to how well this coy is actually run is that it does not need cash at the present, but rather a better capital structure. And .... it is at times like this that quality shows. We will look forward to hearing some more announcements! SD

Agreed the 2010 repayment should be 25.7M, our source was the 2007 AR (Note 11). Interestingly, a quick scan of the 2010 horizon estimate over last few AR's shows that it also grows quite significantly every year. A rough estimate puts it at about 36.8M when it becomes due next year. More reason to get a convertible deb/pref swap done earlier rather than later. Sd

Lot going on in this release. Q4 were actually a lot better than advertized. - Cash reserve increased 2.5M, & net earnings would have been 5.8M were it not for the 3.5M impairment writedown (1.9M net of 45% tax). RBK profitability was up as expected ($CAD depreciation offset NBSK price declines, & allowed the input savings to flow up undiminished). Solid execution in what was a really bad climate Look at where this release quietly directs you, & the outlook commentary. - 2008 & 2007 are the only directly comparable years (acquisition was oct-2006), EBITDA is stable (therefore the years are directly comparable), and the good year following a bad year is pretty typical performance. Average the net earnings, divide by your cap rate, & you essentially have IV. We think about 61c/share. - .22 debt/capitalization is about the same as 2007, & improved because of debt repayment & +ve net earnings. 2009 has essentially the same current portion due .... but 2010 has 15M due, & that's not really doable unless the capital structure changes. If the debs were to become convertibles you'd get roughly .16 debt/capitalization, the 15M becomes easily refinanceable, & there would be interest savings in the financial charges line. IV would dramatically increase. We think about 1.19/share. - A guess, but assume that .22 is a 'magic' number. IV/share is being handicapped because there are so many common ... but if there were 25% fewer common ? IV/share would be around 1.58. 22.5M shares @ 1.60/share + 15M refinancing = 51M = approx the diff between .22 & .16 of debt/capitalization. Then consider that if 2009 FX appreciates an average 7.5%, sales volume falls 10%, & COS increases to approx 90% (on reduced vol) we can expect EBITDA to fall to around 32M. Net earnings would be at least 15-20% better if the deb weren't there. Most convertibles are set at roughly 30-35% above current market. Assuming 1.60 IV .. a price of roughly 2.15 ... or 24M shares. Approx the same number of shares that could potentially get bought in ? Back in Dec we were expecting a dstbn increase to about 1.5c/month. The discount rate at the time was roughly 11%. Capitalize & you get 1.64 (.015x12/.11) Interesting ? SD

We may be a little biased here, but this is an area where the 'business' vs 'investment' view really stands out. FFH's competitive advantage is its ability to consistently invest better than its peers. To do that you need to take on some operational risk, & 'buy' some float. And you have to be willing to pay for it, ie: 2.5%. In Dupont analysis (ROE) terms, they need to weight the business's total degree of leverage more to the operating vs financial end. This has consequences. - They don't need to be a top-flight underwriter, but they do need to reliably contain their expenses within the 2.5% net allowance. If they do better great, but only if the operational benefits exceed the operational costs. - The adverse insurance risk on their UW results increases; so there's more need for exit discipline, & a higher interest/dividend income stream to ensure that their net operating income meets the minimum requirement. A desirable thing , & no different from the standard practice of hedging BS FX risk & not P&L FX risk. We see evidence of exit discipline, & the consequence of increasing the adverse insurance risk to the overall market. If they wrote like Chubb, etc they'd very likely have less float - and might well actually give up more on the investment side than they would save on the UW. Net negative. There is always room for improvement, & operational leverage does change to meet the times. Perhaps a good time to revisit it ? SD

As 'seasoned' value investors we know that concentrated portfolios contribute to volatility, you need long-term stable & knowledgable investors, & you have to be able to tolerate -30+% returns for extended periods. In many ways its a strategy better suited to private vs public money - & public money is extremely nervous at this point. The marketing need essentially dictates the change. The # of ideas held at any one time is also not static. We too currently hold more ideas than we normally would, & an execution bias in favour of funds vs individual securities(diversification, liquidity). Times change, & we need to change with them. SD

T-Bone It's worth looking at where FFH might expect to make its money over each of the next 3 years. Assume (1) 2009 earnings come primarily from UW (hardening market, higher div/int etc). If the market continues to fall, investment gains on the remaining hedges will largely be offseting investment losses on the growing equities/bond portfolio (2) Assume 2010 earnings is a 50/50 mix (3) Assume 2011 earnings is again primarily from investment gains. 2 variables; (a) how profitable is the UW, (b) how long to the next round of investment gains. Depending on the weather, UW could be wildly profitable - or a dog. Long term holders see this as an inherent part of the business. But Mr Market is short-term orientated & sees this as terrible. The more so as investment gains may not start showing up again untill 2010. Manic prices. Should you buy? On a different thread we suggested that over a 5 yr horizon the threshold YTM is about 25%. Mr Market was offering US 239.55 today. If 2009 BV growth was only 15% (< 20% expected average), there was no year-end div, & the 1 yr multiple was only 1.05x you'd earn 43% [(282.70x1.15x1.05)/239.55]-1. If you bought you'd make roughly double what you were allready expecting to make, for simply acting. If you're confident the market will not fall further it makes sense. If you're not so sure, hedge.

Keep in mind Soros’s comments on capital injection, & where that leads: - If key global zombies were nationalized by their home governments, global lending between these banks would effectively become inter-governmental, & those banks own loan sale infrastructures could be used to immediately push government backed credit into the global Main Street. Competitors would be forced to either follow the lead, or risk nationalization themselves. A regulatory & market solution. - If you nationalize, you write the rules. Take it or leave it maximum 500K salary, anti-trust break up into smaller non-toxic entities, reset regulation. No shareholder input. Political capital for removing the corruption. New & healthy financial entities going back to the market. - $ on the sideline can safely move into the new non-toxic entities. Unregulated off BS securitization starts getting refinanced as regulated on BS banker acceptances/commercial paper. If 10% of US GDP is on the sidelines (low estimate) & these entities are capped at 12.5:1 (very conservative) leverage – 1.25x US GDP suddenly becomes available. - Controlled write offs/bankruptcies. Write off particular toxic assets & everyone else holding those particular assets will be forced to follow – bankrupting some. Let the planned fallout pass, & then repeat with another type of toxic asset. Of course if you’re one of the bankers/hedge funds potentially affected you’d collectively do everything that you could to ensure that this didn’t happen. Inaction & stagflation suddenly becomes the only way to go! Soros has been ridiculed by many, but consider that for most of his life he’s called the various emperors out on their lack of clothes, & repeatedly been right. In many ways, he is the ultimate truly independent black sheep. Do you feel lucky enough to ignore him? SD

The technicals (voodoo) suggest waiting untill we know if the whole market is going to go through the Nov-2008 low or not. Assuming it does, another 5-10% is fairly likely.

We're really talking about the table on p23 of the 2008 Full Year Interim Report, & how poorly we understand it. We see a 2008 UW loss of (457.7) & think that's terrible, when we should really be looking at the operating income which was +18.4 - They write longer tail business & they don't discount, so the UW loss is higher that a competitor would report. Example: Assume 100 of total expense at the end of the year distributed as 70 in Yr1, 20 in Yr2, & 10 in Yr + total premium income at the end of year 1 of 97.5. UW cost is -2.5 (97.5-100). But discount at 10% & the UW cost becomes +1.0 (88.6-87.6). Would we rather have the 'pretty' version, or the 'real' numbers ? - UW is their business - & they write it obtain float at a reasonable cost. Investment is our business - but we couldn't predict the collapse of Lehmans last year, & the impact of the auto-industry restructuring this year. Yet somehow when the equivalent events happen in their business we're expecting them to have either priced perfectly or exited the market at the right time. IE: We can have extraordinary investment losses, but underwriters cant ? - You hedge investment results via index options, CDS's, etc; you hedge UW with excess of loss coverage, reinsurance, & exiting markets. But we dont understand the UW hedges so we give them no benefit ? - Long tail CR is the result of business decisions made over the last 1-3 years. 2008 Consolidated CR was 110.1, 2007 was 94.0, & like it or not investment & UW are intimately related. 2008 was a very good year, but why ? They exited UW markets that weren't profitable, they did not 'reach' for cash yield in interest & dividends, they increased runoff by commution, & they sold off pre-established market positions. We were expecting them to write tons of junk business to inflate premium & make the UW loss minimal ? & then load up on junk bonds to maximize interest income & inflate operating income ? Reality is that you have to adjust numbers to get a better idea of what 'normal' looked like, & compare against peers writing the same type of business in similar quantities. I don't want to do it, is not an option. - Most folks would look at the interest & dividend line, normalize the average yield over some period, & then recalculate based on the normalized yield. A UW/Investment adjustment - You would do a similar thing with run-off, but would assess against market conditions at those times when run-off changed significantly. A UW adjustment & a UW quality assessment. - A similar thing with lagged UW loss (net of Katrina's, Ike's, etc) vs premium. Another UW adjustment/quality assessment Make those adjustments & you'll find that the UW is actually very good. If it wasn't good wouldn't HW have let the team go ? Given that he hasn't done so isn't that telling you something ? Folks its easy to criticize, but from what I see we'd be useless at UW. Let them get on with running the business. If you have an objection, sell your shares. SD

Oldeye we had pretty much the same thought, but came at it a little differently. As Prem seems to work with 5yr intervals, what do we need to get to CAD 1000/share if the average ROE between now & then is 20%/yr ? The BV multiple at the end of yr 5 would need to expand to 1.14x [282.70/.8004 x1.2x1.2x1.2x1.2x1.2x1.34]. Today its 1.02x [uSD 282.70/USD 278.28], the closing BOC CAD/US FX rate is .8004, & we still need to get through a truly historic recession/depression. The 5yr compound return (ex divs) would be 23% & seems a reasonable proposition. With divs included the return is even higher. CAD $353.20 today for $CAD 1,000.00 in 5yrs - a 35 cent dollar. But ..... You have to hold for the entire 5yrs. May be the intent, but most on this board will not hold that long. Very bumpy ride. Human nature is to react, averages conveniently ignores that. Variables. ROE average, multiple expansion, FX rate, recessions length. They all need to line up. So ... If you lock the stock away, & treat it essentially as a 5yr bond, it is a 33c dollar with approx a 25% YTM. Over the next 5 yrs, comparable equities need to be at least 3-baggers (& higher if more risky) This should be viewed as the benchmark holding All kinds of PM implications SD

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