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would you borrow to buy Fairfax at current prices given the following terms


Kiltacular
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Loan is $50k, term is 9 years, interest rate fixed @ 2.5% for life of loan, loan cannot be called unless interest isn't paid, interest paid is deductible against any dividends paid by FFH, under some circumstances the interest rate on the loan could drop   

78 members have voted

  1. 1. Loan is $50k, term is 9 years, interest rate fixed @ 2.5% for life of loan, loan cannot be called unless interest isn't paid, interest paid is deductible against any dividends paid by FFH, under some circumstances the interest rate on the loan could drop

    • YES
    • NO


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Can you afford to eat the $50k if the world goes sideways from some sort of outlier event that culminates in FFH's bankruptcy?  Never invest money that you cannot afford to lose...particularly in an insurance company!

 

That consideration aside, Prem is targetting BV growth of 15% annually.  Assuming that he is able to actually achieve this, FFH's BV at the end of 9 years would be roughly 3.5X current BV (ie, 250% return, assuming no change in p/BV multiple).  In theory, at any reasonable rate of interest (ie, 4-8%), you would make out like a bandit on this kind of deal.  Except if you get hit by a black swan....or a whole flock of black swans.

 

SJ

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sorry guys...rate is 2.5% fixed.  I had that in there but somehow screwed it up.

 

It's not a margin loan so can't be called.

 

I will edit the question to include the rate.

 

Would you please let me know as well how you got a loan at that rate?  I am definitely interested!  :) 

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I'm not sure I understand the significance of the question. Is this purely a hypothetical, or a reference to the implied interest rate in a LEAP (when you could still buy them) or the cost of money to large banks?

 

I would absolutely take this deal with at least double my net worth.  Most of the tail risk could be hedged out with some sort of disaster insurance (low strike S&P puts or the like). I am not concerned about FFH's reserves, investments or that they will make a huge mistake. Even decent performance at FFH (say 5-10% BV growth) makes this a no-brainer in my opinion.

 

I'd be curious why some people vote "no" . .. ?

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I would absolutely take this deal with at least double my net worth.  Most of the tail risk could be hedged out with some sort of disaster insurance (low strike S&P puts or the like). I am not concerned about FFH's reserves, investments or that they will make a huge mistake. Even decent performance at FFH (say 5-10% BV growth) makes this a no-brainer in my opinion.

 

I'd be curious why some people vote "no" . .. ?

 

I didn't actually vote, as it is not really a cut and dried question for which there is an absolute yes or no.

 

However, I do think that some sober reflection is needed about the significance of the tail risk, and the ability to hedge it.  In particular, FFH is exposed to a number of possibilities that threaten its existence (most are extremely low probability):

 

1) A series of uncorrelated mega-cats (ie, an 8.0 California earthquake followed by a cat-5 New York hurricane, followed by XXX, etc)

2) Financial fraud, mismanagement or embezzlement within FFH (à la Enron)

3) A ridiculous regulatory change from one or more governments (ex, retroactively applied changes in insurance coverage like in Mississippi, post-Katrina)

4) A drastic change in the credit-worthiness of the US government (ie, devaluation of treasuries)

5) Some crazy development in APH or in health risk related to food (ex, somebody discovers that high fructose corn syrup causes XXX disease and then the lawsuits hit every major food processor and beverage bottler)

6) The US government enacts some sort of legislation to inhibit or expropriate FFH's US operations (something like the Helms-Burton law).

7) Other crazy development that could bankrupt FFH???

 

 

These are all ridiculously low probability, but high impact events.  They are so diverse, it would be hard to predict them, and difficult to hedge the risk.  We know it's part of the package when you buy an insurer like FFH, but these are some of the risks that you really need to think about if you are putting an enormous part of your net worth into an insurer, or if you are going to borrow big-dollars to buy shares in insurers (not sure whether $50k is big dollars for everyone here, but it might be for some people).  On the other hand, if you are reasonably diversified, then you probably don`t care about those risks....

 

SJ

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I voted "no" for two reasons.  The first is that I have enough Fairfax in my portfolio.  The second is that I don't need to borrow to achieve my goals.  My goal isn't to maximize the size of my portfolio, it is to maximize the size of my portfolio with an acceptable level of risk.  The biggest risk to me a achieving my goals is becoming to aggressive trying to maximize wealth, and too confident in an investment, and as a result taking a big loss.

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Every time you put a dollar towards buying more investments vs paying down your mortgage you are implicitly saying that the cheap leverage is worth it.  Those investments can go south but you are still under the mortgage debt load.  Not too different from the risk involved in the proposal given here on this thread.

 

Congratulation if you don't have a mortgage... if you do have one, don't think you're not using leverage to attain your goals.

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The answer should depend on how you plan to repay the loan, i.e. what are your sources of repayment?

 

Take two extremes:

 

If, for e.g., you are going to repay the loan with your employment income and you have a secure job with the Federal govt, then borrowing makes good sense.

 

On the other hand, if you are relying completely on FFH dividends and the sale of FFH stock at the end of 9 nine years, then you will have to consider the risk of black swans and how comfortable with those risks.

 

 

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