Fairfax stock positions

[MMM20]

2 minutes ago, ERICOPOLY said:

 

It was fairly low impairment risk.  The stock was already compressed heading into the summer of 2006 and there was little decay risk to hold it for 3-4 months when it did not expire until January 2008.   The game was to see how the summer 2006 hurricane season played out.

 

How big could you make something like that as a % of net worth, or however you think about it?

 

Edited September 15, 2022 by MMM20

[ERICOPOLY]

And there was not a put/call parity -- the calls were cheap relative to the puts and I believe it was because of the massive borrowing costs of the stock as interest in shorting the stock had increased with speculation over the assumed-to-be-busy 2006 hurricane season.

[ERICOPOLY]

1 minute ago, MMM20 said:

 

How big could you make something like that as a % of net worth, or however you think about it?

 

 

It was all of my investable cash at the time, taxable and IRA combined.  I was only 33 and I could replenish any losses with savings. 

[StubbleJumper]

16 minutes ago, MMM20 said:

 

More interesting to make 3-5x (IMHO) on a massive low impairment risk position anyway.

 

 

I was dumb and only bought the equity instead of the LEAPS.  I only scooped 3-4 bags instead of the 60-80 bags that Eric got.

 

 

SJ

[MMM20]

11 minutes ago, ERICOPOLY said:

 

It was all of my investable cash at the time, taxable and IRA combined.  I was only 33 and I could replenish any losses with savings. 

 

Props. I did something similar for just a couple weeks into the dutch auction last year and didnt sleep much. Similar age to you at the time too. Lots to learn from the OGs.

 

Coming at this one humbly but seems the situation is similar now. Do you disagree?

 

Edited September 15, 2022 by MMM20

[Viking]

Yes, the current set up for Fairfax looks pretty compelling. Near term catalysts?

1.) pet insurance sale: given its size ($1.4 billion and $950 million realized gain) and impact on BV ((increase of $40/share) the closing of this deal should be positive for the stock. Timing? Sometime in 2H. It should be noted, Fairfax tends to be aggressive with the timelines it usually provides (deals often take longer, and sometimes much longer, to close).
- the secondary benefit of this deal is what does Fairfax do with a large portion of the cash? Is it:

a.) left at C&F to allow them to grow in the late innings of a hard market?
b.) Or is a large chunk dividended to the hold co? If it is sent to the hold co, is it used to:

i.) buy out minority partner(s) in Allied World?
ii..) Or is it used for another dutch auction?

 

2.) Q3 earnings when they are reported end of October: could we see record operating earnings in Q3 (underwriting income + interest and dividend income) of around $500 million? (I think that would be a record?)

a.) underwriting income: hurricane season in US so far in 2022 has been much milder than expected.
https://en.wikipedia.org/wiki/2022_Atlantic_hurricane_season

Could we see a sub 95CR from Fairfax in Q3? Could we see a sub 94CR for all of 2022? That would put $1 billion in underwriting income for the year in play.

i.) what is top line growth across company? Close to 20%?

ii.) what is outlook for P&C hard market?
iii.) what is growth of re-insurance? Sounds like re-insurance is now in a hard market. Growth here at Odyssey and Allied World could surprise to the upside.

b.) interest and dividend income: At the end of Q2 Fairfax said current annual run rate was $950 million. Bond yields continue to move much higher in Q3.

i.) does consolidated interest and dividend income (including runoff) come in around $230 million? It grew about $35 million from Q1 ($169 million) to Q2 ($203 million). 
ii.) do we get an update to the annual run rate? To something north of $1.1 billion?

iii.) has Fairfax started to extend duration of fixed income portfolio beyond 1.2 years? 
iv.) as interest rates spike, P&C insurers with much longer average duration in their fixed income holdings (pretty much everyone else) will be taking a third large consecutive hit to book value in Q3. Do regulators care? Will the significant hit to BV impact other insurers ability to grow their business in the current hard market? Does this reality extend the current hard market out another year?

- on the Q2 call Prem mentioned European insurers as being especially hard hit by rising bond yields (big hit to BV). I wonder how BV at the big European reinsurers is being impacted by rising interest rates?

 

- as with pet insurance sale, what does Fairfax do with $500 million in operating earnings in Q3? And another $500 million in Q4? Many of us on this board have long complained about Fairfax hold co being chronically cash poor, especially during down turns. Is it really different this time? It certainly looks like it could be.  
—————

When Q3 results are reported we will also get further details of just how much of Allied World was bought back from OMERS. Does Fairfax buy back only a portion? Sounds like it. If so, that would allow proceeds from pet insurance sale and Q3 operating earnings to be used for something else (another big stock buyback in Q4). 
- “Fairfax intends to use substantially all of the net proceeds of this offering to purchase a portion of the non-controlling interests in Allied World Assurance Company Holdings, Ltd (“Allied World”), and use any remainder for general corporate purposes.”
—————

Another smaller catalyst could be closing of the Resolute deal. I think this is expected to close in Q1, 2023 (i have read different dates so i am not sure… perhaps Q4). The sooner the better. Fairfax will book a nice gain. And the proceeds ($600 million) can get recycled into other opportunities… we are in a bear market. 
—————

Digit, and its IPO, is another potential catalyst. The question is timing. Financial markets will likely remain pretty volatile the next 12 months - not sure how this impacts a Digit IPO. The important thing is that Digit keeps executing well (continuing its growth). Bottom line, i am not expecting a Digit IPO in 2022 or perhaps even 1H 2023… but this is simply an uninformed guess.

—————

Is Fairfax done monetizing assets for 2022? EXCO Resources (nat gas producer) is the private holding that i find most interesting today… i wonder what it would fetch if put up for sale? Or IPO?

Edited September 15, 2022 by Viking

[Parsad]

7 hours ago, ERICOPOLY said:

 

It was all of my investable cash at the time, taxable and IRA combined.  I was only 33 and I could replenish any losses with savings. 

 

Yes, Reddit did not invent meme stocks...it was Ericopoly who did nearly 20 years ago!  I think like half the message board was in on that gravy train...whether they loaded up on FFH shares at $63 or bought large amounts of FFH LEAPs.  Cheers!

[glider3834]

5 hours ago, Viking said:

Bond yields continue to move much higher in Q3.

as well as treasuries, US corporate bond market is starting to look more interesting - effective yield at 5% (was around 2.5% at start of 2022)

 

'The Bloomberg US Corporate Bond Index of investment-grade securities now has a yield of around 4.95%, close to the highest since 2009.'

 

https://www.washingtonpost.com/business/hot-corporate-bond-market-puts-buyers-strike-on-ice/2022/09/13/0737bc34-3354-11ed-a0d6-415299bfebd5_story.html

 

Edited September 15, 2022 by glider3834

[glider3834]

5 minutes ago, glider3834 said:

as well as treasuries, US corporate bond market is starting to look more interesting - effective yield at 5% (was around 2.5% at start of 2022)

 

'The Bloomberg US Corporate Bond Index of investment-grade securities now has a yield of around 4.95%, close to the highest since 2009.'

 

https://www.washingtonpost.com/business/hot-corporate-bond-market-puts-buyers-strike-on-ice/2022/09/13/0737bc34-3354-11ed-a0d6-415299bfebd5_story.html

 

 

I can't help but recall this trade

 

[Viking]

3 hours ago, glider3834 said:

as well as treasuries, US corporate bond market is starting to look more interesting - effective yield at 5% (was around 2.5% at start of 2022)

 

'The Bloomberg US Corporate Bond Index of investment-grade securities now has a yield of around 4.95%, close to the highest since 2009.'

 

https://www.washingtonpost.com/business/hot-corporate-bond-market-puts-buyers-strike-on-ice/2022/09/13/0737bc34-3354-11ed-a0d6-415299bfebd5_story.html

 

@glider3834 it certainly would be interesting to know what is rattling around in Brian Bradstreet’s head these days - and the bond department at Fairfax. We have seen government bond yields spike much higher than anyone expected 6 months ago. I wonder if Fairfax is waiting for credit spreads to blow wider before loading up on corporates. One would think locking in a yield north of 5% for 3 to 4 years (for a portion of the portfolio) would make sense. Europe looks headed for a recession (if its not already there). And growth in the US will be slowing (it takes 12 months or so for rate hikes to work their ‘magic’). If we get a recession in the US in 2023 then it makes sense corporate spreads should widen but we may see Treasury yields fall at the same time as the market starts to price in interest rate cuts by the Fed. Just like with great comedy, the key will be timing. Sept/Oct tend to be very volatile for financial markets so hopefully Fairfax gets a pitch they like.

—————

If Fairfax is able to lock in a yield north of 4% on its bond portfolio - adding duration - that will do wonders to its operating earnings outlook (the interest & dividend income bucket) for the near term. That would deliver interest income alone of $1.4 billion per year (on $35 billion fixed income portfolio). 
—————

Here are details of the corporates they started to buy in March of 2020: the interest rate was 4.25% and the average maturity was 4 years.

 

“Since mid-March 2020, the company has been reinvesting its cash and short term investments at its insurance and reinsurance operations into higher yielding investment grade U.S. corporate bonds with an average maturity date of 4 years and average interest rates of 4.25%, that will benefit interest income in the future. Up to March 31, 2020, taking advantage of the increase in corporate spreads, the company had purchased approximately $2.9 billion of such bonds.”

Edited September 16, 2022 by Viking

[StubbleJumper]

42 minutes ago, Viking said:

One would think locking in a yield north of 5% for 3 to 4 years (for a portion of the portfolio) would make sense

 

Fully agree with the logic and thought process, but I would suggest that you might need to bump up your level of ambition. 

 

At this stage of the game the US sovereign yield curve is strangely flat with all maturities from 6 months to 30 years yielding between 3.5% to 4% (I can't remember the last time it was so flat).  The yield on FFH's fixed income portfolio will definitely be heading north as they roll over maturing bonds, so that is a very sweet situation.  But, if Bradstreet et al makes the decision to reach for yield by deploying a meaningful chunk of the fixed income port into corporates, it will likely take yields of 6%+ to make that happen because if you can get 3.87% for a 2-yr treasury or 3.66% for a 5-yr treasury, you probably wouldn't accept 5% for corporate bonds.

 

These are good problems to have.  It will be interesting to see just how far they push out the duration this fall.  I'd like to see them roll a good chunk of the maturing bonds into 5-yr, but I guess we'll see how FFH views the world.

 

 

SJ

 

[Thrifty3000]

10 hours ago, StubbleJumper said:

 

Fully agree with the logic and thought process, but I would suggest that you might need to bump up your level of ambition. 

 

At this stage of the game the US sovereign yield curve is strangely flat with all maturities from 6 months to 30 years yielding between 3.5% to 4% (I can't remember the last time it was so flat).  The yield on FFH's fixed income portfolio will definitely be heading north as they roll over maturing bonds, so that is a very sweet situation.  But, if Bradstreet et al makes the decision to reach for yield by deploying a meaningful chunk of the fixed income port into corporates, it will likely take yields of 6%+ to make that happen because if you can get 3.87% for a 2-yr treasury or 3.66% for a 5-yr treasury, you probably wouldn't accept 5% for corporate bonds.

 

These are good problems to have.  It will be interesting to see just how far they push out the duration this fall.  I'd like to see them roll a good chunk of the maturing bonds into 5-yr, but I guess we'll see how FFH views the world.

 

 

SJ

 

Yeah, I think we have to rule out seeing FFH reach for yield on the bond front. Prem believes strongly in regression to the historical mean when it comes to interest rates. So, I expect we won’t see them make any aggressive moves unless they find some yields that are at least a standard deviation above historical norms. Prem has mentioned a number of times how scary it was in the 80’s to invest in bonds thinking you were getting a great rate (at 7%, 8%, 10%, etc) only to watch yields continue climbing above 15% with seemingly no end in sight. He doesn’t want to be in that situation.

[maxthetrade]

The stars certainly seem to be aligning for FFH's insurance biz. Reinsurance pricing seems to be pretty firm, Hannover Re said that they expect double digit rate increases, Munich and Swiss also expect higher rates.  If the hurricane season stays benign we should see some really excellent underwriting results.

I agree that 2-3year yields look pretty attractive here as well. 

[StubbleJumper]

47 minutes ago, Thrifty3000 said:

Prem believes strongly in regression to the historical mean when it comes to interest rates.

 

I'm not sure that's entirely true.  The impression that I've had over the years is that FFH's investment team seems to be an adherent to the analysis of Van Hoisington and Lacy Hunt, who propose that we will see a long-term trend to lower real interest rates in the United States.  Bradstreet has made gobs of money for shareholders by periodically exploiting regression-to-trend (ie, Van Hoisington's downward trend), but I don't think that FFH holds the view that 6% treasuries are some sort of long-term norm.

 

 

SJ

[Thrifty3000]

11 hours ago, StubbleJumper said:

 

I'm not sure that's entirely true.  The impression that I've had over the years is that FFH's investment team seems to be an adherent to the analysis of Van Hoisington and Lacy Hunt, who propose that we will see a long-term trend to lower real interest rates in the United States.  Bradstreet has made gobs of money for shareholders by periodically exploiting regression-to-trend (ie, Van Hoisington's downward trend), but I don't think that FFH holds the view that 6% treasuries are some sort of long-term norm.

 

 

SJ

This is from the earnings call in July. Prem may expect long term deflation, but it sounds to me like near term inflation risk is top of mind these days…

 

Edited September 17, 2022 by Thrifty3000

[StubbleJumper]

Ignore what Prem says on the conference calls.  Instead read what Van Hoisington and Lacy Hunt write.  Prem says all kinds of crap, but what they actually do is considerably different. 

 

 

SJ

[Thrifty3000]

11 hours ago, StubbleJumper said:

Ignore what Prem says on the conference calls.  Instead read what Van Hoisington and Lacy Hunt write.  Prem says all kinds of crap, but what they actually do is considerably different. 

 

 

SJ

I’m with you there. I read Hoisington religiously (after popping a few Prozacs haha). For years Hoisington has laid out the case for the forces and trends that will continue pushing long term interest rates lower. Too much debt, too much debt, too much debt. And, they have not faltered on that thesis.

 

They have, however, called out the one scenario they watch for that would have them unload all their long term treasuries in a heartbeat. That is, in short, if congress passes a law legalizing banana republic style money printing.

 

Recently, however, their letters have discussed the near-term implications of the extraordinary fiscal/monetary response to the pandemic. Their position is if the government doesn’t intervene further then we’re looking at a painful recession that has already started. But, if we have a painful recession and the government follows the same playbook used during the GFC and the pandemic, then we’re looking at more near-term inflation and volatility. Hoisington doesn’t have any reason to believe the government will exercise restraint.

 

So, Hoisington is calling for ever more extreme cycles of volatility until the government and the Fed get back on the rails of the original Fed mandate. And, they’re calling for increased risk of banana republic style inflation.

 

Hoisington has the luxury of not having to do anything about near term volatility, as long as their investors trust them. They can hold long term treasuries through the short term cycles, and benefit from the long term deflationary trends.

 

Prem doesn’t have the luxury of ignoring short term volatility, because it can disrupt insurance underwriting capabilities - as is being seen throughout the insurance industry this year.

 

In short, I think Prem and Hoisington can maintain the same long term outlook, but have to position their portfolios differently to navigate near-term volatility and risk.

 

Here is Hoisington’s conclusion from their most recent letter…

 

“Monetary considerations coupled with these real side indicators point to recession and a reduction in inflation and long-term Treasury bond yields. If the Fed stays within the scope of the Federal Reserve Acts, they will have difficulty in containing the recession and fostering a recovery. But that situation puts us on alert to the possibility that the Fed returns to a Pandemic type of response that generated an inflation rate far above their target, as the experience of the past two years has so painfully taught. The economy might recover temporarily, but the expansion would be interrupted by another cost-of-living crisis and the Fed would not achieve either of its mandates for employment or inflation.”

Edited September 17, 2022 by Thrifty3000

[TwoCitiesCapital]

20 hours ago, StubbleJumper said:

Ignore what Prem says on the conference calls.  Instead read what Van Hoisington and Lacy Hunt write.  Prem says all kinds of crap, but what they actually do is considerably different. 

 

 

SJ

 

That was absolutely true of them from 2008 - 2016. But in 2016 they dumped all of the intermediate treasuries and have been in short-term treasuries since. 

 

They're actions over the last 6 years seem to demonstrate that they no longer believe deflation was the risk or they'd have been adding 10-year treasuries @ 3.5% in 2018 and again at 3.5% earlier this year. They didn't in either instance. 

Edited September 17, 2022 by TwoCitiesCapital

[Parsad]

On 9/17/2022 at 2:55 PM, TwoCitiesCapital said:

 

That was absolutely true of them from 2008 - 2016. But in 2016 they dumped all of the intermediate treasuries and have been in short-term treasuries since. 

 

They're actions over the last 6 years seem to demonstrate that they no longer believe deflation was the risk or they'd have been adding 10-year treasuries @ 3.5% in 2018 and again at 3.5% earlier this year. They didn't in either instance. 

 

+1! 

 

I don't see interest rates going down in an environment where budget deficits and large nation-state debt is abundant.  What is going to prop up a falling yen, euro, yuan or rupee?  Certainly not lower rates on future debt issuances if North American debt is offering much higher rates. 

 

We are looking at rising rates on a long-term global basis...not a return to any deflationary environment...the good times for cheap debt are over!  Cheers!

[Thrifty3000]

@Viking all this interest rate and inflation talk begs the question, have you factored in higher interest expense for FFH into your model going forward? Curious what interest expense per share is today and what it could look like when FFH's debt rolls over. (Actually, I think you've mentioned you assume combined ratio and interest rates will correlate in a way that allows overall earnings to remain reasonably protected.)

Edited September 19, 2022 by Thrifty3000

[Viking]

1 hour ago, Thrifty3000 said:

@Viking all this interest rate and inflation talk begs the question, have you factored in higher interest expense for FFH into your model going forward? Curious what interest expense per share is today and what it could look like when FFH's debt rolls over. (Actually, I think you've mentioned you assume combined ratio and interest rates will correlate in a way that allows overall earnings to remain reasonably protected.)

@Thrifty3000 For 2022 my guess is interest expense will finish the year around $450 million (adding $10 million for the recent issuance to the current run rate). 2023 = $475 million. This includes lease liabilities. 
 

My focus with my estimates/models is 12 and 24 months out. There are so many big moving parts - for me - it is pretty useless to try and go further out than that. 

 

Fairfax has little debt maturing the next couple of years (they did a pretty good job refinancing and pushing out some maturities in 2020 and 2021).
 

The future path of interest rates will have a huge impact on Fairfax (to state the obvious). If fed funds goes over 4% late this year and remains over 4% for all of 2023 then Fairfax’s interest income is going to be massive (+$1.4 billion in 2023). They will have ample cash flow to pay off any debt that comes due. Or they might decide to pay a higher interest rate and refinance and push the small amount of 2024 maturing debt further out. But having to refinance a small amount of debt at a higher interest rate is a great problem to have (when you have a $35 billion fixed income portfolio with an average maturity of 1.2 years).

————

From FFH Q2 report: Interest expense in the second quarter and first six months of 2022 of $108.8 and $212.7 (2021 - $117.8 and $283.9) was comprised of interest expense on borrowings of $97.2 and $188.9 (2021 - $101.6 and $252.2, inclusive of a loss on redemptions of holding company unsecured senior notes of nil and $45.7) and interest expense on accretion of lease liabilities of $11.6 and $23.8 (2021 - $16.2 and $31.7).

—————

Upcoming debt maturities:

2024 = $283 million

2025 = $277

Edited September 19, 2022 by Viking

[Viking]

11 hours ago, Parsad said:

 

+1! 

 

I don't see interest rates going down in an environment where budget deficits and large nation-state debt is abundant.  What is going to prop up a falling yen, euro, yuan or rupee?  Certainly not lower rates on future debt issuances if North American debt is offering much higher rates. 

 

We are looking at rising rates on a long-term global basis...not a return to any deflationary environment...the good times for cheap debt are over!  Cheers!

My base case is central banks are chicken hawks. The Fed is trying to talk down inflation. Yes, fed funds has been going up but it is still way below core inflation. It is easy to be an inflation ‘hawk’ today in the US because the economy/employment is still solid. 
 

If US economy/employment starts to roll over my guess is Fed / global central banks will likely show their true colours and chicken out (become more dovish). But this will stimulate the economy and likely drive inflation higher.

 

Bottom line, we look like we are getting closer to a fork in the road…

Edited September 19, 2022 by Viking

[Xerxes]

i wouldnt call that chickening out, they would be doing their jobs by pivoting away if the real economy falls over.  Right now, they got to raise rate as much as they can since the economy can handle it, but the caveat is that what you see in financial market has a lag to the real economy. The big question is how high too high and that no one knows.

 

 

[Viking]

Here is an update of Fairfax's equity holdings for Q3. Bottom line, equity holdings are up $372 million. It is a tale of 2 cities: the mark to market bucket was down a bunch and the associates equity accounted / consolidated equities are up a bunch:

- mark to market/derivatives       - $310 million = @ - $13/share 

- associates - equity accounted + $576 million

- consolidated equities                + $104 million

Total                                              + $372 million

 

Movers:

1.) Atlas =           + $398 million - take private (Poseiden)

2.) Resolute =    + $221              - being purchased by Domtar

3.) Recipe =       + $142              - take private (Fairfax)

4.) FFH Total Return Swaps = - $126

5.) CIB =              - $90           

Fairfax Equity Holdings Sept 30 2022.xlsx

[StubbleJumper]

@Viking  Thanks for the update on the equities.  It provides a more precise view of what we knew was going on -- there will be a mark-to-market loss reported when Q3 gets published in November, and then the benefit of the takeovers won't likely show up until Q1 2023.  So, the headline EPS number will have a M2M loss on equities of $310m, and then looking at the fixed income sensitivity table published on page 20 of the Q2, a 100 bps parallel shift in the yield curve would be a mark-to-market hit to the bond portfolio of $263.2m.  Call it a M2M loss on investments of $500-600m when the numbers are released.

 

The headline numbers won't be pretty, but maybe it'll set up FFH to initiate a buyback at favourable prices.

 

 

SJ