Fairfax 2020

[StubbleJumper]

^ On the issue of the dividend, Prem was entirely right to skate in circles rather than to directly answer the question.  The final decision about a potential January dividend does not need to be taken until a couple of days after Christmas, a day or two before the end of Q4. 

 

If a dividend is paid this year, it looks like it will be funded from the revolving credit facility because in a hard market, FFH will not want to draw meaningful dividends from its insurance subs.  At the moment, there is plenty of revolver space available (only $0.7B out of $2B was drawn as at Sept 30) and the covenants do not appear to be binding as at Sept 30.  But, there are plenty of things that could happen in the next two months before the end of Q4.  Some black swan type of catastrophe could happen which results in $500m or $1B of unexpected claims, the presidential transition could go badly and the stock market could drop 30%, vapourizing $1B of FFH's equity portfolio, or the bean-counters could decide to take a number of asset impairments that add up to $500m or $1B.  So run a couple of scenarios to see where the revolving credit facility sits under varying assumptions:

 

Base Pessimistic Case: FFH earns zero income in Q4 (more or less like Q3), but decides to pay the dividend any way:

 

                                      9/30                                                          12/31

Net Debt                      7,553.7m    draw $300m to pay divvy          7,853.7m

Equity                          16,486.4      reduce $300m for divvy          16,186.4

Total Capital                23,940.1                                                      23,940.1

Debt/Cap Ratio              31.6%                                                          32.8%

 

 

 

1-in-50 Year Scenario: All hell breaks loose in Q4, the stock market crashes and FFH has income of -$1B during Q4, but decides to pay the dividend anyway:

 

                                      9/30                                                                                                                  12/31

Net Debt                      7,553.7m    draw $300m to pay divvy                                                                  7,853.7m

Equity                          16,486.4      reduce $1,000 due to negative income and $300m for divvy          15,186.4

Total Capital                23,940.1                                                                                                                22,940.1

Debt/Cap Ratio              31.6%                                                                                                                    34.2%

 

 

 

Under the base pessimistic scenario, if Prem gets to Christmas and realizes that there will be zero income during Q4, he could declare the annual dividend anyway and the Debt/Cap ratio would still remain nicely below the revolver covenant's 35% threshold.  The revolver would still offer FFH flexibility to operate during Q1, but it might be time to hold some proactive discussions with the lender.  On the other hand, the 1-in-50 stock market crash scenario would see that Debt/Cap ratio blow out to 34.2%, which means that the revolver basically becomes useless for Q1 because you can't go past 35% under the covenant.  At that point, the holdco would need to operate using its cash balances alone and hope that FFH earns some money in Q1 and Q2 (or some other solution would be required).

 

Given FFH's liquidity situation and the obvious potential for the US election to trigger volatility in equity markets, I don't blame Prem at all for not committing to the annual dividend in October.  There's not much upside to making an early verbal commitment, and the potential downside is that it is entirely plausible that FFH could find itself in a position where it needs to conserve capital.  The most likely scenario is that Q4 will be a good one for FFH and they'll earn a couple hundred million dollars, and the divvy can be declared and paid with no trouble at all, but there's no need to make that commitment before you need to...

 

 

SJ

[Xerxes]

Agreed, best be prudent than not to be with the jumbo dividend when it comes to make commitment. I don't care about it anyways, not invested in FFH for its dividend. it is just a bonus.

 

When i have time this weekend, i am going to work through all 'realized' shorts in the past 10 years and post it. Need to understand how much was lost and specifically how much was lost since it was publicly stated that they will no longer do shorts in 2016-17.

 

This year through end of Sept, it comes to a total of $327 million realized losses in shorts. With another $89 million unrealized that be would be covered in Q4. Say another $100 million as estimate. So about ~$427 million estimate realized losses in shorts for the entire 2020.

 

To put things in context, the dividend payment in Q2 is about $300 million i think.

And net earning this quarter has been $133 million. I don't think a company starved for cash should be in the business of shorting. Specially, given the track record.

 

PS: understanding that the shorts and dividends are from different bucket. And that the dollar value of losses in shorts should be compared against a base of a $39 billion. Still it is the size of their position in the Blackberry common stock !

 

If an investor has a certain point of view (in this case, hard core deep value), the shorts when placed against high growth names, wouldn't diversify the overall bet rather it compounds that directional deep-value bet (i.e. digging one's heels). However, had they used the shorts in a way that differed from their main deep value thesis, than the shorts would have been complementary and actually hedged their base-line view and perhaps added value (i.e. being flexible).

 

It is not so much that they might still have new shorts, it is the way they used it that compounds their base-line thesis.

But we don't have much details nor disclosure, so kind of remain as speculation on my part. 

 

 

 

 

 

 

[maxthetrade]

We are in the early stages of a hard insurance market and the shares are trading at a significant discount, paying a dividend doesn't make any sense at all! They really should grow the business opportunistically and buy back shares if they have capital to spare. I much prefer the very rational approach to capital allocation at Berkley, grow the business if it makes sense, buy back shares if they are cheap or pay a special dividend if you have excess capital. 

[cwericb]

With all the talk of a hard market I just had notification from my insurance broker that my car insurance jumped by 35% - no accidents, no traffic tickets, etc and I have been with the same company for years.

 

Broker shopped it to another company and cut it back to about what it was last year.

 

Others seeing things like this?

[mcliu]

Yup, auto & home rates all up double digits.

[doc75]

Yup, auto & home rates all up double digits.

 

My home & auto policy went up 17%. (Canada)

[Viking]

We are in the early stages of a hard insurance market and the shares are trading at a significant discount, paying a dividend doesn't make any sense at all! They really should grow the business opportunistically and buy back shares if they have capital to spare. I much prefer the very rational approach to capital allocation at Berkley, grow the business if it makes sense, buy back shares if they are cheap or pay a special dividend if you have excess capital.

 

That is the single largest reason to buy FFH at current levels. Lower bond yields / lower investment results are not Fairfax specific... every insurer will see lower returns from investments moving forward. The hard market could run some time (years).

[Cardboard]

It was mentioned that there was not enough analyst/institutional participation in latest conference call.

 

Well, let me tell you that Fairfax is now broadly followed vs back in the days when there was no conference call, very little to no analyst coverage and never a mention on TV. I now frequently hear questions about it on BNN and the investment community all know who they are.

 

RBC remains quite positive on them:

 

"02:07 PM EDT, 10/30/2020 (MT Newswires) -- RBC Capital has kept its Outperform on Fairfax Financial after the company reported a Q3 that was better than forecast.

 

Fairfax Financial reported a Q3 2020 net earnings per share of $4.44 vs. earnings of $2.04 last year. Results included $(27.3) million of net realized and unrealized losses on investments. On an operating basis, which excludes these items, the company earned $2.84 per share (RBC forecast was $0.50). The accident-year margin improved 580 basis points year-over-year while NWP growth was 12.6%.

 

The overall combined ratio amounted to 98.5% vs. 97.5%, better than RBC's 101.5% forecast. Total cat losses were $361.8 million, 10.1 combined ratio points (RBC estimate $294 million). Within this total was a $143.2 million (4.0 points) impact from COVID-19 (RBC estimate $50 million) vs. the $308.1 million impact in Q2/20. On an accident-year basis, the company had a combined ratio of 90.4%, much better than RBCe 96.2%."

 

I would also like to point out the following fact from a few months ago. Actions do speak louder than words and this is material buying:

 

https://www.bnnbloomberg.ca/fairfax-chairman-prem-watsa-spends-nearly-us-150-million-to-buy-more-shares-1.1451233.amp.html

 

Cardboard

 

 

[TwoCitiesCapital]

Fairfax always seems to trade with a delay after earnings...

 

Up 6.5% today despite being down 1% on Friday after earnings were announced.

 

I can't say I've paid close attention the last few quarters, but I know this isn't the first time it's taken Fairfax stock a few days to respond to decent earnings. Almost as if the market allows you to see the result, then make the buy decision, and get rewarded for results that were already clear in hindsight.

[Parsad]

Yup, auto & home rates all up double digits.

 

Strata insurance jumped 100% to 700% in British Columbia...auto insurance increased last year by 25%, but will see a slight decrease this year (BC auto insurance is for the most part a public entity).  Cheers!

[cwericb]

Fairfax always seems to trade with a delay after earnings...

 

Up 6.5% today despite being down 1% on Friday after earnings were announced.

 

I can't say I've paid close attention the last few quarters, but I know this isn't the first time it's taken Fairfax stock a few days to respond to decent earnings. Almost as if the market allows you to see the result, then make the buy decision, and get rewarded for results that were already clear in hindsight.

 

I have noticed this for years. Doesn't happen every time but more often than not, especially if there is good news. Who needs a crystal ball?

[Viking]

Listened to the WR Berkley conference call. Like all insurers they are having problems with where to invest. As bonds mature they are building cash. They anticipate higher interest rates in the future.

 

On the conference call lots of questions and concerns from analysts about trying to time bond market purchases and what that does to earnings visibility and predicability. As bonds mature, insurers are going to really struggle to reinvest at acceptable yields.

 

If low rates persist insurance companies will be looking for yield. BAM is positioned ideally and ready to help them out :-)

 

———————————

RBC had this to say in its weekly report on insurance industry: “It’s really simple – margins go up after rate increases. Some improvement happens quickly, some takes longer to leverage but rate increases are good and we’re getting to the part of the rate story that is turning into the earnings story.

 

——————————-

We have been seeing rate increases for 12-18 months. Q4 results might be when we see improving CR’s, improving operating results and improved earnings.

 

But because investment results will be under continued pressure (due to low rates) the hard market should continue to run for some time.

[Parsad]

Fairfax always seems to trade with a delay after earnings...

 

Up 6.5% today despite being down 1% on Friday after earnings were announced.

 

I can't say I've paid close attention the last few quarters, but I know this isn't the first time it's taken Fairfax stock a few days to respond to decent earnings. Almost as if the market allows you to see the result, then make the buy decision, and get rewarded for results that were already clear in hindsight.

 

I have noticed this for years. Doesn't happen every time but more often than not, especially if there is good news. Who needs a crystal ball?

 

Probably buybacks kicking in after the blackout period.  Although, I hope it's just a rational market moving capital to undervalued entities.  Cheers!

[Parsad]

Listened to the WR Berkley conference call. Like all insurers they are having problems with where to invest. As bonds mature they are building cash. They anticipate higher interest rates in the future.

 

On the conference call lots of questions and concerns from analysts about trying to time bond market purchases and what that does to earnings visibility and predicability. As bonds mature, insurers are going to really struggle to reinvest at acceptable yields.

 

If low rates persist insurance companies will be looking for yield. BAM is positioned ideally and ready to help them out :-)

 

———————————

RBC had this to say in its weekly report on insurance industry: “It’s really simple – margins go up after rate increases. Some improvement happens quickly, some takes longer to leverage but rate increases are good and we’re getting to the part of the rate story that is turning into the earnings story.

 

——————————-

We have been seeing rate increases for 12-18 months. Q4 results might be when we see improving CR’s, improving operating results and improved earnings.

 

But because investment results will be under continued pressure (due to low rates) the hard market should continue to run for some time.

 

Large scale renewals will happen in Q4 and into Q1, so you should see a significant bump in premiums relative to the three previous quarters.  Cheers!

[TwoCitiesCapital]

Fairfax always seems to trade with a delay after earnings...

 

Up 6.5% today despite being down 1% on Friday after earnings were announced.

 

I can't say I've paid close attention the last few quarters, but I know this isn't the first time it's taken Fairfax stock a few days to respond to decent earnings. Almost as if the market allows you to see the result, then make the buy decision, and get rewarded for results that were already clear in hindsight.

 

I have noticed this for years. Doesn't happen every time but more often than not, especially if there is good news. Who needs a crystal ball?

 

Right?!?!?! Glad I had an order out at the open to increase my position 25% @ $268. It's possible we revist that, but not counting on it and was glad to see it filled when I noticed we were up 5+% at the time. 7% yesterday. Up another 6% today. Basically back to knocking on $300/share door which is still stupid cheap IMO - but crazy to think we were at $268 following decent earnings just 48 hours ago.

[Xerxes]

To balance my depressing post about FFH's short position since 2016. Here is a more upbeat post for the faithful.

Trying to keep a balance.

 

Markel

Market cap: $13B

 

Markel's gross premium came to about $6.9 billion through end of Q3.

To annualize that based on Q3 that comes to $9.2 billion. Last year total gross premium was $8.7 billion as a comparison.

 

Combined ratio of 101 this year through Q3 compared to 95 last year for Markel.

 

"The combined ratio for the third quarter of 2020 included $48.9 million, or three points, of underwriting losses attributed to the COVID-19 pandemic and $101.0 million, or seven points, of underwriting losses from Hurricanes Laura, Sally and Isaias, as well as the derecho in Iowa and wildfires in the western United States (2020 Catastrophes). The combined ratio for the third quarter of 2019 included $42.6 million, or three points, of underwriting losses from Hurricane Dorian and Typhoon Faxai (2019 Catastrophes).

The combined ratio for the first nine months of 2020 included $373.9 million, or nine points, of underwriting losses attributed to the COVID-19 pandemic and $101.0 million, or two points, of underwriting losses from the 2020 Catastrophes. The combined ratio for the first nine months of 2019 included $42.6 million, or one point, of underwriting losses from the 2019 Catastrophes."

 

FFH

Market cap: $10B

FFH's gross premium came to about $14.2 billion through end of Q3.

To annualize that based on Q3 that comes to $18.9 billion. Last year total gross premium was $17.5 billion as a comparison.

 

Combined ratio of 98.5 this year through Q3 compared to 97 last year for FFH.

 

"In the third quarter of 2020, all of our insurance companies achieved a combined ratio below 100%, except for

Brit. Our consolidated combined ratio of 98.5% in the third quarter of 2020 included catastrophe losses of $218.6

million or 6.1 combined ratio points and COVID-19 losses of $143.2 million or 4.0 combined ratio points. Core

underwriting performance continues to be very strong with a combined ratio excluding COVID-19 losses of 94.5%,

continued favourable reserve development and growth in gross premiums written of 13.9%, and operating income

was $254.7 million despite the catastrophe and COVID-19 losses. We continue to focus on being soundly financed

and ended the quarter with approximately $1.2 billion in cash and investments in the holding company,"

[bluedevil]

This vaccine news should really help Fairfax.  They have so many investments that were hammered by the virus -- Eurobank; Exxon; Thomas Cook India; Bangalore Airport; Recipe restaurant business.  And so few that benefited from the virus.

[petec]

This vaccine news should really help Fairfax.  They have so many investments that were hammered by the virus -- Eurobank; Exxon; Thomas Cook India; Bangalore Airport; Recipe restaurant business.  And so few that benefited from the virus.

 

Yup-plus that Zoom short ;)

[Jurgis]

Yup-plus that Zoom short ;)

 

Fairfax is short Zoom?  :o

[petec]

Yup-plus that Zoom short ;)

 

Fairfax is short Zoom?  :o

 

Speculating! Read upthread (or maybe it was on another thread.)

[Xerxes]

LOL

 

Jurgis

I am partially blame for planting that seed. I have been bashing the shorts lately and specifically the comments made in the Q3 conference call that really sounded like: "ok guys we got burned enough by shorting, we are going to stop now." I think that comment was both meant for external as well as internal audience.

 

In reality we do not know the nature of the shorts (which names), however i think we do know the vehicle being used, i.e. through total return swaps.

See below. If I recall SJ made a comment on these few months back, something about putting a minimum amount and magnifying your gain/loss on a much larger notional amount.

 

Page 19 - Q3 report

 

"Equity contracts

The company may maintain short equity and equity index total return swaps for investment purposes that provide a return which is

inverse to changes in the fair values of the underlying equity indexes and certain individual equities.

During the third quarter and first nine months of 2020 the company paid net cash of $152.9 and $438.1 (2019 - paid net cash of $6.1

and received net cash of $127.1) in connection with the reset provisions of its short equity total return swaps (excluding the impact of

collateral requirements). During the third quarter and first nine months of 2020 the company closed out $90.2 and $494.6 notional

amount of its short equity total return swaps and recorded net losses on investments of $36.2 and $176.7 (realized losses of $79.2 and

$327.3, of which $43.0 and $150.6 was recorded as unrealized losses in prior quarters and prior years). During the third quarter and

first nine months of 2020 the company did not initiate any short equity total return swaps. During the first nine months of 2019 the

company closed out $89.9 notional amount of its short equity total return swaps and recorded net gains on investment of $30.3

(realized losses of $7.9, of which $38.2 was recorded as unrealized losses in prior years).

During the third quarter and first nine months of 2020 the company entered into $148.8 and $1,183.9 notional amounts of long equity

total return swaps for investment purposes following significant declines in global equity markets in the first quarter of 2020. At

September 30, 2020 the company held long equity total return swaps on individual equities for investment purposes with an original

notional amount of $1,342.9 (December 31, 2019 - $501.5). During the third quarter and first nine months of 2020 the company

received net cash of $48.9 and $80.8 (2019 - received net cash of $8.2 and paid net cash of $53.5) in connection with the reset

provisions of its long equity total return swaps (excluding the impact of collateral requirements). During the third quarter and first nine

months of 2020 the company closed out $212.7 and $464.7 notional amounts of its long equity total return swaps and recorded net

realized gains on investments of $52.9 and $122.3. During the third quarter and first nine months of 2019 the company did not initiate

or close out any long equity total return swaps.

At September 30, 2020 the aggregate fair value of the collateral deposited for the benefit of derivative counterparties included in

holding company cash and investments and in assets pledged for short sale and derivative obligations was $298.7 (December 31, 2019

- $152.4), comprised of collateral of $205.2 (December 31, 2019 - $70.3) required to be deposited to enter into such derivative

contracts (principally related to total return swaps) and $93.5 (December 31, 2019 - $82.1) securing amounts owed to counterparties to

the company's derivative contracts arising in respect of changes in the fair values of those derivative contracts since the most recent

reset date. "

[Xerxes]

On the reflationary trade, great news indeed. Should help partially with the mark to market of Q4.

 

However, I am specifically looking forward to see the return of this specific bet some years down the road. To my knowledge, it was the most significant & only move FFH made throughout the mayhem of March-April, trying to lock-in while credit spreads were blowing up. Fairly big bet, give that it is 7% of the portfolio. 

 

"Since mid-March 2020, Fairfax has been reinvesting its cash and short term investments 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. To date, taking

advantage of the increase in corporate spreads, Fairfax has purchased about $2.9 billion of such

bonds."

 

[Viking]

This vaccine news should really help Fairfax.  They have so many investments that were hammered by the virus -- Eurobank; Exxon; Thomas Cook India; Bangalore Airport; Recipe restaurant business.  And so few that benefited from the virus.

 

Crazy 1 day moves.

 

Atlas + 11%

Eurobank + 26%

Fairfax India +10%

Recipe + 10

Should see a spike in Indian investments overnight.

 

If this shift in equity positioning has legs (if the news on the vaccine front continues to be positive, my guess is yes) Fairfax will do exceptionally well moving forward. Can we put a pitchfork in the ‘7 lean years’ trend?

[cwericb]

Anyone who has invested in FFH in the past couple of weeks should be feeling pretty good about now.  :) 

[StubbleJumper]

See below. If I recall SJ made a comment on these few months back, something about putting a minimum amount and magnifying your gain/loss on a much larger notional amount.

 

 

I believe that it may have been TwoCities who helped us better understand the mechanics of the equity swaps.

 

 

SJ