Fairfax 2021

[gary17]

Bear in mind rates and inflation don’t have to move the same way. I can easily imagine a period of financial repression, with policy designed to drive slightly higher inflation while keeping rates low. Dangerous game to play, but ultimately the only realistic solution to high debt levels.

 

Defining just exactly what ‘inflation’ is is part of the challenge. One example is real estate in Vancouver. Single family home prices are expected to increase this year 20-30% (maybe as soon as this spring). Crazy. And prices were already at bubble levels. This looks like asset inflation to me. Ever rising prices :-)

 

So i agree rates and ‘inflation’ often don’t move in the same way.

 

Relative to foreigners Vancouver RE  has gone down in prices because Canadian currency has devalued significantly.

 

[Spekulatius]

Bear in mind rates and inflation don’t have to move the same way. I can easily imagine a period of financial repression, with policy designed to drive slightly higher inflation while keeping rates low. Dangerous game to play, but ultimately the only realistic solution to high debt levels.

 

Defining just exactly what ‘inflation’ is is part of the challenge. One example is real estate in Vancouver. Single family home prices are expected to increase this year 20-30% (maybe as soon as this spring). Crazy. And prices were already at bubble levels. This looks like asset inflation to me. Ever rising prices :-)

 

So i agree rates and ‘inflation’ often don’t move in the same way.

 

Relative to foreigners Vancouver RE  has gone down in prices because Canadian currency has devalued significantly.

 

That’s not correct, the CAD has been strong relative to the USD and is close to a 5 year high.

https://finance.yahoo.com/quote/CADUSD=X?p=CADUSD=X&.tsrc=fin-srch

[gary17]

Bear in mind rates and inflation don’t have to move the same way. I can easily imagine a period of financial repression, with policy designed to drive slightly higher inflation while keeping rates low. Dangerous game to play, but ultimately the only realistic solution to high debt levels.

 

Defining just exactly what ‘inflation’ is is part of the challenge. One example is real estate in Vancouver. Single family home prices are expected to increase this year 20-30% (maybe as soon as this spring). Crazy. And prices were already at bubble levels. This looks like asset inflation to me. Ever rising prices :-)

 

So i agree rates and ‘inflation’ often don’t move in the same way.

 

Relative to foreigners Vancouver RE  has gone down in prices because Canadian currency has devalued significantly.

 

That’s not correct, the CAD has been strong relative to the USD and is close to a 5 year high.

https://finance.yahoo.com/quote/CADUSD=X?p=CADUSD=X&.tsrc=fin-srch

 

I was looking at Asian currencies rmb, jpy, skw, hkd, ntd, etc and Euro

 

 

 

[gary17]

rising rates is not good for Fairfax though right?

[Viking]

rising rates is not good for Fairfax though right?

 

Rising rates is a tailwind for Fairfax (all things considered). They hold a disproportionate amount of their very large bond portfolio in short duration bonds or cash. As rates rise they will take a mark to market loss on existing holdings which will lower BV. However, if they are able to redeploy some of the cash/short term securities into higher yielding bonds then this will increase interest income.

[SafetyinNumbers]

rising rates is not good for Fairfax though right?

 

Rising rates is a tailwind for Fairfax (all things considered). They hold a disproportionate amount of their very large bond portfolio in short duration bonds or cash. As rates rise they will take a mark to market loss on existing holdings which will lower BV. However, if they are able to redeploy some of the cash/short term securities into higher yielding bonds then this will increase interest income.

 

Presumably they would also be able to discount estimated future insurance claims at a higher rate which should help increase book value.

[Phoenix01]

Check this out: Fairfax Launches C$850 Million Senior Notes Offering

https://finance.yahoo.com/news/fairfax-launches-c-850-million-155300225.html

 

Great news!  FFH pushing back debt and lowering rates.

[StubbleJumper]

Check this out: Fairfax Launches C$850 Million Senior Notes Offering

https://finance.yahoo.com/news/fairfax-launches-c-850-million-155300225.html

 

Great news!  FFH pushing back debt and lowering rates.

 

 

Yes, this is good.  They definitely needed to get some cash into the holdco and stop relying on revolving credit to fund the company's operations.  It is noteworthy that this is a relatively large debt issuance for FFH and the interest rate is considerably lower at 3.95%.  I have expressed misgivings in the past about FFH failing to deleverage, and this does not really change the fact that they are more leveraged than I would like and their risk management has been disappointing at times.  But, it's a positive step towards at least managing their maturities and reducing the routine reliance on that revolver.

 

 

SJ

[Cigarbutt]

rising rates is not good for Fairfax though right?

Rising rates is a tailwind for Fairfax (all things considered). They hold a disproportionate amount of their very large bond portfolio in short duration bonds or cash. As rates rise they will take a mark to market loss on existing holdings which will lower BV. However, if they are able to redeploy some of the cash/short term securities into higher yielding bonds then this will increase interest income.

Presumably they would also be able to discount estimated future insurance claims at a higher rate which should help increase book value.

The reserves are established and reported undiscounted.

There was a time when they established and reported reserves for certain workers' comp lines of business (Zenith sub mostly) on a discounted basis but this was a small part of claims overall and, starting in 2012, they no longer described this discounted reserves sub-component.

[SafetyinNumbers]

rising rates is not good for Fairfax though right?

Rising rates is a tailwind for Fairfax (all things considered). They hold a disproportionate amount of their very large bond portfolio in short duration bonds or cash. As rates rise they will take a mark to market loss on existing holdings which will lower BV. However, if they are able to redeploy some of the cash/short term securities into higher yielding bonds then this will increase interest income.

Presumably they would also be able to discount estimated future insurance claims at a higher rate which should help increase book value.

The reserves are established and reported undiscounted.

There was a time when they established and reported reserves for certain workers' comp lines of business (Zenith sub mostly) on a discounted basis but this was a small part of claims overall and, starting in 2012, they no longer described this discounted reserves sub-component.

 

Thanks. Can you tell I'm a new shareholder?

[Cigarbutt]

^It's actually a very important and interesting concept for property-casualty (re)insurers. Let's say you want to acquire a P+C insurer, apart from growth, the goodwill you want to pay over book value will be a function of the discount (mirror image of the money you expect to make from float) of the reported reserves, assuming reserves are adequately stated.

[dartmonkey]

Maybe Fairfax will get another shot at locking in some Blackberry gains? Gamestop is up by over 100% today, and has almost doubled again after hours, to about $170. Looking at the other usual suspects, Koss is up about 200%, AMC is only up about 30%. BB is tamer: up about $1 today and another $1 after hours, to $12.40.

 

Fairfax owns 1.833 BB shares for every share of Fairfax (46.7 million BB shares, for 25.5 million FFH shares), so if you own 1000 FFH shares, you're along for the ride with you 1833 BB shares, up by $2/share today. If you don't like Watsa hanging onto them, you could short them out in your own account, but that would be swapping one form of excitement for another...

 

I believe they also have $330 million worth of debentures that are convertible into BB shares at $6, so in other words they own the upside on another 55 million shares  stake is actually double the above. Someone correct me if I'm wrong.

[Viking]

Maybe Fairfax will get another shot at locking in some Blackberry gains? Gamestop is up by over 100% today, and has almost doubled again after hours, to about $170. Looking at the other usual suspects, Koss is up about 200%, AMC is only up about 30%. BB is tamer: up about $1 today and another $1 after hours, to $12.40.

 

Fairfax owns 1.833 BB shares for every share of Fairfax (46.7 million BB shares, for 25.5 million FFH shares), so if you own 1000 FFH shares, you're along for the ride with you 1833 BB shares, up by $2/share today. If you don't like Watsa hanging onto them, you could short them out in your own account, but that would be swapping one form of excitement for another...

 

I believe they also have $330 million worth of debentures that are convertible into BB shares at $6, so in other words they own the upside on another 55 million shares  stake is actually double the above. Someone correct me if I'm wrong.

 

Yes, i saw the same thing late in trading today. Bottom line, Fairfax has exposure to a little over 100 million BB shares. So every US$1 increase in BB share price = $100 million gain for FFH (pre-tax). This entire position is mark-to-market accounted; meaning it will also directly impact reported book value when Fairfax reports Q1 results. As a reminder, BB was trading at Dec 31 at US$6.63. So with shares trading $12.39 after hours = about $600 million gain = about $22-23 per share pre tax. Significant :-)

[Xerxes]

I would think they could begin locking in significantly before year 20. It obviously depends on starting yields/durations and how quickly rates are rising, but in prior bond bear markets you could recoup the principal losses from rising rates with higher income/higher reinvestment income by year ~4.

 

So even if you expect rates to rise, you can buy a 10-year bond today and still be ahead of short-term bonds by years 5-6 even if you're right about rates moving higher.

 

I don't mind Fairfax's move to short term bonds. It's certainly saved them from some pain. But I would hope that they'd start moving incrementally back to 10 year and longer bonds if rates exceeds 1.5 -2.0%.  Just in recognition that these things don't move in a straight line, roll down yield becomes more attractive as the curve gets steeper (short term still anchored @ 0%), and any unrealized losses from rising rates will likely be mitigated by year 4-5 of holding the bond anyways.

 

And given my ultimate views that we are NOT in a sustainable inflation environment, I would think this exposes them to potential gains from a disinflationary/deflationary environment that they missed in 2018, and again in 2020, when 10-year yields dropped from 3 25% all the way down to 0.5% over that 2.5-3 year period.

 

This is my view. I'm very heavy into commodity companies - but mostly because they're cheap and not because I'm expecting massive inflation.

 

I think we'll get a pop in 2021 due to the trillions pushed into circulation during 2020, but I do think at some point in 2022 we get back to disinflation as rates can never rise significantly with debt loads/equity markets where they're at.

 

Great discussion with J. Currie

https://www.bloomberg.com/news/videos/2020-12-17/goldman-s-currie-sees-tell-tale-signs-of-commodity-super-cycle-video

 

Going back to the reasons as to why we had such a long bull market in bonds, economist typically point to three major points:

1 - deflationary nature of technology

2 - changing in demographic, the baby-boomers hitting peak salary in the past few decades, therefore in aggregate creating a surplus of capital at about the time when the demand for capital was diminishing (point below)

3 - last couple of decades most of the investment has been in information technology sector that doesn't require as much capital as CAPEX heavy old economy. Therefore less capital was needed, putting downward pressure on rates.

 

I think going forward, (1) still is in play more than ever, but (2) will flip as old economy + infrastructure that have been starved for capital need major investment

[Xerxes]

Check this out: Fairfax Launches C$850 Million Senior Notes Offering

https://finance.yahoo.com/news/fairfax-launches-c-850-million-155300225.html

 

Great news!  FFH pushing back debt and lowering rates.

 

 

Yes, this is good.  They definitely needed to get some cash into the holdco and stop relying on revolving credit to fund the company's operations.  It is noteworthy that this is a relatively large debt issuance for FFH and the interest rate is considerably lower at 3.95%.  I have expressed misgivings in the past about FFH failing to deleverage, and this does not really change the fact that they are more leveraged than I would like and their risk management has been disappointing at times.  But, it's a positive step towards at least managing their maturities and reducing the routine reliance on that revolver.

 

 

SJ

 

i think the proceeds are going entirely to refinance old debt .. and not pay back the revolver.

i think Prem did mention that the revolve will be paid via proceeds from asset sale

[Xerxes]

Yes, i saw the same thing late in trading today. Bottom line, Fairfax has exposure to a little over 100 million BB shares. So every US$1 increase in BB share price = $100 million gain for FFH (pre-tax). This entire position is mark-to-market accounted; meaning it will also directly impact reported book value when Fairfax reports Q1 results. As a reminder, BB was trading at Dec 31 at US$6.63. So with shares trading $12.39 after hours = about $600 million gain = about $22-23 per share pre tax. Significant :-)

 

 

Great

we are going to have some "hot air" being marked-to-market on March 31.

As long as it stays hot, i am all good.

[petec]

It will be interesting to see if Fairfax have found any bond opportunities in this little yield spike. Can’t imagine they’ve moved big but they might find something.

[StubbleJumper]

It will be interesting to see if Fairfax have found any bond opportunities in this little yield spike. Can’t imagine they’ve moved big but they might find something.

 

 

Are you thinking that they might be pushing up their duration within governments, or do you think they are looking for corporate spread?  I would understand the idea of rolling a bit of capital into 5-yr treasuries, but yields are still so low that you wouldn't want to go too crazy.  This might be a market where staying mostly short would work better (as painful as that is).

 

 

SJ

[petec]

I agree. Was thinking some 5y and maybe pockets of opportunity in corporate.

[Crip1]

I agree. Was thinking some 5y and maybe pockets of opportunity in corporate.

 

 

FFH has historically shown to be pretty adept at positioning themselves within the bond market. Accordingly, the volatility we're seeing now plays into their hands, IMHO, far moreso than it does the aggregate of the industry. This month the yield on the 5 year is up 39 bps compared to 45 bps on the 10 year, not enough to risk capital loss on a significant portion of their investment portfolio.

 

 

-Crip

[StubbleJumper]

I agree. Was thinking some 5y and maybe pockets of opportunity in corporate.

 

 

FFH has historically shown to be pretty adept at positioning themselves within the bond market. Accordingly, the volatility we're seeing now plays into their hands, IMHO, far moreso than it does the aggregate of the industry. This month the yield on the 5 year is up 39 bps compared to 45 bps on the 10 year, not enough to risk capital loss on a significant portion of their investment portfolio.

 

 

-Crip

 

 

Yes, that's the line that everyone needs to walk.  Either stay short and earn nothing, or roll the dice on the 5-yr and earn like 0.80%.  For an insurance company, it's currently a choice between bad and worse.  Probably best to stay mostly short, but then again, Bradstreet has rolled sevens on how many occasions?  Frankly, I'd trust his judgement.

 

 

SJ

[petec]

I’d also trust him. But there’s no capital loss on a bond, is there? You just hold it to maturity, even if you mark it to market in the meantime. And I’m not even sure treasuries are market to market - one of you will know this but I think they can choose to hold them at amortized cost?

[StubbleJumper]

I’d also trust him. But there’s no capital loss on a bond, is there? You just hold it to maturity, even if you mark it to market in the meantime. And I’m not even sure treasuries are market to market - one of you will know this but I think they can choose to hold them at amortized cost?

 

 

No, there's no capital loss on a bond you hold to maturity (since the change a few years back, there's now a bit of mark-to-market noise, but who cares about that anyway).  The question boils down to whether it's a good idea to lock-in a 0.80% return by investing a portion of the bond port into 5-yr treasuries, or whether you bite the bullet and stay short and earn 0.05 or 0.10 for another six months or a year.  If you hold the view that the economy is going to take off and that there will be a relatively rapid, parallel increase in the curve, you are probably better off to stay short for another year.  If you hold the view that short term rates will remain in the toilet for another few years, but that the curve will steepen relatively rapidly, you are still better to stay short and wait to increase your duration.  But, if you think that rates will muddle along around their current levels for a few years, then the shift of some money into 5-yr is a clear winner.

 

In terms of dollars-and-cents, a large shift for FFH would be to pile perhaps $10 billion into 5-yr treasuries, which would provide the princely sum of $80m annually in interest....or you keep the $10 billion short and only get $5-10m in interest.  It costs maybe $75m per year, pre-tax, to sit and wait for a favourable move in the curve.  The opportunity cost is pretty small.

 

 

SJ

 

 

[TwoCitiesCapital]

I’d also trust him. But there’s no capital loss on a bond, is there? You just hold it to maturity, even if you mark it to market in the meantime. And I’m not even sure treasuries are market to market - one of you will know this but I think they can choose to hold them at amortized cost?

 

 

No, there's no capital loss on a bond you hold to maturity (since the change a few years back, there's now a bit of mark-to-market noise, but who cares about that anyway).  The question boils down to whether it's a good idea to lock-in a 0.80% return by investing a portion of the bond port into 5-yr treasuries, or whether you bite the bullet and stay short and earn 0.05 or 0.10 for another six months or a year.  If you hold the view that the economy is going to take off and that there will be a relatively rapid, parallel increase in the curve, you are probably better off to stay short for another year.  If you hold the view that short term rates will remain in the toilet for another few years, but that the curve will steepen relatively rapidly, you are still better to stay short and wait to increase your duration.  But, if you think that rates will muddle along around their current levels for a few years, then the shift of some money into 5-yr is a clear winner.

 

In terms of dollars-and-cents, a large shift for FFH would be to pile perhaps $10 billion into 5-yr treasuries, which would provide the princely sum of $80m annually in interest....or you keep the $10 billion short and only get $5-10m in interest.  It costs maybe $75m per year, pre-tax, to sit and wait for a favourable move in the curve.  The opportunity cost is pretty small.

 

 

SJ

 

How much further do rates have to rise for buying the 10-year to be worse than holdings 0.1% paper?

 

At 2% on the 10-year, rates have to rise 0.22% this year, 0.28% the next year, and 0.36% the year following for 0.1% to outperform over 3-years. (very rough math in my head using a 9ish year duration starting duration and not considering the benefit of rolldown over 3 years)

 

Do we believe rates will be sustainably higher than 3% on the 10-year after just 3-years?

 

For reference, please recall we were at 3.25% in 2018 with record employment, trillion dollar deficit/spending and tax cut stimulus, and 9 years removed from the last recession. Seems like 3+% would be a tall order today unless if you actually believe they've been successful in creating the inflation they've failed to over the last 10-years.

 

So if we're not going be sustainably above 3% in the next 3 years, buying 10-year at 2% is a no brainer. And if buying at 2% is a no brainer, than beginning to accumulate at 1.5% probably isn't the worst thing you could do.

 

I would hope they consider small incremental buys if duration from here on out

[StubbleJumper]

I’d also trust him. But there’s no capital loss on a bond, is there? You just hold it to maturity, even if you mark it to market in the meantime. And I’m not even sure treasuries are market to market - one of you will know this but I think they can choose to hold them at amortized cost?

 

 

No, there's no capital loss on a bond you hold to maturity (since the change a few years back, there's now a bit of mark-to-market noise, but who cares about that anyway).  The question boils down to whether it's a good idea to lock-in a 0.80% return by investing a portion of the bond port into 5-yr treasuries, or whether you bite the bullet and stay short and earn 0.05 or 0.10 for another six months or a year.  If you hold the view that the economy is going to take off and that there will be a relatively rapid, parallel increase in the curve, you are probably better off to stay short for another year.  If you hold the view that short term rates will remain in the toilet for another few years, but that the curve will steepen relatively rapidly, you are still better to stay short and wait to increase your duration.  But, if you think that rates will muddle along around their current levels for a few years, then the shift of some money into 5-yr is a clear winner.

 

In terms of dollars-and-cents, a large shift for FFH would be to pile perhaps $10 billion into 5-yr treasuries, which would provide the princely sum of $80m annually in interest....or you keep the $10 billion short and only get $5-10m in interest.  It costs maybe $75m per year, pre-tax, to sit and wait for a favourable move in the curve.  The opportunity cost is pretty small.

 

 

SJ

 

How much further do rates have to rise for buying the 10-year to be worse than holdings 0.1% paper?

 

At 2% on the 10-year, rates have to rise 0.22% this year, 0.28% the next year, and 0.36% the year following for 0.1% to outperform over 3-years. (very rough math in my head using a 9ish year duration starting duration and not considering the benefit of rolldown over 3 years)

 

Do we believe rates will be sustainably higher than 3% on the 10-year after just 3-years?

 

For reference, please recall we were at 3.25% in 2018 with record employment, trillion dollar deficit/spending and tax cut stimulus, and 9 years removed from the last recession. Seems like 3+% would be a tall order today unless if you actually believe they've been successful in creating the inflation they've failed to over the last 10-years.

 

So if we're not going be sustainably above 3% in the next 3 years, buying 10-year at 2% is a no brainer. And if buying at 2% is a no brainer, than beginning to accumulate at 1.5% probably isn't the worst thing you could do.

 

I would hope they consider small incremental buys if duration from here on out

 

 

Your rough math looks about right to me.  But, I don't think that anyone was suggesting that FFH should commit to staying short for three years.  The question is whether Bradstreet et al hold the view that there is likely to be a relatively rapid, favourable move in the curve (ie, a healthy parallel increase or a steeping over the next six months or year as economies reopen post-covid).  If you believe that this is likely to be the case, you don't need an enormous increase in the 5-yr or 10-yr to make up for taking it on the chin for another 6 months or year.  But, all of that depends on FFH's particular view of how the curve is likely to evolve (I'm inclined to trust Bradstreet when it comes to bonds).

 

My guess is that they will make the small incremental buys like you suggest.  I just don't expect to see a large increase in duration when the Q1 is published in May.  But, I've been wrong before, and there's still another month left in Q1!

 

 

SJ