Fairfax 2022

[glider3834]

13 hours ago, Viking said:

Well Fairfax AGM just finished. Overall, it provided a great overview of the company. Here are some of my key take-aways. Does anyone know where to get a copy of the powerpoint presentation Prem made? Please feel free to correct my errors:

 

1.) in Q1 purchased $7.5 billion in 1-2 year bonds… did i get this right? Big news if so. Interest income will be increasing…

100 basis point move in interest rates will increase interest income by $222 million and ALSO result in $294 unrealized loss on bonds (pre-tax). 200 basis point increase will result in $444 million increase in interest income and also result in $550 million unrealized loss on bonds (pre-tax).

 

2.) EXCO: nat gas producer. Sounds like their production is hedged out 1 year?

3.) Hard market: Andy Bernard

- growing significantly during hard market bodes well for underwriting results in future. 
- Fairfax is on the right side of so many forces in the industry (i think he means hard market, increase in bond yields, improving results of value investing).

- when they happen, hard markets have a way of re-arranging the insurance industry. Fairfax will be on the right side of the coming re-arranging.

- insurance market remains very favourable.

- Fairfax has been able to take advantage of hard market more than any other large insurer - 25% growth in 2021

4.) Northbridge - Sylvie: 91% customer retention (very high, especially given hard market). A lot of momentum in 2022. Inflation emerging watch out.

5.) Allied - President: doubled in size since being acquired by Fairfax.
- Reasons that started hard market are still in place.

- Pricing is continuing upward but at lower rate.

6.) Odyssey - Brian Young: doubled business last 3 years. Premium growth was only 50% from 2003 to 2018. Company IS VERY DISCIPLINED. 
- three businesses: 1.) Re, 2.) Hudson (US insurance), 3.) Newline (international insurance). 
- all 3 are growing rapidly. Past couple of years Hudson and Newline posted higher growth. Expects Re-insurance to lead growth in 2022.

- growth is moderating

- how do we measure performance? Underwriting profitability. 10 year CR = 92. 5 year CR = 96.4. Fall off in performance the last 5 years due to poor re-insurance results, which is due to elevated catastrophe losses.

- Last 5 years the re-insurance industry achieved a CR = 101.

- rates are moderating; inflation is an emerging risk.

7.) Capital adequacy - Peter Clark: Despite growth in premiums of 20% in 2020 and 25% in 2021, Fairfax is in very good shape.

8.) Eurobank - CEO: guiding to EPS of €1.40. TBV/share = €1.40

9.) Digit - CEO: platform - focus on India next 2 years. Might be opportunity to take platform outside of India after that.

10.) Kennedy Wilson CEO: 1st mortgage platform with Fairfax - 100% of loans are floating rate. Will benefit from rising rates. Avg size of loans 7-8 mill. 

- for KW, 90% of their debt is fixed rate of 3.5% for 7years.

- KW has had many partners over the years; Fairfax is by far the best. 
- partnership with Fairfax started in 2010; done more than $10 billion in deals; realized 75%; generated returns +20%.

thanks viking 

1) stood out for me - if they can get extra 100 bp on 7.5 bil thats extra $75 mil there

2) 'Although a substantial portion of EXCO’s oil & gas production is hedged for the year 2022, we believe that EXCO can fetch much higher prices as the hedges roll off.'https://www.gurufocus.com/news/1675983/francis-chous-chou-associates-fund-annual-2021-letter

9) they indicated Digit now has 2.4% market share - looks like a 50% increase in market share over last 12mths?

 

Just on AGM question time, I think they should have given more time to online questions (JS said he still had a lot at the end).

 

Edited April 22, 2022 by glider3834

[Felixnot]

I missed it. Is there a way to watch or listen to it now?

[glider3834]

7 hours ago, Felixnot said:

I missed it. Is there a way to watch or listen to it now?

No but they should keep webcast on their site - i was up from 11.30pm to 6am syd time watching both ffh and fih AGMs - they usually post the agm presentation 

[gary17]

i just finally got a bit of break from work, trying to catch-up-- i saw a few pages back a few people are suggesting FFH could get about $80/sh USD under-writing profit in 2023.  I was wondering if anyone has done a bit of assessment as to what FFH's under-writing could be like for the next 15 years?  Is that very hard to model?    would it be reasonable to assume similar UR profit , but at a modest 5% growth rate?

TIA

Gary

[Xerxes]

I think this might be the first time I see FFH share price and book value shown in the same currency (USD). 
 

annual reports shows them in CAD and USD, respectively, for some weird reason that I cannot fathom 

 

[valuesource]

Well WRB-NY reported.  Prems +18%, ROE 35.5%

 

I notice Thomson Reuters put out a Q1 consensus on FFH for $1.16/sh.  I'm calling that a little light.

 

[Viking]

3 hours ago, valuesource said:

Well WRB-NY reported.  Prems +18%, ROE 35.5%

 

I notice Thomson Reuters put out a Q1 consensus on FFH for $1.16/sh.  I'm calling that a little light.

 

WRB had a very good quarter. Despite the spike in bond yields they grew book value (thanks in part to realizing a big real estate gain). 
 

The average duration on their bond portfolio was 2.4 Dec 31 and was still 2.4 at March 31. Their average liability is 4 years. When asked when they will stretch duration they said they feel they are not yet getting paid enough on 5 and 10 year bonds… and they want to see where inflation goes before making a big move to stretch duration. 
 

They also discussed the value of having a bond portfolio with duration of 2.4 years (in a rising interest rate environment). It has hurt interest income in short term. With interest rising spiking the hit to BV is MUCH LESS than peers. And as they redeploy, interest income will be higher in future years.

 

Importantly, WRB gave a VERY BULLISH outlook for the rest of 2022, 2023 and 2024. Why? Continied top line growth. Benefit of lag as written premiums become earned. Higher interest income (as duration of bond portfolio is extended). Benefit of hard market pricing (on improving underwriting results) will play out over many years (as they are being very conservative with loss picks).

 

It appears the turn in workers comp (from soft to hard market) is likely 12-36 months away.

[valuesource]

Historically, it's been embarrassing considering how far off Analysts have been on FFH targets.  Without guidance they are naked. 

[gfp]

Results out -

 

https://s1.q4cdn.com/579586326/files/doc_financials/2022/PRFFH-2022-Q1-Press-Release.pdf

[nwoodman]

3 minutes ago, gfp said:

Results out -

 

https://s1.q4cdn.com/579586326/files/doc_financials/2022/PRFFH-2022-Q1-Press-Release.pdf

 

At first pass, it looks fantastic.  CR 93.1%.  A hit to the bond portfolio but that was expected, but they faired better than most . BV 626.  Given the absolute macro craziness of the  first quarter, I say well played Fairfax!

[Thrifty3000]

Net premium growth and operating earnings are outstanding 

[valuesource]

I agree.  Very good at first glance.  Too bad it didn't impact the bottom line more.

[glider3834]

24 minutes ago, Thrifty3000 said:

Net premium growth and operating earnings are outstanding 

+1 - they have added a little over $1 bil of quarterly net earned premium in the last 12 months. I was thinking they might do around 18 bil in net earned premium this year & now with 4.77 bil in Q1, I am thinking potentially closer to 19-20bil area??

 

Below was a bit of a surprise - once off gain affecting result or is this reflecting underlying earnings potential going forward?

 

Consolidated share of profit of associates of ...$38.0 million from EXCO Resources

 

 

 

 

 

Edited April 28, 2022 by glider3834

[nwoodman]

On 4/23/2022 at 7:48 PM, glider3834 said:

No but they should keep webcast on their site - i was up from 11.30pm to 6am syd time watching both ffh and fih AGMs - they usually post the agm presentation 

Now posted

https://s1.q4cdn.com/579586326/files/doc_presentations/2022/Fairfax-2022-AGM.pdf

[Viking]

On 3/19/2022 at 12:46 PM, Viking said:

The Q1 report for Fairfax will be very interesting but for different reasons than in the past (at least for me). My focus the past 15 months has been primarily on the equity portfolio (given how much it fell in value in 2020). Because recovery in the valuation of the equity portfolio was the primary driver of earnings and growth in BV in 2021 (i include Digit, which was an unexpected surprise, in the equity ‘bucket’). Moving forward i am really looking forward to seeing:

1.) how the insurance business is performing

- can written premium growth continue at close to 20% year over year?

- can CR of 95 be maintained or even go lower?

2.) changes to the bond portfolio

- will interest and dividend income increase from Q4? Short term rates have been increasing since Jan 1. Was Q4 the bottom?

- how aggressively is Fairfax buying longer duration and higher yielding fixed income instruments? We already have the Kennedy Wilson announcement. 
- how will these changes impact interest and dividend income moving forward?

We have all seen interest rates across the curve move dramatic dramatically higher so far this year with another pop higher this week after the Fed meeting. I am also reading that credit spreads are also widening. Both are VERY positive developments for Fairfax given how its bond portfolio was positioned at the end of Q4. 

 

Looking ahead, i think it is possible that Fairfax could earn $2 billion in 2023 from underwriting income + interest and dividend income. Q1 results will provide a pretty good early indicator of how likely this is. If this happens then the investment thesis for Fairfax will change dramatically. In a good way. If Fairfax starts kicking out predictable operating earnings of about $500 million each and every quarter it will have an unprecedented amount of free cash flow rolling in. We will see  What we do know is that outcome is not remotely priced into the share price today (trading at US$478). 
—————

We already received one update from Fairfax regarding my second question - changes to the bond portfolio:

 

Fairfax boosts target for debt investment platform to $5 billion

- https://ir.kennedywilson.com/news-events-and-presentations/press-releases/2022/02-23-2022-211613501

 

Fairfax has increased its first mortgage target within Kennedy Wilson’s debt investment platform by $3 billion to $5 billion.

—————

From page 12 of Prem’s letter in the 2021AR: At the end of 2021, our fixed income portfolio, inclusive of cash and short term treasuries, which effectively comprised 72% of our investment portfolio, had a very short duration of approximately 1.2 years and an average rating of AA-. Rising rates in 2021 resulted in a small unrealized bond loss of $261 million. During the last two years, we were able to invest $1.6 billion in first mortgages with Kennedy Wilson at an average rate of 4.5%, with an average term of three years.

—————

Homebuyers and owners scramble to secure low mortgage rates before more hikes come
- https://finance.yahoo.com/news/homebuyers-scramble-to-secure-low-mortgage-rates-160123047.html

 

“This week's more than quarter-point jump in mortgage rates is sending a dire message to homebuyers and owners: Time is running out.

 

Weary buyers already facing the worst affordability conditions are now clambering to snag a low rate before any future increases price them out altogether, according to interviews with real estate pros, while the number of refi candidates coming through the door have dwindled as rates soared past 4% for the first time in almost three years.

 

Mortgage rates have marched up by a full percentage point since the beginning of 2022, hitting 4.16% this week, according to Freddie Mac, and further increases may come as the Federal Reserve is set to raise a key benchmark rate up to six more times this year to combat inflation.”

Some initial thoughts from Q1 earnings:

1.) CR = 93.1 (Q4 was 88.1 - suggests we might see CR below 94 for the year)

2.) interest and dividend income has clearly bottomed and is now growing again (year over year). Growth should accelerate as the year progresses. Average duration in Q1 was increased from 1.2 to 1.4 years. Given the continued spike in bond yields since March 31 it is GREAT NEWS that Fairfax is being patient to redeploy into higher yielding assets. 
3.) Fairfax is on track to deliver $2 billion in operating income (underwriting + interest and dividend income) in 2022. Not sure how run-off affects this right now (subtract $100-$150 million?).

4.) top line growth was +20%. Chubb CEO said we are still in a hard market and it is still going strong. 
5.) hard market (20% top line growth) + sub 94CR (and falling due to hard market) + rapidly increasing interest income (due to spiking bond yields and extremely low avg duration) = 2023 operating income of +$2.4 billion. Not sure how run off affects this ( subtract $100-$150 million?).

6.) an investor today is almost getting all of the upside from the equity investments/Digit pretty much for free. That just cracks me up. Crazy times!

Edited April 29, 2022 by Viking

[Viking]

I was wondering how Mr Market would react to earnings today. 
- Fairfax finished +1.1%

- S&P500 finished -3.6%

 

Perhaps Mr Market is starting to understand that Fairfax will be a BIG winner in a rising interest rate environment. Perhaps record and growing operating earnings will lead to a re-rating of the stock to something closer to 1XBV. RBC just raised price target from US$675 to $750. They call Fairfax ‘best-in-class value opportunity at about 0.85x book value’

—————

From the RBC Report:

 

Underwriting results continue to improve, a shift towards more yield in investment portfolio

 Our view: The hard market continues to drive strong top-line growth and improved underwriting margins and management did an excellent job of protecting book value as interest rates rose, positioning them for improved  investment results going forward. While the portfolio remains complex, the value positioning seems well suited to current market conditions. With underwriting contributions improving and the balance sheet as well positioned as we've seen it in some time, we see significant room for multiple expansion and continue to view FFH shares as a best-in-class value opportunity at about 0.85x book value.

 Estimates: We are lowering our 2022 net income estimate to $54.95 from  $67.50, which primarily reflects the results in the quarter partly offset by improving investment income. Our 2023 estimate rises to $75.00 from $73.75, also reflecting higher investment income partly offset by more conservative margin assumptions. On an operating basis, we are revising our estimate to $55.19 from $55.78 for 2022 and to $63.29 from $62.05 for 2023.

 Price target: We are increasing our price target to $750 from $675 (about C$950, up from C$875 at a 1.27:1 exchange rate). Our target remains based on 1.0x book value, which we now apply to ending 2023 book versus 2022 book previously. With good visibility to further book value growth together with a company generating underwriting profits in the middle of a hard market, we think 1.0x book value is a very attractive multiple.

[Viking]

Fairfax has a long history of making big macro calls. Sometimes they work out spectacularly well like the CDS bet in 2008. Fairfax could have been added as another big winner in Michael Lewis’ book The Big Short. And sometimes the macro call works out spectacularly badly like the short positioning from 2013-2020. 
 

Another big macro call was moving the massive bond portfolio to a duration of 1.2 years at the end of 2021. Given the spike in bond yields that we have seen in the past 4 months Fairfax is the best positioned of all large P&C insurers - and by far. 
 

Fairfax’s bond portfolio has an average duration of 1.2 years. WR Berkley is next at 2.4 years. Most P&C insurers are closer to 4 years. 
 

So how much money will this bet make for shareholders in the coming year? Could it be as much as $1 billion? More? (IE. What if both short and long term treasury interest rates get to 3.5% by year end?)
 

i would love to hear how other board members are thinking about this macro bet and, importantly, what will be the financial impact and rough $ benefit to Fairfax and shareholders?

Edited April 29, 2022 by Viking

[maxthetrade]

Don't know if that was a macro bet, interest rates were so low that the opportunity cost of sitting on a pile of cash was pretty low and the risk of losses from owning bonds pretty high. Hard to tell how much money they'll make from this, depends on how high interest rates go and when they decide to move. At this price it's just gravy, the downside is pretty well protected and upside will take care of itself.

 

BTW, the transcript of the call is now availble on SA: https://seekingalpha.com/article/4505284-fairfax-financial-holdings-limiteds-frfhf-ceo-prem-watsa-on-q1-2022-results-earnings-call 

[bluedevil]

My thoughts on this macro bet:

 

There is no doubt Fairfax's decision to go so heavy on cash is paying off in spades now, and kudos to them.  

 

This was not timed to a t though.  One would have to go back and reconstruct the history, but Fairfax sat is cash for a good period of time and avoided the upside that other insurers received when interest rates went down and the value of those bonds went up and the interest income.  Again, i'm sure it has worked out well now, but the costs of this decision were also being borne for a while.

 

Personally, as i have said before, I would like to see Fairfax transition over time to the Markel style of bond portfolio management.  Use active management to get the best yield while maintaining pristine credit quality, but don't try to predict future interest rates.  Instead match the bond to when you need to pay out claims, and you hedge your exposure, as Tom Gaynor explained recently (below).  I particularly hope they go this route when Brian Bradstreet retires.

 

Fairfax has built a wonderful underwriting machine; and it has great advantages in equity investments because it can take a very long term focus and people want to partner with a friendly, trustworthy source of funds.  Those great strengths are beginning to shine through more and more as shorting + acquisitions have stopped.  The company is also slowly lowering leverage by growing capital, reducing risk.  I think taking away the macro calls on interest rates would be another step in the right direction in the long run.   

 

* * * 

 

The philosophy on fixed income is that we buy fixed income to match against the reserves of what we expect to pay out in claims and expenses of running the business. And the reason we buy fixed income securities that have a duration of between four years and five years is, because that matches the duration of what we expect to pay out the claims over.

So when interest rates rise and you see a mark-to-market decrease in the fixed income portfolio, if you were really doing the net present value of the reserves, you would see an equal and offsetting reduction in the amount of the reserves. Now as an accounting matter, we don’t discount our reserves to their net present value.

So economically what we are doing is we are hedging and matching and saying straight up either way because one of the things that we fully believe is that we have no idea how to predict accurately what interest rates are going to do.

So either way, whether they go up or whether they go down, we are hedged, we are matched. We are making a spread of return between the positive yields on a bond portfolio and the negative cost of flow that we get through underwriting profitability, and as long as we keep that spread positive number, things add up to the good over time.

 

[Parsad]

2 hours ago, Viking said:

So how much money will this bet make for shareholders in the coming year? Could it be as much as $1 billion? More? (IE. What if both short and long term treasury interest rates get to 3.5% by year end?)
 

i would love to hear how other board members are thinking about this macro bet and, importantly, what will be the financial impact and rough $ benefit to Fairfax and shareholders?

 

First, they've avoided most of the downside their competition got hit by...so by the time interest rates finish rising, I think they would have prevented close to $1.5-2B in losses. 

 

Second, with markets and bonds both getting pummeled YTD, they have opportunity in front of them.  So I imagine they will make at least $2-3B in bond gains/income and equity gains/dividends directly related to changes in the cash portfolio as they invest it.

 

Depending on how bad things get, they may find some good acquisitions, both insurance and non-insurance, which they would not be able to take advantage of without cash in the hold co and cash in the portfolio.

 

Net, they will have made/prevented a swing of close to $4-6B looking 2-3 years out just by moving to cash and then putting that cash to work.

 

Cheers! 

[TwoCitiesCapital]

I dont mind the macro bets - but would prefer they do them smaller OR lock in profits on them more quickly. 

 

They successfully called interest rates in 2016-2018, but missed them in 2018 - 2020 and there was basically no net benefit to shareholders (maybe even a net cost after considering 4 years of substantially reduced income). 

 

Now they've nailed them again in 2021, but if they don't start locking it in, we risk losing it all again.

 

If they're gonna bet the entire bond portfolio on the call, I want them to start systematically taking steps to lock it in. Like move 10-15% into 5-10 year bonds when rates hit 2.5%. Move another 10-15% when they hit 3.00%. So on so forth. Still very well positioned for rising rates, but you're steadily locking in higher rates and duration for when the cycle turns. 

[glider3834]

1 hour ago, Parsad said:

 

First, they've avoided most of the downside their competition got hit by...so by the time interest rates finish rising, I think they would have prevented close to $1.5-2B in losses. 

 

Second, with markets and bonds both getting pummeled YTD, they have opportunity in front of them.  So I imagine they will make at least $2-3B in bond gains/income and equity gains/dividends directly related to changes in the cash portfolio as they invest it.

 

Depending on how bad things get, they may find some good acquisitions, both insurance and non-insurance, which they would not be able to take advantage of without cash in the hold co and cash in the portfolio.

 

Net, they will have made/prevented a swing of close to $4-6B looking 2-3 years out just by moving to cash and then putting that cash to work.

 

Cheers! 

Yeh they made some critical moves in 2021, building up their cash, net sellers of bonds & equities, reducing long equity swap positions. I think the best part of Fairfax's strategy evolution, is that they have taken a leaf out of the Berkshire playbook, that the way to deal with an unattractive equity & bond investment environment is to build up your cash & ST investments rather than trying to hedge or short indexes or stocks. This is a critical shift in strategy IMHO. 

 

Just on Q1 results, if you look at other insurers eg Travelers, Chubb they have all had big hits to their book value in Q1 & potentially more come in Q2 given interest rate increases this quarter so far, but as I understand they are classing their bonds as held to maturity, so they are not reporting losses on bonds through their income statement. So the result is that it looks like they had great earnings, but in present value terms, the loss of value on those bonds is significant & is reflected in hit to book value.

 

Whereas Fairfax are reporting their bonds as available for sale or trading, so MTM loss is being reported through their income statement (ie FVTPL), so its a better reflection of the economic impact of higher interest rates ie  present value of their bonds is lower - even though Fairfax said on conference call they expect to hold these bonds to maturity, so these bond losses in Q1 should fully reverse in time - this is an important point to remember when we reflect on Fairfax Q1 result. 

 

 

 

 

[petec]

4 hours ago, glider3834 said:

Yeh they made some critical moves in 2021, building up their cash, net sellers of bonds & equities, reducing long equity swap positions. I think the best part of Fairfax's strategy evolution, is that they have taken a leaf out of the Berkshire playbook, that the way to deal with an unattractive equity & bond investment environment is to build up your cash & ST investments rather than trying to hedge or short indexes or stocks. This is a critical shift in strategy IMHO. 

 

Just on Q1 results, if you look at other insurers eg Travelers, Chubb they have all had big hits to their book value in Q1 & potentially more come in Q2 given interest rate increases this quarter so far, but as I understand they are classing their bonds as held to maturity, so they are not reporting losses on bonds through their income statement. So the result is that it looks like they had great earnings, but in present value terms, the loss of value on those bonds is significant & is reflected in hit to book value.

 

Whereas Fairfax are reporting their bonds as available for sale or trading, so MTM loss is being reported through their income statement (ie FVTPL), so its a better reflection of the economic impact of higher interest rates ie  present value of their bonds is lower - even though Fairfax said on conference call they expect to hold these bonds to maturity, so these bond losses in Q1 should fully reverse in time - this is an important point to remember when we reflect on Fairfax Q1 result. 

 

 

 

 

Interesting point on the accounting. Do you know which applies to capital for solvency purposes? I’m half hoping that Fairfax can continue to outgrow peers because they’ve taken less of a capital hit. Is that possible?

 

 

[petec]

I’ve said this before, so at the risk of sounding like a broken record: why is the cash position a macro bet rather than a risk-reward bet? When curves are as flat as they’ve been, there simply isn’t enough interest rate reward to justify duration risk. The AGM deck is good on this - look how much higher the duration on a 30y treasury is compared to 30 years ago. Bond price risk is real. You guys are all focussed on the absolute level of rates, but how steep the curve is matters just as much. To invert, when the curve is flat, to go long you *must* believe rates are going to *fall*. 
 

*That’s* a macro bet. What Fairfax is currently doing is actually macro agnostic in my view. 

[Crip1]

10 hours ago, petec said:

I’ve said this before, so at the risk of sounding like a broken record: why is the cash position a macro bet rather than a risk-reward bet? When curves are as flat as they’ve been, there simply isn’t enough interest rate reward to justify duration risk. The AGM deck is good on this - look how much higher the duration on a 30y treasury is compared to 30 years ago. Bond price risk is real. You guys are all focussed on the absolute level of rates, but how steep the curve is matters just as much. To invert, when the curve is flat, to go long you *must* believe rates are going to *fall*. 
 

*That’s* a macro bet. What Fairfax is currently doing is actually macro agnostic in my view. 

I completely agree. I think to an extent the financial press refers to anything and everything as a bet. It's a lot easier to say that than it is to explain the risk-reward analysis.

 

-Crip