Fairfax 2022

[longlake95]

2 year treasury 12 months ago: 0.207

2 year treasury today: 4.259

 

remarkable

[Parsad]

13 hours ago, longlake95 said:

2 year treasury 12 months ago: 0.207

2 year treasury today: 4.259

 

remarkable

 

That's going to at least 5.5...maybe 6-6.5 if things aren't slowing.  Cheers!

[Viking]

18 hours ago, longlake95 said:

2 year treasury 12 months ago: 0.207

2 year treasury today: 4.259

 

remarkable

 

@longlake95 I agree. The increase in US Treasury rates, across the curve, continues its upward march: 

 

2022	1 Mth	1 Yr	3 Yr	5 Yr	10 Yr
Jan 1	0.05%	0.40%	1.04%	1.37%	1.63%
Mar 31	0.17%	1.63%	2.45%	2.42%	2.32%
Jun 30	1.28%	2.80%	2.99%	3.01%	2.98%
Sep23	2.67%	4.15%	4.21%	3.96%	3.69%

 

This is a big, big win for Fairfax. How much of a win will depend on a couple of factors:

1.) how high do rates ultimately go?

2.) how long do rates stay high?

Treasury rates are already higher than I thought possible. But Powell just said rates will be going higher and staying higher well into 2023. Now I don't necessarily believe that is what will happen. Lets hope I continue to be wrong.

3.) does Fairfax increase duration? Not as of June 30 (still at 1.2 years). This will be perhaps the key piece of information I will be looking for when they report Q3 results. If they start to push the average duration out then that will give investors more certainty regarding the future path of interest income.

4.) do credit spreads blow wider? Not yet. But if the economy starts to roll over we likely will get a credit event. The Fed looks like it is going to keep raising rates until something breaks... I wonder if credit markets blowing out (and volatility soaring) will be the trigger for the Fed to stop and eventually reverse course.

----------

There is a short term negative to rising interest rates. And that is the significant market-to-market loss that gets booked at the end of the quarter as the fixed income portfolio gets re-valued:

- Quarter 2 = ($445 million)

- YTD 2022 = ($1.008 bilion)

- small offset: U.S. treasury bond forward contracts gain Q2 = +$32 million and YTD = +$100 million

Given the move in rates so far, it loos like the hit in Q3 will again be large: $500 million? Still, rising interest rates is a very good news story for Fairfax in 2 important ways:

1.) much higher interest income earned for years into the future 

2.) potential for significant mark-to-market gains should interest rates ever come down again. Especially if Fairfax increases duration at attractive interest rates.

Edited September 24, 2022 by Viking

[glider3834]

18 hours ago, Viking said:

 

@longlake95 I agree. The increase in US Treasury rates, across the curve, continues its upward march: 

 

2022	1 Mth	1 Yr	3 Yr	5 Yr	10 Yr
Jan 1	0.05%	0.40%	1.04%	1.37%	1.63%
Mar 31	0.17%	1.63%	2.45%	2.42%	2.32%
Jun 30	1.28%	2.80%	2.99%	3.01%	2.98%
Sep23	2.67%	4.15%	4.21%	3.96%	3.69%

 

This is a big, big win for Fairfax. How much of a win will depend on a couple of factors:

1.) how high do rates ultimately go?

2.) how long do rates stay high?

Treasury rates are already higher than I thought possible. But Powell just said rates will be going higher and staying higher well into 2023. Now I don't necessarily believe that is what will happen. Lets hope I continue to be wrong.

3.) does Fairfax increase duration? Not as of June 30 (still at 1.2 years). This will be perhaps the key piece of information I will be looking for when they report Q3 results. If they start to push the average duration out then that will give investors more certainty regarding the future path of interest income.

4.) do credit spreads blow wider? Not yet. But if the economy starts to roll over we likely will get a credit event. The Fed looks like it is going to keep raising rates until something breaks... I wonder if credit markets blowing out (and volatility soaring) will be the trigger for the Fed to stop and eventually reverse course.

----------

There is a short term negative to rising interest rates. And that is the significant market-to-market loss that gets booked at the end of the quarter as the fixed income portfolio gets re-valued:

- Quarter 2 = ($445 million)

- YTD 2022 = ($1.008 bilion)

- small offset: U.S. treasury bond forward contracts gain Q2 = +$32 million and YTD = +$100 million

Given the move in rates so far, it loos like the hit in Q3 will again be large: $500 million? Still, rising interest rates is a very good news story for Fairfax in 2 important ways:

1.) much higher interest income earned for years into the future 

2.) potential for significant mark-to-market gains should interest rates ever come down again. Especially if Fairfax increases duration at attractive interest rates.

I thought this article was interesting

 

“Credit spreads are too tight, they are not adequately reflecting the risk of recession. Other models that we use, whether it’s the yield curve or the macro-economic hard data are more bearish,” said Matthew Mish, head of credit strategy at UBS, adding that at some point “these need to converge.”

https://www.reuters.com/markets/us/credit-markets-see-less-risk-recession-earnings-may-challenge-that-2022-09-23/

 

 

[racemize]

1 hour ago, glider3834 said:

I thought this article was interesting

 

“Credit spreads are too tight, they are not adequately reflecting the risk of recession. Other models that we use, whether it’s the yield curve or the macro-economic hard data are more bearish,” said Matthew Mish, head of credit strategy at UBS, adding that at some point “these need to converge.”

https://www.reuters.com/markets/us/credit-markets-see-less-risk-recession-earnings-may-challenge-that-2022-09-23/

 

 

interesting that the same time, the mortgage spreads are very high.

[UK]

https://www.bloomberg.com/news/articles/2022-09-27/hurricane-ian-threatens-to-overshadow-andrew-s-devastation?srnd=premium-europe

 

Would FFH felt substantial impact if such predictions come true? 

[Parsad]

41 minutes ago, UK said:

https://www.bloomberg.com/news/articles/2022-09-27/hurricane-ian-threatens-to-overshadow-andrew-s-devastation?srnd=premium-europe

 

Would FFH felt substantial impact if such predictions come true? 

 

Fairfax is in much better financial position to withstand hurricane losses than it was in previous large scale hurricane catastrophes like Andrew.  Fairfax will incur about a 0.75-1% loss, while someone like Berkshire will probably incur a 5-8% loss.  Also, as tragic as Ian will be, this will only bode well for a continued hard market in reinsurance.  Premium pricing was expected to be strong through 2023, but with Ian and other potential losses this year, the hard market will likely continue into 2024 as well.  Cheers!

[Gregmal]

UVE was always the go to blow up short if you’re betting on hurricanes. The bigger guys will eat it, then pass it on. Key is seeing the other side.

[UK]

1 hour ago, Parsad said:

 

Fairfax is in much better financial position to withstand hurricane losses than it was in previous large scale hurricane catastrophes like Andrew.  Fairfax will incur about a 0.75-1% loss, while someone like Berkshire will probably incur a 5-8% loss.  Also, as tragic as Ian will be, this will only bode well for a continued hard market in reinsurance.  Premium pricing was expected to be strong through 2023, but with Ian and other potential losses this year, the hard market will likely continue into 2024 as well.  Cheers!

 

Thank you. So, if I understand correctly, at upper bands, it would be something like about 6 per cent from CAP for FFH (and 1 per cent to BRK).

 

 

 

[Parsad]

40 minutes ago, UK said:

 

Thank you. So, if I understand correctly, at upper bands, it would be something like about 6 per cent from CAP for FFH (and 1 per cent to BRK).

 

 

 

 

Other way around.  FFH 1% and BRK probably 6%.  If a $60B loss, FFH would be hit with $600M or so and BRK would be hit with a $3.6B loss or so.  Cheers!

[UK]

11 minutes ago, Parsad said:

 

Other way around.  FFH 1% and BRK probably 6%.  If a $60B loss, FFH would be hit with $600M or so and BRK would be hit with a $3.6B loss or so.  Cheers!

 

Thanks, yes, but than I compared those possible losses (acctually 0.7 and 5.6 B) to market CAP of FFH and BRK and come to 6 and 1, respectively.

Edited September 28, 2022 by UK

[Parsad]

17 minutes ago, UK said:

 

Thanks, yes, but than I compared those possible losses (acctually 0.7 and 5.6 B) to market CAP of FFH and BRK and come to 6 and 1, respectively.

 

Not straight line.  FFH has about $56B of insurance portfolio assets...so a $600M hit would be around 2%.  BRK has about $450B in insurance portfolio assets...so a $3.6B hit would be around 0.8%.  

 

FFH could withstand a 9.0 earthquake in Los Angeles and a 50% drop in the stock market in the same year.  BRK could withstand losses even greater than that.  Cheers!

[StubbleJumper]

5 hours ago, Parsad said:

Other way around.  FFH 1% and BRK probably 6%.  If a $60B loss, FFH would be hit with $600M or so and BRK would be hit with a $3.6B loss or so.  Cheers!

 

 

One small caution for readers of this discussion on the potential hit from Ian is that the Bloomberg article is quoting the total potential damage number from Ian, not the insurable damage.  So, $60 billion sounds like a really large number, but that includes all perils, including damage from wind, rain, flooding and storm surge.  Not all of those perils are insured under a typical policy.  So, if there's $60B of damage in total, the insured damage might be more like half of that, depending on what exactly drove the losses.  It's still going to be a large bill, but...

 

 

SJ

[This2ShallPass]

10 hours ago, Parsad said:

Fairfax will incur about a 0.75-1% loss, while someone like Berkshire will probably incur a 5-8% loss.

Which other large insurance companies would be a close comparable to Fairfax? Trying to decide if I should take some cheap insurance () against Ian.. 

[longlake95]

Here's the buyback. 10% of the float and a bunch of the prefs. Also, an automatic share purchase plan so they can buy back even during blackout periods.

https://www.fairfax.ca/news/press-releases/press-release-details/2022/Fairfax-Financial-Holdings-Intention-to-Make-a-Normal-Course-Issuer-Bid-for-Subordinate-Voting-Shares-and-Preferred-Shares/default.aspx

Edited September 28, 2022 by longlake95

[StubbleJumper]

7 minutes ago, longlake95 said:

Here's the buyback. 10% of the float and a bunch of the prefs. Also, an automatic share purchase plan so they can buy back even during blackout periods.

https://www.fairfax.ca/news/press-releases/press-release-details/2022/Fairfax-Financial-Holdings-Intention-to-Make-a-Normal-Course-Issuer-Bid-for-Subordinate-Voting-Shares-and-Preferred-Shares/default.aspx

 

Yeah, the NCIB is an annual thing.  It's good that they've filed it because it enables FFH to scoop up a few shares at prices well below what they paid through the SIB from Christmas last year. 

 

Given what's happened with interest rates and equity prices, we should fully expect to see some significant mark-to-market losses on the fixed income portfolio during Q3 and considerable mark-to-market losses on the equity portfolio.  Add to this a 9-digit loss from Hurricane Ian which should be booked to Q3 (through IBNR).  Headline EPS numbers could once again be pretty gruesome for Q3, even though FFH's core business is strengthening and the operating environment for its equity portfolio has become more favourable!  The stock price has already been flirting with the US$450s over the past week, so perhaps there will be a truly excellent re-purchase opportunity during November after the superficially gruesome Q3 EPS numbers are released.  The NCIB might enable FFH to pick up 100k or 200k shares during November, which would be great if the share price drops down to the low-$400s.

 

Does anyone have any insight on whether the Pethealth transaction is likely to be booked to Q3?  Here we are with two days remaining, and I don't recall seeing a press release indicating that the deal has been consummated.  Maybe that one will be booked to Q4 and Resolute to Q1 2023.  If those gains happen to coincide with a slowing of the M2M losses, we could see some really nice Q4 and Q1 numbers.

 

Time to start digging in the chesterfield cushions to scrape together a few bucks.

 

 

SJ

[Xerxes]

The last few years, the uncertainty seem to really peak (and with it share price bottom), few days before the Q3 earning call.

[This2ShallPass]

9 hours ago, StubbleJumper said:

Does anyone have any insight on whether the Pethealth transaction is likely to be booked to Q3?

I was just looking at it this weekend, it's supposed to close 2H. Since the deal was only announced June 20th, might be late Q4 or even early Q1.

 

I also had a slight concern about the buyer pulling out due to the current market conditions and looked them up. The first thing that struck me was they had a decade (not annual!) shareholder letter. Skimming through that and their '22 mid-year report, I'm no longer worried. They seem like a high quality partner and long term oriented..

 

[Daphne]

Fairfax shares merit consideration for investors willing to look beyond past headlines

TREVOR SCOTT

SPECIAL TO THE GLOBE AND MAIL
 

 

In Berkshire Hathaway’s 1985 shareholder letter, Warren Buffett discussed his 1973 partial purchase of The Washington Post, which he had viewed as value hiding in plain sight, and which subsequently skyrocketed to more than 20 times his initial cost.

“Our advantage, rather, was attitude: We had learned from Ben Graham that the key to successful investing was the purchase of shares in good businesses when market prices were at a large discount from underlying business values.”

Mr. Buffett’s ability to ignore preconceived notions and instead focus on the underlying value allowed him to invest in a fantastic company at a bargain basement price.

STORY CONTINUES BELOW ADVERTISEMENT

 

I believe there is a similar behavioural investment opportunity currently with Fairfax Financial 

FFH-T +5.00%increase

 

, a US$11-billion Toronto-based property and casualty insurer that is being punished today for the sins of its past.

 

In what now feels like a lifetime ago, Fairfax was once wildly popular with Bay Street fund managers and traded at an astounding four times its book value (an accounting term equal to a firm’s assets minus its liabilities). But for the past decade investor opinions have soured, with many lamenting its weak insurance underwriting and costly macro economic speculation.

Consequently, Fairfax trades for 0.75 times its book value (half of its peer group), indicating investors now believe it will be unable to earn a satisfactory return.

Much like a large ship turning at sea, it takes time to change investor opinions, and Fairfax is no exception. Although the company suffered from underwriting losses in 14 of the 20 years leading up to 2011, since then it has turned an underwriting profit in every year except one. Furthermore, the large macro investment calls were stopped back in 2016 with follow-up declarations from management that they will not return to shorting the market or individual stocks. Yet investors refuse to update their prior views to this new simplified reality. Even when an undeniably positive event happens to Fairfax, investors often greet the news with little more than a shrug.

A recent example occurred in June when the company unexpectedly announced it had sold its pet insurance division for US$1.4-billion, or approximately six times its book value. This was a massive win for shareholders, yet the stock decreased slightly for the week while the insurance sector advanced.

Continuing with the nautical metaphor, the investment horizon has never been brighter for Fairfax. Insurance is one of the few industries that actually benefits from higher interest rates (owing to an insurer’s ability to invest customer premiums prior to claims).

Fairfax’s bond portfolio is uniquely positioned for this new higher interest rate reality. When rates were low, Fairfax did not “reach for yield” like many of its peers. Management tolerated the lower yielding cash and short term debt, unwilling to lock shareholders into bonds that would provide a negative real return. With central banks now aggressively hiking rates to fight inflation, Fairfax’s interest and dividend income will double this year to US$1-billion?
Even better, the massive decline in long-term bond values is constraining competitors’ capacity to write new policies, allowing Fairfax to aggressively capitalize on this opportunity. In fact, most readers might be surprised to learn that Fairfax’s gross insurance premiums have grown from US$8-billion in 2015 to an expected US$28-billion in 2022. This is an incredible transformation, yet Fairfax shares today trade for less than they did seven years ago.

Undoubtedly, risks remain with Fairfax; shareholders will only find out in the future whether today’s insurance underwriting was adequate, management could revert to macro speculation and with the global economy slowing, bond yields could give up some of their recent move higher. However, today’s stock price has already deeply discounted many of these pessimistic scenarios and I believe Fairfax shares merit consideration for investors willing to look beyond past headlines to its underlying business value.

[Candyman1]

Just wondering, if one looks at the price declines of bonds in general and specifically long dated bonds.

- How much of a dent has that been to capital in the industry? I would expect a decent impact.

- Do regulators allow the insurance industry to treat those bonds like either for sale (mark to market) or to maturity (no mark to market) as they do with banks? One argument that is being made is that they often match their bond portfolio to their liabilities. I would like to know the actual treatment works overall.

- My guess is that most of it is mark to market. And if so, given leverage in insurance industry, isn't there an additional argument for maintaining the hard market for a while? 

[Candyman1]

For what it is worth, an estimate of about $60 billion in insured losses. Reasonable estimate of about $600 million for FFH, so I guess the loss will be between $20 and $30 per share for FFH.

 

https://www.wsj.com/articles/flood-insurance-fell-in-florida-before-hurricane-ian-struck-11664591058?mod=saved_content

 

Risk-modeler Karen Clark & Co. on Friday estimated that the privately insured loss from Hurricane Ian would be close to $63 billion, including wind, storm surge and inland flood damages, while total economic damage will be well over $100 billion, including uninsured properties, damage to infrastructure and cleanup costs. 

 

 

[Cigarbutt]

4 hours ago, Candyman1 said:

Just wondering, if one looks at the price declines of bonds in general and specifically long dated bonds.

- How much of a dent has that been to capital in the industry? I would expect a decent impact.

- Do regulators allow the insurance industry to treat those bonds like either for sale (mark to market) or to maturity (no mark to market) as they do with banks? One argument that is being made is that they often match their bond portfolio to their liabilities. I would like to know the actual treatment works overall.

- My guess is that most of it is mark to market. And if so, given leverage in insurance industry, isn't there an additional argument for maintaining the hard market for a while? 

Take the following as potentially reasonable answers to your questions.

Statutory accounting for bonds (at least NAIC based in US and similar elsewhere) requires bonds to be recorded at cost with an asset valuation reserve recorded immediately against surplus. For NAIC class 1 and 2 bonds (investment grade), this charge used to buffer future losses (mostly default-type losses) is between 0 and 2%. Then, unless an impairment needs to be recognized or somehow the insurer cannot demonstrate that the bonds can be held to maturity (also regulators look (and account for) idiosyncratic market exposure), there is no additional charge to surplus along the way to maturity. Note that, for the overall insurers' float portfolios in bonds, 94% of bonds are NAIC 1 or 2.

Here's a decent reference for the statutory accounting part:

-----

Just for fun (relevant for Fairfax now?), there was a time (annual report 1999) when potentially unsettling unrealized bond losses were not considered unsettling at head office (although the unusual concentration likely raised questions in some regulators' minds). Then, it seems that FFH wanted to protect against (and benefit from) the deflationary consequences of bu**ble bursting. That was then and now is now.

[Spekulatius]

The same is true for banks. Market to market losses on bonds losses don't affect statutory capital unless they are realized.

GAAP accounting <> statutory accounting. Some banks with an outsized bond portfolio have high market to market losses but it should not affect the statutory capital. EXSR is an example.

[Candyman1]

26 minutes ago, Cigarbutt said:

Take the following as potentially reasonable answers to your questions.

Statutory accounting for bonds (at least NAIC based in US and similar elsewhere) requires bonds to be recorded at cost with an asset valuation reserve recorded immediately against surplus. For NAIC class 1 and 2 bonds (investment grade), this charge used to buffer future losses (mostly default-type losses) is between 0 and 2%. Then, unless an impairment needs to be recognized or somehow the insurer cannot demonstrate that the bonds can be held to maturity (also regulators look (and account for) idiosyncratic market exposure), there is no additional charge to surplus along the way to maturity. Note that, for the overall insurers' float portfolios in bonds, 94% of bonds are NAIC 1 or 2.

Here's a decent reference for the statutory accounting part:

-----

Just for fun (relevant for Fairfax now?), there was a time (annual report 1999) when potentially unsettling unrealized bond losses were not considered unsettling at head office (although the unusual concentration likely raised questions in some regulators' minds). Then, it seems that FFH wanted to protect against (and benefit from) the deflationary consequences of bu**ble bursting. That was then and now is now.

Thank you for clarifying.

[Viking]

When you look at the various asset classes, so far in 2022, bonds (@-20%) and stocks (@-30%) have gotten absolutely crushed. The clear winner - and its not even close - has been cash. With an average duration of 1.2 years at Dec 31 and still the same at June 30, Fairfax’s $35 billion bond portfolio is as close to cash as an insurance company can get. This positioning is shaping up to be a massive winner for future Fairfax shareholders.
 

There were costs to moving to this very low duration.
1.) Interest income was much lower than it otherwise would have been in past years. But this cost was largely borne by past shareholders.

2.) Fairfax in 2022 is reporting large mark to market losses as its bond portfolio is revalued as yields across the curve move to much higher levels. This cost is being borne by current Fairfax shareholders.
 

There are big benefits of the move to very low duration.

1.) Fairfax is immediately able to earn much higher interest income on its very large cash balances. And as bonds mature the bonds will be reinvested at much higher yields (with 1.2 year average duration lots of bonds can be reinvested each quarter).

2.) in the future, if bond yields fall, Fairfax will record large mark to market gains on its bond portfolio.
These benefits will be reaped by Fairfax shareholders in future quarters and years.
 

How big will the benefits be? Well, that will depend on a number of factors:

1.) how high do interest rates go?

2.) do spreads widen?

3.) does Fairfax extend duration?

4.) does Fairfax shift into higher yielding munis/corporates etc. 

The math of the impact of higher interest rates on interest income on a $35 billion bond portfolio is pretty compelling. (For reference, interest income was less than $500 million in 2021.)

1.) 3% = $1.05 billion = $44/share (pre-tax)

2.) 3.5% = $1.23 billion = $52/share

3.) 4% = $1.4 billion = $59/share

4.) 4.5% = $1.58 million = $66/share

 

My guess is Fairfax’s run rate yield on their bond portfolio will be over 3% at the end of Q3 and perhaps approaching 3.5% by year end 2022 (setting them up Jan 1 to be on track to earn $1.2 billion in interest income in 2023).

—————

The Fed is telegraphing the terminal Fed funds rate to go to 4.5% and stay there until late 2023. If this happens, both bonds and stocks will likely continue to sell off and cash will continue to outperform.

Edited October 8, 2022 by Viking