Fairfax 2022

[Crip1]

42 minutes ago, KFS said:

 

 

Fair point.  I guess I tend to assume Bradstreet & gang would be able to make some intelligent decisions if/when the opportunities arise, but of course you may be right.  

 

It would also be interesting to see whether the correlation and subsequent disconnect impacted other "peer" companies such as Markel. Cinc Financial, etc to determine whether this was a macro thing or specific to FFH.

 

-Crip

[glider3834]

I have just updated my fixed income portfolio duration chart for Fairfax vs peers

 

 

 

[glider3834]

5 hours ago, TwoCitiesCapital said:

 

The only reason for the correlation is b/c people expect higher rates to result in higher income. But that's only true if you invest the cash into higher rates. Fairfax didn't do that last time we went through the cycle and rates were significantly higher than they are today. 

 

I don't have a ton of confidence they're gonna put a ton of cash to work with rates even lower than prior opportunities they've passed on. Seems like the market agrees which is why the correlation broke down. We learned from history. 

 

If interest rates go to 5%, I'll eat my words. But I'm highly skeptical that the 10-year gets sustainably above 2.5% for more than a 3-6 month period and it's not clear that Fairfax will put it's cash to work until rates get well above the 3.25% that was passed on in 2018. 

 

Forward rate curve is already inverted for 2s-10s suggesting potential for another recession within 12-18 months. There's a very real possibility we sit on cash and miss it again. 

In 2018 they more than doubled their bond portfolio allocation & increased interest income

'Our interest and dividend income of $784 million was up from $559 million in 2017 as we moved from cash to 2 – 3 year treasuries and high quality corporate bonds – but we did not reach for yield!' (AR 2018)

 

We do know that 1-3 year treasuries are yielding 100 bp more than they were at start of year. So straight away they have the play it safe, high quality, short term debt option on the table that will boost their interest income. Also we know the duration on their fixed income portfolio is 1.2 yrs at 31 Dec, so they have flexibility to redeploy their portfolio at higher rates within a short timeframe so we should see impact on interest income sooner. Plus we now have a lot more volatility in equity & credit markets, that is opening up opportunities in corporates.

 

So I think key points here are their positioning & the fact we now have a higher rate environment that is more conducive to them increasing their interest income.

 

There is generally a correlation between interest rates & P&C insurer P/B multiples, because lower interest rates lower interest income & contribute to lower returns on equity. 

Edited March 17, 2022 by glider3834

[nwoodman]

9 hours ago, glider3834 said:

I have just updated my fixed income portfolio duration chart for Fairfax vs peers

 

 

Thanks @glider3834

[jbwent63]

5Paisa Capital Limited shares popped over 19% overnight. I haven't been able to find any company news to explain such a move. Does anyone have any insight? Is it related to the IIFL possible sale news? Thanks.

[petec]

One thing that has been nagging at me for a couple of years - and I know it has been discussed here before, but I'm not sure we ever got to a good answer - is why does FFH keep putting capital into the subs when according to the annual report the subs have capacity (in aggregate) to grow underwriting 1.5x or more on the existing capital base?

 

Anyone got a clear view on this?

 

It's potentially very important, because if the subs can grow without needing capital - or even, while dividending it to the holdco - that really changes the cash flow dynamics at the holdco and the possibilities for buying back shares or stakes.

[petec]

19 hours ago, TwoCitiesCapital said:

The only reason for the correlation is b/c people expect higher rates to result in higher income. But that's only true if you invest the cash into higher rates.

 

Surely your income on your cash and short bonds responds almost immediately to the Fed raising rates? 

 

If you also get paid to increase duration, that's a double win, but it is not the only one.

 

Clearly the discount rate rises so the impact on p/bv from rates rising on short term investments should be negligible, but I am not entirely sure the market works that way. I think it may well capitalise "predictable" interest income at a higher rate than lumpy underwriting income or very lumpy investment income, so as interest income rises in absolute terms the p/bv may rise. I am speculating.

[bearprowler6]

1 minute ago, petec said:

One thing that has been nagging at me for a couple of years - and I know it has been discussed here before, but I'm not sure we ever got to a good answer - is why does FFH keep putting capital into the subs when according to the annual report the subs have capacity (in aggregate) to grow underwriting 1.5x or more on the existing capital base?

 

Anyone got a clear view on this?

 

It's potentially very important, because if the subs can grow without needing capital - or even, while dividending it to the holdco - that really changes the cash flow dynamics at the holdco and the possibilities for buying back shares or stakes.

This question needs to be put to Prem at the upcoming annual meeting and we should insist on a clear/detailed response. Good luck with that.

 

One answer provided on here that made some sense is that the comments about the subs having adequate capital was made when interest rates were trending upwards and before the equity markets collapsed at the beginning of covid. 

 

This may explain things but it is a classic example of how Prem communicates. He says/writes something definitively and is taken as such by certain investors yet situations exist which could potentially derail what he has said. I have come to label this as "Prem speak". He either does  this purposely or is blind to the risks of saying something with such certainty that could be proven to be inaccurate. Either scenario is not good! 

 

 

 

 

 

 

[petec]

11 minutes ago, bearprowler6 said:

One answer provided on here that made some sense is that the comments about the subs having adequate capital was made when interest rates were trending upwards and before the equity markets collapsed at the beginning of covid. 

 

If that is the case then we should not see any further capital injections, and might start to see dividends. That would be positive.

[TwoCitiesCapital]

53 minutes ago, petec said:

 

Surely your income on your cash and short bonds responds almost immediately to the Fed raising rates? 

 

If you also get paid to increase duration, that's a double win, but it is not the only one.

 

Clearly the discount rate rises so the impact on p/bv from rates rising on short term investments should be negligible, but I am not entirely sure the market works that way. I think it may well capitalise "predictable" interest income at a higher rate than lumpy underwriting income or very lumpy investment income, so as interest income rises in absolute terms the p/bv may rise. I am speculating.

 

You do get the benefit of higher income - temporarily. You also get the immediate loss of income when the Fed cuts - which they immediately in 2019. 

 

Fairfax got 1-2 years of lower income in 2017/2018, 1-2 years of "higher" income in 2018/2019, and then 2-3 years of lower income in 2019 - 2022. 

  

They missed out on $1+B of paper losses in 2016/2017. Amazing!

They also missed out on over $1B of paper gains in 2019/2020. Sucks!

And with all of that, rates are about where they were when they dumped the bonds. 

 

Just wish at some point they'd have congratulated themselves on the great call, and moved 30-50% of the portfolio back into intermediate bonds to lock it in. Particularly once yield curves inverted, the Fed was cutting, global PMIs dipped below 50, and was clear we were in a manufacturing recession - all reasons to question their higher inflation/higher rate narrative and all occurred in 2019 long before covid. 

 

Also, I agree with your skepticism on markets working via a discount rate. It makes sense in theory, but doesn't seem to hold much water in practice.  Particularly comparing relative values across countries or the same country across time. 

Edited March 17, 2022 by TwoCitiesCapital

[Viking]

On 3/16/2022 at 9:44 AM, KFS said:

There are obviously many factors impacting Fairfax's stock price as discussed endlessly on this board, but I think it’s worth remembering FFH’s price/book ratio over the past several years -- like many insurance companies -- has been fairly well correlated with interest rates as you can see in the two 5-year charts below. 

 

Just looking at some random data points over the past 5 years:

                                                P/B                       10-year %

July 2017                              1.15                        2.30%

August 2018                        1.20                        2.95%

October 2018                     1.25                        3.15%

August 2019                        1.03                        1.80%

Feb 2020                              1.00                        1.50% (just prior to covid crash)

April 2020                            0.70                        0.65% (just after covid crash)

August 2021                        0.86                        1.28%

March 2022 (today)          0.76                        2.16%

 

Today, with the recent increase in rates, it sure seems FFH stock has not responded in the typical way….  As perhaps other factors are weighing heavily on the stock, or the market is simply asleep in failing to acknowledge this rise and the impact it could have on the company’s earning potential.  Today the 10-year yield is at 2.16% and rising, and yet the P/B is lagging behind, still ~0.76.  FFH’s insurance business/float has increased quite dramatically over the past few years, and one would expect rates to be an even stronger factor going forward, yet here we are.  Like I said, there are obviously many other things affecting the stock as you all know, but I think it’s worth being aware of this historical relationship vs. the apparent lapse today... 

 

 

@KFS my guess is reported traditional ‘operating income’ is the financial metric most highly correlated with Fairfax’s price to BV multiple. By operating income i mean strictly underwriting profit + interest/dividends (not share of profit of associates). And for underwriting profit this includes runoff. When ‘operating income’ is trending up then Fairfax trades at a higher price to BV multiple. When ‘operating income’ is trending down (like now) Fairfax trades at a lower price to BV multiple. (At least that is my guess…). I think this is how most analysts look at and report on all insurance companies, including Fairfax (90% of their reports, including earnings estimates, focusses pretty much exclusively on operating income). 
 

So as per your question, this incorporates the importance of interest rates but with 2 important caveats:

1.) changes Fairfax makes to its fixed income portfolio matters

2.) there will be a lag before these changes flow through to reported results and analysts update their models

From my perspective how interest rates actually increase or decrease interest and dividend income in reported results is what matters. 
—————

I think the equity investing side of Fairfax is largely ignored by most analysts (in terms of including in earnings estimates). Results are way, way too volatile - and not just quarter to quarter but also year to year. Even if they wanted to, whatever estimate they put in for equities will likely be wildly wrong and they will look stupid. So they do what any rational analyst would do and that is ignore the equity holdings (in terms of earnings estimates). And report on this ‘bucket’ only after the fact.

—————

The good news? I think Fairfax could be at the next inflection point for operating income. I think 2021 might be the bottom. And i think operating income will increase nicely in 2022 - and it could increase significantly. Why?

1.) underwriting income should improve from 2021 (lower CR and much higher net premiums)

2.) interest and dividend income should increase from 2021 (given big increase in short term rates since Jan 1)

If Fairfax reports higher operating income, starting with Q1 results, i would expect analysts to update their models and it makes sense to me the improved visibility into future earnings will result in Fairfax stock trading at a higher price to BV.

Edited March 17, 2022 by Viking

[Xerxes]

19 hours ago, glider3834 said:

I have just updated my fixed income portfolio duration chart for Fairfax vs peers

 

 

 

Thats a great chart. Watsa the outlier. 
One big call option that other have less of. 
 

- Everybody else is right now until they aren’t. 
- Watsa the outlier is wrong now until he is right. 

[StubbleJumper]

3 hours ago, petec said:

One thing that has been nagging at me for a couple of years - and I know it has been discussed here before, but I'm not sure we ever got to a good answer - is why does FFH keep putting capital into the subs when according to the annual report the subs have capacity (in aggregate) to grow underwriting 1.5x or more on the existing capital base?

 

Anyone got a clear view on this?

 

It's potentially very important, because if the subs can grow without needing capital - or even, while dividending it to the holdco - that really changes the cash flow dynamics at the holdco and the possibilities for buying back shares or stake.

 

Ok.  One dollar of capital allows NB or C&F to write about $1.60 or $1.70 of premium.  At a 94 CR that generates about 10 cents of UW profit, and then hopefully they make another 8 cents by investing the premiums.  So, if they make 18 cents on that $1 of capital, ignoring taxes and the return on investing the original dollar, how much more business can they write the following year?  About 28 or 30 cents more (ie 1.6x or 1.7x incremental capital).  That would be growing the book by about 17 or 18 pct.  But, in 2021, the book grew *faster* than that.  Need to inject a bit of capital if you want 20+ pct growth!

 

The subs will gush cash when growth slows and capital will be in surplus.

 

 

SJ

 

 

[glider3834]

5 hours ago, TwoCitiesCapital said:

 

You do get the benefit of higher income - temporarily. You also get the immediate loss of income when the Fed cuts - which they immediately in 2019. 

 

Fairfax got 1-2 years of lower income in 2017/2018, 1-2 years of "higher" income in 2018/2019, and then 2-3 years of lower income in 2019 - 2022. 

  

They missed out on $1+B of paper losses in 2016/2017. Amazing!

They also missed out on over $1B of paper gains in 2019/2020. Sucks!

And with all of that, rates are about where they were when they dumped the bonds. 

 

Just wish at some point they'd have congratulated themselves on the great call, and moved 30-50% of the portfolio back into intermediate bonds to lock it in. Particularly once yield curves inverted, the Fed was cutting, global PMIs dipped below 50, and was clear we were in a manufacturing recession - all reasons to question their higher inflation/higher rate narrative and all occurred in 2019 long before covid. 

 

Also, I agree with your skepticism on markets working via a discount rate. It makes sense in theory, but doesn't seem to hold much water in practice.  Particularly comparing relative values across countries or the same country across time. 

twocities I think the answer to your question is around how they manage liabilities/loss reserves. 

 

This is an extreme scenario but just to illustrate - in 2018, Argentina had mid 40s inflation rate, Fairfax's sub there had a CR in 120s as a result. But Fairfax I believe was able to still make a profit as it was able to invest in short-term rates at 40%. So having that flexibility by being short duration, if you believe inflation could go a lot higher can be important.

 

I don't disagree that they should have invested more in intermediate bonds in 2018, so yes that was a missed opportunity - but at the same time we are looking in hindsight too. Fairfax have to brainstorming these 'what if' scenarios all the time & I think they will also make bets on different scenarios.

 

Here is a good article on this subject The Inflation Specter Looms for Property/Casualty Insurers  https://www.insurancejournal.com/news/national/2021/03/23/606467.htm

 

 

 

 

Edited March 17, 2022 by glider3834

[petec]

2 hours ago, StubbleJumper said:

Need to inject a bit of capital if you want 20+ pct growth!

Not if you started with excess capital, which is effectively what Prem has said repeatedly in his letters with the “in the last hard market we wrote at 1.5x” claims. 

[Madpawn]

Hey everyone, I've been following this Forum since I started investing 5 yrs ago and finally pulled the trigger on buying a membership (I think it used to be free but became pay to comment?) ~

 

So a bit of a beginner question from me: Why does Fairfax not acquire businesses like Berkshire does, nor does it mention having any plans / ambitions to do so? It has acquired meaningful positions in many companies but correct me if I'm wrong - it has not really "absorbed" other companies, why is that?

[Viking]

Now i am not sure what goes into AM Best estimates, but if US P&C finished 2021 with a 102CR then it makes sense to me we should see the hard market continue well into 2022. And with inflation ripping and likely to stay elevated perhaps the hard market continues into 2023. 
 

If interest rates continue to increase the value of bond holdings will fall, especially for those insurers with long duration portfolios. In Q1 we will likely see large mark to market losses which will hit earnings and also hit book value. Fairfax, with an average duration of 1.2 years in its bond portfolio, is exceptionally well positioned versus peers. Just another reason for the hard market to continue.
—————
U.S. P/C Industry Grew Surplus Despite Underwriting Loss in 2021
- https://www.mynewmarkets.com/articles/183933/u-s-p-c-industry-grew-surplus-despite-underwriting-loss-in-2021

 

“Insurance rating agency AM Best said it expects the U.S. property/casualty insurance industry to record an increase in surplus in 2021 thanks to investment income and capital gains improvements despite booking an underwriting loss of $15.7 billion.

 

Best’s Market Segment Report, “P/C Industry Maintains Solid Capital Despite Increased Challenges in 2021,” said factors such as catastrophe activity, secondary perils, increased loss costs, and more-normalized losses in auto insurance will likely result in an industry combined ratio of 101.8 in 2021 compared to 98.8 in 2020.

 

AM Best expects industry surplus to increase 7.1%, or $66.9 billion, in 2021 to a little more than $1 trillion.”

Edited March 18, 2022 by Viking

[Viking]

5 hours ago, Madpawn said:

Hey everyone, I've been following this Forum since I started investing 5 yrs ago and finally pulled the trigger on buying a membership (I think it used to be free but became pay to comment?) ~

 

So a bit of a beginner question from me: Why does Fairfax not acquire businesses like Berkshire does, nor does it mention having any plans / ambitions to do so? It has acquired meaningful positions in many companies but correct me if I'm wrong - it has not really "absorbed" other companies, why is that?

@Madpawn welcome to the dark side  

 

While Fairfax, Berkshire and Markel are all insurance companies that invest heavily in equities, all 3 do so in a very different way. Why the differences? Different business models. Berkshire is looking to own its positions forever. Fairfax, on the other hand, is looking to buy low and sell high. Fairfax also likes for businesses it controls to also trade on the stock market to allow for better price discovery (for Fairfax shareholders to better understand the actual market value of its various equity holdings).

[StubbleJumper]

7 hours ago, petec said:

Not if you started with excess capital, which is effectively what Prem has said repeatedly in his letters with the “in the last hard market we wrote at 1.5x” claims. 

7 hours ago, petec said:

 

 

Yeah.  Not too sure why Prem keeps saying that's. C&F has been visibly capital constrained for two or three years now.  ORH, on the other hand, hasn't had any problem.  

 

SJ

[Madpawn]

9 hours ago, Viking said:

@Madpawn welcome to the dark side  

 

While Fairfax, Berkshire and Markel are all insurance companies that invest heavily in equities, all 3 do so in a very different way. Why the differences? Different business models. Berkshire is looking to own its positions forever. Fairfax, on the other hand, is looking to buy low and sell high. Fairfax also likes for businesses it controls to also trade on the stock market to allow for better price discovery (for Fairfax shareholders to better understand the actual market value of its various equity holdings).

Do we know why this model hasn’t changed? Given how Fairfax hasn’t been that successful with stock picks, why not own a few OpCos?

[Viking]

1 hour ago, Madpawn said:

Do we know why this model hasn’t changed? Given how Fairfax hasn’t been that successful with stock picks, why not own a few OpCos?

One strategy is responsible for Fairfax’s underperformance from 2011-2020: shorting strategy. That aspect of their investing strategy has changed: they will no longer short stocks or indices.

 

In terms of stock picking, Fairfax has a pretty good track record over their 35 years (this is my guess… i have not run the numbers). Atlas was their most recent massive purchase and it is looking very good. Another recent medium sized purchase, Stelco, is also looking very good. Another recent smaller purchase, Dexterra, is also looking very good. 
 

Fairfax also employs some non-traditional strategies that i group in the equity bucket: their recent purchase of FFH TRS giving them exposure to 1.96 million Fairfax shares looks like a solid move to me.

 

Bottom line, Fairfax is not Berkshire and never will be. It is Fairfax. With the shorting strategy in the rear view mirror my guess is reported results and BV growth at Fairfax will be much better the next 5 years than it was the 10 years from 2011-2020. 

[Madpawn]

1 hour ago, Viking said:

One strategy is responsible for Fairfax’s underperformance from 2011-2020: shorting strategy. That aspect of their investing strategy has changed: they will no longer short stocks or indices.

 

In terms of stock picking, Fairfax has a pretty good track record over their 35 years (this is my guess… i have not run the numbers). Atlas was their most recent massive purchase and it is looking very good. Another recent medium sized purchase, Stelco, is also looking very good. Another recent smaller purchase, Dexterra, is also looking very good. 
 

Fairfax also employs some non-traditional strategies that i group in the equity bucket: their recent purchase of FFH TRS giving them exposure to 1.96 million Fairfax shares looks like a solid move to me.

 

Bottom line, Fairfax is not Berkshire and never will be. It is Fairfax. With the shorting strategy in the rear view mirror my guess is reported results and BV growth at Fairfax will be much better the next 5 years than it was the 10 years from 2011-2020. 

Yes I agree with the leaving shorting behind strategy. I guess I’ve always hoped Fairfax to get into OpCos because they do have a similar set of values to Berkshire. Prem has frequently brought up how Fairfax is a long term partner to the companies it invests in. That’s why I thought it might aswell buyout some companies and go on a similar path as Berkshire. I simply hope Fairfax doesn’t use the funds from its insurance business to do trading rather than investing.
 

[glider3834]

5 hours ago, Madpawn said:

I simply hope Fairfax doesn’t use the funds from its insurance business to do trading rather than investing.

I would probably describe them as active portfolio managers - they have a mix of long-term strategic holdings & other non-strategic investments. They will be opportunistic - for example last year they were net sellers of equities & bonds & built up their cash & ST investments to 50% of their portfolio as at 31 Dec-21. I think that is just a function of them being unable to find enough value in both equity or bond markets & concern around inflation driving interest rates higher.

 

After the stock market crash in March/April 2020, we added approximately $1.1 billion in common stocks. We have sold these positions for a gain of $620 million or 56%.

 

During 2021, we sold $5.2 billion in corporate bonds, mainly acquired in March/April of 2020, at a yield of approximately 1%, for a gain of $253 million.

 

 

 

 

 

 

 

Edited March 19, 2022 by glider3834

[Viking]

I have updated my spreadsheet that captures Fairfax's various 'equity' holdings. I have started updating the information to capture what was supplied in the AR and new news like the increase in Fairfax India. So how are Fairfax's equity holdings performing Jan 1 - March 18? In aggregate my spreadsheet says they are down about $300-$350 million or about 2-2.5%. Given the S&P 500 is down YTD by 6.4% this is solid performance. Mark-to-market decline is about $250 million = $10/share (pre-tax). 

 

QTD Big Swingers

- Blackberry - $236

- Quess         - $178

- CIB                - $81

- Eurobank    +$166

- Atlas            +$131

- Stelco           +$85 

 

Please note: for some holdings my share count does not exactly match the share count provided in Prem’s letter. My share count includes Riverstone UK holdings; i will update my count as we learn more over 2022. As per usual, let me know if you catch any big errors with my numbers  

Fairfax Equity Holdings March 18 2022.xlsx

Edited March 19, 2022 by Viking

[Parsad]

On 3/17/2022 at 9:01 AM, petec said:

One thing that has been nagging at me for a couple of years - and I know it has been discussed here before, but I'm not sure we ever got to a good answer - is why does FFH keep putting capital into the subs when according to the annual report the subs have capacity (in aggregate) to grow underwriting 1.5x or more on the existing capital base?

 

Anyone got a clear view on this?

 

It's potentially very important, because if the subs can grow without needing capital - or even, while dividending it to the holdco - that really changes the cash flow dynamics at the holdco and the possibilities for buying back shares or stakes.

 

Say there was a large catastrophe year and now premiums for ORH's business skyrocket.  ORH can write business at 1.5 x statutory surplus, but that may lead to a review or downgrade by credit rating agencies.  So while you can write at 1.5 x statutory surplus, you don't want to unless premiums are extremely favorable.  Instead, if you increase the amount of statutory surplus within the insurance business, you can still write at below 1.5 x statutory surplus while taking advantage of better premium pricing. 

 

The higher ratio you are writing at, worries credit rating agencies that you have less capacity to underwrite new business...in other words, they may assume that you are underpricing business, or have less capacity to write at a higher price, and may incur more future losses.  Does that make sense? 

 

When Prem says the subs have excess capital, he means that they will generally be profitable and over reserved on the business they are underwriting in future development years as the claim is paid out.  2002-2005, the last time they wrote at 1.5 x statutory surplus was after 9/11, Hurricanes Katrina, Andrew, Ivan, Charley & Rita, so you had like four or five outlier events in a row, with over the equivalent of $150-$200B in insurance losses in today's dollars.  It's unlikely they will risk writing at 1.5 x statutory surplus unless we see more catastrophe losses and continued upward pressure on premium pricing.  Cheers!