Fairfax 2023

[modiva]

20 hours ago, SafetyinNumbers said:

 

Can you expand on why you think leverage hurts the increase in equity/share? Usually leverage accelerates returns as long as they are above the cost of debt, which they certainly have been for the past 5 years.

 

@SafetyinNumbers   The key is if the returns on debt are better than otherwise.   Let's look at the numbers for Fairfax and compare with Berkshire for the same period.  Although, it is not apples to apples, exactly.  I put together these numbers quickly from the annual reports so they may not be precise.  

 

During 2017-2022, Berkshire's book value went up more than Fairfax's book value, despite Berkshire's share count went down less than Fairfax's share count (and all the other good things such as increase in float etc.).  Fairfax's net debt went up much more in that period.  

 

This doesn't make Fairfax's performance any less impressive.  It is that the equity returns should be more than the debt increases.  Perhaps there is a time lag, and we see outsized equity returns in the coming years, but they are not there just yet. 

 

 

[SafetyinNumbers]

2 hours ago, modiva said:

 

@SafetyinNumbers   The key is if the returns on debt are better than otherwise.   Let's look at the numbers for Fairfax and compare with Berkshire for the same period.  Although, it is not apples to apples, exactly.  I put together these numbers quickly from the annual reports so they may not be precise.  

 

During 2017-2022, Berkshire's book value went up more than Fairfax's book value, despite Berkshire's share count went down less than Fairfax's share count (and all the other good things such as increase in float etc.).  Fairfax's net debt went up much more in that period.  

 

This doesn't make Fairfax's performance any less impressive.  It is that the equity returns should be more than the debt increases.  Perhaps there is a time lag, and we see outsized equity returns in the coming years, but they are not there just yet. 

 

 

With less debt, they wouldn't have been able to buyback as many shares as they did. I don't see how comparing it to BRK helps your position. 

[modiva]

43 minutes ago, SafetyinNumbers said:

With less debt, they wouldn't have been able to buyback as many shares as they did. I don't see how comparing it to BRK helps your position. 

 

True it helped with more buybacks, but overall, their debt isn't translating to greater equity returns yet.  The comparison is to show how BRK's debt is translating to greater equity returns (relative to FFH). 

[TwoCitiesCapital]

2-year treasuries are off recent highs (yields) by over 0.80%. that's a pretty big move - especially when more rate hikes were expected. 

 

Historical Fed action has basically just followed the market rate for the 2-year. Is this the end of the hiking cycle? 

 

Without knowing what Fairfax did in Q1, we won't know if they added duration. But seeing as they didn't buy 10-years at 4.25%, I doubt they're buying them today at 3.5%. It's possible they locked in more 2-years near 5% which would be nice, but I'm afraid even that will roll off quickly in a rate cutting scenario. 

[glider3834]

5 hours ago, TwoCitiesCapital said:

2-year treasuries are off recent highs (yields) by over 0.80%. that's a pretty big move - especially when more rate hikes were expected. 

 

Historical Fed action has basically just followed the market rate for the 2-year. Is this the end of the hiking cycle? 

 

Without knowing what Fairfax did in Q1, we won't know if they added duration. But seeing as they didn't buy 10-years at 4.25%, I doubt they're buying them today at 3.5%. It's possible they locked in more 2-years near 5% which would be nice, but I'm afraid even that will roll off quickly in a rate cutting scenario. 

I am not sure to what extent 10 year Treasuries are an option for Fairfax if you look at their  maturities table, appears around 56% of insurance and financial liabilities mature within 0-3 years, 14% in 3-5 years & remaining 30% after 5 years.

 

For those longer duration liabilities like 10 yrs or more, & looks like Fairfax doesn't break out insurance liabilities after 5 yrs, wouldn't inflation hedge like investments, such as real estate, be preferable because rents can be increased whereas 10 year treasury rate are fixed

 

 

Edited March 13, 2023 by glider3834

[glider3834]

29 minutes ago, glider3834 said:

I am not sure to what extent 10 year Treasuries are an option for Fairfax if you look at their  maturities table, appears around 56% of insurance and financial liabilities mature within 0-3 years, 14% in 3-5 years & remaining 30% after 5 years.

 

For those longer duration liabilities like 10 yrs or more, & looks like Fairfax doesn't break out insurance liabilities after 5 yrs, wouldn't inflation hedge like investments, such as real estate, would be preferable because rents can be increased whereas 10 year treasury rate are fixed?

 

 

looking at their portfolio slide from last years AGM, I suspect that the common stock positions, real estate etc are being used to match the longer duration, 5 yr plus maturing liabilities 

 

Edited March 13, 2023 by glider3834

[TwoCitiesCapital]

5 hours ago, glider3834 said:

I am not sure to what extent 10 year Treasuries are an option for Fairfax if you look at their  maturities table, appears around 56% of insurance and financial liabilities mature within 0-3 years, 14% in 3-5 years & remaining 30% after 5 years.

 

For those longer duration liabilities like 10 yrs or more, & looks like Fairfax doesn't break out insurance liabilities after 5 yrs, wouldn't inflation hedge like investments, such as real estate, be preferable because rents can be increased whereas 10 year treasury rate are fixed

 

 

 

The 10-year treasury is less about hedging insurance liabilities (in which case you'd probably want to opt for corporates and mortgages for the spread).

 

It's about locking in the benefits of the previous underweight in duration by locking in exposure now so if rates fall we don't backtrack on all of interest income growth we've seen. Additionally, it provides consistency and transparency to forward interest income so the market can put a multiple on future earnings and rerate the stock (good for TRS swaps too;). Lastly, it can hedge a prolonged equity drawdown/economic event. 

 

Leading indicators are at levels that have previous been consistent with -4 to -6% GDP growth. What happens to equities on that environment? What happens to interest rates? 10-year bonds immediately add duration to an excessively short duration portfolio and help hedge that event while locking in rates near their highest levels in 15+ years. I would love to see duration of at least 4 before rates start cratering. 

 

 

Edited March 14, 2023 by TwoCitiesCapital

[gurjot]

On 3/10/2023 at 2:53 PM, vinod1 said:

Almost! 20 percent! increase! in! exclamation! points! from! 2021 AL!

 

27 to 32!!!!!!!!

good year all around including exclamations!  and modi praises!

 

[Xerxes]

This BBC documentary caused a raid at their office in India !

[vinod1]

On 3/14/2023 at 12:31 AM, gurjot said:

good year all around including exclamations!  and modi praises!

 

 

The level of ass kissing is nauseous. Cost of doing business in India.

[giulio]

Here is what I found most interesting reading FFH 2022 annual report:

• Ki had a CR of 99% and received a $152M investment from a third-party investor

  • gross premiums written of $834 million in only its second year of operation

  • IIRC Brit has 20% economic interest in Ki; curious to know what the plans are for Ki and why Brit opted for only a 20% interest

  • Interestingly, Ki and Digit writes similar level of premiums; of course, prospects are materially different, I wonder what Ki valuation might be

• consolidated investments' total revenue of $5.6 billion, EBITDA of $743 million and pre-tax income of $303 million (excluding a $133 million writedown of Farmers Edge) before minority interest in 2022

  • Management guidance: 15% on 2.1B BV (this is what I understand from Watsa's letters)

  • Nice to see a table on consolidated companies' EBITDA, interest expense, D&A and pre-tax income (page 208)

  • Markel ventures in 2022 = revenues of $4.8 billion, record EBITDA of $506 million

• 

  • Reserves development has not been so "favourable" since 2017: 3 years of losses, an improvement in the last 2 years, but a major "help" was from FX

  • Maybe this will improve as past acquisitions are digested and a better underwriting discipline prevails

• Future allocation -> I think FFH will spend roughly $2.3B repurchasing minority interests in its insurance companies (excluding dividends). I think these deals, similar to Eurolife's, have a fixed price (i.e. a call option). In 2022 FFH paid $650M for 12% of Allied (650M cash + value of the option + dividend accrued = 733.5M as reported); based on these numbers, I estimate FFH will pay another $930M for the remaining 17.1%, for a total of approximately $1.6B (what co-investors invested in 2016). Add to this $900M related to Odyssey and $375M for Brit.

  • FFH has the option to purchase the remaining interests of the minority shareholders

    • in Allied World at certain dates until September 2024

    • in Brit at certain dates commencing in October 2023

    • in Odyssey Group at certain dates commencing in January 2025

  • As a side note: FFH essentially uses OMERS et alius as debt providers, paying them dividends (interests) at a 7-8% rate

• Insurance market: "Favourable underwriting conditions are expected to continue into 2023, albeit more modestly after very healthy rate increases in both 2021 and 2022"

  • don't expect 15%+ growth in 2023

• Unless...

  • "if interest rates remain higher for longer, the unrealized investment losses will take many years to unwind and could prolong the hard market for a few years

  • The reinsurance sector continued (...) to achieve significant rate increases. Following the landfall of Hurricane Ian, in 2023 the reinsurance market sustained its most challenging January 1st renewal season since 2001, following the 9/11 attacks

• float increased by $3,393.1 to $31,230.0 (12% growth)

• I highlighted a couple of lines on the company strong culture which I believe is underestimated and not  enough appreciated as a competitive advantage (20 years of service for officers...these people want to stay and grow within Fairfax, it must be good!)

Very happy to receive comments and discuss if I missed something or if there are errors in what I wrote!

 

Thanks,

G

[TwoCitiesCapital]

On 3/13/2023 at 9:41 AM, TwoCitiesCapital said:

2-year treasuries are off recent highs (yields) by over 0.80%. that's a pretty big move - especially when more rate hikes were expected. 

 

Historical Fed action has basically just followed the market rate for the 2-year. Is this the end of the hiking cycle? 

 

Without knowing what Fairfax did in Q1, we won't know if they added duration. But seeing as they didn't buy 10-years at 4.25%, I doubt they're buying them today at 3.5%. It's possible they locked in more 2-years near 5% which would be nice, but I'm afraid even that will roll off quickly in a rate cutting scenario. 

 

2-year is now off by nearly 1.25% in less than a week. 10-year is still at 3.5% but curve is massively bull flattening. 

 

Unless if Fairfax acted fast in Q1, I'm gonna guess we missed the duration extension again

 

Best hope now is they make it up on the back end with some savvy purchases in credit turmoil like they did in 2020, but still not as good as going  into this thing with duration and still making those same plays. 

Edited March 15, 2023 by TwoCitiesCapital

[Xerxes]

They stayed short-term since 2016, and kept the view no matter what came (covid), believing that secular bear in interest rate will be long term, secular and with many cyclical dips, here and there.  
 

I think today’ yield dropping is a scenario in line with a cyclical dip.  
 

So FFH stock will/should dip, because market will see that as them missing the boat. But they got their eyes on that long term secular bear. 

[This2ShallPass]

13 hours ago, Xerxes said:

They stayed short-term since 2016

So, how did they do in 7 years overall vs. say a Markel who state they will not try to predict rates?

 

I know most folks are giving them a pass, but unwilling to extend the duration even by a little in Q4 was a mistake. No need to go all-in when they already had the huge win.

[TwoCitiesCapital]

2 hours ago, This2ShallPass said:

So, how did they do in 7 years overall vs. say a Markel who state they will not try to predict rates?

 

I know most folks are giving them a pass, but unwilling to extend the duration even by a little in Q4 was a mistake. No need to go all-in when they already had the huge win.

+1

 

Even staying on the short end, they have underperformed inflation - so that's a terrible strategy for a secular inflationist. 

 

And by not extending duration, they lose any chance of outperforming inflation on the way down via capital gains/duration. 

 

Owning short duration worked for the last 18 months. With rates at 15+ year highs while economic data deteriorated? Yea, it was obvious it was time to start locking it in. 4 years wouldn't have been imprudent and would still have largely been very short relative to liabilities and fixed income benchmarks.

 

We'll see if they extended in Q3, but I'm not optimistic. 

[Santayana]

But they have been extending duration, maybe not as much as you'd like, but it definitely went up from YE 2021 to 2022. 

 

It also might be a bit premature to say they've missed the opportunity to keep extending just because there's been some market turmoil over the last week.  I still believe that Powell has been very clear that rates aren't coming down anytime soon, higher for longer has been his mantra, and the 2 things that drive the Fed, inflation and jobs, aren't giving signs that they should reverse course.

[Xerxes]

Hey at least they are getting some snap back on the M2M unrealized paper losses. 
 

If we can’t have FFH locked in even at higher rate (higher interest payment), reversing paper losses is your second prize (unwanted as it is) 

[Dudley]

Does anyone have a good handle on the impact of the implementation of IFRS 17?

 

My understanding is that it would require insurers to apply a discount rate (for the first time) to long-term insurance contract liabilities. As a result of rising rates, this should in theory shrink liabilities and expand book value.

[TwoCitiesCapital]

2 hours ago, Santayana said:

But they have been extending duration, maybe not as much as you'd like, but it definitely went up from YE 2021 to 2022. 

 

It also might be a bit premature to say they've missed the opportunity to keep extending just because there's been some market turmoil over the last week.  I still believe that Powell has been very clear that rates aren't coming down anytime soon, higher for longer has been his mantra, and the 2 things that drive the Fed, inflation and jobs, aren't giving signs that they should reverse course.

 

A cascading banking crisis will kill both AND tighten financial conditions. 

 

The measures put in place to allow banks to borrow liquidity instead of selling treasuries simply moves the pain to their income statement (due to the negative NIM) as opposed to the balance sheet. As consumers move cash deposits to productive allocations like money market, short term treasuries OR liability reduction/negative savings, banks lose deposits, accept negative NIM for the liquidity, and earnings get killed. 

 

Credit was already constrained and tightening - it's about to do even more of that and banks will have cratering earnings in response (but not solvency issues ). 

 

The Fed has maybe one 0.25% hike in March left in it. That'll demonstrate their commitment to fighting inflation. Then, they'll hold short end rates higher for longer to further demonstrate that commitment. But rate hikes are basically done and inflation 12 months of out is already 0 to negative IMO. 

 

It IS too early to say they missed it, but I doubt they did much in Q1 since they didn't in Q4 and I'm gonna go out on a limb and say the highs are in for long term rates. Probably the 2-year as well. 

Edited March 16, 2023 by TwoCitiesCapital

[MMM20]

Lots of interest rate prognosticators with a clear crystal ball on here, apparently. Idk why Fairfax would lock in anything below 5% with any sort of duration when they should be able to do twice that (and with less inflation risk) in other areas of the portfolio. Hopefully Prem has truly internalized Buffetts lesson to take what the market gives you and 3-4% rates are still insanely low in the long arc of history. Cash and cheap stocks are still looking much better to me. Even 7%+ mortgages with the ability to foreclose and own the properties it comes to that… IMHO makes a lot more sense for an insurer (and basically anyone else) than lending to the government with similar duration at half that return in a best case scenario. 

 

Edited March 16, 2023 by MMM20

[TwoCitiesCapital]

1 hour ago, MMM20 said:

Lots of interest rate prognosticators with a clear crystal ball on here, apparently. Idk why Fairfax would lock in anything below 5% with any sort of duration when they should be able to do twice that (and with less inflation risk) in other areas of the portfolio. Hopefully Prem has truly internalized Buffetts lesson to take what the market gives you and 3-4% rates are still insanely low in the long arc of history. Cash and cheap stocks are still looking much better to me. Even 7%+ mortgages with the ability to foreclose and own the properties it comes to that… IMHO makes a lot more sense for an insurer (and basically anyone else) than lending to the government with similar duration at half that return in a best case scenario. 

 

 

Sure, would love to see them buy agency MBS too. I've been commenting favorably on that in other threads. ANYTHING other than keeping duration at sub-2 years.

 

I just want SOME consistency in interest income for the next 2-4 years and for them to lock in the benefit of being short rates during a historic hiking cycle. If we go back near zero, and interest income is cut by more than half over the ensuing twelve months as 1/2 of the highest yielding securities in the portfolio roll off, then we're right back to where we we started. No benefit from being short rates, interest income back in the dump, no hedge to equities, and only one-off savvy/opportunistic credit investing to make money.

 

And the shame of it all would be is that by owning treasuries and MBS they'd be enhancing option #3 because they could most likely be sold for gains in that environment. 

Edited March 16, 2023 by TwoCitiesCapital

[SafetyinNumbers]

It's hard for me to argue with them on market timing of interest rates. They seem to be doing pretty well. 

 

I can't imagine what they would do with the book right now that would make me want to sell the stock because although rates might come down, float and premiums are likely to keep growing. It's hard to see operating earnings being under US$100/share in 5 years so it's hard to see returns being under 10% year over 5 years as well. That's without attributing any returns to the investment portfolio and I don't believe they have had a negative 5 year period on the investments.

 

If the stock goes down, don't buybacks go up especially if premium growth slows down? Does that makes drawdowns temporary until we get to 1.2x book value? 

[Viking]

Happy to add to my already oversized position in FFH today. Price traded at $635 for much of the day. Stock is down 9% off its recent highs. BV is $658. My guess is they will earn $130/share in 2023. My guess is Q1 earnings will come in around $35/share. They paid a $10 dividend in January. So my guess is March 31, 2023 BV will be about $685 ($658 + $35 - $10 = $685). 

 

But what about its $38 billion fixed income portfolio. Rising interest rates over the past year must have resulted in billions in held-to-maturity losses… right? Wrong. As crazy as it sounds, Fairfax fixed income portfolio was positioned perfectly on Dec 31, 2022. It is a big, big WINNER from rising interest rates. It is better positioned than any large financial institution i know (bank, insurance etc).
 

Most insurance companies are sitting on billions of held-to-maturity losses right now. These losses did not flow through the income statement. These losses did hit book value (so most now prefer to report ‘adjusted book value’). Yes, the held to maturity losses don’t matter. Silicon Valley Bank thought the exact same thing 10 days ago… and it didn’t matter. Until something happened THAT NO ONE THOUGHT WOULD HAPPEN. Well, now all those held-to-maturity losses do matter. so much so that Silicon Valley Bank is out of business and its shareholders have been wiped out.
 

An accounting gimmick resulted in poor decision making at financial institutions (they did not manage their interest rate risk properly). That is now resulting in a loss in confidence in the financial viability of many financial institutions. An interest rate risk has quickly and unexpectedly morphed into a solvency issue.
 

It will be interesting to see how investors discount held-to-maturity losses on insurance companies books moving forward. Insurance is different? Really? That is what banks thought 10 days ago too. And it was right. Until is wasn’t.

 

I would imagine insurance regulators are probably better understanding which insurance companies a have large held-to-maturity losses sitting on their books. Does this force more conservatism at insurance companies moving forward (i.e. slower growth)? Does this extend the hard market? Bottom line, financial system panics are never a good thing.

 

So at a share price of $635, Fairfax shares are trading at a P/BV of 0.93. Cheap. For a company that is poised to grow earnings by $130 in 2023. This is an effective earnings yield of 20%; or a P/E = 4.9. That is very cheap. And a company that is a big winner of rising interest rates… 

 

I hope the stock keeps going lower in the current financial panic. Fairfax stock has become the gift that keeps on giving (rising stock price with big swings happening 2 or 3 times a year).

Edited March 17, 2023 by Viking

[Dudley]

20 minutes ago, Viking said:

But what about its $38 billion fixed income portfolio. Rising interest rates over the past year must have resulted in billions in held-to-maturity losses… right? Wrong. As crazy as it sounds, Fairfax fixed income portfolio was positioned perfectly on Dec 31, 2022. It is a big, big WINNER from rising interest rates. It is better positioned than any large financial institution i know (bank, insurance etc).

 

Spot on. Who benefits from rising rates? The answer to that question is exactly what drew me into Fairfax this year after watching this stock for the past 7-8 years!

[Parsad]

9 hours ago, Viking said:

 

Most insurance companies are sitting on billions of held-to-maturity losses right now. These losses did not flow through the income statement. These losses did hit book value (so most now prefer to report ‘adjusted book value’). Yes, the held to maturity losses don’t matter. Silicon Valley Bank thought the exact same thing 10 days ago… and it didn’t matter. Until something happened THAT NO ONE THOUGHT WOULD HAPPEN. Well, now all those held-to-maturity losses do matter. so much so that Silicon Valley Bank is out of business and its shareholders have been wiped out.
 

An accounting gimmick resulted in poor decision making at financial institutions (they did not manage their interest rate risk properly). That is now resulting in a loss in confidence in the financial viability of many financial institutions. An interest rate risk has quickly and unexpectedly morphed into a solvency issue.
 

It will be interesting to see how investors discount held-to-maturity losses on insurance companies books moving forward. Insurance is different? Really? That is what banks thought 10 days ago too. And it was right. Until is wasn’t.

 

I would imagine insurance regulators are probably better understanding which insurance companies a have large held-to-maturity losses sitting on their books. Does this force more conservatism at insurance companies moving forward (i.e. slower growth)? Does this extend the hard market? Bottom line, financial system panics are never a good thing.

 

 

Insurance is different than banking.  Really no other industry uses as much leverage as banking.  When depositors start to demand their money, there is little a bank can do but sell their fixed income portfolio and meet redemptions.

 

Insurance on the other hand has two significant advantages over banking...less leverage and reinsurance to protect a sudden large claim loss.  People don't understand how vulnerable banks actually are and there aren't more run on banks!

 

That being said, Fairfax operates with more leverage than many other insurers, which makes it more vulnerable than other insurers (something I wish they would reduce over time).  It's just fortunate they have great portfolio managers that usually position themselves well compared to macro events. 

 

Really, does Fairfax even need to operate with half the debt that they carry?  They have plenty of asset to equity leverage to hit their ROE target.  They don't need at least half their present debt load...if any!

 

If Fairfax would reduce leverage, I think the markets would be more comfortable maintaining a price above book.  As long as they continue to operate with significant leverage, they will have more problems maintaining the same level in market price stability as Markel or Berkshire.  Cheers!