Fairfax 2023

[vinod1]

15 hours ago, Viking said:

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).

 

Insurance is really different from banking. The insured cannot claim hurricane damage for the year and ask for the money to be paid. The liabilities are pretty predictable. That is why ALM is a big deal at P&C's.

 

 

[SafetyinNumbers]

16 hours ago, Viking said:

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).

 

Viking with great analysis as usual. I think the impact to book value from IFRS 17 could push BV closer to $700 which will make it look slightly cheaper on P/B all else being equal. 

[SafetyinNumbers]

7 hours ago, Parsad said:

 

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!

 

Is it the debt at the holdco that concerns you? What do you think the risks are associated with that debt?

[newtovalue]

I was like Viking yesterday and further made FFH my largest position.

 

It’s getting grouped in with other financials and banks - and Mr market is giving us a chance to add at a great price.

 

Viking thank you as always for your great analysis! 

[modiva]

8 hours ago, Parsad said:

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!

 

Agreed.  For comparison, Fairfax's net debt is twice that of Berkshire's. Fairfax's net debt is ~35% of book, while Berkshire's is ~18% book.  Total debt to book is 43% and 25% respectively.  

[Thrifty3000]

9 hours ago, Parsad said:

 

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!

I’m all for reduced leverage in general. If I look at HOW they’re using debt case by case I can’t get too mad at them for borrowing at historically low rates to buy out minority owners of existing, growing, insurance operations. I’m sure the insurance earnings will cover the debt servicing costs by a sound and growing margin. And, the way their portfolio is structured, any rising interest expense over the next few years should be offset by rising interest income and insurance rates.
 

Now if they were levering up to take a big short position in Tesla I’d be out, haha.

[Viking]

4 hours ago, vinod1 said:

 

Insurance is really different from banking. The insured cannot claim hurricane damage for the year and ask for the money to be paid. The liabilities are pretty predictable. That is why ALM is a big deal at P&C's.

i agree that insurance is different from banking. Here is the piece i do not understand… when interest rates were falling the past 5 years to essentially zero in 2020/2021 did all these P&C insurers not book massive ($billions) in gains on their fixed income holdings? It looks to me that when interest rates were falling the gains from most of the fixed income portfolio flowed through the income statement and book value. I would have expected that in Dec 31, 2001 there should have been billions of gains sitting in the ‘held-to-maturity’ portfolio at all these insurers. 
 

But now that interest rates have spiked higher massive losses are suddenly showing up… and have conveniently been tucked into the ‘held-to-maturity’ bucket so losses do not flow through the income statement. Is my understanding correct?
 

Essentially, the gain (from cratering interest rates) is allowed to flow though the income statement but the loss (from spiking interest rates) is not allowed to flow through the income statement?
 

There is a logic here i do not understand. If anyone has an answer i am all ears. 

Edited March 18 by Viking

[Thrifty3000]

On 3/16/2023 at 12:31 PM, 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. 

 

+1  adding duration risk is pure speculation. God bless the likes of Prem, Buffett and Jamie Dimon for recognizing that and having the discipline to not reach for yield. That’s truly acting like an owner with a long term perspective. Complete opposite of how the bonus-hungry “managers” of SVB, BAC, etc behaved.

[Thrifty3000]

5 minutes ago, Viking said:

i agree that insurance is different from banking. Here is the piece i do not understand… when interest rates were falling the past 5 years to essentially zero in 2020/2021 did all these P&C insurers not book massive ($billions) in gains on their fixed income holdings? It looks to me that when interest rates were falling the gains from most of the fixed income portfolio flowed through the income statement and book value.
 

But now that interest rates have spiked higher the losses are now conveniently tucked into the ‘held-to-maturity’ bucket so losses do not flow through the income statement. is my understanding correct?
 

There is a logic here i do not understand. If anyone has an answer i am all ears. 

Also, if there is a major catastrophe year wouldn’t these insurers have to liquidate HTM assets, book the incurred losses, and essentially have the same effect as what’s happening to the banks? A magnified hit to book value.

 

It seems insurers with large unrealized losses will have to underwrite more conservatively to minimize risk of liquidating HTM assets. That would extend the hard market.

Edited March 18 by Thrifty3000

[vinod1]

8 hours ago, Viking said:

i agree that insurance is different from banking. Here is the piece i do not understand… when interest rates were falling the past 5 years to essentially zero in 2020/2021 did all these P&C insurers not book massive ($billions) in gains on their fixed income holdings? It looks to me that when interest rates were falling the gains from most of the fixed income portfolio flowed through the income statement and book value. I would have expected that in Dec 31, 2001 there should have been billions of gains sitting in the ‘held-to-maturity’ portfolio at all these insurers. 
 

But now that interest rates have spiked higher massive losses are suddenly showing up… and have conveniently been tucked into the ‘held-to-maturity’ bucket so losses do not flow through the income statement. Is my understanding correct?
 

Essentially, the gain (from cratering interest rates) is allowed to flow though the income statement but the loss (from spiking interest rates) is not allowed to flow through the income statement?
 

There is a logic here i do not understand. If anyone has an answer i am all ears. 

 

There is a difference between Statutory Accounting Principles (SAP) used by insurance regulators to assess an insurer's viability vs. GAAP which focuses on financial reporting of economic profits.

 

SAP is more focused on solvency and per my understanding uses amortized cost not MTM. GAAP allows either based on HTM or Trading Assets and profits are reported based on this classification.

 

So yes, to the extent that any insurance company did not use HTM, they would have booked gains and now have to book losses. But insurance regulators are not looking at GAAP book value, they are looking at Statutory Surplus (Statutory Book Value if you will).

 

Many P&C companies have 5-6 year on average for payout. So any given year you are looking at 15%to 20% of portfolio that needs to be liquidated at a maximum and that if the company is in runoff. Most likely it is at least maintaining its book of business which means that much in cash in coming on for new investments. So I do not see much impact from bond losses to P&C companies. 

 

Even if you assume they liquidate 20% of bond portfolio and that fell 15%, we are talking about a 3% hit to overall portfolio. Simply no way P&C can be compared to a bank which is subject to runs.

 

Most P&C companies use ALM strategies. In fact that is a core function. Their payoffs closely match the bond portfolio. 

 

My biggest position is FFX for little over an year. First bought sometime in 2005/6/7 I think at $106, completely exiting in 2011 at $418, sat out most of the last decade except for a cigar puff buy and sell for tiny bumps. I did not trade any stocks in all of 2021 and did not look at the market and hence did not realize how cheaply it was trading. I went to all index in 2020 soon after the pandemic to focus on my kids as I knew if I have any individual stocks I would sucked into spending a lot of time on 10K's. I again started looking at individual stocks in 2022 and bought FFX again and this time, for a longer term hold.

 

I am not arguing FFX strength at this time. But that does not mean other P&C companies are somehow in trouble.

Edited March 19 by vinod1

[MMM20]

 

Analysts starting to get it...maybe just less career risk now that the stock has been up

[Crip1]

1 hour ago, MMM20 said:

 

 

Analysts starting to get it...maybe just less career risk now that the stock has been up

 

Analysts starting to get it...the final paragraph looks like all they did was read Viking's posts.

 

-Crip

[Parsad]

On 3/18/2023 at 7:16 AM, SafetyinNumbers said:

 

Is it the debt at the holdco that concerns you? What do you think the risks are associated with that debt?

 

Not necessarily the debt.  I think under the wrong managers, too much leverage (asset to equity or debt) can kill Fairfax.  Berkshire is built...literally...to be here 100 years from now.  While Fairfax wants to be around 100 years from now, it isn't built for that. 

 

It's the Fairfax managers who've turned around the crappy insurance businesses to make them great insurers, and managed the bond portfolio and equities to prevent a crisis.  Too much leverage under different managers is going to set up a scenario where Fairfax will face its greatest crisis one day.  Cheers!

[Parsad]

On 3/18/2023 at 10:35 AM, Viking said:

 

Essentially, the gain (from cratering interest rates) is allowed to flow though the income statement but the loss (from spiking interest rates) is not allowed to flow through the income statement?
 

There is a logic here i do not understand. If anyone has an answer i am all ears. 

 

It's a matter of practicality versus real world application.  Old bulletin, but still applicable...especially considering what has happened in the last month:

 

https://www.stlouisfed.org/publications/regional-economist/january-1994/making-sense-of-mark-to-market

 

Cheers!

[SafetyinNumbers]

15 hours ago, Parsad said:

 

Not necessarily the debt.  I think under the wrong managers, too much leverage (asset to equity or debt) can kill Fairfax.  Berkshire is built...literally...to be here 100 years from now.  While Fairfax wants to be around 100 years from now, it isn't built for that. 

 

It's the Fairfax managers who've turned around the crappy insurance businesses to make them great insurers, and managed the bond portfolio and equities to prevent a crisis.  Too much leverage under different managers is going to set up a scenario where Fairfax will face its greatest crisis one day.  Cheers!

If it’s not the debt then you think the insurance business is too big vs the other holdings?

[Parsad]

3 hours ago, SafetyinNumbers said:

If it’s not the debt then you think the insurance business is too big vs the other holdings?

 

The combination of the debt with the asset to equity leverage...it's not built like Berkshire to survive a 500-year event and be around for 100 years.  We barely survived Hugo and Andrew...I want Fairfax to be around 100 years plus like Berkshire.  Cut the debt in half and keep another billion in the holdco.  Cheers!

[SafetyinNumbers]

6 hours ago, Parsad said:

 

The combination of the debt with the asset to equity leverage...it's not built like Berkshire to survive a 500-year event and be around for 100 years.  We barely survived Hugo and Andrew...I want Fairfax to be around 100 years plus like Berkshire.  Cut the debt in half and keep another billion in the holdco.  Cheers!

The Asset to equity leverage is just another way of saying our float is too big, isn’t it? Earning $3bn a year should help and I’m guessing you would prefer FFH build capital as opposed to share buybacks. It’s an interesting trade off.

[glider3834]

5 hours ago, SafetyinNumbers said:

The Asset to equity leverage is just another way of saying our float is too big, isn’t it? Earning $3bn a year should help and I’m guessing you would prefer FFH build capital as opposed to share buybacks. It’s an interesting trade off.

Fairfax's avg interest rate is 4.4% on its holdco debt & its mostly fixed and long term with staggered maturities and looks like no '23 maturities- it looks attractive from a funding/cost of capital standpoint at the moment considering the current Fed funds rate is around 4.5%.

 

I think Fairfax should continue buying back shares held by minorities at Allied -they are paying an 8% preferred div to Allied minorities, so it makes sense to me to eliminate this  plus they have a time limit - the option to buyout minorities expires Sep-24.

 

Apart from debt, Fairfax can also target & reduce cat exposure as it is currently doing at Brit. 

 

'Catastrophe losses continued to take their toll on Brit’s loss ratio, adding almost 11 points in 2022. Under new CEO Martin Thompson, actions are being taken to reduce the catastrophe exposure in the future.' (AR 2022)

 

'Only Brit has had a combined ratio greater than 100% since our purchase – due to larger than expected catastrophe losses. We expect this not to be repeated as Brit is reducing its catastrophe exposure significantly.' (AR 2022) (I have highlighted in bold)

 

 

 

 

 

Edited Wednesday at 06:27 AM by glider3834