Fairfax 2023

[Viking]

Of all of the many positive developments at Fairfax over the past 18 months, the spike in interest rates (and subsequent increase in interest income) is the most exciting for shareholders. That is because the interest and dividend bucket is now the biggest driver of earnings for Fairfax.

 

Fairfax has done a masterful job over the past 2 years of navigating the extreme volatility we have seen in interest rates. In Q4 2021, Fairfax did two things: they moved their average duration to 1.2 years and shifted their fixed income portfolio to high quality government securities. In 2022, as interest rates spiked higher, they began extending duration - in Q4, 2022 the average duration had been increased to 1.6 years. The positioning in late 2021 protected Fairfax’s balance sheet when interest rates spiked in 2022 (saving them billions in unrealized losses). It also allowed them to quickly take advantage of much higher interest rates. As a result, Fairfax earned record interest and dividend income in 2022. And 2023 is going to blow 2022 out of the water.  

 

What did we learn when Fairfax reported Q1 results?

 

The big news was they had pushed the average duration of their fixed income portfolio out to 2.5 years. This is a significant development. Because it means the record interest and dividend income will continue for 2023, 2024 and into 2025 - this earnings stream is now predictable and durable. Investors and analysts like this.

 

What did we learn in Q2?

 

We learned four very important things in Q2:

 

1.) Central banks are not done raising interest rates. This is because inflation (especially core readings) is still too high. And parts of the economy are starting to grow again (like housing) and employment remains tight. So, some central banks who had paused rate hikes in early 2023, like Canada and UK, have been forced to start hiking rates again. And despite the recent pause, Powell has telegraphed the Fed will be hiking the US rates at least one more time (and likely two) in the coming months.

 

In addition to the US, Fairfax has significant fixed income holdings in Canada, the UK and Europe. The average duration of their fixed income portfolio is still quite low at 2.5 years (especially when compared to peers, who are closer to 4 years). A higher for longer interest rate regime means Fairfax will be able to roll their maturing bonds into higher yielding securities - which should deliver even higher interest income.

 

2.) Interest rates are rising again. It looked like treasury yields peaked out March 8 in the US. At the end of March yields had plummeted. Fast forward three months to the end of June and treasury yields have spiked higher, with durations of 3 years and less setting new highs.

 

Fairfax is being given another opportunity to increase the average duration of their fixed income portfolio if they want to. Doing so would lock in meaningful interest income beyond 2025. This will be something to monitor when they report Q2 results. 

 

3.) Higher interest rates are causing parts of the financial market to crack, with the meltdown in US regional banks in April the most recent example. Some regional banks have been forced to sell loans at a heavy discount to raise liquidity. In partnership with Fairfax, Kennedy Wilson purchased $2.3 billion (face value) in loans from PacWest Bank. Fairfax will earn 10% on its $2 billion investment, which will generate about $200 million annually in interest income (mostly) and investment gains. I think we can assume Fairfax is likely earning an incremental 5% on this investment (if we assume they were earning 5% on their old investment) so this should result in about $100 million in incremental interest income per year beginning in July (+$25 million per quarter). 

 

4.) Dividend income is headed higher. Extending its close partnership with Kennedy Wilson, Fairfax also invested $200 million in preferred shares with a 6% dividend. This will deliver an incremental $12 million in dividend income to Fairfax each year. (As part of the deal, Fairfax also received warrants for 12.3 million shares of KW with a strike price of $16.21.)

 

Fairfax has most of its fixed income portfolio in government bonds. One of the big advantages of this positioning in the current environment is it allows Fairfax to be very opportunistic to quickly take advantage of temporary market dislocations, like we have just seen with the KW/PacWest transaction. Smart.

 

As central banks continue to increase interest rates it is possible the US could enter a recession later in 2023 or 2024. If this happens it is normal for credit spreads to dramatically widen. Fairfax has stated they are ready to shift a chunk of their fixed income portfolio from government into corporate bonds should yields on the latter pop higher. The cat is ready to pounce.     

 

Over the past 20 months we have been getting a master-class from Fairfax on the benefits of active management of a fixed income portfolio.

 

What does all this mean for Fairfax?

 

Record interest and dividend income is going even higher. The already good ‘fundamentals’ of Fairfax continue to get better.

 

What do the actual numbers look like?

 

Interest and Dividend Income:

• 2021 = $641 million ($27/share).
• 2022 = $962 million ($41/share) = 54% increase YOY.
• 2023E = $1.674 billion ($73/share) = 76% increase YOY.

Fairfax’s share price is $753. The company is trading today for 10 x 2023E interest and dividend income. Compare that to any other insurer… that is NUTS. Especially given the durability of this earnings stream and the quality of the bond portfolio.

 

—————

Interest & dividend income = interest income + dividend income - investment expenses.

 

Interest income:

• Fairfax has a fixed income portfolio of about $40 billion. Interest income will come in around $1.59 billion in 2023 = yield of 3.98%. This is up from 2.25% in 2022 and 1.54% in 2021.

Dividend income:

• Fairfax currently earns about $135 to $140 million per year in dividends from its equity holdings.

Investment expenses:

• Fairfax incurred investment expenses of $52 million in 2022, up from $36 million in 2021. My estimate for 2023 is $52 million.

FYI, Fairfax did not break out interest, dividends and investment expenses when they reported Q1 earnings (they just reported the total number). So some guesswork as to the split will be needed moving forward.

 

 

Check out the unbelievable move in Treasury yields over the past 18 months from Jan 1, 2022 to June 30, 2023.

 

 

Edited July 5, 2023 by Viking

[UK]

16 minutes ago, Viking said:

Of all of the many positive developments at Fairfax over the past 18 months, the spike in interest rates (and subsequent increase in interest income) is the most exciting for shareholders. That is because the interest and dividend bucket is now the biggest driver of earnings for Fairfax.

 

Fairfax has done a masterful job over the past 2 years of navigating the extreme volatility we have seen in interest rates. In Q4 2021, Fairfax did two things: they moved their average duration to 1.2 years and shifted their fixed income portfolio to high quality government securities. In 2022, as interest rates spiked higher, they began extending duration - in Q4, 2002 the average duration had been increased to 1.6 years. The positioning in late 2021 protected Fairfax’s balance sheet when interest rates spiked in 2022 (saving them billions in unrealized losses). It also allowed them to take advantage of much higher interest rates. As a result, Fairfax earned record interest and dividend income in 2022. And 2023 is going to blow 2022 out of the water.  

 

What did we learn when Fairfax reported Q1 results?

 

The big news was they had pushed the average duration of their fixed income portfolio out to 2.5 years. This is a significant development. Because it means the record interest and dividend income will continue for 2023, 2024 and into 2025 - this earnings stream is now predictable and durable. Investors and analysts like this.

 

What did we learn in Q2?

 

We learned four very important things in Q2:

 

1.) Central banks are not done raising interest rates. This is because inflation (especially core readings) is still too high. And parts of the economy are starting to grow again (like housing) and employment remains tight. So, some central banks who had paused rate hikes in early 2023, like Canada and UK, have been forced to start hiking rates again. And despite the recent pause, Powell has telegraphed the Fed will be hiking the US rates at least one more time (and likely two) in the coming months.

 

In addition to the US, Fairfax has significant fixed income holdings in Canada, the UK and Europe. The average duration of their fixed income portfolio is still quite low at 2.5 years (especially when compared to peers, who are closer to 4 years). A higher for longer interest rate regime means Fairfax will be able to roll their maturing bonds into higher yielding securities - which should deliver even higher interest income.

 

2.) Interest rates are rising again. It looked like treasury yields peaked out March 8 in the US. At the end of March yields had plummeted. Fast forward three months to the end of June and treasury yields have spiked higher, with durations of 3 years and less setting new highs.

 

Fairfax is being given another opportunity to increase the average duration of their fixed income portfolio if they want to. Doing so would lock in meaningful interest income beyond 2025.

 

3.) Higher interest rates are causing parts of the financial market to crack, with the meltdown in US regional banks in April the most recent example. Some regional banks have been forced to sell loans at a heavy discount to raise liquidity. In partnership with Fairfax, Kennedy Wilson purchased $2.3 billion (face value) in loans from PacWest Bank. Fairfax will earn 10% on its $2 billion investment, which will generate about $200 million in interest income (mostly) and investment gains (expected 10% total return).

 

4.) Dividend income is headed higher. Extending its close partnership with Kennedy Wilson, Fairfax also invested $200 million in preferred shares with a 6% dividend. This will deliver an incremental $12 million in dividend income to Fairfax each year. (As part of the deal, Fairfax also received warrants for 12.3 million shares of KW with a strike price of $16.21.)

 

Fairfax has most of its fixed income portfolio in government bonds. One of the big advantages of this positioning in the current environment is it allows Fairfax to be very opportunistic to quickly take advantage of temporary market dislocations, like we have just seen with the KW/PacWest transaction. Smart.

 

As central banks continue to increase interest rates it is possible the US could enter a recession later in 2023 or 2024. If this happens it is normal for credit spreads to dramatically widen. Fairfax has stated they are ready to shift a chunk of their fixed income portfolio from government into corporate bonds should yields on the latter pop higher. The cat is ready to pounce.     

 

Over the past 20 months we have been getting a master-class from Fairfax on the benefits of active management of a fixed income portfolio.

 

What does all this mean for Fairfax?

 

Record interest and dividend income is going even higher. The already good ‘fundamentals’ of Fairfax continue to get better.

 

What do the actual numbers look like?

 

Interest and Dividend Income:

• 2021 = $641 million ($27/share).
• 2022 = $962 million ($41/share) = 54% increase YOY.
• 2023E = $1.674 billion ($73/share) = 76% increase YOY.

Fairfax’s share price is $753. The company is trading today for 10 x 2023E interest and dividend income. Compare that to any other insurer… that is NUTS. Especially given the durability of this earnings stream and the quality of the bond portfolio.

 

—————

Interest & dividend income = interest income + dividend income - investment expenses.

 

Interest income:

• Fairfax has a fixed income portfolio of about $40 billion. Interest income will come in around $1.59 billion in 2023 = yield of 3.98%. This is up from 2.25% in 2022 and 1.54% in 2021.

Dividend income:

• Fairfax currently earns about $135 to $140 million per year in dividends from its equity holdings.

 

Investment expenses:

• Fairfax incurred investment expenses of $52 million in 2022, up from $36 million in 2021. My estimate for 2023 is $52 million.

FYI, Fairfax did not break out interest, dividends and investment expenses when they reported Q1 earnings (they just reported the total number).

 

 

Check out the unbelievable move in Treasury yields over the past 18 months from Jan 1, 2022 to June 30, 2023.

 

 

 

Viking, thank you for sharing you analysis and thinking on FFH! Given you extensive knowledge and conviction on possible opportunity with FFH still present, may I ask you, what are your thoughts on position sizing with FFH? Given that FFH is still an insurance and somewhat levered company, what would be max position size in FFH you could still sleep well with? 

 

[Viking]

2 hours ago, UK said:

 

Viking, thank you for sharing you analysis and thinking on FFH! Given you extensive knowledge and conviction on possible opportunity with FFH still present, may I ask you, what are your thoughts on position sizing with FFH? Given that FFH is still an insurance and somewhat levered company, what would be max position size in FFH you could still sleep well with? 

@UK i will give you a portfolio update as of today. But please note, i am ok with concentrated positions. This strategy has worked well for me for +20 years but it is not for everyone. Please note, I might decide to change my position tomorrow and i will not provide an update. I have no desire to provide daily, weekly or monthly portfolio updates. Because it messes with my head too much (i start to feel responsible for everyone else). People need to do their own research. And come to their own conclusions. And not get overly influenced by what some anonymous blogger is posting. 
 

Having got that out of the way, Fairfax has been may largest position since late 2020. ‘The story’ at the company continues to improve every quarter. As a result, despite the incredible run-up, i think the stock is still dirt cheap. So i continue to hold a concentrated position. I consider 30% to be a minimum position for me today (given what i know today). Currently i am at a 45% weighting. And I move around quite a bit (around the edges). 
 

I am also 35% cash today. The remainder is split pretty evenly between 3 other buckets: oil, banks and Canadian high yielding dividend stocks. I move around i these holdings quite a bit.
—————

If you look at most successful investors most of their outperformance was the result of only a couple of holdings that performed spectacularly well over 5 or 10 years. 
 

My view is these turbocharged opportunities only come along every couple of years (something you understand very well that is dirt cheap with catalysts). So when you find one you have to be patient and ride it for as long as possible. Because the next one might be years away.
 

My fear right now with Fairfax isn’t holding too much… it is holding too little. My fear is lightening up (locking in big gains) and then having the stock take off higher on me.
 

My biggest mistake investing is selling my big winners too early. Selling because they went up a lot. And then they kept going higher… My mistake was selling using price as my guide. So i am trying to be more patient in situations where the fundamentals continue to improve - like the situation with Fairfax today.

—————

My average return over the past 20 years is 19% per year. Over that 20 year span i have had two down years (of -4% each year). So my strategy works for me. I also spend LOTS of time on investing… because i really enjoy it.
 

People need to figure out their own strategy. Something that fits their knowledge, emotional make-up, situation, interest, time etc.  There are no short cuts. 

Edited July 5, 2023 by Viking

[Luke]

8 hours ago, Parsad said:

 

That's what I thought too!  Until Apple burst through 2T and kept compounding to 3T!

 

It will get tougher and slower for BRK to find investments.  But a lot of their core holdings, including their amazing insurance businesses, should keep the pot growing for another century.

 

Cheers!

Yeah true, lots of juice left to be squeezed!

[UK]

3 hours ago, Viking said:

@UK i will give you a portfolio update as of today. But please note, i am ok with concentrated positions. This strategy has worked well for me for +20 years but it is not for everyone. Please note, I might decide to change my position tomorrow and i will not provide an update. I have no desire to provide daily, weekly or monthly portfolio updates. Because it messes with my head too much (i start to feel responsible for everyone else). People need to do their own research. And come to their own conclusions. And not get overly influenced by what some anonymous blogger is posting. 
 

Having got that out of the way, Fairfax has been may largest position since late 2020. ‘The story’ at the company continues to improve every quarter. As a result, despite the incredible run-up, i think the stock is still dirt cheap. So i continue to hold a concentrated position. I consider 30% to be a minimum position for me today (given what i know today). Currently i am at a 45% weighting. And I move around quite a bit (around the edges). 
 

I am also 35% cash today. The remainder is split pretty evenly between 3 other buckets: oil, banks and Canadian high yielding dividend stocks. I move around i these holdings quite a bit.
—————

If you look at most successful investors most of their outperformance was the result of only a couple of holdings that performed spectacularly well over 5 or 10 years. 
 

My view is these turbocharged opportunities only come along every couple of years (something you understand very well that is dirt cheap with catalysts). So when you find one you have to be patient and ride it for as long as possible. Because the next one might be years away.
 

My fear right now with Fairfax isn’t holding too much… it is holding too little. My fear is lightening up (locking in big gains) and then having the stock take off higher on me.
 

My biggest mistake investing is selling my big winners too early. Selling because they went up a lot. And then they kept going higher… My mistake was selling using price as my guide. So i am trying to be more patient in situations where the fundamentals continue to improve - like the situation with Fairfax today.

—————

My average return over the past 20 years is 19% per year. Over that 20 year span i have had two down years (of -4% each year). So my strategy works for me. I also spend LOTS of time on investing… because i really enjoy it.
 

People need to figure out their own strategy. Something that fits their knowledge, emotional make-up, situation, interest, time etc.  There are no short cuts. 

 

Thanks very much for your answer!

 

[dartmonkey]

18 hours ago, Parsad said:

 

The funny thing is that Eurobank may still be considerably undervalued!  Should trade at book or better over the next couple of years.  That being said, I wouldn't mind if they take a little off the table here.

 

Cheers!

 

Agreed. Remembering the successful Bank of Ireland investment, they purchased 8.7% in 2011 for 0.10 eurs, and sold most of it in 2014 and 2015 for between 0.33 and 0.36 euros, and cut it further from 2.9% to 1.5% in 2016, and the rest in 2017, for a total profit of over $1b US. (In the 2002 AR, Watsa called Richie Boucher from the Bank of Ireland Fairfax's 'first billion dollar man', with George Chryssikos's of Grivalia and Eurobank having his name added to this illustrious list. Interestingly, Boucher was on Eurobank's board from 2017 to 2020, so maybe it's contagious.)

 

Anyways, the Bank of Ireland has not done much since 2017, going from about 8 euros to 9, and paying out 0.67 euros since then. Hopefully, Eurobank will not suffer the same fate, but if Fairfax lightens its investment a bit, there would be a good precedent.

[maxthetrade]

13 hours ago, Viking said:

@UK i will give you a portfolio update as of today. But please note, i am ok with concentrated positions. This strategy has worked well for me for +20 years but it is not for everyone. Please note, I might decide to change my position tomorrow and i will not provide an update. I have no desire to provide daily, weekly or monthly portfolio updates. Because it messes with my head too much (i start to feel responsible for everyone else). People need to do their own research. And come to their own conclusions. And not get overly influenced by what some anonymous blogger is posting. 
 

Having got that out of the way, Fairfax has been may largest position since late 2020. ‘The story’ at the company continues to improve every quarter. As a result, despite the incredible run-up, i think the stock is still dirt cheap. So i continue to hold a concentrated position. I consider 30% to be a minimum position for me today (given what i know today). Currently i am at a 45% weighting. And I move around quite a bit (around the edges). 
 

I am also 35% cash today. The remainder is split pretty evenly between 3 other buckets: oil, banks and Canadian high yielding dividend stocks. I move around i these holdings quite a bit.
—————

If you look at most successful investors most of their outperformance was the result of only a couple of holdings that performed spectacularly well over 5 or 10 years. 
 

My view is these turbocharged opportunities only come along every couple of years (something you understand very well that is dirt cheap with catalysts). So when you find one you have to be patient and ride it for as long as possible. Because the next one might be years away.
 

My fear right now with Fairfax isn’t holding too much… it is holding too little. My fear is lightening up (locking in big gains) and then having the stock take off higher on me.
 

My biggest mistake investing is selling my big winners too early. Selling because they went up a lot. And then they kept going higher… My mistake was selling using price as my guide. So i am trying to be more patient in situations where the fundamentals continue to improve - like the situation with Fairfax today.

—————

My average return over the past 20 years is 19% per year. Over that 20 year span i have had two down years (of -4% each year). So my strategy works for me. I also spend LOTS of time on investing… because i really enjoy it.
 

People need to figure out their own strategy. Something that fits their knowledge, emotional make-up, situation, interest, time etc.  There are no short cuts. 

 

Awesome post Viking! Like you I'm more concerned that I don't own enough FFH.

[Munger_Disciple]

23 hours ago, gfp said:

It's pretty great that the corner of Berkshire and Fairfax message board was named after two securities that are almost tied in performance this millennium, with the smaller up-and-comer, Fairfax, clocking in at 846% vs. Berkshire's 826%.  Going forward it is likely that Fairfax will continue to outperform Berkshire over long periods due primarily to the size difference.  Unfortunately my dividends are taxed so Berkshire is ahead for this taxable American.

 

 

In the case of Fairfax, the CAGR seems to a very strong function of the start date of one's investment even in the very long term. If you zoom out a bit further, the chart looks like this in CAD (it hit a local peak of $540 CAD in 1998). If one invested in Fairfax on 1/1/1999 and kept it until 6/30/2023 for example, the CAGR after 24.5 years is only 4.54%. On the other hand, if you invested in FFH on 1/1/2003 and kept it till 6/30/23, CAGR jumps to 13.4% over the 20.5 year period. 

 

Edited July 5, 2023 by Munger_Disciple

[maxthetrade]

16 minutes ago, Munger_Disciple said:

If one invested in Fairfax on 1/1/1999 and kept it until 6/30/2023 for example, the CAGR after 24.5 years is only 4.54%. On the other hand, if you invested in FFH on 1/1/2003 and kept it till 6/30/23, CAGR jumps to 13.4% over the 20.5 year period. 

 

Yes, the price you pay is important! I still own some shares that I bought in 2003 in a tax free account. I can't sell them without loosing the tax free status so I'll hold them as long as I see an reasonable future return compared to other after tax opportunities.

[Munger_Disciple]

37 minutes ago, maxthetrade said:

 

Yes, the price you pay is important! I still own some shares that I bought in 2003 in a tax free account. I can't sell them without loosing the tax free status so I'll hold them as long as I see an reasonable future return compared to other after tax opportunities.

 

Of course the price you pay counts. The surprising thing is that even after 25 years, the returns were really poor after the purchase in 1999. I guess FFH was way overvalued in 1998-1999 time frame. 

[treasurehunt]

58 minutes ago, Munger_Disciple said:

 

In the case of Fairfax, the CAGR seems to a very strong function of the start date of one's investment even in the very long term. If you zoom out a bit further, the chart looks like this in CAD (it hit a local peak of $540 CAD in 1998). If one invested in Fairfax on 1/1/1999 and kept it until 6/30/2023 for example, the CAGR after 24.5 years is only 4.54%. On the other hand, if you invested in FFH on 1/1/2003 and kept it till 6/30/23, CAGR jumps to 13.4% over the 20.5 year period. 

 

 

Yes, the stock price has historically been very volatile. Perhaps it is better to look at changes in book value per share (plus dividends) to get a better idea of how the business has been doing over time.

 

[Viking]

1 hour ago, Munger_Disciple said:

 

In the case of Fairfax, the CAGR seems to a very strong function of the start date of one's investment even in the very long term. If you zoom out a bit further, the chart looks like this in CAD (it hit a local peak of $540 CAD in 1998). If one invested in Fairfax on 1/1/1999 and kept it until 6/30/2023 for example, the CAGR after 24.5 years is only 4.54%. On the other hand, if you invested in FFH on 1/1/2003 and kept it till 6/30/23, CAGR jumps to 13.4% over the 20.5 year period. 

 

 

@Munger_Disciple I do not spend a great deal of time looking far into the past. It is interesting/fun to do. What I really care about is the future. My guess is Fairfax should easily outperform Berkshire moving forward. And by a lot. There are a couple of reasons for this:

1.) Fairfax is way underpriced - probably 30% or more. Berkshire no where near as cheap. So Fairfax's starting point is much better.

2.) Fairfax earnings are spiking for all the reasons we have discussed on this board. This will drive the stock price higher.

3.) Active management is working right now. And Fairfax has been on a hot streak. The management team at Fairfax has been executing exceptionally well in recent years. 

 

That is not to suggest that there isn't a place for Berkshire in an investors portfolio. It is a well run, rock solid company. With a pretty good guy in charge.

[Munger_Disciple]

58 minutes ago, Viking said:

 

@Munger_Disciple I do not spend a great deal of time looking far into the past. It is interesting/fun to do. What I really care about is the future. My guess is Fairfax should easily outperform Berkshire moving forward. And by a lot. There are a couple of reasons for this:

1.) Fairfax is way underpriced - probably 30% or more. Berkshire no where near as cheap. So Fairfax's starting point is much better.

2.) Fairfax earnings are spiking for all the reasons we have discussed on this board. This will drive the stock price higher.

3.) Active management is working right now. And Fairfax has been on a hot streak. The management team at Fairfax has been executing exceptionally well in recent years. 

 

That is not to suggest that there isn't a place for Berkshire in an investors portfolio. It is a well run, rock solid company. With a pretty good guy in charge.

 

 I agree with you that FFH will likely do better than BRK (mainly because it is cheaper) from this starting point over the next 5 years with the following caveats: (1) FFH insurance underwriting results produce a decent combined ratio (I would take 98% but I know you think it will be 95%), and they don't get their head handed to them in the case of a catastrophic event (2) the Fed doesn't cut rates too much which it would in the case of a rough recession.  

Edited July 6, 2023 by Munger_Disciple

[TwoCitiesCapital]

13 minutes ago, Munger_Disciple said:

 

 I agree with you that FFH will likely do better than BRK from this starting point over the next 5 years with the following caveats: (1) FFH insurance underwriting results produce a decent combined ratio (I would take 98% but I know you think it will be 95%), and they don't get their head handed to them in the case of a catastrophic event (2) the Fed doesn't cut rates too much which it would in the case of a rough recession.  

 

I'm actually thinking the recessionary scenario is better for Fairfax than status quo now that they're locking in duration. 

 

Having $1B+ per year in stable interest income and/or billions on capital gains from Treasuries in a rate cur scenario gives them plenty to work with in the case of credit dislocation. This will be especially true if they start pairing down the TRS position prior to any recession taking away a potential liquidity drain from a dropping share price. 

 

Credit spreads haven't budged yet, but the pace of bankruptcies in the US is currently at levels that have previously seen 8-10% HY spreads (currently at ~5). If the Fed keeps hiking, I'd expect the pain will become more acute and we could see absolute mayhem in corporate spreads - IG and HY. That environment would give Fairfax the potential to reinvest gains/income at significantly higher rates than the 4-6% currently available to them

[Munger_Disciple]

20 minutes ago, TwoCitiesCapital said:

 

I'm actually thinking the recessionary scenario is better for Fairfax than status quo now that they're locking in duration. 

 

Having $1B+ per year in stable interest income and/or billions on capital gains from Treasuries in a rate cur scenario gives them plenty to work with in the case of credit dislocation. This will be especially true if they start pairing down the TRS position prior to any recession taking away a potential liquidity drain from a dropping share price. 

 

Credit spreads haven't budged yet, but the pace of bankruptcies in the US is currently at levels that have previously seen 8-10% HY spreads (currently at ~5). If the Fed keeps hiking, I'd expect the pain will become more acute and we could see absolute mayhem in corporate spreads - IG and HY. That environment would give Fairfax the potential to reinvest gains/income at significantly higher rates than the 4-6% currently available to them

 

Yeah that's a good point. 

[jbwent63]

On 7/4/2023 at 5:46 PM, gfp said:

 

The way morningstar's chart works, they are telling you that Berkshire's A shares increased by that dollar amount during the period.  It isn't the closing price.

Thank you for the helpful response, unlike another just before yours....

[Intelligent_Investor]

Treasury yields are popping, 30 year bond now at a 4 handle, this could be very good for FFH

Edited July 6, 2023 by Intelligent_Investor

[gfp]

24 minutes ago, Intelligent_Investor said:

Treasury yields are popping, 30 year bond now at a 4 handle, this could be very good for FFH

 

Well they didn't bite the last four times it happened in the past 8 months.

[glider3834]

https://www.businesswire.com/news/home/20230706093283/en/AM-Best-Upgrades-Credit-Ratings-of-Odyssey-Group-Holdings-Inc.’s-Members

[nwoodman]

2 hours ago, glider3834 said:

https://www.businesswire.com/news/home/20230706093283/en/AM-Best-Upgrades-Credit-Ratings-of-Odyssey-Group-Holdings-Inc.’s-Members

Positively gushing, thanks for the link

 

“The rating upgrades recognize the removal of ratings drag from Odyssey Group’s parent company, Fairfax Financial Holdings Limited (Fairfax), which has demonstrated sustained improvement in its overall credit profile in recent years. Fairfax has reduced its debt leverage materially and improved its overall operating performance, while maintaining consistently sound balance sheet strength and financial flexibility. As a result, debt servicing metrics have improved sustainably, reducing the burden imposed on Fairfax subsidiaries and supporting the removal of ratings drag on Odyssey Group.”

 

Can take or leave ratings agencies a the best of times but this is well deserved .  Fairfax with a strong balance sheet who woulda thunk.

[Viking]

6 hours ago, glider3834 said:

https://www.businesswire.com/news/home/20230706093283/en/AM-Best-Upgrades-Credit-Ratings-of-Odyssey-Group-Holdings-Inc.’s-Members

@glider3834 thanks for sharing. Great to see the ratings agencies recognizing the significant improvements being made under the hood at Fairfax and its largest subsidiary. Its funny because it looks to me like AM Best might be further along in this regard than the equity analysts; probably because they are more specialized? 
 

Who is AM Best? 
 

AM Best is the largest credit agency in the world specializing in the insurance industry. It is the gold standard for insurance companies (please correct me if i am wrong).
 

What did we learn from this news release?

 

The financial strength rating of Odyssey has been upgraded to A+ (Superior). This is the same rating that AM Best currently has for both WR Berkley and Markel. As far as AM Best is concerned, Fairfax’s largest insurance subsidiary, Odyssey, belongs in that group.

 

Why the upgrade? 

• balance sheet strength, which AM Best assesses as strongest
• strong operating performance
• favorable business profile
• appropriate enterprise risk management

I am not an insurance expert. AM Best is. For those board members who are worried about ‘reserving’ or ‘risk management’, at least at Odyssey, things look very good. 

 

We also learn a little about Fairfax in the news release:
 

“The rating upgrades recognize the removal of ratings drag from Odyssey Group’s parent company, Fairfax Financial Holdings Limited (Fairfax), which has demonstrated sustained improvement in its overall credit profile in recent years. Fairfax has reduced its debt leverage materially and improved its overall operating performance, while maintaining consistently sound balance sheet strength and financial flexibility. As a result, debt servicing metrics have improved sustainably, reducing the burden imposed on Fairfax subsidiaries and supporting the removal of ratings drag on Odyssey Group.”

 

We also learn a little more about Odyssey in the news release:

Odyssey has been slowly building out is specialty insurance business (the business everyone is trying to grow because it is higher margin and has more of a moat) in the US and this positive development gets a shout-out from AM Best.

 

“Odyssey Group otherwise continues to produce consistently strong underwriting results, despite elevated global catastrophe losses and is well-positioned to take advantage of continued rate improvement in many of its key business lines. Odyssey Group’s risk-adjusted capitalization remains strongly supportive of its strongest overall balance sheet strength assessment, and the group continues to benefit from its position as a global reinsurer with a well-diversified portfolio that also includes a significant position in the specialty primary market in the United States.”

Edited July 7, 2023 by Viking

[Maverick47]

The balance sheet management for Fairfax has been impressive, compared to almost any other insurer not named Berkshire.  With interest rates rising, many other competitors saw the market value of their bond portfolios fall, in many cases reducing their policyholder surplus/shareholder equity year over year for 2022 over 2021, at the exact same time that inflation in loss costs was requiring dramatic rate increases.  
 

For competitors that were writing (in 2021) almost as much premium as their surplus could support, 2022 was a rude wake-up call.  All else being equal, to keep the same level of claims paying ability/AM Best rating in 2022 that they had in 2021 simply while writing the same customers (no growth in policy count) would require an increase in surplus roughly equivalent to the double digit rate increases many of them filed for in 2022.  

 

Since their surplus often dropped year over year at the exact time that they would have desired it to increase, they face some difficult management choices — they can limit their appetite for new business until surplus valuations recover, raise equity or debt, or watch their ratings possibly be put on watch with negative outlooks.  Fairfax is in exactly the opposite position (as is Berkshire, and, I believe, Markel).  

 

Reminds me of former Citigroup CEO chuck Prince’s famous quote before the 2008 mortgage disaster:  “As long as the music plays you have to keep on dancing.  We’re still dancing”.  With their refusal to reach for yield on their bonds, Fairfax is now reaping the benefits of taking the long term view for the health of their business over the long run.

 

 Now Fairfax can dance while most of their competitors have had to take a seat.

Edited July 7, 2023 by Maverick47
Readability and add name of Citigroup CEO.

[Haryana]

On 5/13/2023 at 10:29 PM, Viking said:

Fairfax Financial: 'The big fish that got away’

 

Investors have lots of regrets. Missed opportunities. 'The big fish that got away.' Like not buying Fairfax (or selling your position) at US$492 on Dec 31, 2021. On Friday, FFH shares closed at US$690. That is a 40% increase in 15.5 months. Fairfax also paid out two $10 dividends.

 

How has the S&P500 performed since December 31, 2021? It is down 13%. Yikes! That makes Fairfax’s performance even better!

 

But guess what? Fairfax is actually a better buy today (at US$690) than it was on Dec 31, 2021 (at $492). As we digest Q1 results, the big fish is back and once again taunting investors…

 

How can this be? It’s not that complicated if you believe the following: a stock is worth the present value of the cash flows that are expected to be generated in the future.

 

To prove our preposterous claim we need to answer three questions (we are going to keep things very top line… to make it as easy as possible to follow):

1.) what did investors expect future operating cash flows to be for Fairfax at Dec 31, 2021 when shares closed at $492?

2.) what actually happened with the business over the past 15.5 months?

3.) what do investors expect future operating cash flows to be for Fairfax at May 13, 2023 when shares closed at $690?

-----------

1.) what did investors expect future operating cash flows to be for Fairfax at Dec 31, 2021 when shares closed at $492?

• Fairfax earned $1.8 billion in operating income in 2021 (see table below) or $77/share pre-tax.
• investors expected this to increase to perhaps to $2 billion in 2022, with modest growth thereafter.
• that was the level of operating earnings that were built into Fairfax’s stock price of $490 at December 31, 2021.

2.) what actually happened with the business over the past 15.5 months? For this part, we are only going to look at three asset sales by Fairfax:

• in June 2022, Fairfax sold its pet insurance business for $992 million after-tax = $40/share
• in July 2022, Fairfax sold Resolute Forest Products at the top of the lumber cycle for $625 million plus $180 million CVR. Dec 31, 2021, Resolute had a carrying value of $276 million. With the sale, Fairfax crystallized $350 a million gain (plus $180 CVR). Let’s say this was a $10 after-tax gain (let's be conservative).
• in January 2023, Fairfax sold Ambridge Partners for $400 million plus $100 million performance incentive. Pre-tax gain will be $255 million (plus present value of performance incentive). The deal closed in May. Let’s say this is another $10/share after-tax gain.

These three transaction delivered an unexpected $60/share after-tax gain for Fairfax shareholders. This $60 was a one time gift for shareholders. Totally unexpected. Like finding a pile of gold in your back yard.

 

3.) what do investors expect future operating cash flows to be for Fairfax at May 13, 2023 when shares closed at $690?

• Fairfax earned $3.1 billion, or $132/share pre-tax, in operating income in 2022. This was much more than expected at the start of the year.
• Fairfax is poised to earn $3.8 billion in operating income in 2023, or $167/share pre-tax. Nobody thought this was remotely possible Dec 31, 2021.
• This is more than double what Fairfax earned in 2021, or an increase of $90/share pre-tax. Think about that. Double.
• And Fairfax is poised to earn $3.8 billion in operating income in 2024 and 2025. 

What happened?

• underwriting profit beat expectations: hard market is lasting longer than expected. In 2022, Fairfax grew net premiums written by 25% and delivered a better than expected CR of 94.7. 
• interest and dividend income: interest rates spike much higher than expected. And Fairfax just locked in higher rates moving from 1.2 year average duration Dec 31, 2021 to 2.5 years at March 31, 2023. 
• share of profit of associates: earnings from Fairfax’s collection of associate holdings increased much more than expected. This is expected to grow further in the coming years.
• all three 'buckets' are delivering much more earnings than expected - new records every year. Especially interest and dividends and share of profit of associates. 

Most importantly, 2023 operating earnings of $3.8 billion are expected to be the new baseline for Fairfax moving forward. 2024 and 2025 operating earnings should be able to grow from 2023 levels. In short, $3.8 billion in operating earnings will be D-U-R-A-B-L-E. This is the critical point that I think many investors are missing today.

 

So Fairfax’s stock price went up $200 over the past 15.5 months. Three unexpected asset sales delivered $60 after-tax to shareholders. That leaves us with $140. How much is an increase in operating earnings of $1.9 billion ($90/share pre-tax = $70/after-tax) worth to shareholders? Is it worth $140/share? It is worth much, much more than that. Because it is durable.

 

What is the better buy?

 

A.) Fairfax at $490/share at Dec 31, 2021 - knowing what was known then.

B.) Fairfax at $690/share at May 13, 2023 - knowing what we know now.

 

My choice is B. And it’s not even close.

 

Just like December 31, 2021, that big fish (called Fairfax) is once again staring investors right in the face. And guess what? It’s probably going to slip away from most investors for a second time. And in another couple of years they will think back to today and kick themselves. And the story of ‘the big fish that got away’ will get even bigger.

 

 

 

Maybe a good time to reread this post by Viking before the Q2 results.

 

[Thrifty3000]

23 hours ago, glider3834 said:

https://www.businesswire.com/news/home/20230706093283/en/AM-Best-Upgrades-Credit-Ratings-of-Odyssey-Group-Holdings-Inc.’s-Members

Great news.

 

My understanding is if a reinsurer fails to pay claims then the primary insurer is still on the hook for the liabilities. (That’s why insurers disclose gross premiums and net premiums.) 

Therefore the reinsured premiums involve a certain amount of credit/counterparty risk (which should correlate with the reinsurer’s credit ratings). That’s why higher credit ratings are an important competitive advantage for reinsurers. I’m sure the A+ rating increase will drive additional pricing power.

[Tommm50]

20 hours ago, Thrifty3000 said:

Great news.

 

My understanding is if a reinsurer fails to pay claims then the primary insurer is still on the hook for the liabilities. (That’s why insurers disclose gross premiums and net premiums.) 

Therefore the reinsured premiums involve a certain amount of credit/counterparty risk (which should correlate with the reinsurer’s credit ratings). That’s why higher credit ratings are an important competitive advantage for reinsurers. I’m sure the A+ rating increase will drive additional pricing power.

 

That's correct. The back end purchase of reinsurance does not alter the insurance company's obligation to the policy holder.