Fairfax 2023

[MMM20]

17 hours ago, Parsad said:

What durable competitive advantage does Fairfax have outside of management?

 

17 hours ago, Parsad said:

The biggest advantage FFH has is that it is family-controlled and has a stellar CEO and team.

 

I agree! The family control + massive skin in the game —> management for long term wealth creation, not income statement optics really is a massive and durable competitive advantage. Permanent owner style value investing + float = structural durable high returns through cycles. Sort like an individual investor with a 3% 30 year mortgage and no asset/liability mismatch (no quarterly or annual client liquidity to worry about)… but on steroids! They’ve proven that over almost 4 decades and we saw it play out in a big way over the past ~5 years. It seems to me that from this point on through cycles they should durably and structurally earn a ~400-600 bps spread on their mostly cash/ short term fixed income plus some longer duration investments, vs roughly zero or slightly negative borrowing cost. So therefore the recent float growth has added ~$1B of structural earning power that did not exist ~5 years ago, driven by savvy insurance acquisitions/turnarounds —> growth into the hard market. (BTW that incremental earning power would be roughly zero if they’d had to issue ~6-8% debt to finance all that incremental growth after the acquisitions!) Looking forward, that growth alone is worth an incremental $500+/share which is not reflected properly in accounting BV. IMHO that is the core of the opportunity!

 

That’s my best Prem impression!

 

Edited July 25, 2023 by MMM20

[Parsad]

6 hours ago, MMM20 said:

 

 

I agree! The family control + massive skin in the game —> management for long term wealth creation, not income statement optics really is a massive and durable competitive advantage. Permanent owner style value investing + float = structural durable high returns through cycles. Sort like an individual investor with a 3% 30 year mortgage and no asset/liability mismatch (no quarterly or annual client liquidity to worry about)… but on steroids! They’ve proven that over almost 4 decades and we saw it play out in a big way over the past ~5 years. It seems to me that from this point on through cycles they should durably and structurally earn a ~400-600 bps spread on their mostly cash/ short term fixed income plus some longer duration investments, vs roughly zero or slightly negative borrowing cost. So therefore the recent float growth has added ~$1B of structural earning power that did not exist ~5 years ago, driven by savvy insurance acquisitions/turnarounds —> growth into the hard market. (BTW that incremental earning power would be roughly zero if they’d had to issue ~6-8% debt to finance all that incremental growth after the acquisitions!) Looking forward, that growth alone is worth an incremental $500+/share which is not reflected properly in accounting BV. IMHO that is the core of the opportunity!

 

That’s my best Prem impression!

 

 

Yes, I agree with that.  I had fair value pegged at $1,300 CDN this year and I'm very comfortable with a $1,500 CDN valuation for FFH in 2024.  I think $1,500 USD is probably the top end of the estimate for 2024...that would be pushing it to 1.5-1.6 times 2024 book value. 

 

Also depends on how bad losses are from wildfires this year.  It's looking near catastrophic for Canadian wildfires.  BC is approaching $500M in wildfire losses already with half the season to go.  And it's been pretty bad on the East Coast as well.  Hurricane season is just beginning and they expect an above average one because of the warm waters.  Cheers!

[Viking]

I need the help of board members. It can be confusing to understand how the business results of Fairfax's vast collection of equity holdings flows through to Fairfax's income statement and balance sheet at the end of each quarter. I have put together a 'cheat sheet' with 'rules of thumb' to help investors better understand this flow. 

 

Does this look generally accurate? What is wrong? What is missing? Can the layout be improved?

 

Please feel free to rip it apart (you won't hurt my feelings). Comment on this thread or private message me. Thanks!

 

PS: it is one sheet, but I copied it with two pictures so it can be more easily read.

 

 

 

 

 

 

[MMM20]

@Viking my only comment would be to hide gridlines - ALT WVG (yes I still have investment banking PTSD)

 

[treasurehunt]

Does anyone know when Fairfax is scheduled to release Q2 results? I thought today might be the day, but there doesn't seem to be any notification regarding this. So maybe the earnings release is scheduled for Thursday of next week?

[ValueMaven]

Mid-August historically.  It will be an interesting quarter

[SafetyinNumbers]

3 hours ago, treasurehunt said:

Does anyone know when Fairfax is scheduled to release Q2 results? I thought today might be the day, but there doesn't seem to be any notification regarding this. So maybe the earnings release is scheduled for Thursday of next week?

 They usually give notice the Friday before. So I’m guessing tomorrow.

[Dipesh Patel]

Aug 2 2023 

[glider3834]

10 hours ago, Viking said:

I need the help of board members. It can be confusing to understand how the business results of Fairfax's vast collection of equity holdings flows through to Fairfax's income statement and balance sheet at the end of each quarter. I have put together a 'cheat sheet' with 'rules of thumb' to help investors better understand this flow. 

 

Does this look generally accurate? What is wrong? What is missing? Can the layout be improved?

 

Please feel free to rip it apart (you won't hurt my feelings). Comment on this thread or private message me. Thanks!

 

PS: it is one sheet, but I copied it with two pictures so it can be more easily read.

 

 

 

 

 

 

viking with Excess of fair value over book value number that Fairfax reports, I believe it excludes non-market traded, non-insurance consolidated subs like Sporting Life Group or AGT 

 

 

 

 

 

Edited July 28, 2023 by glider3834

[ValueMaven]

From Everest RE's most recent quarter: 

 

“The property cat pricing remains strong, and the 2023 hard market has now surpassed the post-Hurricane Andrew [1992] market” "there’s simply been no meaningful capital formation to tip the supply demand imbalance"

[Dipesh Patel]

[Luke]

14 minutes ago, DM1 said:

Nice!

[MMM20]

9 hours ago, ValueMaven said:

"there’s simply been no meaningful capital formation to tip the supply demand imbalance"

Right. Are we actually still going the other direction? Supply seems to be dropping off. What if we’re in a structurally hard market, at least in certain pockets, b/c the supply side is falling apart even as demand accelerates? It seems like those in a position of strength can almost name their price in certain areas. What’s the math on FFH intrinsic value if pricing is up massively over another few years and we end up $10-15B of new float just by taking price. Am I missing something? Not possible b/c no reinsurance? Of course always worried that rate still doesn’t match risk!

 

Premiums are rising, but so is everything else—and insurance isn’t yet expensive enough to deter buyers, with utilities and property taxes representing a bigger share of the price of a house. Even at twice the cost, insurance would “still only account for a small proportion of asset prices,” says Danny Ismail, a researcher at analytics company Green Street.

 

https://www.bloomberg.com/news/articles/2023-07-27/homebuyers-ignore-risk-of-climate-change-insurance-meltdown

When Farmers Insurance Group on July 12 said it would stop writing new homeowners policies in Florida, it became the 15th insurer in the state to take that step since early last year. Florida officials fault widespread insurance fraud for the exodus, but Farmers said it needed to “manage risk exposure” in a place where climate change threatens more natural disasters.

 

Florida’s slow-motion insurance meltdown is happening as new people pour into the places with the greatest risk of flooding, a pattern playing out across the US. Almost 400,000 more people moved into than out of the nation’s most flood-prone counties in 2021 and 2022, double the increase in the preceding two years, according to real estate firm Redfin Corp. Counties vulnerable to wildfires and heat have also seen more people arrive than leave.

Insurance cost is the main way the market signals risk to homeowners. Yet in California, Florida and Louisiana the markets are flashing warnings that homeowners are largely ignoring. “There are definitely disruptions in the feedback loop,” says Nancy Watkins, an actuary at Milliman Inc., an insurance consulting firm. Why aren’t property owners taking the hint?

 

A Fundamental Mismatch

Mortgages last 30 years, while insurance premiums are adjusted annually. When the climate was stable, Year 1 was a pretty good predictor of Year 30. But rapid warming means the perils are constantly growing, so the premium for the first year could be wildly off 10 years later, leaving homeowners at risk of far higher premiums later on. “The entire system is predicated on climate stability,” says Spencer Glendon, founder of Probable Futures, a nonprofit dedicated to climate literacy. “I think we can expect that nexus to break down soon.”

● Demographic Danger

Many people moving to risky areas are retirees thinking about little more than warm weather and lower taxes “who accelerated their retirement plans,” says Benjamin Keys, a professor of real estate at the University of Pennsylvania’s Wharton School. “They haven’t experienced a weather disaster.” It doesn’t help that most people—and developers—have short memories about destruction. Or that building codes and zoning can’t keep up.

● Information Breakdown

Even when buyers seek reliable information on long-term risk, it’s hard to find, with some government maps of severe flood zones dating to the 1970s. Homeowners in those areas must purchase flood insurance to get a federally insured mortgage, but people outside the zones—or those who own their home outright—have no such requirement. First Street Foundation says some 6 million homes that should be considered at severe risk of flooding lie outside those zones. And Milliman estimates there’s $520 billion of unpriced flood loss in the housing market—a number that will only increase.

Then there’s the question of how much insurance should cost. Carly Fabian of consumer-rights group Public Citizen says buyers deserve access to average home insurance prices by ZIP code over time, which would help them assess where insurers believe risks are spiking and whether they’re paying inflated rates. But insurance companies have blocked such efforts, saying the information is proprietary. “They’ve proven unreliable narrators on climate,” Fabian says.

● The Government Backstop

In the 1960s private insurers largely pulled the plug on residential flood coverage, deeming it too risky. The federal government stepped in with the National Flood Insurance Program (NFIP), which racks up about $1.4 billion a year in losses because it can’t charge market rates. Similar state programs in California, Florida and Louisiana only insure homes that can’t get private coverage, but with insurers backing out, they’re adding customers rapidly. Florida’s Citizens Property Insurance Corp. is already the largest single insurer in the state.

The Federal Emergency Management Agency is promising reforms that will bring NFIP premiums more in line with climate risks, but Keys is skeptical. “It’s like a dad threatening to turn the car around when the kids aren’t behaving properly,” he says. “The government isn’t not going to step in and bail out people when there’s a disaster.”

● Not Yet a Deal-Breaker

Premiums are rising, but so is everything else—and insurance isn’t yet expensive enough to deter buyers, with utilities and property taxes representing a bigger share of the price of a house. Even at twice the cost, insurance would “still only account for a small proportion of asset prices,” says Danny Ismail, a researcher at analytics company Green Street. But investors in mortgage-backed securities may soon start demanding coverage for the full length of the loan. “The common denominator is that risk does not really belong to the insurance companies; it belongs to the community,” Watkins says. “The insurance market is not sufficient to tackle this problem.”

Edited July 29, 2023 by MMM20

[Maverick47]

Both California and Florida are similar in that their primary property rate regulatory regimes are in large part responsible for the insurance availability problems facing their respective insurance markets.  Neither state allows the marketplace to work unfettered to set an appropriate price at which a large national insurance carrier would be interested in increasing or even maintaining their exposure in the state.

 

Both states place artificial limits on the profit/risk load that a home insurer may build into their rates.  Both states regulators presume to know how much surplus capital an insurer should allocate to support the writing of a home policy in their state, and it is less than an insurer would independently calculate would be necessary to support the writing of a property policy in the state, particularly in the riskiest hurricane or wildfire or Fire following earthquake exposed geographies.

Then they attempt to regulate a reasonable allowable return on a surplus/equity amount that is artificially too low.

 

Florida does allow companies to build in the cost of catastrophe reinsurance into their rate levels, but California does not.  Florida also encourages thinly capitalized insurers to set up shop in their state to provide home insurance in Florida alone.  All insurers are required to belong to the state guaranty fund, so that if any insurer goes bankrupt, their customers claims are paid by he guaranty fund, which is supported by assessments against the remaining solvent insurers.  
 

Not surprisingly, large national carriers don’t want to be played as chumps in such a market.  Their competition for customers comes from small Florida only home insurance companies that likely will go bankrupt after running into a few back to back years of storms, with the national carriers funding losses for their own Florida customers from national surplus, and left holding the bag for additional assessments from the guaranty fund to pay the claims of their less financially strong competitors.

 

Regulators will retort that guaranty fund assessments may be recouped from customers over time, but that misses the point:  those payments come from surviving companies’ surplus equity on which they pay an opportunity cost because it’s no longer available to be invested elsewhere.  They are not allowed to earn a return on that capital and they lose the time value of money since they only recover the funds years later.

 

Gresham’s Law states that bad money drives out good.  There’s a similar force at work in Florida and California:  Bad insurance policies (meaning those provided by financially weak companies) will drive out good policies (those provided by financially strong companies) if they are forced by regulators to be sold at the same price.

 

In California, a prudent home insurer will manage the risk posed by catastrophe exposures such as wildfire or earthquake by purchasing catastrophe insurance from companies such as Odyssey Re or National Indemnity (Fairfax or Berkshire).  But they can’t pass this cost on to their customers.  
 

Prudent national carriers that can’t afford to expose their owners to the risk of bankruptcy will buy the reinsurance, even though they can’t build the cost into their primary rates.  Less responsible carriers will either not buy reinsurance at all, or buy less than they ought to.  Either way, Gresham’s Insurance corollary will work its inexorable force on the California market as it has in Florida, and the stronger national carriers will begin to flee the market.

 

California could work to improve their market in three main ways:  allow insurers to include the cost of catastrophe insurance in their primary rate making calculations, and allow companies to calculate how much capital they have at risk in supporting their varied exposures, and also let them earn a reasonable return on that risk capital.  Currently, California typically assumes that surplus of no more than half the

Annual written premium for a policy is at risk.  In wildfire exposed areas, that rule of thumb is laughably inadequate.  It can easily be the case, even after the purchase of catastrophe reinsurance, that a company will need to hold at least the full amount of an annual policy premium in the form of allocated surplus if not more, instead of merely half.  
 

If the state won’t allow you to include the cost of wildfire cat reinsurance in pricing a wildfire exposed home policy, then allows you to earn only an inadequate return on an amount of supporting surplus that is also inadequate for the risk, is it any surprise that rational decision makers decide that they shouldn’t sell policies under such constraints?

 

The good news for Fairfax (and Berkshire) shareholders is that neither company  is playing such a game.  Both companies sell an absolutely necessary product (cat reinsurance) to companies that absolutely need to buy it (primary property insurance companies).  

 

 

 

 

 

[UK]

This is very interesting discussion!

 

Recently there is a lot of publicity about all this climate, weather, increasing catastrophe costs and 'uninsurable' future, such as:

 

https://www.wsj.com/articles/climate-risk-a-major-challenge-for-insurance-industry-treasury-says-6725f954

https://www.wsj.com/articles/business-insurance-roiled-by-climate-inflation-205049df

https://www.wsj.com/articles/insurers-are-in-the-hot-seat-on-climate-change-74e27330

https://www.bloomberg.com/graphics/2023-us-climate-disaster-costs-wildfires-storms/?srnd=premium-europe#xj4y7vzkg

https://www.bloomberg.com/news/articles/2023-07-28/treasury-s-yellen-says-extreme-weather-exposes-gaps-in-insurance-protection?srnd=premium-europe

https://www.bloomberg.com/news/articles/2023-07-28/extreme-weather-risks-making-parts-of-the-worlds-un-insurable?srnd=premium-europe

 

Climate change “has the potential of changing the insurance business profoundly and making part of the world un-insurable,” Gonzalo Gortazar, CaixaBank SA’s chief executive officer, said in an interview with Bloomberg TV Friday. “It’s not happening yet, but if we keep moving in that direction this is something we will have to face in due course.”

 

Yet, is that represents more of a threat (unexpected losses, regulatory risks, etc) or an opportunity (increasing market, better pricing, etc) for insurance/reinsurance companies? Perhaps everything will come down even more to execution quality of any particular company? Could all this negative publicity at least help improve pricing somewhat:)?

 

Edited July 29, 2023 by UK

[LC]

Thank you for the insightful post, Maverick. A question: given the dynamic as you have described, is it ultimately the state which is bankrolling homeowner policies in CA?

[Maverick47]

In California I think it’s fair to say that neither the state government itself nor the taxpayers are currently on the hook for insurance losses, nor are they providing any capital to support the writing of risks in the property insurance marketplace.

 

There are some CA state run/organized providers of basic property insurance (the FAIR plan for example was set up to provide basic property insurance to customers who can’t find coverage in the voluntary market).  But all property insurers in the state are required to belong to and support the program.  If there are any losses not covered by the FAIR plans surplus, then, just as with mandatory Guaranty Fund membership, the member companies who are not bankrupt themselves are levied assessments to pay for any shortfall in claims paying ability for FAIR plan customers’ losses…and they can then pass on those assessments to their own customers (I may have the details of this wrong — it’s possible that they may just be ordered to add an assessment to their own customers and forward the collected funds to the FAIR plan without having to first pay an assessment up front).

 

 As long as there are private insurers to levy assessments against who can in turn charge their own customers in the future to repay those assessments, then it is private insurance customers who in essence are paying the “tax” to provide a backstop for coverage provided to customers who live in risky areas and can only find insurance coverage in the FAIR plan.

The California Earthquake Authority is a somewhat different animal.  It was funded with surplus contributions from member companies who were allowed thereby to offer earthquake coverage to their own home insurance customers from the Earthquake Authority and not expose their own company’s surplus to a large quake.  The Authority does not pay income tax on any underwriting profits, so its surplus can grow much as an individual’s 401k retirement account.  The major flaw is that its investment strategy is pretty much forced to only invest in government bonds and so cannot grow anywhere near as rapidly as would be the case if it were allowed a wider range of investments.  Nevertheless it does have many billions of dollars of retained earnings/surplus and also purchases cat reinsurance (Berkshire provided one of its initial multi year cat reinsurance covers when it started in 1996).

 

However,if there ever is an EQ shake event or perhaps several in close succession to each other that might exhaust the claims paying ability, beyond a modest assessment against member companies, it’s technically possible that claimants would not be made whole….and would have to receive prorata settlements of their claims.  The CEA is not a member of the Guaranty Fund, so if it becomes insolvent, there is no Guaranty Fund backstop for individual claims, so in this case, neither the state’s taxpayers nor private insurer customers provide a backstop.

When the private property insurance market shows strains, the effect is most likely to drive a reduction in the rate of economic growth in the state.  Real estate transactions become more difficult if buyers are not able to find affordable policies (which is a requirement for any mortgage provider).  Homeowners may find it more difficult to sell when they want to move, and to the extent that insurance becomes more difficult to obtain and the price increases, I would presume that it would impact home prices.  In the long run, if the private marketplace doesn’t improve, then it could very well be the case that the state ends up becoming a provider of last resort.  In my opinion that would likely be a mistake for California as I don’t have great confidence in the ability of a single state to manage insurance risks…nor does it make sense to end up with the only providers being the state itself or companies that only write property in that state.  
 

Florida is a poster child in this regard. Citizens Insurance, the state run insurer of last resort is often the largest provider of property insurance in the state. Very few national companies have a material market share in the state, so the ability to spread risks nationally across many risk geographies is lost.  Insurance is a form of lubrication to keep the gears of an economy moving after catastrophes.  When the insurance system in a given state loses the ability to spread risk broadly, the probability increases that a large, somewhat uninsured catastrophe in a state would effectively throw sand into the gears of the economy and cause it to slow down if not stop temporarily.  That is one way in which a state itself (or rather its economy) would be paying after the fact for a regulatory failure to support the private insurance marketplace.

 

 

 

 

 

 

[LC]

Interesting- I was thinking if the state does provide some backstop then essentially pricing is provided by reinsurers and “paid for” by the state (well, by taxes). So while price controls exist for the homeowner, ultimately they are paying a market rate set by reinsurers but paid for by their taxes. But seems that is not the case.

 

Regardless I agree with you: price controls seem like a very uneconomic setup which will only push logical players out of the market, thereby increasing risk overall. 
 

Thanks for the discussion.

[dartmonkey]

9 hours ago, UK said:

 

 

Climate change “has the potential of changing the insurance business profoundly and making part of the world un-insurable,” Gonzalo Gortazar, CaixaBank SA’s chief executive officer, said in an interview with Bloomberg TV Friday. “It’s not happening yet, but if we keep moving in that direction this is something we will have to face in due course.”

 

Yet, is that represents more of a threat (unexpected losses, regulatory risks, etc) or an opportunity (increasing market, better pricing, etc) for insurance/reinsurance companies? Perhaps everything will come down even more to execution quality of any particular company? Could all this negative publicity at least help improve pricing somewhat:)?

 

It seems to me that this possibility of more climate change disasters (although this is more of a fear than a current reality) is an opportunity for insurers, not a threat. Of course if the risk increases, rates will have to go up, but this just expands the total addressable market of the insurance industry. In the same way that fully self-driving cars might drastically shrink the auto insurance industry, more hurricanes or flooding or fires might expand it. That may not be good for humans, but it’s good for insurance companies. 

[newtovalue]

@ValueMaven - thanks for posting the Everest Call. Reading through the transcript and it seems they are very bullish on pricing. They did a capital raise in May 2023 of $1.5BB and were asked about it on the call.

 

They are confident at exceeding 21.8% ROE on the new capital they raised and looking to have the majority deployed by year end. 

 

So FFH is obviously not raising more capital - but any views if they are able to ramp up premiums into this harder market. 

 

Mark Kociancic

Group Chief Financial Officer at Everest Re Group

Thank you, Juan, and good morning, everyone. Everest had a very strong quarter, rounding out a solid start to the first half of 2023. The company reported record operating income of $627 million or $15.21 per diluted share in the quarter, equating to an operating income ROE of 21.8%.

 

Mark Kociancic

Group Chief Financial Officer at Everest Re Group

And again, the ROE on that incremental $1.5 billion of capital is something we feel confident in exceeding our Q1 operating ROE going forwards.

 

 

[Thrifty3000]

High: $799.99

Up 35% YTD
 

Edited July 29, 2023 by Thrifty3000

[MMM20]

Thanks all for the responses and especially @Maverick47 for helping me understand the Florida/California dynamics better.

I still will not be surprised if the hard market reaccelerates in certain pockets and in fits and starts and Fairfax ends up cash flowing its whole market cap over the next 4-5 years or so. The supply side / capital formation dynamics just seem increasingly wacky. I’m not sure how they get generally better across the board anytime soon and we know Fairfax will grow aggressively into pockets of strength.
 

Edited July 30, 2023 by MMM20

[Viking]

Kennedy Wilson is a misunderstood and underappreciated part of Fairfax’s investment portfolio. Most investors think of Kennedy Wilson through the lens of an equity holding. Looking at the performance of KW’s stock price the past 5 years… what a dog! Woof! KW shares were trading around $21.40 five years ago and today they closed at $16.44/share.

 

What a terrible investment by Fairfax. Right? Wrong.  

 

Kennedy Wilson has been one of Fairfax’s best investments. What is wrong with the analysis above? It completely misses the point of WHY Fairfax is invested in Kennedy Wilson – it is to tap into Kennedy Wilson’s extensive global real estate expertise.  

 

First, let’s do a quick review. 

 

Fairfax began its relationship with Kennedy Wilson in 2010. A very successful real estate investment partnership has recently blossomed to now include a significant real estate debt platform. Over the past 3 years, Kennedy Wilson has become a much more important part of Fairfax’s investment portfolio. The partnership now includes both equity and fixed income investments:

• 2010: $100 million direct investment in Kennedy Wilson stock
• 2010: Real estate investment partnerships
• 2020: Real estate debt platform
• 2022: $300 million debenture (4.75%)
  • 7-year warrants for 13 million common shares with strike price of $23. 
• 2023: Purchase of $2.3 billion in real estate loans from PacWest
• 2023: $200 million debenture (6%)
  • 7-year warrants for 12.3 million common shares with strike price of $16.21 

Roughly, how much does Fairfax currently earn annually from its different investments with Kennedy Wilson? 

 

My very rough estimate is around $481 million. Fairfax has about $5.7 billion invested with Kennedy Wilson so this represents about a 8.4% annual rate of return for Fairfax (mostly interest and dividends).
 

Of this total, about $429 million is interest and dividends. The PacWest loan transaction just closed so the incremental earnings from this investment will start to show in the interest and dividend income bucket starting in Q3. 

 

 

The expansion of the relationship with Kennedy Wilson provides another good example of how Fairfax over the last 5 years has been:

• Leveraging and expanding existing, successful, long-term partnerships
• Methodically diversifying their investment portfolio - in this case into real estate

The result is yet another new, growing, significant and steady stream of earnings for Fairfax.

—————

What is the timeline of Fairfax’s various investments in/with Kennedy Wilson?

 

Started in 2010

• Kennedy Wilson (KW) stock
  • initial equity investment was US$100 million (9% of company)
  • today position is worth $200 million (13.3 million shares x $14.98/share)
  • current annual dividend of $0.96 = 6.4% yield = $12.8 million in dividend income per year
  • Wade Burton is on the board (along with Stanley Zax, who sold Zenith to Fairfax in 2010)
• investment partnership:
  • started with $278 million in 2010
  • Prem’s 2022 letter: “we have invested $1.2 billion alongside with them in real estate, have received cash proceeds of $1.1 billion and still have real estate worth about $570 million. Our average annual realized return on completed projects is approximately 22%.”

Expanded in 2020

• Launched a real estate debt platform: to pursue first mortgage loans secured by high-quality real estate in the Western U.S., Ireland and the U.K.
  • 2020 = initial amount of $2 billion
  • 2022 = increased to $5 billion
  • Prem’s 2022 letter: “$2.4 billion invested through Kennedy Wilson in well-secured first mortgages, primarily on high quality residential apartment buildings, at a floating rate (currently 7.9%)” = $190 million in interest income.

Expanded further in 2022

• 2022: KW perpetual preferred equity investment = $300 million
  • pays an annual dividend of 4.75% = $14.25 million
  • includes 7-Year warrants for 13 million shares at strike price of $23/share.

Expanded further in 2023

• PacWest debt purchase of $2.3 billion: KW is buying loans at a discount for $2.1 billion, of which Fairfax is buying $2 billion (95%). Fairfax is also assuming $1.7 billion in future funding obligations. 
  • Average loan to value is 51%.
  • More than 70% of the loans relate to multifamily or student residences; the remainder are a mix of industrial, hotel and life sciences office property projects. 
  • Fairfax expects the average annual return to exceed 10%.
  • Remaining term to maturity is 1.7 years, with some loans carrying extension rights (max 2 years).
• 2023: KW perpetual preferred equity investment = $200 million
  • pays an annual dividend of 6% = $12 million
  • includes 7-Year warrants for 12.3 million shares at strike price of $16.21/share.

Ownership of stock:

• Kennedy Wilson has 139.4 million shares outstanding
• Fairfax owns 13.3 million = 9.5%
• Fairfax also owns warrants:
  • 13 million at $23
  • 12.3 million at $16.21
• If Fairfax exercises all warrants it would own 38.6 million shares = 23.4% (164.7 total)

Fairfax is getting paid 4.75% and 6% while waiting for the warrants to get in the money (they have seven years). 

 

What does Fairfax see in Kennedy Wilson?

 

Prem’s comment from the 2022 press release from Kennedy Wilson announcing the PacWest transaction: “We are pleased to make this new investment in Kennedy Wilson and to build on our outstanding partnership that dates back to 2010,” said Prem Watsa, Chairman and CEO of Fairfax. “We believe in their global business model, the strength of their high-quality, income-generating assets, and their best-in-class management team.”

• https://ir.kennedywilson.com
• Q4 2022 Investor Presentation: https://ir.kennedywilson.com/~/media/Files/K/Kennedy-Wilson-IR-V2/reports-and-presentations/presentations/q4-2022-investors-presentation.pdf

—————

Interesting trivia point: Bill McMorrow (CEO and Chairman of KW) was the genesis behind Fairfax's investment in Bank of Ireland in 2011. Fairfax made around $1 billion from that one investment. Thank you, Bill! (see Prem's comments below from 2011AR)

—————

2020: Kennedy Wilson and Fairfax Launch New $2 Billion Real Estate Debt Platform

• https://ir.kennedywilson.com/news-events-and-presentations/press-releases/2020/05-14-2020-105955816

“Kennedy Wilson and Fairfax first invested together in 2010 when the two companies acquired $250 million of real estate assets, including real estate secured loans and real property. Over the past decade, the companies have partnered on $7 billion in aggregate acquisitions, including over $3 billion of real estate related debt investments. In addition, Fairfax currently has an equity ownership interest in Kennedy Wilson of approximately 9%.”

 

2022: Kennedy Wilson Announces $300 Million Perpetual Preferred Equity Investment From Fairfax Financial

• https://ir.kennedywilson.com/news-events-and-presentations/press-releases/2022/02-23-2022-211613501

“Kennedy Wilson and Fairfax began their relationship in 2010 when Fairfax made a $100 million equity investment in Kennedy Wilson. Over the past decade, the companies have partnered on $8 billion in aggregate acquisitions, including approximately $5 billion of real estate related debt investments. Fairfax currently has an equity ownership interest in KW of approximately 9%.”

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2023: Fairfax Financial Partners With Kennedy Wilson to Acquire Loan Portfolio From Pacific Western Bank, Makes Additional Equity Investment in Kennedy Wilson

• https://www.fairfax.ca/press-releases/fairfax-financial-partners-with-kennedy-wilson-to-acquire-loan-portfolio-from-pacific-western-bank-makes-additional-equity-investment-in-kennedy-wilson-2023-06-05/

Kennedy Wilson’s Press Release

• https://ir.kennedywilson.com/news-events-and-presentations/press-releases/2023/06-09-2023-110020523

“The acquisition of this Loan Portfolio from Pacific Western Bank highlights Kennedy Wilson’s historic ability to find off-market transactions during periods of uncertainty, move with speed, and build on our successful track record of investing through all real estate cycles,” said William McMorrow, Chairman and CEO at Kennedy Wilson. “The foundations of Kennedy Wilson are our deep relationships, our reputation as a great partner, and our strength in being nimble when opportunity arises; all of which came into play with this loan portfolio acquisition.”

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2022AR Prem: “Since we met Bill McMorrow and Kennedy Wilson in 2010, we have invested $1.2 billion alongside with them in real estate, have received cash proceeds of $1.1 billion and still have real estate worth about $570 million. Our average annual realized return on completed projects is approximately 22%. We also own 10% of the company. More recently we have been investing with Kennedy Wilson in first mortgage loans secured by high quality real estate in the western United States, Ireland and the United Kingdom with a loan-to-value ratio of 60% on average. At the end of 2022, we had invested in $2.0 billion of mortgage loans in the U.S. at an average yield of 8.1% and an average maturity of 1.7 years, and in approximately $350 million of mortgage loans in the U.K. and Europe at an average yield of 6.0% and an average maturity of 2.5 years.”

 

“The combination of interest and dividends and profit from associates accounted for a 3.7% return on our portfolio in 2022, the highest return in the last five years (average 2.5%). We expect to earn these returns in 2023 as well, partly because we have $2.4 billion invested through Kennedy Wilson in well-secured first mortgages, primarily on high quality residential apartment buildings, at a floating rate (currently 7.9%).”

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2013AR: “The KWF LPs are partnerships formed between the company and Kennedy-Wilson, Inc. and its affiliates to invest in U.S. and international real estate properties. The company participates as a limited partner in the KWF LPs, with limited partnership interests ranging from 50% to 90%. Kennedy-Wilson holds the remaining limited partnership interests in each of the KWF LPs and is also the General Partner. For the KWF LPs where the company may exercise veto rights over one or more key activities, those partnerships are considered joint ventures under IFRS 11. Where the company has no veto rights over key activities, the company is considered to have significant influence under IAS 28. The equity method of accounting is applied to all of the KWF LPs.”

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2011AR Prem: “I have attended the Berkshire Hathaway shareholders’ meeting since there were only 200 shareholders in attendance about 30 years ago. I still find I learn something each year from Warren and Charlie. At the meeting in 2010, I met Bill McMorrow through Alan Parsow, who is a money manager based in Omaha and a great friend. Bill founded Kennedy Wilson, a real estate services and investment company, in 1988, and he now owns 26% of the company. As a result of this meeting, we invested $100 million in a Kennedy Wilson 6% preferred convertible at $12.41 per share, and later purchased $32.5 million of a 6.45% preferred convertible at $10.70 per share and 400,000 common shares at $10.70 per share. Fully diluted we own 18.5% of the company. In 2010 and 2011, we also invested $290 million in several real estate deals with Kennedy Wilson in California, Japan and the U.K. – deals at significant discounts to replacement cost and with excellent unlevered cash on cash returns, in which Kennedy Wilson is the managing partner and a minority investor. We are thrilled to be partners with Bill and his team, who always focus on the downside and have the expertise to manage these investments and finally harvest them. You never know what you will find at a Berkshire meeting!!”

 

“And there is more to the McMorrow story. While Bill was negotiating the purchase of some real estate loans from Bank of Ireland, he was really impressed with Ritchie Boucher, the Bank’s CEO. Bill introduced Ritchie to us, and we too were very impressed. With the help of our friends at Canadian Western Bank, one of the best banks in Canada, we thoroughly reviewed the opportunity and then quickly formed an investment group with Wilbur Ross, Mark Denning from Capital Research and Will Danoff at Fidelity, which purchased $1.6 billion of Bank of Ireland shares on a rights issue (Fairfax’s share was $387 million).”

Edited August 2, 2023 by Viking

[nwoodman]

2 hours ago, Viking said:

You never know what you will find at a Berkshire meeting!!”

 

“And there is more to the McMorrow story. While Bill was negotiating the purchase of some real estate loans from Bank of Ireland, he was really impressed with Ritchie Boucher, the Bank’s CEO. Bill introduced Ritchie to us, and we too were very impressed. With the help of our friends at Canadian Western Bank, one of the best banks in Canada, we thoroughly reviewed the opportunity and then quickly formed an investment group with Wilbur Ross, Mark Denning from Capital Research and Will Danoff at Fidelity, which purchased $1.6 billion of Bank of Ireland shares on a rights issue (Fairfax’s share was $387 million).”

 

I have been thinking a lot lately that one of the magic ingredients to these styles of companies is deal flow.  Berkshire was able to use their brand and capital to backstop companies during the GFC but the phone nary rang during Covid (I know the Fed backstopped before things got truly interesting).  Perhaps Fairfax's deal flow is lower quality, and they are less discerning than Berkshire or Markel. However, they always seem to have something on the go. Often to the point of more ideas than capital i.e over leveraged.  Even their misadventures have yielded silver linings, Greece being the prime example. Anyway, back to your thoughtful post, the more partners you have turning over rocks on your behalf, the better

[Parsad]

4 hours ago, Viking said:

Kennedy Wilson is a misunderstood and underappreciated part of Fairfax’s investment portfolio. Most investors think of Kennedy Wilson through the lens of an equity holding. Looking at the performance of KW’s stock price the past 5 years… what a dog! Woof! KW shares were trading around $21.40 five years ago and today they closed at $16.44/share.

 

What a terrible investment by Fairfax. Right? Wrong.  

 

Kennedy Wilson has been one of Fairfax’s best investments. What is wrong with the analysis above? It completely misses the point of WHY Fairfax is invested in Kennedy Wilson – it is to tap into Kennedy Wilson’s extensive global real estate expertise.  

 

First, let’s do a quick review. 

 

Fairfax began its relationship with Kennedy Wilson in 2010. A very successful real estate investment partnership has recently blossomed to now include a significant real estate debt platform. Over the past 3 years, Kennedy Wilson has become a much more important part of Fairfax’s investment portfolio. The partnership now includes both equity and fixed income investments:

• 2010: $100 million direct investment in Kennedy Wilson stock
• 2010: Real estate investment partnerships
• 2020: Real estate debt platform
• 2022: $300 million debenture (4.75%)
  • 7-year warrants for 13 million common shares with strike price of $23. 
• 2023: Purchase of $2.3 billion in real estate loans from PacWest
• 2023: $200 million debenture (6%)
  • 7-year warrants for 12.3 million common shares with strike price of $16.21 

Roughly, how much does Fairfax currently earn annually from its different investments with Kennedy Wilson? 

 

My very rough estimate is around $481 million. Fairfax has about $5.7 billion invested with Kennedy Wilson so this represents about a 8.4% annual rate of return for Fairfax (mostly interest and dividends).
 

Of this total, about $429 million is interest and dividends. The PacWest loan transaction just closed so the incremental earnings from this investment will start to show in the interest and dividend income bucket starting in Q3. 

 

 

The expansion of the relationship with Kennedy Wilson provides another good example of how Fairfax over the last 5 years has been:

• Leveraging and expanding existing, successful, long-term partnerships
• Methodically diversifying their investment portfolio - in this case into real estate

The result is yet another new, growing, significant and steady stream of earnings for Fairfax.

—————

What is the timeline of Fairfax’s various investments in/with Kennedy Wilson?

 

Started in 2010

• Kennedy Wilson (KW) stock
  • initial equity investment was US$100 million (9% of company)
  • today position is worth $200 million (13.3 million shares x $14.98/share)
  • current annual dividend of $0.96 = 6.4% yield = $12.8 million in dividend income per year
  • Wade Burton is on the board (along with Stanley Zax, who sold Zenith to Fairfax in 2010)
• investment partnership:
  • started with $278 million in 2010
  • Prem’s 2022 letter: “we have invested $1.2 billion alongside with them in real estate, have received cash proceeds of $1.1 billion and still have real estate worth about $570 million. Our average annual realized return on completed projects is approximately 22%.”

Expanded in 2020

• Launched a real estate debt platform: to pursue first mortgage loans secured by high-quality real estate in the Western U.S., Ireland and the U.K.
  • 2020 = initial amount of $2 billion
  • 2022 = increased to $5 billion
  • Prem’s 2022 letter: “$2.4 billion invested through Kennedy Wilson in well-secured first mortgages, primarily on high quality residential apartment buildings, at a floating rate (currently 7.9%)” = $190 million in interest income.

Expanded further in 2022

• 2022: KW perpetual preferred equity investment = $300 million
  • pays an annual dividend of 4.75% = $14.25 million
  • includes 7-Year warrants for 13 million shares at strike price of $23/share.

Expanded further in 2023

• PacWest debt purchase of $2.3 billion: KW is buying loans at a discount for $2.1 billion, of which Fairfax is buying $2 billion (95%). Fairfax is also assuming $1.7 billion in future funding obligations. 
  • Average loan to value is 51%.
  • More than 70% of the loans relate to multifamily or student residences; the remainder are a mix of industrial, hotel and life sciences office property projects. 
  • Fairfax expects the average annual return to exceed 10%.
  • Remaining term to maturity is 1.7 years, with some loans carrying extension rights (max 2 years).
• 2023: KW perpetual preferred equity investment = $200 million
  • pays an annual dividend of 6% = $12 million
  • includes 7-Year warrants for 12.3 million shares at strike price of $16.21/share.

Ownership of stock:

• Kennedy Wilson has 139.4 million shares outstanding
• Fairfax owns 13.3 million = 9.5%
• Fairfax also owns warrants:
  • 13 million at $23
  • 12.3 million at $16.21
• If Fairfax exercises all warrants it would own 38.6 million shares = 23.4% (164.7 total)

Fairfax is getting paid 4.75% and 6% while waiting for the warrants to get in the money (they have seven years). 

 

What does Fairfax see in Kennedy Wilson?

 

Prem’s comment from the 2022 press release from Kennedy Wilson announcing the PacWest transaction: “We are pleased to make this new investment in Kennedy Wilson and to build on our outstanding partnership that dates back to 2010,” said Prem Watsa, Chairman and CEO of Fairfax. “We believe in their global business model, the strength of their high-quality, income-generating assets, and their best-in-class management team.”

• https://ir.kennedywilson.com
• Q4 2022 Investor Presentation: https://ir.kennedywilson.com/~/media/Files/K/Kennedy-Wilson-IR-V2/reports-and-presentations/presentations/q4-2022-investors-presentation.pdf

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Interesting trivia point: Bill McMorrow (CEO and Chairman of KW) was the genesis behind Fairfax's investment in Bank of Ireland in 2011. Fairfax made around $1 billion from that one investment. Thank you, Bill! (see Prem's comments below from 2011AR)

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2020: Kennedy Wilson and Fairfax Launch New $2 Billion Real Estate Debt Platform

• https://ir.kennedywilson.com/news-events-and-presentations/press-releases/2020/05-14-2020-105955816

“Kennedy Wilson and Fairfax first invested together in 2010 when the two companies acquired $250 million of real estate assets, including real estate secured loans and real property. Over the past decade, the companies have partnered on $7 billion in aggregate acquisitions, including over $3 billion of real estate related debt investments. In addition, Fairfax currently has an equity ownership interest in Kennedy Wilson of approximately 9%.”

 

2022: Kennedy Wilson Announces $300 Million Perpetual Preferred Equity Investment From Fairfax Financial

• https://ir.kennedywilson.com/news-events-and-presentations/press-releases/2022/02-23-2022-211613501

“Kennedy Wilson and Fairfax began their relationship in 2010 when Fairfax made a $100 million equity investment in Kennedy Wilson. Over the past decade, the companies have partnered on $8 billion in aggregate acquisitions, including approximately $5 billion of real estate related debt investments. Fairfax currently has an equity ownership interest in KW of approximately 9%.”

—————

2023: Fairfax Financial Partners With Kennedy Wilson to Acquire Loan Portfolio From Pacific Western Bank, Makes Additional Equity Investment in Kennedy Wilson

• https://www.fairfax.ca/press-releases/fairfax-financial-partners-with-kennedy-wilson-to-acquire-loan-portfolio-from-pacific-western-bank-makes-additional-equity-investment-in-kennedy-wilson-2023-06-05/

Kennedy Wilson’s Press Release

• https://ir.kennedywilson.com/news-events-and-presentations/press-releases/2023/06-09-2023-110020523

“The acquisition of this Loan Portfolio from Pacific Western Bank highlights Kennedy Wilson’s historic ability to find off-market transactions during periods of uncertainty, move with speed, and build on our successful track record of investing through all real estate cycles,” said William McMorrow, Chairman and CEO at Kennedy Wilson. “The foundations of Kennedy Wilson are our deep relationships, our reputation as a great partner, and our strength in being nimble when opportunity arises; all of which came into play with this loan portfolio acquisition.”

—————

2022AR Prem: “Since we met Bill McMorrow and Kennedy Wilson in 2010, we have invested $1.2 billion alongside with them in real estate, have received cash proceeds of $1.1 billion and still have real estate worth about $570 million. Our average annual realized return on completed projects is approximately 22%. We also own 10% of the company. More recently we have been investing with Kennedy Wilson in first mortgage loans secured by high quality real estate in the western United States, Ireland and the United Kingdom with a loan-to-value ratio of 60% on average. At the end of 2022, we had invested in $2.0 billion of mortgage loans in the U.S. at an average yield of 8.1% and an average maturity of 1.7 years, and in approximately $350 million of mortgage loans in the U.K. and Europe at an average yield of 6.0% and an average maturity of 2.5 years.”

 

“The combination of interest and dividends and profit from associates accounted for a 3.7% return on our portfolio in 2022, the highest return in the last five years (average 2.5%). We expect to earn these returns in 2023 as well, partly because we have $2.4 billion invested through Kennedy Wilson in well-secured first mortgages, primarily on high quality residential apartment buildings, at a floating rate (currently 7.9%).”

—————

2013AR: “The KWF LPs are partnerships formed between the company and Kennedy-Wilson, Inc. and its affiliates to invest in U.S. and international real estate properties. The company participates as a limited partner in the KWF LPs, with limited partnership interests ranging from 50% to 90%. Kennedy-Wilson holds the remaining limited partnership interests in each of the KWF LPs and is also the General Partner. For the KWF LPs where the company may exercise veto rights over one or more key activities, those partnerships are considered joint ventures under IFRS 11. Where the company has no veto rights over key activities, the company is considered to have significant influence under IAS 28. The equity method of accounting is applied to all of the KWF LPs.”

—————

2011AR Prem: “I have attended the Berkshire Hathaway shareholders’ meeting since there were only 200 shareholders in attendance about 30 years ago. I still find I learn something each year from Warren and Charlie. At the meeting in 2010, I met Bill McMorrow through Alan Parsow, who is a money manager based in Omaha and a great friend. Bill founded Kennedy Wilson, a real estate services and investment company, in 1988, and he now owns 26% of the company. As a result of this meeting, we invested $100 million in a Kennedy Wilson 6% preferred convertible at $12.41 per share, and later purchased $32.5 million of a 6.45% preferred convertible at $10.70 per share and 400,000 common shares at $10.70 per share. Fully diluted we own 18.5% of the company. In 2010 and 2011, we also invested $290 million in several real estate deals with Kennedy Wilson in California, Japan and the U.K. – deals at significant discounts to replacement cost and with excellent unlevered cash on cash returns, in which Kennedy Wilson is the managing partner and a minority investor. We are thrilled to be partners with Bill and his team, who always focus on the downside and have the expertise to manage these investments and finally harvest them. You never know what you will find at a Berkshire meeting!!”

 

“And there is more to the McMorrow story. While Bill was negotiating the purchase of some real estate loans from Bank of Ireland, he was really impressed with Ritchie Boucher, the Bank’s CEO. Bill introduced Ritchie to us, and we too were very impressed. With the help of our friends at Canadian Western Bank, one of the best banks in Canada, we thoroughly reviewed the opportunity and then quickly formed an investment group with Wilbur Ross, Mark Denning from Capital Research and Will Danoff at Fidelity, which purchased $1.6 billion of Bank of Ireland shares on a rights issue (Fairfax’s share was $387 million).”

 

Great review of KW Viking!  Cheers!