Fairfax 2023

[giulio]

@Parsad given the recent growth in premiums and their stated objective of limiting cat losses to 1 year of normalized earnings (i.e. 15% pre-tax ROE), do you think that FFH will hold more cash at holdco going forward? Should we expect $3B as a new average level of cash?

TIA

[StubbleJumper]

3 hours ago, nwoodman said:

Am I wrong in seeing this as simply debt recycling and not really news?  I don’t see it as necessarily improving medium term liquidity in itself at the HoldCo, but I question whether this is a real problem anyway.  

 

 

I guess we will see when the AR is released in April, right?  FFH does have US$280m coming due in August.  It's possible that they might have taken care of this (or some other notes) early, or it's possible that they are just being cute and simply plan to repay that debt in August when it comes due.  In the mean time, they get to use the cash for general corporate purposes and it buys another 8 months before they need to issue a larger than usual divvy or float some other debt.

 

Fine in either case.  They have been obviously running short on actual cash unless you hold the view that the derivative line in Note 5 is actually something that they could easily liquidate and use (meaning that the derivative was speculative rather than for risk management or other strategic objectives).  Sometimes the Holdco sources - uses forecast exercise is instructive.

 

While FFH does have a large revolver available, I dislike that option because they are subject to covenants and need to be renewed relatively soon (ie, they are usually 3 years or less between renewals).  It is preferable to not be reliant on the kindness of bankers.  In Spring/summer of 2020, Prem came surprisingly close to driving FFH into a wall because of those covenants.

 

 

SJ

[StubbleJumper]

1 hour ago, giulio said:

@Parsad given the recent growth in premiums and their stated objective of limiting cat losses to 1 year of normalized earnings (i.e. 15% pre-tax ROE), do you think that FFH will hold more cash at holdco going forward? Should we expect $3B as a new average level of cash?

TIA

 

I'm not Sanj, but I'll chip in a viewpoint anyway,.  

 

The Holdco requires cash for interest, the annual divvy, corporate overhead, and the pref divvies.  Sometimes it will require cash for debt repayments, and sometimes for "re-purchasing" minority positions in the subs from outfits like OMERS.  Add on a buffer, and that's the basic need.

 

Then consider the strategic opportunity.  Suppose the market goes to hell and FFH suddenly trades at 0.7x adjusted-BV.   How much cash would be required to hammer the gas on that NCIB and repurchase 1 million shares?  I'd say roughly $750m....

 

Add it up, and maybe $2b of short-term securities that can actually be easily liquidated might be about right (that derivative line in Note 5 might not count).

 

 

SJ

[giulio]

makes a lot of sense, thank you @StubbleJumper!

I am very curious about how this cycle evolves and how FFH adapts, many levers to pull.

We will see!

[nwoodman]

16 minutes ago, StubbleJumper said:

 

I'm not Sanj, but I'll chip in a viewpoint anyway,.  

 

The Holdco requires cash for interest, the annual divvy, corporate overhead, and the pref divvies.  Sometimes it will require cash for debt repayments, and sometimes for "re-purchasing" minority positions in the subs from outfits like OMERS.  Add on a buffer, and that's the basic need.

 

Then consider the strategic opportunity.  Suppose the market goes to hell and FFH suddenly trades at 0.7x adjusted-BV.   How much cash would be required to hammer the gas on that NCIB and repurchase 1 million shares?  I'd say roughly $750m....

 

Add it up, and maybe $2b of short-term securities that can actually be easily liquidated might be about right (that derivative line in Note 5 might not count).

 

 

SJ

Great post, but are you seeing something across the entire entity less stat requirements that can’t be solved “in a stroke of a pen”  or is it more a sub risk.  Along the lines of we had liquidity but it was good until reached for but has now ceased to exist.  I.e multi cats.

Edited December 5, 2023 by nwoodman

[srtadimeti]

https://networkthoughts.com/2023/12/05/bengaluru-the-most-profitable-airport/

[StubbleJumper]

1 hour ago, nwoodman said:

Great post, but are you seeing something across the entire entity less stat requirements that can’t be solved “in a stroke of a pen”  or is it more a sub risk.  Along the lines of we had liquidity but it was good until reached for but has now ceased to exist.  I.e multi cats.

 

No, my point is not to convey some sort of crisis, as the regulators have approved significant dividends from the insurance subs, so as you say, a short term cash need can be addressed at the stroke of a pen.  But, as always, during a hard market, that stroke of a pen does not come without cost.

 

 

SJ

[Parsad]

11 hours ago, StubbleJumper said:

 

I'm not Sanj, but I'll chip in a viewpoint anyway,.  

 

The Holdco requires cash for interest, the annual divvy, corporate overhead, and the pref divvies.  Sometimes it will require cash for debt repayments, and sometimes for "re-purchasing" minority positions in the subs from outfits like OMERS.  Add on a buffer, and that's the basic need.

 

Then consider the strategic opportunity.  Suppose the market goes to hell and FFH suddenly trades at 0.7x adjusted-BV.   How much cash would be required to hammer the gas on that NCIB and repurchase 1 million shares?  I'd say roughly $750m....

 

Add it up, and maybe $2b of short-term securities that can actually be easily liquidated might be about right (that derivative line in Note 5 might not count).

 

 

SJ

 

Yes, I think $2B at the holdco would be the new comfort level with the size of operations now...and I'm not keen on including the revolver in that amount.  

 

If you want to say we're a rock solid company, then you have to keep cash at the holdco...simple!  Cheers!

[SafetyinNumbers]

2 hours ago, Parsad said:

 

Yes, I think $2B at the holdco would be the new comfort level with the size of operations now...and I'm not keen on including the revolver in that amount.  

 

If you want to say we're a rock solid company, then you have to keep cash at the holdco...simple!  Cheers!

 

I assume the insurance companies benefit with ratings agencies and clients by having excess capital sit at the subsidiaries.

 

What do you see as the benefit of having cash at the holdco instead besides Social Value?

[Crip1]

12 hours ago, StubbleJumper said:

 

No, my point is not to convey some sort of crisis, as the regulators have approved significant dividends from the insurance subs, so as you say, a short term cash need can be addressed at the stroke of a pen.  But, as always, during a hard market, that stroke of a pen does not come without cost.

 

 

SJ

I'd appreciate anyone chiming in as something is not quite adding up here.

 

Dividend capacity at the subs has been constrained for years during the hard market as premium volume has been increasing dramatically. All good. But last quarter we saw premium volume increase about 5% YOY, much lower than in previous years and most industry folks I've seen are not seeing double-digit premium increases. At the same time, capital is increasing at a faster rate than we've seen in years due to substantially increased interest income coupled with still profitable underwriting. If these trends continue into 2024, it seems the subs would soon have excess capital that could be dividended (not sure that's really a word but, oh well) to the parent. So, assuming this all plays out, there really should not be a need for additional cash at the holding company, unless I am missing something.

 

-Crip

[StubbleJumper]

@Crip1 We have seen one quarter of slower premium growth, which may be the beginning of a trend, or it may be simply an aberration.  Personally, I hope it's the latter, but we know every hard market must eventually turn.

 

You are correct that the subs can release more capital to the Holdco if growth does slow (we will see in the next couple of quarters).  That being said, in the short-term, FFH has been running light on Holdco cash this year, which carries its own risk.  In this most recent note flotation, they've shown they can borrow at 6% over 10 years and we know that the holdco can buy treasuries at ~5%, at least in the short-term, so what does it cost to float an extra $300m or $400m of debt?  For me, it's basic risk management.

 

 

SJ

[Viking]

As bond yields continue lower it is instructive to reflect on what Fairfax did in October (as per Prem’s comments on the Q3 earnings call). In October, when bond yields were hitting 15 year highs, Fairfax meaningfully extended the average duration of their fixed income portfolio from 2.4 years to 3.1 years. In Nov/Dec bond yields have come down significantly (70-80 basis points) from the highs reached in October.

 

Fairfax, obviously, did not hit every move with perfect timing - that, of course, would be impossible. Fairfax has a massive fixed income portfolio of $42 billion - it is a supertanker not a speedboat. It also, at its core, an insurance company. All things considered, Fairfax has done an exceptional job of navigating its fixed income portfolio through some very treacherous waters over the past 2 years.

 

Fairfax could be sitting on sizeable unrealized gains in its fixed income portfolio in Q4. Yes, this will be offset by losses due to IFRS-17. We will see how it all shakes out when Fairfax reports Q4 results. Bottom line, aggressively extending duration in October looks to have been anther great move by the fixed income team at Fairfax. 

 

It really is amazing to look at what Fairfax has done with its fixed income portfolio over the past 2 years:

1.) Q4-2021: shift to 1.2 years average duration as bond yields were bumping along the bottom.

• avoided billions in losses - protected the balance sheet

2.) over next 6 quarters slowly extend duration from 1.2 years to 2.5 years

3.) October 2023: extend duration to 3.1 years.

• this likely locks in $500 million/quarter in interest income for years into the future
• for reference, interest income was $130 million in Q4, 2021 (2 short years ago).

4.) opportunistic: late in Q2, invested $2 billion in PacWest real estate loans with expected total return of 10%

5.) current bond portfolio is weighted heavily to government bonds - positioned very defensively

 

Fairfax’s fixed income portfolio = high yield AND high quality

 

Edited December 6, 2023 by Viking

[Haryana]

 

I just like to quote this from the 2022 letter:

"This rapid growth in the last five years focused on underwriting profit and not reaching for yield. This has resulted
in our expected future annual operating income of more than $3.0 billion: $1.5 billion from interest and dividend
income, more than $1.0 billion in underwriting profit and more than $0.5 billion profit from non-insurance
companies (associates and consolidated investments), resulting in Fairfax earning approximately $100 per share
even without any potential gains on our stock positions! "

 

 

With expected increases in interest income and from investments, we may upgrade the annual estimate to 4 billion.

Dividing this by the current market cap we get a P/E of 5.5. Nothing too speculative, this is a conservative scenario.

 

[Parsad]

19 hours ago, SafetyinNumbers said:

 

I assume the insurance companies benefit with ratings agencies and clients by having excess capital sit at the subsidiaries.

 

What do you see as the benefit of having cash at the holdco instead besides Social Value?

 

When 9/11 happened, BCN (biological, chemical, nuclear) exclusions were added to all insurance policies.  But insurers were still on the hook for losses for policies written before that.

 

What if your insurance subs need an injection of capital and it is hard to raise capital?  We've been there before.  Fortunately, we had good friends who bailed us out until we could get our legs under ourselves again.

 

I don't want FFH to be an insurer that has to go looking for capital in an outlier event.  Like Berkshire, I want them to be self-funding.  Because when money is tight, cash is king...including for your own protection!

 

Yes, you give up some gains, but you will live when others perish!  It's why I always have a fair amount of cash in everything I do.  And it works for corporations as well!

 

Cheers!

[StubbleJumper]

1 hour ago, Parsad said:

 

When 9/11 happened, BCN (biological, chemical, nuclear) exclusions were added to all insurance policies.  But insurers were still on the hook for losses for policies written before that.

 

What if your insurance subs need an injection of capital and it is hard to raise capital?  We've been there before.  Fortunately, we had good friends who bailed us out until we could get our legs under ourselves again.

 

 

+1

 

The pandemic didn't put any (many?) insurers out of business, but it should be instructive for us.  What didn't happen was an enormous hit from business interruption claims.  Thankfully, the legal framework prevented that ridiculous cat claim.  But what if it had not done so?  What if there would have been a couple billion of BI indemnities at FFH?  And what if Ffh's reinsurers had been hammered with enormous claims as a result?

 

Go back in history almost four years.  In spring 2020 credit markets seized up briefly, equity markets went into the shitter, and FFH reported significant M2M losses on its equity port, and moderate cat losses from covid.  At that time, the company had already tapped its revolver for general corporate purposes before that virus even broke out and they were already subject to the covenants.  Imo, FFH came uncomfortably close to violating those covenants in summer 2020.  Had the cat claims been meaningfully worse or if the collectibility of ffh's reinsurance receivables had been called into question (ie reinsurers who can't pay or won't pay), Prem might have driven the company onto a wall.  For me, it was masterfully managed by Prem given the cards he had available, but it was uncomfortable.

 

The lesson is to not fuck around.  Have plenty of capital and plenty of Holdco cash.  Keep a revolver, but never put yourself in a position where you might be reliant on the kindness of bankers.

 

 

SJ

[Parsad]

3 hours ago, StubbleJumper said:

 

 

+1

 

The pandemic didn't put any (many?) insurers out of business, but it should be instructive for us.  What didn't happen was an enormous hit from business interruption claims.  Thankfully, the legal framework prevented that ridiculous cat claim.  But what if it had not done so?  What if there would have been a couple billion of BI indemnities at FFH?  And what if Ffh's reinsurers had been hammered with enormous claims as a result?

 

Go back in history almost four years.  In spring 2020 credit markets seized up briefly, equity markets went into the shitter, and FFH reported significant M2M losses on its equity port, and moderate cat losses from covid.  At that time, the company had already tapped its revolver for general corporate purposes before that virus even broke out and they were already subject to the covenants.  Imo, FFH came uncomfortably close to violating those covenants in summer 2020.  Had the cat claims been meaningfully worse or if the collectibility of ffh's reinsurance receivables had been called into question (ie reinsurers who can't pay or won't pay), Prem might have driven the company onto a wall.  For me, it was masterfully managed by Prem given the cards he had available, but it was uncomfortable.

 

The lesson is to not fuck around.  Have plenty of capital and plenty of Holdco cash.  Keep a revolver, but never put yourself in a position where you might be reliant on the kindness of bankers.

 

 

SJ

 

+1!

 

In the late 70's as interest rates started to rise, Jim Pattison (a local billionaire) said that the Bank of Montreal called all of his loans.  He scrambled to find money to save his businesses at the time...he was days away from losing everything!  He promised himself at that time, that he will never put himself or his businesses in a position where he has to rely on outside capital, especially the banks!

 

Today, Jim Pattison Group is probably the largest private enterprise in Canada valued at about $10B USD...he owns all of it...and he does not rely on the banks or anyone else!  He's also good buddies with Buffett.  Cheers!

[Dazel]

Someone can check but I am assuming that Digit is owned by the Fairfax Holding company? Their IPO was expected early this year and would add great deal of cash into the hold co. Depending  in the IPO size. The serendipitous timing is that the coming IPO comes at a time when the Indian stock market is screaming higher. Ie the sales of Thomas Cook shares after a great year. 

[netcash1]

[StubbleJumper]

@netcash1It's interesting that Bradstreet et Al have chosen now as the time to reach for yield.  When they picked up the $2b of Pacificorp debt at 10%, I raised my eyebrows, but it was a smallish bond investment at an attractive rate.  If the next $2 billion have a similar risk-reward profile, it's pretty aggressive.  If it works out, the results will be outstanding.  But you don't get 10% without taking on a bit of credit risk.

 

The easiest thing in the world to do for FFH would be to sit back and roll the US treasuries as they mature.  It would lock in good profits for the next few years.   But it requires some balls to reach for yield.  Let's hope it works out!

 

 

SJ

Edited December 7, 2023 by StubbleJumper

[gfp]

Here are the two KW filings for those that can't read the small print in netcash1's post.  SJ, I thought 10% Pacificorp debt sounded pretty wild even with the wildfire liabilities but realized you meant PacWest LOL...

 

https://otp.investis.com/clients/us/kennedy_wilson1/SEC/sec-show.aspx?Type=html&FilingId=17105470&CIK=0001408100&Index=10000

 

https://otp.investis.com/clients/us/kennedy_wilson1/SEC/sec-show.aspx?Type=html&FilingId=17105435&CIK=0001408100&Index=10000

[Xerxes]

54 minutes ago, netcash1 said:

hi

what is the source for this. It is not available on the “news” on the website ?

[gfp]

6 minutes ago, Xerxes said:

hi

what is the source for this. It is not available on the “news” on the website ?

Read my post above yours.  I linked to both Kennedy Wilson 8-Ks

[Xerxes]

59 minutes ago, gfp said:

Here are the two KW filings for those that can't read the small print in netcash1's post.  SJ, I thought 10% Pacificorp debt sounded pretty wild even with the wildfire liabilities but realized you meant PacWest LOL...

 

https://otp.investis.com/clients/us/kennedy_wilson1/SEC/sec-show.aspx?Type=html&FilingId=17105470&CIK=0001408100&Index=10000

 

https://otp.investis.com/clients/us/kennedy_wilson1/SEC/sec-show.aspx?Type=html&FilingId=17105435&CIK=0001408100&Index=10000

Got it. Thank you.

[MMM20]

3 hours ago, StubbleJumper said:

But you don't get 10% without taking on a bit of credit risk.

 

In a downside case where cap rates double or whatever, can't KW/Fairfax foreclose and just hold the properties?

[StubbleJumper]

2 hours ago, MMM20 said:

 

In a downside case where cap rates double or whatever, can't KW/Fairfax foreclose and just hold the properties?

 

Would you want to do that?  Really, you just want your capital back with a return.  Foreclosing on actual real estate and hoping you can eventually sell it to get your capital back doesn't sound so enticing.

 

 

Sj