Fairfax 2024

[Hamburg Investor]

2 hours ago, Viking said:

@Hamburg Investor I am going to push back on what you are trying to ask: I don’t think you can separate Fairfax management from external factors/events - the two are symbiotic. Is this what Soros called ‘reflexivity’?

 

Let’s look at interest rates. If interest rates stay where they are, Fairfax will likely  sit on current holdings/positions and collect interest. If interest rates fall 100 basis points on the long end, Fairfax will perhaps shorten duration and harvest some gains. If interest rates increase 100 basis points on the long end, Fairfax will likely extend duration and lock in high yields.

 

My point is Fairfax will thoughtfully adjust to high volatility events. 

 

Look what happened last April. We had a mini-banking crisis. If we had discussed it before it happened, we probably would have guessed it would probably be bad for Fairfax (for any number of reasons). It ended up being good for Fairfax because they were able to pick up $1.8 billion in real estate loans that they will earn a return on of about 10%. Partner Kennedy Wilson picked up PacWest’s real estate team - greatly expanding their capabilities; my guess is this over time will prove be a great move. 

 

There will also be second order effects over time. 

 

Back to interest rates… Over time, where interest rates go will also impact parts of the insurance market (underwriting margins), although i am sceptical the linkage is as strong as some on this board think is the case. So if long rates decline 100 basis points then perhaps the hard market continues in parts of the insurance market. The opposite id long rates increase 100 basis points. 

 

If the hard market persists Fairfax will continue to allocate capital to insurance subs. If the hard market turns soft, Fairfax will shift and allocate capital to investments / dividends / stock buybacks. 

 

My point is Fairfax will thoughtfully adjust to events. 

 

A Trump victory in the fall? We need to see what the platform is for each candidate. My guess is Trump will run on a pro-business (less government) type of platform. He also will likely be a big spender (the government will continue to run big deficits) - he is a real estate guy after all. I think you would want to have your portfolio positioned for higher economic growth and higher inflation - but that is my early guess. (It would not surprise me to see Trump fire Powell and appoint Fed members who will support his views/policies.)

 

How will this impact Fairfax? No idea. But i am confident we will get volatility in financial markets and Fairfax will be ready to pounce (again). 

 

In terms of investors reaction and stock price… well, anything can happen in the short run. Fairfax’s stock price is being set day-to-day by Mr Market (a manic depressive). 

 

With Fairfax I am focussed on earnings. And capital allocation. Macro, especially high volatility, is opportunity for Fairfax. At least that is how things have played out the past 5 years.
 

Active management appears to matter again.

 

Did i answer your question? 

—————

Perhaps you are trying to look at Fairfax through the lens of an economist… let’s assume Fairfax management does nothing… how would a change in interest rates affect Fairfax? This is perhaps a ‘theory’ based way of looking at things.

 

I prefer (try?) to focus on a ‘reality’ based way of looking at Fairfax. What do i think will actually happen in the real world. 
 

Toggling between the two is perhaps the best approach (understand the theory but also how things are likely to play out in the real world). 

again, thank you for making really good points. 
 

I really wanted to focus on this year, on 2024. So I focussed on the same time frame you took with your initial post (“the 10 points”).

And of course, you’re definitely right, when you write, we can’t predict the share price for such a short time frame, for just one year. Mr. Market is, well, Mr. Market. But still I see a lot of discussion here about exactly that topic, so I felt like why don’t speculate yourself for fun (something I haven’t done a lot ubtil now).

 

But I agree on what you said regarding Fairfax Financials special ability to profit from volatility in bond rates. Imho they are better than any other insurer I follow. 
 

You’re points regarding reflexivity and taking a more dynamic approach when looking at value creation is totally valid, although I think one year being a little bit too short in normal (whatever that is) years, to watch that in the surface. What everyone sees on the surface is earnings and growth in book value. We were a little bit lucky, that treasuries at the beginning and end of 2023 weren’t that far away from each other after some wild swings. Something that was really different the year before and could easily happen again. My best guess is, that volatility in esrnings and book value grwoth doesn’t help to win new investors for any (insurance) stock, the more Fairfax not being loved by the market at present.
 

As I tried to point out, I tried to think about the stock price, focussing more (and maybe too much) on the question, what might help other investors, not yet being aware about this fantastic company, to find it and build trust into it and its management. To me looking at this company, I don’t understand, how anybody can’t just fall in love with it immediately. But that’s me and I can’t buy more having over 40 per cent of my portfolio in Fairfax. 

 

After all less volatility in interest rates in my eyes would support this process of trust building. But at the same time I totally agree, that a volatile and/or not too low interest rate environment would be better for Fairfax value creation. Just as it would be better for growth of intrinsic value, if Fairfax shareprice would fall, the dividend would be dropped and the “freed” ressources would be used for buybacks (I am not saying, I want that to happen; just illustrating what helps growth in intrinsic value; but that’s not everything that counts). 
 

Does anybody have an idea/guess, how the mechanism regarding the management of the bond portfolio looks like? I mean, something like, when interest rates fall below 1%, they buy bonds with 1 year to maturity, under 2% they go for 3 years. And what would they do with really higher rates like 6% or 8%? Would they go above 5 years? I started in 2011 so I haven’t watched Fairfax going through the 80ies (I was 10 years old in 1986) or 90ies…

 

[Tommm50]

Large volume on FRFHF the last few days, pattern seems to be price rises in the morning session and sells off as the day goes on. Very large volume on FFH.CA today with no movement in price. Any insights into the activity? Related to building a position prior to year end results announcement?

[Tommm50]

Simply looking to pick up the dividend?

[gfp]

12 minutes ago, Tommm50 said:

Large volume on FRFHF the last few days, pattern seems to be price rises in the morning session and sells off as the day goes on. Very large volume on FFH.CA today with no movement in price. Any insights into the activity? Related to building a position prior to year end results announcement?

 

I would assume it is more related to the stock going ex-dividend on Thursday of next week than the results announcement over a month away.  There are also usually some large share crosses around the turn of the year related to the total return swap counter-party but I haven't noticed anything.

[Spekulatius]

On 1/9/2024 at 11:33 PM, Viking said:

@SafetyinNumbers i think your list is a good start. Here are some thoughts:

1.) equity position with most upside in 2024? Eurobank. I was surprised to see the stock value of Fairfax’s position up +$700 million in 2023. That values Eurobank at Euro 1.61/share. I think analyst price targets are currently in the Euro 2.25/share range.  Eurobank could easily be up 30% in 2024 = $600 million gain for Fairfax. Re-starting the dividend at Eurobank will be very good. But Hellenic Bank could really drive earnings later in the year. The Eurobank management team is very good - my guess is they are not done growing.

 

2.) FFH-TRS: it would not shock me to see Fairfax’s share price increase $300 in 2024 = another $600 million gain. Not a prediction. We will see. If you prediction of Fairfax getting added to the TSX60 comes true - that would just be another tailwind, and probably a significant one.

 

3.) India has been a very quiet region for Fairfax for a couple of years now. I suspect that will change in 2024. You highlight two big potential catalysts:

- Digit IPO: could we see a +$500 million increase in the value of Fairfax’s stake? There are also the ‘compulsory convertible preferred shares’ that Fairfax owns… when they get valued properly that will increase Fairfax’s ownership stake in Digit (74%?) and result in a big gain ($300 million?).

- Anchorage IPO (BIAL): i think BIAL is the real deal. The more i read/research the more i like that asset. 

And there are reports Fairfax is bidding for part of IDBI Bank. if successful, that would be a big investment (even for a 10% stake).
- https://www.livemint.com/companies/news/carlyle-fairfax-dbs-bank-may-bid-for-idbi-bank-11670349260107.html

The problem with India is it is impossible to predict the timing of these events. I would probably be 50% for Digit IPO and 40% for Anchorage IPO - but those are wild guesses (more than my usual guesses).

 

4.) Is 2024 the year investors start to notice Fairfax’s group of consolidated holdings? Do we see $200 million in annual earnings from this group? Perhaps $250 million? Does Fairfax continue to grow the number of holdings in this group? 
 

Is the plan at Fairfax to morph into more of a Berkshire type structure? And make a concerted effort to grow another large income stream (that would complement the insurance businesses)? I am not sure. But they kind of appear to be moving in that direction a little.
 

5.) Poseidon. This is a massive holding for Fairfax. And it has been in a holding pattern for the past 2 years. More of the same in 2024? Or do we see earnings (finally) start to grow as the company modelled a couple of short years ago. They certainly messed up with the structure of their debt in a rising rate environment (surprising given Fairfax’s positioning two years ago). But i do think Sokol will get the train back on the rails… just not sure if it happens in 2024 or 2025. Probably 2025 - but we will see.

 

6.) Commodity holdings: Stelco, Foran Mining, EXCO, OXY, Altius Minerals

- i think some of these holdings are going to rip higher in the next up-cycle in commodities (late 2024 or 2025?). Just not sure if that is 2024 or 2025. I love Stelco - it is a coiled spring. Foran is a lottery ticket. I wonder if EXCO gets sold (nat gas). Buffett sees something with OXY. 
 

7.) Insurance

- I am looking forward to seeing what GIG does to Fairfax’s balance sheet at year end when it gets consolidated. Total investments/float should get a nice pop. 
- Does the hard market continue into 2024? If Fairfax can get another year of 5 or 6% growth in net premiums written that would be great. With GIG that would put them +10% for the year, which would be very good. 
- Can we get another year with CR of around 95% or 96%? Lots of investors think it has to go to 100% - and quickly. I am not convinced.

 

8.) Kennedy Wilson debt platform. This went from $2 to over $4 billion in 2023. Do we go over $6 billion (or higher) in 2024? What is average interest rate earned? Is 8% a crazy high number? $6 billion at 8% = $480 million. 

 

9.) Rabbit: For the past couple of years, Fairfax has pulled a rabbit out of their hat - something that no one is expecting that is good for shareholders. I think we get another one in 2024 - and, of course, i have no idea what it is. 
 

10.) Like each of the past 5 or 6 years, capital allocation is going to be huge again in 2024. Why? Earnings at Fairfax are so high. The team is going to have billions to allocate, especially if they sell/monetize one or two largish holdings. What new income streams are they going to seed/create? In what bucket? Insurance or investments? Public or private?
 

Anyways, there are some random/rambling thoughts about 2024… Would love to hear what others are thinking. 

They better be careful with $KW. I don't know about the loans, but the stock does not look good.

[Haryana]

7 minutes ago, gfp said:

 

I would assume it is more related to the stock going ex-dividend on Thursday of next week than the results announcement over a month away.  There are also usually some large share crosses around the turn of the year related to the total return swap counter-party but I haven't noticed anything.

 

I would like to confirm that if the dividend is paid to shareholders of record on Jan18 and it takes 2 days to settle then the shareholders upto Jan16 will get paid and therefore the ex-dividend date should be Jan17 on Wednesday or is it Thursday?

 

[gfp]

22 minutes ago, Haryana said:

 

I would like to confirm that if the dividend is paid to shareholders of record on Jan18 and it takes 2 days to settle then the shareholders upto Jan16 will get paid and therefore the ex-dividend date should be Jan17 on Wednesday or is it Thursday?

 

 

Sorry, I was sloppy with my wording.  Shareholders of record on Jan 18th, so you would have to own the stock by Jan 16 to receive the dividend.  (with Jan 17th being the ex-div. date)

[SafetyinNumbers]

30 minutes ago, Spekulatius said:

They better be careful with $KW. I don't know about the loans, but the stock does not look good.

We’ll find out if FFH added to their position when they report earnings. Recall, they adjusted their agreement to be able to add late last year.
 

The stock hasn’t really done much in two months, why do you think it looks particularly bad now?

[Haryana]

TORONTO (Globe Newswire)

January 12, 2024

 

Fairfax Financial Holdings Limited (“Fairfax”) (TSX: FFH and FFH.U) has completed its previously announced offering of an additional US$200,000,000 of its 6.000% Senior Notes due December 7, 2033 (the “Notes”). Together with the previously issued US$400,000,000 aggregate principal amount of notes of this series (the “Original Notes”), there is US$600,000,000 aggregate principal amount of notes of this series outstanding. In connection with the closing of the offering, Fairfax entered into a customary registration rights agreement. 

 

[dartmonkey]

On 1/12/2024 at 4:33 PM, Tommm50 said:

Simply looking to pick up the dividend?

Yes, for people who think they don’t pay enough tax already this might be an attractive idea. 

[Dipesh Patel]

On 1/14/2024 at 4:02 PM, dartmonkey said:

Yes, for people who think they don’t pay enough tax already this might be an attractive idea. 

 

[Dipesh Patel]

Just now, DM1 said:

 

Congratulations Prem well deserved 

[Haryana]

4 hours ago, DM1 said:

Congratulations Prem well deserved 

 

"Since 1979, over 200 business leaders have been bestowed with Canada’s highest business honour."

https://cbhf.ca/companions/

 

I went through all those over 200 names and his is the only one there with an Indian name.

He has broken some ceiling here. Even Michael Lazaridis and James Balsillie got it in 2009.

 

[Crip1]

OK, so there has been some conversation on this board about how great the next three years ahead look and how great of a job management did to position the company as it is, and so on. All of that is valid and correct. There have been concerns around what happens after these 3 years (not sure whether the “3 years” is because Viking has been projecting that time period, or because of the stated run rate by the company). Specifically, concern over what happens when this “gravy train” ends and interest rates come back down to 1% or thereabouts. The more I ponder this, I’m increasingly less concerned about three years down the road for the following reasons:

• After peaking in October rates have come down, but they are still notably higher compared to Covid-times.
• Every day that the market moves sideways, and we’re a month plus into the sideways movement, that three years gets extended into 2026. (and I’m willing to bet that we don’t see 6 rate cuts by the fed in 2024, nor do I see that happening in 2024 and 2025 combined FWIW). 
• The assumption (fear) that rates go back down to 1% is, in my opinion, overblown. Yes, if we do go into a recession, rates will drop, but we seem to be anchored into recent memory when rates were at historical lows and expect that to happen again. That fear is overblown.
• Assuming treasury yields do move lower, at some point the spread between treasuries and high-grade corporates is going to widen such that the risk-reward equation moves squarely in favor of moving some monies into corporates. It’s not always wrong to take prudent steps to “reach for yield” and with the size of the investment portfolio FFH is better able to benefit from this compared to the competition.

Of course, black swan events do occur, and there is no guarantee that Fairfax will avoid doing unwise things as has happened in the past, but risk-reward is squarely in “reward” at this juncture, and I think will be 2-3 years from now. 

 

-Crip
 

[dartmonkey]

There have been concerns around what happens after these 3 years (not sure whether the “3 years” is because Viking has been projecting that time period, or because of the stated run rate by the company).

 

 

Here is what Watsa has said about prospects in the next few years:

 

Q3 Press release:

 

During the first nine months of 2023 the company used cash and net proceeds from sales and maturities of U.S. treasury and other government short term investments and short-dated U.S. treasuries to purchase $5.8 billion of U.S. treasuries with maturities between 3 to 5 years and $2.4 billion of U.S. treasuries with maturities between 5 to 7 years, and to make net purchases of $2.1 billion of short-dated first mortgage loans and $1.6 billion of corporate and other bonds with maturities primarily between 2 to 5 years. These actions should result in continued higher levels of interest income for approximately the next 4 years.

 

and more recently, announcing the dividend increase:

 

“Given Fairfax’s substantial growth since it inaugurated a US$10 per share annual dividend 14 years ago, and given Fairfax’s current position of foreseeing strong earnings for the next few years based on insurance company underwriting income, locked-in interest and dividend income and income from associates, we felt it was appropriate to raise our annual dividend this year to US$15 per share, and we believe that this should be a sustainable level,” said Prem Watsa, Chairman and Chief Executive Officer of Fairfax.

 

It seems to me that it is the extension of the average maturity of the bond portfolio to an average maturity of about 4 years that gives them this confidence about the next few years, since interest income of something like $2b/y is now locked in. 

 

I think this was also mentioned by Watsa in the 3Q conference call but I can't find a transcript - does anyone have one? 

[Viking]

57 minutes ago, dartmonkey said:

There have been concerns around what happens after these 3 years (not sure whether the “3 years” is because Viking has been projecting that time period, or because of the stated run rate by the company).

 

 

Here is what Watsa has said about prospects in the next few years:

 

Q3 Press release:

 

During the first nine months of 2023 the company used cash and net proceeds from sales and maturities of U.S. treasury and other government short term investments and short-dated U.S. treasuries to purchase $5.8 billion of U.S. treasuries with maturities between 3 to 5 years and $2.4 billion of U.S. treasuries with maturities between 5 to 7 years, and to make net purchases of $2.1 billion of short-dated first mortgage loans and $1.6 billion of corporate and other bonds with maturities primarily between 2 to 5 years. These actions should result in continued higher levels of interest income for approximately the next 4 years.

 

and more recently, announcing the dividend increase:

 

“Given Fairfax’s substantial growth since it inaugurated a US$10 per share annual dividend 14 years ago, and given Fairfax’s current position of foreseeing strong earnings for the next few years based on insurance company underwriting income, locked-in interest and dividend income and income from associates, we felt it was appropriate to raise our annual dividend this year to US$15 per share, and we believe that this should be a sustainable level,” said Prem Watsa, Chairman and Chief Executive Officer of Fairfax.

 

It seems to me that it is the extension of the average maturity of the bond portfolio to an average maturity of about 4 years that gives them this confidence about the next few years, since interest income of something like $2b/y is now locked in. 

 

I think this was also mentioned by Watsa in the 3Q conference call but I can't find a transcript - does anyone have one? 

 

Prem Watsa - Fairfax Q3, 2023 Conference Call:

 

“As I've said for the last number of quarters, the most important point I can make for you is to repeat what I have said in the past. For the first time in our 37-year history, almost 38 years now, I can say to you we expect, of course no guarantees, our operating income to be more than $3 billion annually for the next three years. Operating income consisting of $1.5 billion-plus frominterest and dividend income we earned $1.4 billion year-to-date, $1 billion from underwriting profit, we made $943 million year-to-date, and $500 million from associates and management companies versus $1 billion year-to-date. This works out to be over $100 per share after interest expenses overhead and taxes.

 

“We continue to exceed our expectations for the year with the year-to-date operating income already at $3.1 billion, excluding the effects of discounting and risk margin. Fluctuations in stock and bond prices will be on top of that. And this only really matters, as I've said many times, over the long-term. Recently, in October, during spike in treasury yields, we have extended our duration to 3.1 years with an average maturity of approximately 4 years, and yield of 4.9%. In the next four years, we are likely to have a recession in the United States, resulting in corporate spreads widening, allowing us to extend our maturities further.”

[Hoodlum]

13 minutes ago, Viking said:

In the next four years, we are likely to have a recession in the United States, resulting in corporate spreads widening, allowing us to extend our maturities further.”

 

I think this last sentence is important because if we do see a sizable drop in interest rates, then that would suggest we are in a recession and allows them to move to longer corporate bonds with higher interest rates.  This would allow them to extend the duration further for higher yields.

[Parsad]

6 hours ago, Haryana said:

 

"Since 1979, over 200 business leaders have been bestowed with Canada’s highest business honour."

https://cbhf.ca/companions/

 

I went through all those over 200 names and his is the only one there with an Indian name.

He has broken some ceiling here. Even Michael Lazaridis and James Balsillie got it in 2009.

 

 

I thought he was already in there!  This is long overdue.  Congratulations Prem!  Cheers!

[Viking]

4 hours ago, Crip1 said:

OK, so there has been some conversation on this board about how great the next three years ahead look and how great of a job management did to position the company as it is, and so on. All of that is valid and correct. There have been concerns around what happens after these 3 years (not sure whether the “3 years” is because Viking has been projecting that time period, or because of the stated run rate by the company). Specifically, concern over what happens when this “gravy train” ends and interest rates come back down to 1% or thereabouts. The more I ponder this, I’m increasingly less concerned about three years down the road for the following reasons:

• After peaking in October rates have come down, but they are still notably higher compared to Covid-times.
• Every day that the market moves sideways, and we’re a month plus into the sideways movement, that three years gets extended into 2026. (and I’m willing to bet that we don’t see 6 rate cuts by the fed in 2024, nor do I see that happening in 2024 and 2025 combined FWIW). 
• The assumption (fear) that rates go back down to 1% is, in my opinion, overblown. Yes, if we do go into a recession, rates will drop, but we seem to be anchored into recent memory when rates were at historical lows and expect that to happen again. That fear is overblown.
• Assuming treasury yields do move lower, at some point the spread between treasuries and high-grade corporates is going to widen such that the risk-reward equation moves squarely in favor of moving some monies into corporates. It’s not always wrong to take prudent steps to “reach for yield” and with the size of the investment portfolio FFH is better able to benefit from this compared to the competition.

Of course, black swan events do occur, and there is no guarantee that Fairfax will avoid doing unwise things as has happened in the past, but risk-reward is squarely in “reward” at this juncture, and I think will be 2-3 years from now. 

 

-Crip

 

 

@Crip1 i agree with your thinking: “I’m increasingly less concerned about three years down the road…”

At the start of 2023, many people were concerned that higher interest income was not sustainable. Fairfax’s fixed income portfolio had an average duration of 1.6 years and there were concerns a recession was likely later in 2023 (which would drive interest rates lower). 
 

A year later… what actually happened?
1.) Fairfax earned a record amount of interest income in 2023 (est $1.8 billion). That baby has been delivered. What a surprise. 

2.) current run rate of interest income is likely over $500 million per quarter. It looks like 2024 will deliver another record year of interest income (third straight year). A second surprise.

3.) on the Q3 conf call, Prem stated average duration was extended to 3.1 years. High interest income is now locked in for 2024, 2025 and 2026. A third surprise.

 

Investors response? Yes… BUT…
 

My guess is lots of people still think interest income still has to come down… ‘soon’. My guess is this line of thinking is driven by recency bias. 

From Charles Schwab: “Recency bias can lead investors to put too much emphasis on recent events, potentially leading to short-term decisions that may negatively affect their long-term financial plans.”

 

With hindsight, it is now clear that Fairfax was grossly under-earning on its fixed income portfolio for many years. It was under-earning primarily for two reasons:

1.) central bank policy - zero interest rate

2.) Fairfax positioning - very short duration and high quality (government). This happened way back in late 2016 (Fairfax pivoted after Trumps’s election).

 

So the interest income numbers from 2017-2021 are abnormally low for Fairfax - and probably by a lot in some years (like 2021). Are they a good number to use as a baseline? Only if you think the Fed is going back to zero interest rates and you think Fairfax is going to go back to extremely conservative positioning (low duration and high quality government bonds). 

Otherwise, Fairfax’s historical numbers are a terrible baseline to use for interest income - looking forward. They will lead you to expect something that is highly unlikely. That is not being conservative… That is simply using faulty logic.

For example, interest income was $568 million in 2021. It will come in around $1.8 billion in 2023 and likely north of $2 billion in 2024. What is the right number to use looking out a few years? An average of 2021 and 2023 = $1.2 billion?

 

No. That is complete garbage. $568 million in 2021 is an outlier. As a result, you have to throw it out when doing your estimates for future interest income.
 

What is a reasonable number? Probably something north of $2 billion. Why?
 

1.) Today, it looks highly unlikely that global central banks will be returning to zero interest rate policy. The risks look (to me) more skewed to inflation turning up again - but that is just a guess.  

2.) The fixed income portfolio at Fairfax is going to increase in size - and it will probably be meaningful:

- We are still in a hard market.
- The GIG acquisition will add about 5%.

- Minority partners (insurance) will likely get taken out.
- Fairfax will do some other things in the coming years that will grow the size of the fixed income bucket.

 

If the fixed income portfolio increases in size by 10% and the average yield comes down 10% (not a given) then total interest income will be (about)… flat. Still a very big number.

 

3.) Fairfax has been moving up (not down) the risk spectrum with its fixed income portfolio. And, as we said earlier, it has been extending duration not shortening it.

- $1.8 billion in Pac West loans, taking the KW real estate loan portfolio to over $4 billion. In December, Fairfax increased the ‘capacity’ of this program to $10 billion, suggesting more real estate loans will be brought on board. These were earning around 8 to 9% in Q3. 
 

What if Fairfax expands the KW real estate program to $6 billion? Or $8 billion in 2024. Remember, capacity just got expanded to $10 billion. Earning an average yield of even 8%. That would support an even higher average yield on the total fixed income portfolio than what we have today. 

- Fairfax also has been slowly increasing its corporate holdings and they have talked about doing more of this should the right opportunity come along. 

When i forecast i like to stick to one or two years (three max). Looking out 4+ years, as i have said before, it is really a bet on the capital allocation skills of management. And for the past 6 years Fairfax has been best-in-class. And that is just another reason to be optimistic about future results. 

Edited January 16 by Viking

[Viking]

10 minutes ago, Parsad said:

 

I thought he was already in there!  This is long overdue.  Congratulations Prem!  Cheers!

+1

[TwoCitiesCapital]

Now that they've locked in duration, I too am far less concerned about the next few years. 

 

Having some foresight into a certainty of a level of earnings regardless of the economic scenario is great

[SafetyinNumbers]

11 hours ago, Viking said:

 

 

@Crip1 i agree with your thinking: “I’m increasingly less concerned about three years down the road…”

At the start of 2023, many people were concerned that higher interest income was not sustainable. Fairfax’s fixed income portfolio had an average duration of 1.6 years and there were concerns a recession was likely later in 2023 (which would drive interest rates lower). 
 

A year later… what actually happened?
1.) Fairfax earned a record amount of interest income in 2023 (est $1.8 billion). That baby has been delivered. What a surprise. 

2.) current run rate of interest income is likely over $500 million per quarter. It looks like 2024 will deliver another record year of interest income (third straight year). A second surprise.

3.) on the Q3 conf call, Prem stated average duration was extended to 3.1 years. High interest income is now locked in for 2024, 2025 and 2026. A third surprise.

 

Investors response? Yes… BUT…
 

My guess is lots of people still think interest income still has to come down… ‘soon’. My guess is this line of thinking is driven by recency bias. 

From Charles Schwab: “Recency bias can lead investors to put too much emphasis on recent events, potentially leading to short-term decisions that may negatively affect their long-term financial plans.”

 

With hindsight, it is now clear that Fairfax was grossly under-earning on its fixed income portfolio for many years. It was under-earning primarily for two reasons:

1.) central bank policy - zero interest rate

2.) Fairfax positioning - very short duration and high quality (government). This happened way back in late 2016 (Fairfax pivoted after Trumps’s election).

 

So the interest income numbers from 2017-2021 are abnormally low for Fairfax - and probably by a lot in some years (like 2021). Are they a good number to use as a baseline? Only if you think the Fed is going back to zero interest rates and you think Fairfax is going to go back to extremely conservative positioning (low duration and high quality government bonds). 

Otherwise, Fairfax’s historical numbers are a terrible baseline to use for interest income - looking forward. They will lead you to expect something that is highly unlikely. That is not being conservative… That is simply using faulty logic.

For example, interest income was $568 million in 2021. It will come in around $1.8 billion in 2023 and likely north of $2 billion in 2024. What is the right number to use looking out a few years? An average of 2021 and 2023 = $1.2 billion?

 

No. That is complete garbage. $568 million in 2021 is an outlier. As a result, you have to throw it out when doing your estimates for future interest income.
 

What is a reasonable number? Probably something north of $2 billion. Why?
 

1.) Today, it looks highly unlikely that global central banks will be returning to zero interest rate policy. The risks look (to me) more skewed to inflation turning up again - but that is just a guess.  

2.) The fixed income portfolio at Fairfax is going to increase in size - and it will probably be meaningful:

- We are still in a hard market.
- The GIG acquisition will add about 5%.

- Minority partners (insurance) will likely get taken out.
- Fairfax will do some other things in the coming years that will grow the size of the fixed income bucket.

 

If the fixed income portfolio increases in size by 10% and the average yield comes down 10% (not a given) then total interest income will be (about)… flat. Still a very big number.

 

3.) Fairfax has been moving up (not down) the risk spectrum with its fixed income portfolio. And, as we said earlier, it has been extending duration not shortening it.

- $1.8 billion in Pac West loans, taking the KW real estate loan portfolio to over $4 billion. In December, Fairfax increased the ‘capacity’ of this program to $10 billion, suggesting more real estate loans will be brought on board. These were earning around 8 to 9% in Q3. 
 

What if Fairfax expands the KW real estate program to $6 billion? Or $8 billion in 2024. Remember, capacity just got expanded to $10 billion. Earning an average yield of even 8%. That would support an even higher average yield on the total fixed income portfolio than what we have today. 

- Fairfax also has been slowly increasing its corporate holdings and they have talked about doing more of this should the right opportunity come along. 

When i forecast i like to stick to one or two years (three max). Looking out 4+ years, as i have said before, it is really a bet on the capital allocation skills of management. And for the past 6 years Fairfax has been best-in-class. And that is just another reason to be optimistic about future results. 

All great points. I think most investors are focused on the downside risk and not the optionality which is open ended on forward ROE and multiple expansion.

 

With the stock trading ~1x BV, the market is assuming a forward ROE of 10%. Based on Viking’s analysis, it’s pretty clear that the odds of only a 10% ROE for the foreseeable future are pretty low. I would argue the odds of 20% ROE over the next 3-5 years are higher. 
 

If forward ROE does surprise i.e. exceeds 10% for a few years, the multiple might expand to where IFC trades or where FFH has traded historically I.e. 2.5-3x+ P/B. I think with Fairfax’s near term outlook, the stock is unlikely to trade below 1x so the multiple expansion optionality also seems to the upside. 
 

Multiple expansion so far has been relatively slow. Lifting 0.1x P/B in past 6 months. That could change dramatically once those benchmarked to the S&P/TSX Composite/60 figure out that FFH is likely next in line to go in the 60.

 

That equates  ~1m shares of buying in a short time frame which has a greater impact than buying spread out over long periods of time. Further, all of those benchmarked to the index may feel compelled to get to market weight so as not to underperform.  It makes sense to do that before the add and not after but plenty of both is possible. Inevitably a spot in the 60 will open up and it could happen at any time either on active deletion or M&A. 

 

 

Edited January 17 by SafetyinNumbers

[nwoodman]

Hardly an original thought but while the TRS position remains open at a carrying cost of Libor + spread they are expecting something north of book value as a multiple. 

[MMM20]

9 hours ago, SafetyinNumbers said:

the multiple might expand to where IFC trades or where FFH has traded historically I.e. 2.5-3x+ P/B

 

many will scoff at 2.5-3x P/B but that roughly equates to intrinsic value IMHO

[SafetyinNumbers]

1 hour ago, MMM20 said:

 

many will scoff at 2.5-3x P/B but that roughly equates to intrinsic value IMHO

I think you’re correct. The multiple is open ended so if FFH can keep up a strong ROE, the flows could take multiples above fair value (north of 3x) but I doubt most of us will have the patience to hold on that long. I think it’s important to think about the outcomes probabilistically to avoid selling too soon and letting in the institutions that are underweight in too cheaply.