Fairfax 2024

[Viking]

Q4 Earnings Review

 

Below are a few of the things i will be watching for when Fairfax reports tomorrow. Anything missing from my list?

 

1.) What is the size of the bond gains?

Interest rates came down aggressively in Nov/Dec. With Fairfax extending duration in October (perfectly timed) this could be a very big number. 

 

One offset might be the shorter dated bonds they likely sold and any losses they booked. When they increased the average duration to 2.5 years in Q1 there were some realized losses on the shorter dated bonds they sold. 

 

2.) What is the size of IFRS 17 impact?

Interest rates changes also impacts this bucket. This could also be a big number - but in the opposite direction to bond gains.

 

One offset should be new business growth.

 

3.) What is the average duration of the fixed income portfolio?

 

This is a big deal as it telegraphs the durability of the interest income stream of earnings. Which is an important input to future ROE estimates.

 

4.) What is interest and dividend income for Q4?

Is it still increasing quarter over quarter? If so, how much? 

 

Do we get any update on the Kennedy Wilson debt platform (size and average yield)?

 

The Stelco special dividend will be in the Q4 number. It will be important to see if Eurobank initiates a dividend when they report year end results - when this happens it will likely be a material development for future dividend income at Fairfax.

 

5a.) What is premium growth in Q4?

5b.) What is the Q4 and YE combined ratio?

 

Is the hard market continuing? 

Any commentary on reinsurance?

Do we see reserve releases? If so, level?

 

6.) What is share of profit of associates?

 

7a.) What are investment gains from equities?

7b.) For equities, what is the excess of market value to carrying value?

 

What is status of RiverStone Barbados AVLN’s? We may have to wait for AR for this answer.

 

8.) How does the closing/consolidation of Gulf Insurance Group impact financials?

Do we see an investment gain booked of around $290 million?

What is the impact on: total investments? The IFRS 17 bucket?

What is expected impact in 2024 on interest income and net premiums written?  

 

9.) What is the size of adverse development for runoff?

 

This business is lumped together with Eurolife’s life insurance business so we likely will need to wait for the AR for specifics.

 

10.) What is year-end share count?

 

Do we get any commentary on the pace of buybacks moving forward?

 

11.) What is year-end book value per share?

 

The answers from the first 10 questions will then give us the answer to this question.

Edited February 14, 2024 by Viking

[newtovalue]

thanks @Viking - very informative as always!

 

would also be interested to see what they did with the TRS. would not be sad if they unwound that and used the capital to actually buy back stock

 

 

 

[Hektor]

Thanks @Viking  I assume you have included any update and/or future plans for TRS under #10.

[dartmonkey]

15 minutes ago, Viking said:

11.) What is year-end book value per share?

 

The answers from the first 10 questions will then give us the answer to this question.

 

12. Why do they keep shamelessly manipulating book value with aggressive marks like the ones Muddy Waters has brought up? Ok, maybe we won't get that, but if they prefer, what are some marks where BV might reasonably be marked significantly HIGHER? And to what extent do the feel that BV useful for investors, anyway?

 

13. What's happening in some of the big holdings, like Eurobank, Digit, Atlas, Recipe, etc.?

 

14. What is the game plan with the TRSs, and how do they think about putting the choice between holding money in reserve against the TRSs vs using money to repurchase shares?

[SafetyinNumbers]

7 minutes ago, newtovalue said:

thanks @Viking - very informative as always!

 

would also be interested to see what they did with the TRS. would not be sad if they unwound that and used the capital to actually buy back stock

 

 

 

 

I don’t think it’s a benefit to reduce TRS in benefit of buybacks as shrinking the market cap hurts eligibility into the S&P/TSX 60 and reduces financial flexibility. I hope they in fact put more TRS on during the quarter. There was a decent sized cross back in November that looked like it could be TRS related but as usual, I’m just speculating. 

[newtovalue]

@SafetyinNumbers - the market cap is already way past any requirement to be included in the TSX60 - and if they unwind the TRS - they will not have enough capital to buyback the same number of shares as the TRS supported. 

 

Agree - the crosses may be related to the TRS (adding or unwinding). My concern with the TRS are:

 

1. Perceived added complexity (market likes simplicity). even though it was a brilliant move - i'm sure its giving some investors pause and some PTSD to the inflation swaps and the shorting. 

2. Financing costs - the TRS was cheap when interest rates were low - now @ 5% plus rates its much more expensive to keep on

 

 

[SafetyinNumbers]

24 minutes ago, newtovalue said:

@SafetyinNumbers - the market cap is already way past any requirement to be included in the TSX60 - and if they unwind the TRS - they will not have enough capital to buyback the same number of shares as the TRS supported. 

 

Agree - the crosses may be related to the TRS (adding or unwinding). My concern with the TRS are:

 

1. Perceived added complexity (market likes simplicity). even though it was a brilliant move - i'm sure its giving some investors pause and some PTSD to the inflation swaps and the shorting. 

2. Financing costs - the TRS was cheap when interest rates were low - now @ 5% plus rates its much more expensive to keep on

 

 

Sure but the weight is what forces everyone benchmarked to the index to chase. Shrink the weight and it reduces the incentive. Plus they have high certainty on book value growth for the foreseeable future. The only reason to take it off now is drawdown aversion, which I know most investors have but Fairfax shouldn’t .
 

The spread on the financing cost vs what the cash you want to deploy earns is probably ~100bps so not that big a concern. 

[MMM20]

Don't we want them buying back as many shares as possible (without stretching too thin from a liquidity POV) at the current discount to intrinsic value - even if it makes them a bit less likely to get into the TSX 60? Would getting into the TSX 60 be so meaningful as to push the stock well above IV, giving them a good opportunity to issue shares? Does that tend to be the effect of TSX 60 inclusion? Idk what to root for.

 

Edited February 14, 2024 by MMM20

[Hektor]

8 minutes ago, SafetyinNumbers said:

reason to take it off now is drawdown aversion, which I know most investors have but Fairfax shouldn’t .

[Hektor]

4 minutes ago, MMM20 said:

Don't we want them buying back as many shares possible (without stretching too thin from a liquidity POV) at the current discount to intrinsic value - even if it makes them marginally less likely to get into the TSX 60?

 

4 minutes ago, MMM20 said:

Would getting into the TSX 60 be so meaningful as to push the stock well above intrinsic value, giving them a good opportunity to issue shares? Does that tend to be the typical effect of TSX 60 inclusion? 

Good one.

[Viking]

41 minutes ago, newtovalue said:

@SafetyinNumbers - the market cap is already way past any requirement to be included in the TSX60 - and if they unwind the TRS - they will not have enough capital to buyback the same number of shares as the TRS supported. 

 

Agree - the crosses may be related to the TRS (adding or unwinding). My concern with the TRS are:

 

1. Perceived added complexity (market likes simplicity). even though it was a brilliant move - i'm sure its giving some investors pause and some PTSD to the inflation swaps and the shorting. 

2. Financing costs - the TRS was cheap when interest rates were low - now @ 5% plus rates its much more expensive to keep on

@newtovalue What do you think the intrinsic value of Fairfax shares are? Once you answer this question, you get your answer to what Fairfax should to with the TRS position. At least that is how i would approach it. 
 

Why sell an investment when it is just starting to work? And its prospects have never been better? Is that not just cutting your flowers to water your weeds?

Edited February 14, 2024 by Viking

[dartmonkey]

22 minutes ago, newtovalue said:

@SafetyinNumbers - the market cap is already way past any requirement to be included in the TSX60 - and if they unwind the TRS - they will not have enough capital to buyback the same number of shares as the TRS supported. 

 

Agree - the crosses may be related to the TRS (adding or unwinding). My concern with the TRS are:

 

1. Perceived added complexity (market likes simplicity). even though it was a brilliant move - i'm sure its giving some investors pause and some PTSD to the inflation swaps and the shorting. 

2. Financing costs - the TRS was cheap when interest rates were low - now @ 5% plus rates its much more expensive to keep on

 

 

It certainly makes it harder to understand what's going on than if they just bought back shares. I presume there are liquidity consequences or tax consequences (repurchases are now subject to a 2% tax in Canada) or versus taxes on gains on the TRS, or something else that motivates them to keep these positions, and I trust them to do whatever's best, but I would much appreciate some discussion of this by Fairfax management.

[dartmonkey]

6 minutes ago, Viking said:

Why sell an investment when it is just starting to work? And its prospects have never been better? Is that not just cutting your flowers to water your weeds?

 

Ok, sure, but can't they do the same thing with an equivalently-sized share repurchase?

[nwoodman]

7 minutes ago, dartmonkey said:

 

Ok, sure, but can't they do the same thing with an equivalently-sized share repurchase?

Stating the obvious but the best outcome below IV is to do both.  

[Viking]

26 minutes ago, dartmonkey said:

It certainly makes it harder to understand what's going on than if they just bought back shares. I presume there are liquidity consequences or tax consequences (repurchases are now subject to a 2% tax in Canada) or versus taxes on gains on the TRS, or something else that motivates them to keep these positions, and I trust them to do whatever's best, but I would much appreciate some discussion of this by Fairfax management.

@dartmonkey  I think management has commented on the TRS in the past. I think they have said they hold it as an investment. Not complicated. 
 

How do you evaluate an investment? By calculating intrinsic value. My guess is Fairfax can do this… for itself.

 

I don’t understand all the hand-wringing / urgency to ‘do something’ with the TRS position. Especially given the likelihood of mid to high teens ROE the next couple of years. 

[TwoCitiesCapital]

49 minutes ago, Viking said:

@dartmonkey  I think management has commented on the TRS in the past. I think they have said they hold it as an investment. Not complicated. 
 

How do you evaluate an investment? By calculating intrinsic value. My guess is Fairfax can do this… for itself.

 

I don’t understand all the hand-wringing / urgency to ‘do something’ with the TRS position. Especially given the likelihood of mid to high teens ROE the next couple of years. 

 

The hand wringing is largely just due to the liquidity drag it can potentially create. Just like I was paranoid about their duration until they got around to locking it in. There has been a history of mistakes made that we don't want repeated. 

 

Fairfax damn near run afoul of covenants and cash @ holdings company before. Having to come up with cash to front the movement on 7% of it's shares every quarter is not chump change. Particularly as the share price has moved from $500s to $1000s. 

 

This isn't like their other equity investments because those wouldn't necessarily require additional cash infusions to continue holding through a downturn. And as the financing hurdle rises, and as the stock price rises, the potential cash cost of holding a position through a downturn is rising significantly

 

For now, I'm comfortable with it. But I would prefer them to let it go too early than to be forced to let it go too late.

 

"Buy fear, sell dear". Selling dear by definition means it hurts to sell and you don't want to do it. 

Edited February 14, 2024 by TwoCitiesCapital

[giulio]

1 hour ago, MMM20 said:

Don't we want them buying back as many shares as possible (without stretching too thin from a liquidity POV) at the current discount to intrinsic value - even if it makes them a bit less likely to get into the TSX 60? Would getting into the TSX 60 be so meaningful as to push the stock well above IV, giving them a good opportunity to issue shares? Does that tend to be the effect of TSX 60 inclusion? Idk what to root for.

 

I would not care about index inclusion as long as you plan to hold the share for the long term, which I assume you do given your estimates of fair value.

Imo, Best thing that can happen is that shares remain undervalued, they keep buying back 2-3% pa and invest to grow the business.

Think about the money they can deploy in India, or grow the insurance in this hard market or take advantage of a widening in spreads if something unexpected happens.

 

The cash coming from their bond portfolio probably offers a sufficient cushion in case of a bad year.

Share price will follow the cash generation capability of the business, regardless of accounting standards or the trs position.

 

G

Edited February 14, 2024 by giulio

[SafetyinNumbers]

1 hour ago, MMM20 said:

Don't we want them buying back as many shares as possible (without stretching too thin from a liquidity POV) at the current discount to intrinsic value - even if it makes them a bit less likely to get into the TSX 60? Would getting into the TSX 60 be so meaningful as to push the stock well above IV, giving them a good opportunity to issue shares? Does that tend to be the effect of TSX 60 inclusion? Idk what to root for.

 

I want us to be valued as highly in the intrinsic value range as possible for as long as it takes to issue equity accretively. Having a high valuation has a ton of optionality because if disaster strikes in terms of large cat losses, it would be much cheaper to raise equity not necessarily because it was needed but to grow aggressively in a hard market with cheap capital. If Fairfax could issue paper at 2.5x BV like IFC and TSU do whenever an opportunity comes their way to make a nice return it provides huge option value and has a big impact on ROE. 

[giulio]

Thanks @SafetyinNumbers, i did not consider this optionality actually.

Still, it's way easier to hold the stock now. If the stock ran way higher than the actual business results/prospects it would be harder to hold on. What do you think?

[Crip1]

2 hours ago, Viking said:

@dartmonkey  I think management has commented on the TRS in the past. I think they have said they hold it as an investment. Not complicated. 
 

How do you evaluate an investment? By calculating intrinsic value. My guess is Fairfax can do this… for itself.

 

I don’t understand all the hand-wringing / urgency to ‘do something’ with the TRS position. Especially given the likelihood of mid to high teens ROE the next couple of years. 

 

Not sure if it is technically "hand-wringing" but I do like the idea of using some proceeds from the TRSs to buy back stock. The difference I see between investing in TRSs and buying back one's own stock is that the TRS is technically temporary where the buyback is more permanent. Example, we get some black swan even that harms the company and, accordingly, brings the price of the stock down, we're hit with a double-whammy as not only is there harm done to the company, but the TRS investment becomes less valuable, driving down the price even more. It's leverage against the shareholders. Keynes famously said "the markets can remain irrational longer than you can remain solvent". Buying back stock is more permanent. 

 

So, while I am not in favor of getting out of the TRS position, I'd be happy trimming the position and using proceeds to juice the buyback. Also, not pounding the table on this...just seeing the attractiveness of doing so.

 

-Crip

[Viking]

1 hour ago, TwoCitiesCapital said:

 

The hand wringing is largely just due to the liquidity drag it can potentially create. Just like I was paranoid about their duration until they got around to locking it in. There has been a history of mistakes made that we don't want repeated. 

 

Fairfax damn near run afoul of covenants and cash @ holdings company before. Having to come up with cash to front the movement on 7% of it's shares every quarter is not chump change. Particularly as the share price has moved from $500s to $1000s. 

 

This isn't like their other equity investments because those wouldn't necessarily require additional cash infusions to continue holding through a downturn. And as the financing hurdle rises, and as the stock price rises, the potential cash cost of holding a position through a downturn is rising significantly

 

For now, I'm comfortable with it. But I would prefer them to let it go too early than to be forced to let it go too late.

 

"Buy fear, sell dear". Selling dear by definition means it hurts to sell and you don't want to do it. 

 

25 minutes ago, Crip1 said:

 

Not sure if it is technically "hand-wringing" but I do like the idea of using some proceeds from the TRSs to buy back stock. The difference I see between investing in TRSs and buying back one's own stock is that the TRS is technically temporary where the buyback is more permanent. Example, we get some black swan even that harms the company and, accordingly, brings the price of the stock down, we're hit with a double-whammy as not only is there harm done to the company, but the TRS investment becomes less valuable, driving down the price even more. It's leverage against the shareholders. Keynes famously said "the markets can remain irrational longer than you can remain solvent". Buying back stock is more permanent. 

 

So, while I am not in favor of getting out of the TRS position, I'd be happy trimming the position and using proceeds to juice the buyback. Also, not pounding the table on this...just seeing the attractiveness of doing so.

 

-Crip

@Crip1  I like your description of the TRS position as leverage. It will be interesting to see if Fairfax comments. Kind of an obvious question for an analyst to ask: what is the exit strategy for TRS?

 

The other interesting angle is all the cash Fairfax is currently generating. In 2023 very little went into buybacks. What if Fairfax gets more aggressive on the buyback front in 2024? Every $100 increase in the share price = $200 million in investment gains. This is a very bizarre set-up. The ‘ultimate’ alignment of interests between management and shareholders?

Edited February 14, 2024 by Viking

[Hoodlum]

As long as we have a hard market and the share price is below intrinsic value, then I would want them to keep the TRS position in place as is.  Any available cash would be best spent on expanding the insurance business.  The TRS can be closed once the share price is much close to the value of Fairfax.   It would be better to buy back shares during a softer market when share price is down from the peak. 

 

Also, I don't think that using cash from selling some TRS to buy shares would be the best way to use the funds, as the TRS provides leverage for share price increase which has a ways to go.  

[StubbleJumper]

2 hours ago, TwoCitiesCapital said:

Fairfax damn near run afoul of covenants and cash @ holdings company before. Having to come up with cash to front the movement on 7% of it's shares every quarter is not chump change. Particularly as the share price has moved from $500s to $1000s. 

 

It's interesting that the events of last week haven't seemed to have triggered much angst about the holdco cash flow aspect of the TRS.  Those clowns managed to push the share price down by 10-ish% for a few days (thank you very much!) and then it rebounded a couple of days later like nothing ever happened.  But, a short attack by some clowns isn't the only thing that can drive a considerable drop in the share price.  Other events could do so, and it could be considerably more than 10%.

 

As a basic exercise, people should consider some wacko event in financial markets that result in FFH's share price dropping by, say, 25% in a day (eg, October 19) and that credit markets freeze up (ie, like the financial crisis or early in covid).  What happens to the FFH holdco? 

 

Well, if the share price crashes by 25%, even for silly reasons, the holdco needs to write a cheque to the counter party for about US$250/share, or about US$500m.  Everyone should take a look at Note 5 to the financial statements and consider what that means for holdco cash.  Now, people will say that FFH can just send some dividends from the insurance subs to the holdco and all is well, but don't forget that the insurance subs' equity holdings would also be marked to market by perhaps -25% in the event of a broad-based crash.  That then leaves the revolving line of credit, providing that the bankers don't think of a good reason to cancel it...

 

Jen Allen seems like a pretty sharp cat and has probably done a bit of thinking about this, but it seems to me that FFH needs to carry much larger holdco cash balances (true liquidity, not some of the bullshit portrayed in Note 5) if it wants to continue to carry those TRS.

 

 

SJ

[Parsad]

5 minutes ago, StubbleJumper said:

 

It's interesting that the events of last week haven't seemed to have triggered much angst about the holdco cash flow aspect of the TRS.  Those clowns managed to push the share price down by 10-ish% for a few days (thank you very much!) and then it rebounded a couple of days later like nothing ever happened.  But, a short attack by some clowns isn't the only thing that can drive a considerable drop in the share price.  Other events could do so, and it could be considerably more than 10%.

 

As a basic exercise, people should consider some wacko event in financial markets that result in FFH's share price dropping by, say, 25% in a day (eg, October 19) and that credit markets freeze up (ie, like the financial crisis or early in covid).  What happens to the FFH holdco? 

 

Well, if the share price crashes by 25%, even for silly reasons, the holdco needs to write a cheque to the counter party for about US$250/share, or about US$500m.  Everyone should take a look at Note 5 to the financial statements and consider what that means for holdco cash.  Now, people will say that FFH can just send some dividends from the insurance subs to the holdco and all is well, but don't forget that the insurance subs' equity holdings would also be marked to market by perhaps -25% in the event of a broad-based crash.  That then leaves the revolving line of credit, providing that the bankers don't think of a good reason to cancel it...

 

Jen Allen seems like a pretty sharp cat and has probably done a bit of thinking about this, but it seems to me that FFH needs to carry much larger holdco cash balances (true liquidity, not some of the bullshit portrayed in Note 5) if it wants to continue to carry those TRS.

 

 

SJ

 

100% agree!  They'll tell you that they have access to the revolver, but I would be much happier if they just kept $2.5B in the holdco.  No one is going to sink that boat if they have $2.5B in there.  Either that or reduce the debt by $2B. 

 

Problem is that in a scenario like yours, even reduced debt won't help if liquidity is really strained in the system...you're seeking the kindness of strangers, and in a global economic catastrophe, strangers usually aren't kind!  If you need to come up with $1B suddenly, borrowing might not be an available option, or the rate might be through the roof.

 

Cheers!

[SafetyinNumbers]

25 minutes ago, StubbleJumper said:

 

It's interesting that the events of last week haven't seemed to have triggered much angst about the holdco cash flow aspect of the TRS.  Those clowns managed to push the share price down by 10-ish% for a few days (thank you very much!) and then it rebounded a couple of days later like nothing ever happened.  But, a short attack by some clowns isn't the only thing that can drive a considerable drop in the share price.  Other events could do so, and it could be considerably more than 10%.

 

As a basic exercise, people should consider some wacko event in financial markets that result in FFH's share price dropping by, say, 25% in a day (eg, October 19) and that credit markets freeze up (ie, like the financial crisis or early in covid).  What happens to the FFH holdco? 

 

Well, if the share price crashes by 25%, even for silly reasons, the holdco needs to write a cheque to the counter party for about US$250/share, or about US$500m.  Everyone should take a look at Note 5 to the financial statements and consider what that means for holdco cash.  Now, people will say that FFH can just send some dividends from the insurance subs to the holdco and all is well, but don't forget that the insurance subs' equity holdings would also be marked to market by perhaps -25% in the event of a broad-based crash.  That then leaves the revolving line of credit, providing that the bankers don't think of a good reason to cancel it...

 

Jen Allen seems like a pretty sharp cat and has probably done a bit of thinking about this, but it seems to me that FFH needs to carry much larger holdco cash balances (true liquidity, not some of the bullshit portrayed in Note 5) if it wants to continue to carry those TRS.

 

 

SJ

That would have been more of a concern a few years ago but they are earning ~$1bn a quarter now. It gives them a lot more leeway. The equity portfolio might go down 25% but it’s unlikely the bond portfolio would. They might have large gains there if rates plunged.