Why FFH's ratings may be low.

[twacowfca]

Today, I spoke with S&P's Managing Director of Ratings Services at the Bermuda reinsurance conference.  I asked if S&P and the other ratings agencies discounted equities held on the balance sheet when determining capital adequacy for P&C companies.  His answer was yes.  They discount equity holdings 40% to 50%, compared to investment grade debt when determining capital adequacy.

 

My question was not about the ratings of any particular company.  However, his answer may be relevant to the question many on the board have posed about FFH's surprisingly low ratings.

[StubbleJumper]

They can go ahead and discount the equities all they like....but they're hedged, and FFH's subs have ridiculous net written to statutory capital ratios. 

 

I think that they're still gun-shy about ratings and will be much more hesitant to raise anyone's ratings for the next couple years.

 

SJ

[Parsad]

That's kind of a crock!  Fairfax has only $3.5B in equities and $22B in investments.  Assume that their equity portfolio falls 50%...ignoring the fact that it is hedged...the investment portfolio would still be at over $20B! 

 

- Now if the markets are down 50%, do you think going forward Fairfax's risk profile is better or worse? 

- Do you think that going forward they would be able to recover that $1.75B in equity losses?  Surpass it handsomely?

- Would the drop in equity from $8.9B to 7.2B indicate that their claims paying ability going forward would be better or worse, if they could now deploy more capital into a depressed market?

- Would they have difficulty refinancing their debt with $1.25B in cash in the holding company?

 

The ratings agencies are simply awful at their job.  I think many boardmembers would have a higher probability of rating the credit worthiness of most businesses better than the analysts.  The reason being is that the ratings agencies are very much like other analysts...they look backwards not forwards...they rate based on parallel levels of capitalization, instead of looking at the underlying capital composition and risk profile. 

 

During the credit crisis, we invested in a fair amount of corporate debt.  We did not even remotely consider what the credit rating agencies had graded the debt.  We made our own estimation of the credit quality, risk and commensurate return.  On average, we made a 40%+ annualized return and batted 100%!  All the companies we invested in had zero financing risk for the ensuing 12 months, as they had ample cash or credit lines on hand to refinance.  Yet, they had various ratings given by the rating agencies, and many, many higher rated companies went under.  Go figure!  Cheers! 

[Guest longinvestor]

..... The reason being is that the ratings agencies are very much like other analysts...they look backwards not forwards...they rate based on parallel levels of capitalization, instead of looking at the underlying capital composition and risk profile.  ................Go figure!  Cheers! 

This is exactly the problem. The root cause I'd like to believe is "they all read the same book"....and the book is wrong. Kinda like Munger saying Biz schools have been teaching the same wrong things since his time in college. Proffs get it wrong, they hire only those that think like themselves and boom, you now have 2-3 generations of teachers spreading the word. Boy is it institutional or what? Stock and ratings analysts are paid to keep it going this way. The fact that they get paid disallows them to do any independent analysis. I've been trying to tell a close friend of mine about FFH as an investment and his consistent ? to me is, "what does Morningstar say about them"?

 

Independent thinking is live & well. The herd is very strong and very wrong. I say bring 'em on. 

[cayale]

Agreed. I have never understood how a cash generative company with net cash on the balance sheet can have its debt rated as junk versus a bank, an inherently leveraged entity, rated high-investment grade. Seems bass-ackwards to me. It's just plain dumb.

[cayale]

Just to clarify, I am not speaking to ffh specifically, but referring to debt ratings more generally.

[Guest Bronco]

When BRK was reduced below AAA, that is all you had to know.

 

Strongest company in the US, maybe excluding Apple.  And a downgrade?

 

 

 

I work for a company with almost no debt (200 million or so) which is covered by cash flow in one year of four times that.  And tons of cash on the balance sheet.  And we have trouble getting above BBB.  Come on.  

[Uccmal]

Maybe companies should just stop playing the game at all.  FFH sold the bonds and preferreds this year without any ratings.  The ratings came out after the private placements were done. 

 

Not related to the debt ratings - at least not directly:

The only use I see for FFH is the insurance side ratings.  Undoubtably, alot of their clients require some sort of external rating before buying P&C insurance.  Not every company has the internal ability to assess the strength of the insurance they by on their own.