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Estimating FFH Annualized and Q4 2010 earnings


Viking
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Here is my very rough calculation of what FFH should earn going forward (annualized snapshot). Please correct me as you see fit. I am going to also throw out some stuff regarding Q4 to get the ball rolling in a second update.

 

It looks to me that underwriting for the industry is only going to get worse in 2011. I am assuming FFH earns just under 8.5% on its investments of $22.5 bill (med term avg = 9%).

 

My guess is FFH should be able to earn $50/year. With stock trading at about BV it looks to be a reasonable value.

 

1.) Underwriting income (YTD Q3 CR = 105) = -$200 mill

2.) Int / Div Income (Q4 $200x4) = +$800

Operating Income = +$600

3.) Net Gains on Invest (5% on $20 bill) = +$1,000 (incl change in realized gains/losses)

4.) Interest Exp (Q4 $50x4) = -$200

5.) Corporate Overhead = -$100

6.) Runoff = -$50

Pre Tax Income = 1250

6.) Inc Taxes (20%) = $250

Net Earnings = $1,000 = $50/share (about)

 

Q3 BV = $401

BV Growth = $50 = 12.5%

 

Note: tax rate is 31%; factor in tax exempt bonds and dividends results in actual rate closer to 20%

 

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Regarding Q4 earnings, here are some comments. Bottom line is I really am quite lost trying to understand all the hedges FFH has in place. Instead I am just going to assume mgmt knows what they are doing. There are going to be some very large puts and takes this quarter!

 

ICO Sale

1.) $7.35-$3.70=$3.65x22.5 mill = $82 mill gain

2.) does this mean the remaining stake will no longer be captured under Investments at Equity (as FFH will own less than 20%). If so, and holding is valued at mark to market then they will also see a nice $7.74-$3.70=$4.04x22.5 mill = $91 million 'gain'.

 

Equity Holdings: before market hedges gains est = $370 mill

(note: I have updated my old excel sheet. In a previous thread it was mentioned that FFH has replaced their KFT, WFC & USB sales with derivatives so in the attached sheet I have not changed their overall position for these three securities. The Canadian holdings in the spreadsheet are quite old and I have not attempted to update quantities although I did add some prices).

 

Municipal Bonds Yields: have spiked 1% in Q4 which will hurt valuations and BV. In Q3 interest rate moves were favourable and bond gains were $400 million. On the positive side, given that more than 1/2 of FFH municipal holdings are insured by BRK I wonder if their yields held up better???

 

Derivatives: does anyone have a perspective on all the derivative holdings and how they are going to net out?

 

Abitibi: anyone have a perspective on what we might see?

 

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I haven't run the numbers recently, but with the equity hedge added recently I struggle to see much upside there, especially given it was a bunch of Russell 2k hedges which have been decimated in Q4 as small caps exploded (certainly ICO and ABH recap will help).  But the big thing that I don't see much discussion of is just their straight long bond / rate bets.  This company is fully positioned for deflation (I don't think calling the CPI derivatives hedges is appropriate since they are already making deflation bets with the bond portfolio) and for Q4 of '10 at least that was a very very bad stance.

 

I'm still majorly long FRFHF, so don't mistake the above comments, but those looking for a near term pop are (I think) going to be very disappointed, and I'm a bit worried about downside (price wise only) here given the lack of concern I see displayed about the huge rate move during the quarter.

 

We'll see what pans out, but I'd be hesitant even talking about a >0% book value increase this quarter.  IF anyone thinks I'm out to lunch, let me know and I'll get to running the numbers here sooner or later.

 

Ben

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Municipal Bonds Yields: have spiked 1% in Q4 which will hurt valuations and BV. In Q3 interest rate moves were favourable and bond gains were $400 million. On the positive side, given that more than 1/2 of FFH municipal holdings are insured by BRK I wonder if their yields held up better???

 

Why would it hurt their BV? I tough their bond portfolio is not marked to market unless categorized as held for trading.

 

BeerBaron

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I think $130 million in gains from Abitibibowater this quarter;

Also a large amount invested in 10% abitibibowater notes which should help future yields;

 

Euro down, so expect some currency translation losses there.

 

There have been some terrific results in their biggest investments, approximately:

Sandridge, 45%

ICO, 36%

USG, 24%

Wells Fargo, 24%

 

But that may cancel out with some of the other ones which haven't moved much.

 

What may be more fun is the growth in Fairfax Asia, and the shareholder letter.  But I agree that Q4 may not do much to move the stock price in the near term.  Now, if deflation kicks in . . .

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Municipal Bonds Yields: have spiked 1% in Q4 which will hurt valuations and BV. In Q3 interest rate moves were favourable and bond gains were $400 million. On the positive side, given that more than 1/2 of FFH municipal holdings are insured by BRK I wonder if their yields held up better???

 

Why would it hurt their BV? I tough their bond portfolio is not marked to market unless categorized as held for trading.

 

BeerBaron

 

 

Most of the bonds are held as available for sale, so they flow through the comprehensive income statement.

 

 

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yeah, I think the bonds will hit the AOCI account (mostly, some are held for trading ~20% of the Munis for example).  I'm not predicting earnings, I'm monitoring book value so even if Other Comprehensive Income isn't in headline earnings, we all know that book value is the most watched (and more meaningful) metric.

 

Just some notes:

1) $6.2B in 10+ year maturity bonds.  We know Munis got hit this quarter with all the BAB supply and that rates moved in a unprecidented upward direction.  Long Muni, and long treasury funds (in USD) lost >10% each this quarter... let's say Fairfax was shorter duration than these, and better at bond selection, so they lost 6%.  That's $360m just in the long bond container.  I think they'd lose another $100m at least on the rest of the bond port this quarter.

2) Total Return Swaps - Added $3.3B last quarter (certainly hedged some of that with long calls) of Russell 2k TRS... the Russell 2k did +17% or something horrific during Q4.  $560m loss, let's round to $500m.  Another $200-300m on the S&P swaps lost as well.

 

I'm getting darn close to $1B in losses here, so I think we need to see the FFH equity portfolio do maybe 15% during the quarter (assuming some small underwriting gains... which may be losses) to break even, and I'm not sure we got that.  ICO is good, ABH is good, WFC was good.

 

I'm not saying the sky is falling, but you can't talk about gains without talking about nearly $1B in losses.

 

Oh year, and the CPI derivatives... these are hard to model so I wouldn't think these fell a lot even though rates rose, but I bet they fell some...

 

Ben

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  • 2 weeks later...
Ouch.  Someone out there agrees with the sky is falling premise....

 

Well, I don't think I heard anyone disagree with me, so those who are pricing fair value off of forward/current book, seemed like an opportune time to sell.

 

I think it's a good investment because the multiple to book the market has been assigning *I* think is too low, and look forward to adding again if prices keep weakening.

 

Ben

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Does anybody know what all of the Long Total Return Swap positions are in?

I've got the 3 pieces reported in the ORH insurance filing.

KFT, USB and WFC at notional values of 150 million, 150 million, and 243 million, however, this only adds up to ~$550 million. The 3rd quarter interim report said that there were $1.13 billion of notional TR swaps on a long basis. What's the other $550 million? Additionally, have there been any indications of what the single name total return swap shorts (not the indices) are ($518 million short; these had to have hurt in the quarter)?

Thank you.

 

AHamilton

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What's important for me is not if BV will go down because of munis, but rather does it hurt their statutory capital?

 

Having lower valuations has no meanings if the bonds are insured by BRK. It does not reduce the expected cash flow or increase risk. Just a change of perception.

 

But not being able to write business because of this lower valuation is a totally different story for FFH.

 

BeerBaron

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So far the stock price and price to book ratio has a similar pattern between Jan 2010 and Jan2011.

Looks like we are getting closer to another buying opportunity.

 

USA Book Value: $369.80 USA Book Value: $401.32

 

            FFH.TO Trading             FFH.TO Trading

            Stock      At Book             Stock At Book

Date                  Price Ratio Date             Price Ratio

 

2010Jan04 $406.99 1.06 2011Jan04 $414.00 1.03

2010Jan05 $406.49 1.06 2011Jan05 $407.26 1.02

2010Jan06 $403.80 1.06 2011Jan06 $408.15 1.02

2010Jan07 $402.27 1.05 2011Jan07 $405.69 1.02

2010Jan08 $394.90 1.04 2011Jan10 $410.00 1.03

2010Jan11 $396.00 1.04 2011Jan11 $404.50 1.02

2010Jan12 $399.07 1.04 2011Jan12 $407.70 1.03

2010Jan13 $398.00 1.04 2011Jan13 $402.00 1.01

2010Jan14 $394.99 1.04 2011Jan14 $404.49 1.02

2010Jan15 $388.25 1.02 2011Jan17 $398.32 1.00

2010Jan18 $384.10 1.01 2011Jan18 $391.99 0.98

2010Jan19 $381.00 1.00 2011Jan19 $390.50 0.98

2010Jan20 $373.49 0.96 2011Jan20 $388.00 0.97

2010Jan21 $368.14 0.95 2011Jan21 $378.56 0.95

2010Jan22 $366.85 0.94 2011Jan24

2010Jan25 $366.50 0.94 2011Jan25

2010Jan26 $362.38 0.92 2011Jan26

2010Jan27 $367.80 0.94 2011Jan27

2010Jan28 $366.90 0.93 2011Jan28

2010Jan29 $362.81 0.92 2011Jan31

 

 

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I dont think the BV is anywhere near 401 US at the moment.  They have taken a bath on some of the mark to market derivative positions.  I cant recall if they had collared some of their puts with high strike call positions - they have in the past. 

 

A combination of the $10 post dividend swoon and the assumption that they are looking at some pretty big unrealized losses has the stock tanking.  What's annoying about the table above is that the stock trades at an ever cheaper multiple to book.

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What's important for me is not if BV will go down because of munis, but rather does it hurt their statutory capital?

 

Having lower valuations has no meanings if the bonds are insured by BRK. It does not reduce the expected cash flow or increase risk. Just a change of perception.

 

But not being able to write business because of this lower valuation is a totally different story for FFH.

 

BeerBaron

 

 

FFH is swimming in statutory capital.  The challenge will be to find enough business that's worth writing in this soft market.

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