Fairfax Releases Q1 Financial Data; Rocked by Japan

[Guest ValueCarl]

Fairfax Financial Holdings Limited: First Quarter Financial Results       04/28 02:02 PM

 

 

 

TORONTO, ONTARIO--(Marketwire - April 28, 2011) -

(Note: All dollar amounts in this news release are expressed in U.S. dollars, except as otherwise noted. The financial results are reported under International Financial Reporting Standards, except as otherwise noted.)

Fairfax Financial Holdings Limited (FRFHF:$400.0000,$-1.7200,-0.43%) (TSX:FFH.U) announces a net loss of $240.6 million in the first quarter of 2011 ($12.42 per diluted share) compared to net earnings of $418.4 million in the first quarter of 2010 ($20.38 per diluted share). The decrease in earnings arose primarily from the impact of $311.3 million of pre-tax ($217.7 million after tax) Japan earthquake losses net of reinsurance and reinstatement premiums and from net investment losses of $101.5 million. Book value per share decreased to $354.72 at March 31, 2011 from $376.33 at December 31, 2010, a decrease of 3.1% (adjusted for the $10.00 per share common dividend paid in the first quarter of 2011).

"During the first quarter, the company suffered losses from the Japan earthquake as well as from the New Zealand earthquake and Australian floods. Despite these events, the company continues to be soundly financed, and we continue to hold $1 billion in cash and marketable securities at the holding company level. Also please note that this is our first quarter reporting under International Financial Reporting Standards (IFRS). Our investments are now shown at market value at the end of the quarter and the fluctuation in market values resulted in unrealized losses of $134.9 million causing net investment losses of $101.5 million for the quarter," said Prem Watsa, Chairman and Chief Executive Officer of Fairfax.

Highlights in the first quarter included the following:

 

--  The combined ratio of the company's insurance and reinsurance operations

   was 128.7% on a consolidated basis, producing an underwriting loss of

   $352.0 million, compared to a combined ratio and underwriting loss of

   111.3% and $120.6 million, respectively, in the first quarter of 2010.

   Underwriting results in the first quarter of 2011 were negatively

   affected by $401.4 million of pre-tax catastrophe losses (net of

   reinsurance and reinstatement premiums), including the earthquake losses

   in Japan. Prior to giving effect to the impact of the Japanese, New

   Zealand and Australian catastrophe losses, the company generated a

   combined ratio of 97.5%.

 

--  The company's estimation of its losses from the Tohoku Japan earthquake

   event assumes an approximate $30 billion industry loss and is based on a

   combination of modeled information, underwriter analysis, client

   discussions, and a profile of exposed limits within the affected region.

   The nature and scale of the loss and its recent occurrence introduces

   significant uncertainty to the loss estimation process. The company

   therefore advises that ultimate losses could differ, perhaps materially,

   as further information becomes available. The $217.7 million of after

   tax losses from the Japanese earthquake was under 3% of shareholders'

   equity, well within our risk tolerance limits.

 

--  Net premiums written by the company's insurance and reinsurance

   operations in the first quarter of 2011 increased 28.0% to $1,399.7

   million from $1,093.3 million in the first quarter of 2010 due primarily

   to the acquisition of Zenith National and First Mercury.

 

--  Operating loss of the company's insurance and reinsurance operations

   (excluding net losses on investments) in the first quarter of 2011 was

   $242.0 million compared to a $19.1 million operating profit in the first

   quarter of 2010, primarily as a result of the above-described

   catastrophe losses.

 

--  Interest and dividend income of $178.5 million in the first quarter of

   2011 increased 2.8% from $173.6 million in the first quarter of 2010.

   The year-over-year increase was attributable to the larger average

   investment portfolio which resulted from the acquisition of Zenith

   National and First Mercury partially offset by increased investment

   expenses incurred in connection with the company's equity hedges.

   Interest income as reported is unadjusted for the positive tax effect of

   the company's significant holdings of tax-advantaged debt securities

   (holdings of $4,377.8 million at March 31, 2011 compared to $4,625.0

   million at March 31, 2010).

 

--  Net investment losses of $101.5 million in the first quarter of 2011

   consisted of the following:

 

                                                  March 31, 2011

                                        -----------------------------------

                                        -----------------------------------

                                                    Unrealized

                                          Realized       gains   Net gains

                                             gains    (losses)    (losses)

                                        ----------- ----------- -----------

                                        ----------- ----------- -----------

Net gains (losses) on:

 Equities and equity-related investments      34.0       588.4       622.4

 Economic equity hedges                          -      (428.4)     (428.4)

                                        ----------- ----------- -----------

 Equities and equity-related investments

  after equity hedges                         34.0       160.0       194.0

 Bonds                                        (7.3)     (133.0)     (140.3)

 CPI-linked derivatives                          -      (167.2)     (167.2)

 Other                                         6.7         5.3        12.0

                                        ----------- ----------- -----------

                                              33.4      (134.9)     (101.5)

                                        ----------- ----------- -----------

                                        ----------- ----------- -----------

 

--  The company held $1,061.0 million of cash, short term investments and

   marketable securities at the holding company level ($989.3 million net

   of short sale and derivative obligations) at March 31, 2011, compared to

   $1,540.7 million ($1,474.2 million net of short sale and derivative

   obligations) at December 31, 2010.

 

--  The company's total debt to total capital ratio increased to 25.5% at

   March 31, 2011 from 23.9% at December 31, 2010, primarily as a result of

   the net loss, dividends paid and debt of companies acquired in the first

   quarter of 2011.

 

--  At March 31, 2011, common shareholders' equity was $7,245.2 million, or

   $354.72 per basic share, compared to $7,697.9 million, or $376.33 per

   basic share, at December 31, 2010.

 

--  On February 9, 2011, the company completed the purchase of First Mercury

   Financial Corporation at a cost of $294.3 million.

 

--  On March 24, 2011, the company completed the purchase of Pacific

   Insurance Berhad of Malaysia for $71.5 million.

 

 

Fairfax holds significant investments in equities and equity-related securities. In response to the significant appreciation in equity market valuations during 2010 and uncertainty in the economy, the company has hedged its equity investment exposure by entering into total return swaps referenced to the Russell 2000 index (at an average Russell 2000 index value of 659.00) in addition to its existing swap contracts referenced to the S&P 500 index (at an average S&P 500 index value of 1,071.96). At March 31, 2011, these hedges represented 83.1% of the company's equity and equity-related holdings. The market value and the liquidity of these investments are volatile and may vary dramatically either up or down in short periods, and their ultimate value will therefore only be known over the long term.

There were 20.4 and 20.2 million weighted average shares outstanding during the first quarters of 2011 and 2010, respectively. At March 31, 2011 there were 20,425,132 common shares effectively outstanding.

Summarized (without notes) consolidated balance sheets and statements of earnings and comprehensive income, along with segmented premium and combined ratio information, follow and form part of this news release. Fairfax's detailed first quarter report can be accessed at its website www.fairfax.ca.

As previously announced, Fairfax will hold a conference call to discuss its first quarter results at 8:30 a.m. Eastern time on Friday, April 29, 2011. The call, consisting of a presentation by the company followed by a question period, may be accessed at (800) 857-9641 (Canada or U.S.) or 1 (517) 308-9408 (International) with the passcode "Fairfax". A replay of the call will be available from shortly after the termination of the call until 5:00 p.m. Eastern time on Friday, May 13, 2011. The replay may be accessed at (800) 819-5743 (Canada and U.S.) or 1 (203) 369-3828 (International).

[Guest Bronco]

Maybe I'll get my chance to get back in.

 

We'll see tomorrow.

[Guest misterstockwell]

Maybe I'll get my chance to get back in.

 

We'll see tomorrow.

 

I'd want a discount to book. A big discount. Lots of catastrophes still happening out there, and they truly stink at underwriting.

[Guest Bronco]

Misterstockwell - John Mayer playing "say what you mean to say" in the background.

 

Don't beat around the bush - how do you really feel?

[A_Hamilton]

Anyone else not seeing the interim financials on their website?

[Parsad]

Exactly what are people talking about here?  What do you mean they stink at underwriting?  Most insurers got hit hard by Japan, New Zealand and Australia.  Guaranteed their losses are nearly identical to Berkshire's on the same business.  I was expecting worse!  Cheers! 

[Hoodlum]

Well, it was a little worse than I expected.  Not sure what the market was thinking over the past few weeks as it drove up the price of FFH.  The same thing happened last quarter.

 

So FFH was trading about 13% above Q1 book $354US ($337cnd).

[Nnejad]

But then, there are the $15 per share in fair value gains that are excluded from that measure.

[ERICOPOLY]

Which cancels out the goodwill.

[Guest ValueCarl]

Mr. Watsa, etal, remain very, very cautious, downright bearish indeed.

 

Fairfax holds significant investments in equities and equity-related securities. In response to the significant appreciation in equity market valuations during 2010 and uncertainty in the economy, the company has hedged its equity investment exposure by entering into total return swaps referenced to the Russell 2000 index (at an average Russell 2000 index value of 659.00) in addition to its existing swap contracts referenced to the S&P 500 index (at an average S&P 500 index value of 1,071.96). At March 31, 2011, these hedges represented 83.1% of the company's equity and equity-related holdings. The market value and the liquidity of these investments are volatile and may vary dramatically either up or down in short periods, and their ultimate value will therefore only be known over the long term.

 

What I find interesting about the after tax terminology and reporting on "catastrophic losses" is the fact that although the higher pre-tax amount($311.3 million) is factual, what they're allowed to say is that, had we earned that higher amount of money($311.3 million) instead of paying it out or reserving it towards losses, it would have equated to what we're reporting in after tax losses($217.7 million) due to tax liabilities that were avoided.

 

Do I have that right, or am I missing some other 30 percent factor insurance savings tied to losses? If I am correct, I would prefer to have $217.7 million in after tax profits vs. $311.3 million in losses when all is said and done. It's net of reinsurance, so I seem to be honing in on the 30 percent tax rate.  

 

The decrease in earnings arose primarily from the impact of $311.3 million of pre-tax ($217.7 million after tax) Japan earthquake losses net of reinsurance.  

 

In the big scheme of Japanese loss estimates, and assuming their estimates are not off the mark, I agree with Sanjeev.  

[bluedevil]

By my rough calculations, Fairfax's tangible book value is around $315 per share right now (once you credit fair value for their equity investments).  Thus, as the trading price now stands, shares are trading at around 1.3x tangible book.  Based on its trading prices over the past couple of years, I would expect the price to drop substantially over the next couple of days.

[Nnejad]

Well, that's one opinion.  Then again, nearly all of the goodwill came over the last two years... You should probably check what brought up that goodwill value.

[biaggio]

Is there a chance we can reach $315 (1 x tangible BV)?

[Parsad]

Well, that's one opinion.  Then again, nearly all of the goodwill came over the last two years... You should probably check what brought up that goodwill value.

 

Yup!  Investor's in the past complained that Fairfax bought crappy insurance businesses and then spent five years turning them around.  Now they spend fair value on a great insurance business that they don't have to turnaround, and they get crapped on because of the goodwill.  

 

The only thing I can say is that the critics must be writers for the friggin' Vancouver sports media.  Prem's Luongo, while Brian Bradstreet is one of the Sedin sisters!  What have you done for us lately Prem...what have you done for us lately Brian...how come book value didn't grow by another $2B this year...what have you done for us lately?  Oh yeah, you just brought your whole executive team to our dinner, and then Brian & Francis stayed till 11pm answering questions!   ;D  Cheers!

[ERICOPOLY]

Well, that's one opinion.  Then again, nearly all of the goodwill came over the last two years... You should probably check what brought up that goodwill value.

 

No need to check.  I had notional 100% of my net worth into ORH calls 2 months before the buyout -- after they telegraphed the move.  (much thanks to Cardboard)

 

We used to talk about ORH's book value.  When we did so, we didn't inflate it by 20% or 30% to account for the goodwill that wasn't there.  Likewise, when I think about FFH with ORH integrated, I like to think of it consistently just as I used to think of ORH.

 

 

[Parsad]

That's a very good analogy Eric!  Cheers!

[ERICOPOLY]

I have to do things that way.  Otherwise WFC is really trading at a 33% discount to book value right now (because it's worth $45 in a buyout).

 

[link01]

The company's estimation of its losses from the Tohoku Japan earthquake

   event assumes an approximate $30 billion industry loss and ...

 

does anybody know what the total statutory surplus of this 'industry' is, where a 30 bil loss is estimated?

[beerbaron]

I have a few questions, that I need to dig to find answer. Maybe someone else might have the answer before me...

 

What's the impact of IFRS compared to old GAAP?

 

Are unrealized gains calculated in the net income or just in BV?

 

I tough muni bonds were flat in Q1 why the big drop in the bond portfolio? Did it come from high yield?

 

Hedges are somewhat going down to 83% from 91% (If I remember correctly), is it a change of perception in FFH team or because their equity increased more then their hedge?

 

I'm impressed by this month's equity return 3.4% when almost fully hedged, that's pretty good.

 

BeerBaron

 

 

 

 

[Valuebo]

Seems like I picked a great time to buy my first ever FFH shares months ago at around 380.  ::)

 

Well, still hoping to get more under BV any time! =)

[Guest ValueCarl]

I was missing much. Thanks, Sanjeev!

 

<No, the after-tax rate is after they’ve recovered taxes from their losses and past net operating losses.  If you go to Note 18 in the 10-Q on their website, they discuss in depth where all of the various tax refunds come from.  Their actual after-tax loss is their actual net dollar loss from an operational standpoint.>

 

[bluedevil]

Well, that's one opinion.  Then again, nearly all of the goodwill came over the last two years... You should probably check what brought up that goodwill value.

 

Yup!  Investor's in the past complained that Fairfax bought crappy insurance businesses and then spent five years turning them around.  Now they spend fair value on a great insurance business that they don't have to turnaround, and they get crapped on because of the goodwill.  

 

The only thing I can say is that the critics must be writers for the friggin' Vancouver sports media.  Prem's Luongo, while Brian Bradstreet is one of the Sedin sisters!  What have you done for us lately Prem...what have you done for us lately Brian...how come book value didn't grow by another $2B this year...what have you done for us lately?  Oh yeah, you just brought your whole executive team to our dinner, and then Brian & Francis stayed till 11pm answering questions!   ;D  Cheers!

 

WHOA-who crapped on Fairfax?!?  I love the company, have never sold a share, and think the stock is absolutely undervalued.  I'm just saying, since I think most traders value insurance companies off of tangible book value, and given that Fairfax hasn't traded at 1.3 tangible in a while, I think we're going to see the price slink below $400 US over the next few days.

[A_Hamilton]

Well they sure do have conviction in the CPI Floors. Notional value is up to 49.1 billion. Over 5% of book value (at cost) has been put into the trade! Hope I own enough FFH to survive what they see coming!

[ERICOPOLY]

So what does the goodwill really signify?  After all, it is only attributed to the minority positions that were taken private.

 

I suppose if one wants to defend the goodwill, then you should also argue there isn't enough goodwill on the balance sheet.

 

They had (rough numbers) 80% of ORH before the takeout and 60% of NB before the takeout.

 

If goodwill is to be believed, then the ORH goodwill is understated by 80% and the NB goodwill is understated by 60%.

 

My methodology simply means this:  treat the value of the minority position exactly the same as we treat the previously owned majority positions.  To do that you either need to bump up the goodwill or throw it out entirely!

 

The good news is one can perhaps then argue that book value is back up near $400 already!  Perhaps even more than $400.  After all, that's a 2.5x increase in NB's goodwill and a 5x increase in ORH's goodwill. 

[ERICOPOLY]

Stated differently, the goodwill is a relic of what happened to them.  Had they never IPO'd NB and ORH in the first place (in a parallel universe), then they never would have needed to buy them back above book value and thus there would be no goodwill.  They would have a cash asset instead of the intangible asset.  

 

I can't argue that the cash from that parallel world is worth as much as the goodwill from our real world.  I think the cash is worth full value and the goodwill can be ignored.  In that parallel world, the goodwill is implicitly there (in addition to the cash!) just as in today's world the previously consolidated majority positions have goodwill that is implicitly there (but not explicitly stated as a component of book value).