finally...been waiting for this for the last 2 weeks

[Vinayd]

Nice summary Viking, thanks!

 

These FFH/NB/ORH arbitrage discussions are always interesting. Putting the multiple discussions of which is better value (FFH/ORH), the CDN$/US$ valuation, the purchase price of NB in January, and the stock buybacks from ORH/FFH over the last 12-18 months, a notion comes into my head on how/why it would be a good deal for FFH to buyout ORH now.

 

I don't remember if this was discussed before, but the purchase of NB in January for 1.3X book was more than a good deal when taking into account currency exchange.  NB was purchased with US$ -- when the US$ was near a high compared to now (U$ has dropped approx 12% against CDN$ in last few weeks). So there may likely be a gain on FFH books in relation to the value of NB when translated back into US$.  There may be a way to capitalize on this currency gain to puchase ORH.

 

The bulk of the share buybacks (mainly at ORH) have been done via cash accumulated through operations/investment activities.  Therefore net/net, they have SHRUNK their capital structure accross the group -- to the benefit of existing shareholders. Buying back the rest of ORH could be done via a combination of cash/debt (in effect re-expanding their capital structure), but still be very conservitavely leveraged.

 

A buyout by FFH of ORH has been discussed extensively, but with the lowered cash holdings at FFH (approx $885M), it may be too much of a strain to buyout the remaining 17.8M shares at $58-$60 US with cash alone.

 

Recently, there has been a strong appetite for preferred share offerings in Canada by CDN financial institutions, and the rates being asked have contracted along with yield spreads.

 

I think the time may be ripe for FFH to issue Canadian Preferred shares (likely baring 6.5% interest), to Canadian investors only, in the order of $500M (...or about the price they paid for NB).  This money could be used, along with current FFH cash holdings and the remaining $150M in the ORH NCIB funding envelope to buyout ORH shares while the $CDN dollar is soaring.  This will effectively allow FFH to capitalize on the  currency  arbitrage they inadvertently entered with the purchase of NB with US$.

 

...great discussions as always.

 

Vinayd

[Viking]

Vinayd, thanks for pointing out the NB purchase from a currency perspective. The purchase price was US$374 million or CAN$458.4 (exchange rate = $0.816)! I wondered at the time why they took out NB versus ORH and in hindsight perhaps the level of the CAN$ was a key factor. And with the CAN$ now appreciating NB is becoming more valuable to FFH (reporting in US$).

 

Regarding ORH, they actually discuss exchange rate risk in their 1Q results (see btoom of post).

- a 10% (equal) decline in Euro/BP/CAN$ = $189 million hit to ORH

- can we not assume the opposite (roughly) 10% decline in US$ = $189 million gain

- $189/60 milliuon shares = $3.15 - 35% taxes = $2.00/share = 4.7% increase in BV

 

The investments they hold with significant operations overseas will also mitigate the impact of a declining US$ (J&J, Kraft, GE, Intel, Magna, Pfizer etc).

 

As a Canadian investor what this all tells me is that a weakening US dollar is a net negative, but the actual hit to my ORH investment is something less than 50% of the currency move. (This assumes the CAN$ appreciates a similar amount to the Euro and BP.)

 

Foreign Currency Risk (page 60, ORH-Q1 report)

"Through investment in securities denominated in foreign currencies, we are exposed to foreign (i.e., non-U.S.) currency risk. Foreign currency exchange risk exists because changes in the exchange rates of the underlying foreign currencies in which our investments are denominated affect the fair values of these investments when they are converted to the U.S. dollar. As of both March 31, 2009 and December 31, 2008, our total exposure to foreign-denominated securities in U.S. dollar terms was approximately $1.9 billion, or 25.4% and 23.8%, respectively, of our total investments and cash. The primary foreign currency exposures were from securities denominated in the Euro, which represented 10.3% and 9.7% of our total investments and cash as of March 31, 2009 and December 31, 2008, respectively, the British pound, which represented 5.8% and 6.0% of our total investments and cash as of March 31, 2009 and December 31, 2008, respectively, and the Canadian dollar, which represented 4.6% and 3.5%, of our total investments and cash as of March 31, 2009 and December 31, 2008, respectively. As of March 31, 2009, the potential impact of a 10% decline in each of the foreign exchange rates on the valuation of investment assets denominated in those respective foreign currencies would result in a $189.2 million decline in the fair value of our total investments and cash, before taxes."

 

[ERICOPOLY]

I am betting they have unloaded a portion of WFC, or possibly all, since the latest filing.  Unlike Buffett FFH can unload their holding in a day or two without dropping the price.

 

There is absolutely no reason for FFH to sit on those gains.  We may be very surprised at Q end when we are told that there are a few hundred million in realized gains.  

 

 

 

They held $100m in WFC at $30 at Dec 31st.

 

I hope they have not sold any of it.  Buffett's opinion on WFC's earnings power makes it a cheap stock even at 1.5x book.

[Cardboard]

Ericopoly,

 

They have grown that WFC position massively in the first quarter from 3.5 million to 20.0 million shares. The average cost would have fallen off a cliff and I suspect that the original stake of 3.5 million was likely bought in the low 20's considering that it was built in the 4th quarter looking at the various 13-F's. I figure that the overall cost was around $325 million. Their stake is now worth $500 million and was above $550 million at the most recent spike.

 

There is no way that they did not lighten up a bit. We shall see in the next 13-F. My view is that they see WFC as a core holding or a long term hold. When they saw the price plummet in the first quarter, they loaded up. It does not mean that they won't take some gains as the stake grows larger in size due to price appreciation vs everything else that they own. So it could still be a good deal at $30 a share, but likely not with 20.0 million shares, especially with Prem's warranted cautious view of the U.S. economy.

 

Another thing to consider for the U.S. banks fans out there. I am absolutely convinced that there are massive limit orders and short sell orders already setup at the following prices:

 

JPM: $33

WFC: $23

USB: $17

 

If these stocks touch these levels, there will be quite a correction. The reason is that people long these stocks will fear a return to March lows and for short sellers, these prices will confirm a technical breakdown telling them to step in. So for those who feel that they have missed the boat, I suspect that a juicy opportunity will present itself in July/August. I also suspect that by then that many will fear and few will want to step in.

 

Cardboard

[ERICOPOLY]

Ericopoly,

 

They have grown that WFC position massively in the first quarter from 3.5 million to 20.0 million shares. The average cost would have fallen off a cliff and I suspect that the original stake of 3.5 million was likely bought in the low 20's considering that it was built in the 4th quarter looking at the various 13-F's. I figure that the overall cost was around $325 million. Their stake is now worth $500 million and was above $550 million at the most recent spike.

 

There is no way that they did not lighten up a bit. We shall see in the next 13-F. My view is that they see WFC as a core holding or a long term hold. When they saw the price plummet in the first quarter, they loaded up. It does not mean that they won't take some gains as the stake grows larger in size due to price appreciation vs everything else that they own. So it could still be a good deal at $30 a share, but likely not with 20.0 million shares, especially with Prem's warranted cautious view of the U.S. economy.

 

Another thing to consider for the U.S. banks fans out there. I am absolutely convinced that there are massive limit orders and short sell orders already setup at the following prices:

 

JPM: $33

WFC: $23

USB: $17

 

If these stocks touch these levels, there will be quite a correction. The reason is that people long these stocks will fear a return to March lows and for short sellers, these prices will confirm a technical breakdown telling them to step in. So for those who feel that they have missed the boat, I suspect that a juicy opportunity will present itself in July/August. I also suspect that by then that many will fear and few will want to step in.

 

Cardboard

 

Their initial 3.5 million share stake in WFC cost them $21.93 per share (that's the price listed in the 2008 annual report).

 

I believe their average cost is in the high teens.  From my understanding they were fully bought in before it traded under book value.  Average cost is probably in the $17-$18 range.  Somebody posted the ORH holdings from the NAIC filing the other day and it looked like there were WFC buys in the $17.50 range.  I believe (maybe it was Al) somebody mentioned that (at the annual meeting) the officers claimed to have bought the stock down to $15 but then no more.  (stock then fell nearly 50% more)

 

[ERICOPOLY]

Aha, here it is from Viking's post:

 

7.6 million WFC shares at $18.41 (46% of total new FFH purchases)

 

I know WFC has had this tremendous run from it's bottom, but it's not all that spectacular of a run from where they bought most of their WFC shares. 

 

Of course they still might lighten up like you say, but I don't think they will because of the breadth of options they had before them at the time they were buying.  They would likely have discussed this problem of needing to lighten up after a 30% pop at the time they initially had built their big position.  Then perhaps somebody in the room would have said "Look, if we're going to settle for a 50% gain on the incremental invested dollar, why not put the money into something else, given that everything else in the market is getting slaughtered too?  That way we can avoid paying out the tax on the realized gain."  They did a year or two ago state in the annual letter that they had realized belatedly that they'd like to hold higher quality investments long term for tax benefits.

 

You are probably right, but I guess I will be disappointed a little bit if so.

 

 

 

[ERICOPOLY]

I think I read that Fairfax looks at it's insurance exposures and keeps them positioned such that a major catastrophe won't hurt them by more than a single year's investment income.

 

A total wipeout of WFC to $0 (however improbable) would cost FFH about 6% of book value.  The position is also only marginally larger than their JNJ position.

 

For whatever it's worth it seems to me like the WFC exposure is not really that large.  

[Smazz]

I think I read that Fairfax looks at it's insurance exposures and keeps them positioned such that a major catastrophe won't hurt them by more than a single year's investment income.

 

Yes Eric that was definately the communication that came out from Prem after the horrendous hurricane seasons. I thought I remembered it as tied to what they could achieve on realized gains but could be wrong.